Even if Warren Buffet personally told you that he found you a solid real estate investment opportunity and needed all your savings, you wouldn’t just give it away to him blindly. After all, you would want to know more about what he was proposing to purchase with your hard-earned money! However— by failing to ask important questions beforehand— you not only open yourself to uncertainty, you also risk taking on an ill-advised investment.
That’s why it’s important to perform due diligence and properly vet all potential investments, as well as the companies you are partnering with, early on. After all, you don’t want to be caught off guard by any surprises that result in a seemingly solid investment turning into a money pit.
So before investing in real estate, ask the company these 5 essential questions:
1. Who owns the property?
When it comes to real estate investing, it’s normal to have some initial anxiety— it can even aid the vetting process by motivating you to be extra thorough. For instance, you want to verify with the company brokering the deal that once it’s completed, it’s YOU who will own the full-rights to the property. By owning it outright, you’ll have full control of all buy-sell decisions, thus giving yourself the flexibility needed to protect your interests.
An alternative to this is the REIT concept. With a REIT, a third party (typically a large company) owns the property that you’re investing in; what your investment money is going towards is the purchase of equity in that property. The downside lies in the fact that many other investors will be purchasing equity in it too. In fact, there could be hundreds of other shareholders who own the same exact amount of stock as you. This results not only in you having less control, but also having to depend on a formal vote when making any major decisions regarding your own money.
2. Are there tenants in place?
Instead of looking at a tenant that’s already in-place as guaranteed money— you should be focusing on vetting their payment history and job status. 23% of the time those tenants were 60 to 90-days delinquent on their rent payments! Avoid this situation and the dishonesty of the third parties who didn’t reveal it by asking for the current tenant’s financial status and payment history from the very start!
3. How are the company’s projections calculated?
Your broker’s formula(s) for determining the likely return on investment (ROI) may actually not be in your best interest. For instance, many companies often leave out expenses like vacancies, the cost of maintenance, and other fees. By neglecting these expenses, their yield and cash-on-cash return projections become over-inflated and unrealistic. Before deciding on who you should partner with, you should ask the following questions regarding their projections:
- Do you account for vacancies?
- Are rehab costs factored into the yield? Or are they separate?
- Does the cash flow account for fees, maintenance and other expenses?
- What factors are used to calculate the yield?
- Is the cash-on-cash return an accurate percentage?
4. Who takes care of the property management?
Before you invest, it’s important to know your responsibilities versus what the company is responsible for. For instance, who will be managing your property and what the cost of that service is estimated to be. Some companies may leave it up to you to find and hire a property management company, whereas others may offer an all-inclusive package. These are all aspects to inquire about prior to investing; as is asking how long you can expect it to take— on average— for you to research and hire a qualified property management company. As you may be unable to find the time to hire a property management company, having this information gives you a chance to plan accordingly.
5. Do I need to be an accredited investor?
Depending on the type of investment, you may need to become an accredited investor before proceeding. Here are a few examples of how the U.S. Securities and Exchange Commission (SEC) defines an accredited investor:
- Someone who earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year.
- Someone that has a net worth of over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
The SEC lays out all the steps that need to be completed in order for a potential buyer/seller to gain accreditation and if required to do so, there are many steps that you will have to complete if your investment calls for it.
Perform Your Due Diligence
Remember that performing your due diligence comes with many rewards. By asking the five critical questions listed above, you’re able to stand more confidently in the face of any lingering doubts… and as a result, you will be off to a great start!