Master Due Diligence

I have always been surprised by the lack of time investors, wholesalers and even real estate agents put into properly advertising an investment deal. They all invest an endless amount of time and money on contracting a deal, only to drop the ball on the advertising side. Many times you can take the numbers, CMAs, spreadsheets, etc. that are used to advertise a property and in a few minutes pick the deal apart. Maybe it is a lack of time or knowledge but unfortunately I feel most of the time it is an attempt to mislead or just make a paycheck. Sometimes the info looks so well put together and impressive that it might even slip by an experienced buyer. Therefore you must know your numbers.

If you are a wholesaler, investor and/or real estate agent you really need to know your numbers. There is not a day I do not receive a wannabe deal that looks good at first glance. However, once I take a closer look, it is as bad as the ones I just deleted. Let us start with the most obvious mistake, the numbers. So the very first thing I do is add the recommended repairs plus the asking price and divide it by the estimated after repair value (ARV). I like for this number to be between 70%- 75% loan to value (LTV). Nowadays, this number is 80%+ which is usually not worth the headache unless the property value is higher. But even then, I try to stay away from that high of a LTV. Heck sometime the property is marketed at one LTV when it is a completely different LTV. 

Assuming the numbers are correct and/or close to what I like to see I run my own CMA. I run this CMA to see if it matches or comes close to the ARV that the seller is marketing. Keep in mind that a CMA and ARV is an opinion of value and an argument can be made for the ARV being presented but will they place their money in the deal. Probably not. If you see a local real estate investor wholesaling a “deal” ask yourself why he is not doing the deal himself. I can tell you that it is most commonly because it is not a good enough deal. The first sign that a property is overpriced is the marketing starts with, “Great Rental.” This usually means it costs too much to fix and flip and not clean enough to offer it to an owner occupant. So the investor or wholesaler begins marketing it knowing that someone will settle for $100-$200/month cash flow or is willing to put down a large down payment in order to buy their cash flow. And guess what, there are a ton of buyers that are more than happy to settle for a scenario just like this.

Here are some ways that a value can be proven but, in my opinion, not be correct.

Square Footage: If the seller is advertising an ARV based on a price/sqft approach when there are plenty of similar sold homes in the neighborhood. They take the smaller homes in the neighborhood, which usually sell for a higher price/sqft, and use those price/sqft to justify a higher ARV. If you do a CMA using the similar properties you will find the value is usually much lower, but that would not help the selling of the home.

Location: Look at the location of the properties the seller used. You may discover that the properties that were used in their CMA was outside the immediate submarket. In many cities, one street N, S, E or W can translate into thousands of dollars in value or value loss. Even if the neighborhood name is the same it can be in a different section and have different values.

Sold Date: The properties on the CMA sold a long time ago. I like to stay within 3-6 months when establishing an ARV. Sometimes, I notice the properties presented do not show up in my results and the reason is usually because the seller had to go back further in time to prove a value that may no longer exist.

Acknowledge Actives: Not taking the active properties into consideration is a huge mistake. If or when the actives sell, they will become the new values. Some may still be on the market when you are ready to list and will be the competition. The actives might also make you aware of a declining market. If nice well priced properties have not gone pending, when all signs show that they should have already sold, that neighborhood may be declining.

If one of these tricks are used on a property I am seriously considering, I look into it more thoroughly to make sure there are no other tricks up the seller’s sleeve.

Once you master the due diligence process you may be able to use the seller’s own marketing material as a strong negotiating tool. Just yesterday, I received financials for a value add $650,000 16 unit apartment complex claiming a 6% cap based on actuals. The financials were on a spreadsheet and the NOI did not justify the price, at all. In an attempt to find an error on the spreadsheet that would justify the asking price, I found an error that resulted in a lower NOI. I presented the corrected financials to the seller’s agent, on his own spreadsheet and an offer much lower than asking price based on the actual NOI and the advertised 6% cap. My offer was not considered but I bet those financials will no longer be used.

Master your due diligence and you will be able to not only sell more properties but you will also acquire better deals. You might even educate some sellers that were just not taught how to properly evaluate and present a deal. At some point, you may even help an investor, wholesaler and/or agent renegotiate a property, which will lead to a purchase for you and a sell for the seller. A win-win all around, which I love.