Investor should be able to make money both buying and selling real estate.  Perfecting the due diligence process is a great way to save money when purchasing a property.  The first step in the due diligence process is to verify the revenue stream.  In order to verify the revenues an investor should request the following documents: Rent Roll, Operating Statement, Rent Receipts, Bank Statement to verify deposits and either the owner’s tax record (past 3-5 years) or the LLC’s tax records if the property is incorporated.

All of these documents work in conjunction with each other.  The rent roll represents the highest possible collected rent.  Assuming every tenant pays on time every month, the operating revenues should match the rent rolls exactly.  This is rarely the case.  Some times tenants receive rent concessions, they pay late, move out mid-month, etc.  The closer the total rent roll and the operating rent are, the better the collections and the higher quality the tenants.  It is a sign of a good operator.  On the other hand, huge disparities could mean an opportunity to increase value significantly through sound operational excellence.  The further the gap, the more important it is to verify all of the items listed above.

Rent receipts and bank statements should be used to verify the rent collected in the operating statement.  It’s very easy to falsify receipts.  While landlords typically will not do this to inflate the NOI, they will do this to give the perception that their tenants pay in a timely fashion, when in reality they do not.  Comparing monthly deposits is a way to ferret out this issue.  In this case, monthly deposits should match the operating statement exactly.

Tax records should be used as an additional check.  Some can be hard to navigate depending on how they were prepared and whether the entity is a stand alone LLC or tie to other properties, but sellers should be willing to provide this information to potential investors.

Remember, all sellers are not created equal.  Some sellers will be able to produce all of these items with no problem, while other sellers may not even have a current rent roll.  Be firm and adjust the offer price according to the data provided.  If there is no way to verify the last 12 months of Net Operating Income, the offer should be extremely conservative.  If bank records cannot be provided to prove when rent was collected, assume a higher than average bad debt collection and reduce the price accordingly.

The due diligence process is designed to mitigate risk.  Even if an investor chooses to purchase a property after receiving very little information, the investor knows the risk of that decision.  Failing to do proper due diligence leaves money on the table.

A major difference between purchasing an investment property and personal property is the due diligence process.  Typically, when buying personal property due diligence consists of hiring an appraiser and a home inspector.  Personal home buyers depend upon other general experts to ensure their purchase matches its general description.  An investor’s due diligence process should go much further.

Investors must verify cash flow.  Remember investment properties are valued based on Net Operating Income, which is essentially income available after all property related expenses have been paid, and the Capitalization Rate (cap rate).  The cap rate represents the risk adjusted expected growth rate over time.  Older properties in secondary neighborhood would command higher cap rates because they have more risk and lower expected growth rates.

With that in mind, verification of Net Operating Income will directly affect the price that should be paid for the asset.  In this vein, investors should look to understand and check every line item in detail.

Revenues

Rent receipts should be compared against actually bank deposits.  Any unscrupulous landlord can produce receipts, but it is important to verify that the cash was collected and specifically when the cash was collected.  This should then be compared to the in-place leases to understand if tenants are paying rent on time.  These record should be easy to produce and easy to check.  If you have problems at this stage, be very suspicious of the seller.

Don’t forget to verify ancillary income as well.  Any cash collected from washer/dryers on site or use of specific facilities like a weight room or pool should also be verified against bank deposits.

Expenses

Like revenues, expenses should be verified with bank statements or cancelled checks.  Unlike revenues, there is no rent roll to check expenses against.  The only way to verify that all property expenses have been accounted for is to check against tax filings.  For larger properties, investors will probably incorporate each building, making it easy to verify tax records.  Smaller properties will require looking at the owner’s tax records.  Some make balk at this request, but be firm.  This is the best way to verify the income on the property.

For novice investors, a No Money Down strategy will look very different than it will for an experienced investor.  The risks of a true No Money Down strategy are too high for investors just getting into real estate investing.  While many novice investors started with this strategy in 2003 – 2006, 2009/2010 will not be a great time to secure these mortgages.  Additionally, the high costs and high risks of this financing strategy make it a poor fit for the novice investor.

So what is a novice investor to do when they are short on capital?  Take the traditional fundraising approach: Family, Friends, Investment Clubs and well wishers.  Fundraising in this manner not only gets a novice investor much needed capital, but it forces him/her to critically analyze their investment opportunity because they have to present it in a compelling manner to their future investors.

There are critical rules to working with friends, family, investment clubs, etc.  First, an investor should prepare clear terms and spell out exactly what will be done with any funding received.  For example, if an investment property will be purchased for $100,000 and the money received will go towards the down payment that should be clearly stated. 

Next, an investor should create a simple return structure.  It’s easy for non-real estate people to understand a monthly cash flow and it’s easy for an investor to manage.  Returning to the $100,000 example, if friends or family members commit $20,000 for the down payment, an investor should promise a fair return.  Assuming a 10% return on $20,000 ($2,000/year), an investor should commit to paying $167/month and returning the full principal upon the sell of the property.

These agreements should always be in writing.  This is a best practice for any investor and should be no different with friends, family, etc.  The more structure and professionalism an investor brings to the deal, the more credibility he/she will have when pitching their investment.  Be detailed about the role of the general manager and the role of the silent investment partner.  It might be worth having a lawyer draw up a very basic boilerplate contract to use for future deals.

Investors should also try to under-promise and over-deliver.  Never promise unrealistic returns or understate the risk of an investment to secure funding.  This only serves to ruin your credibility and cut off future funding sources when the road gets rough.  Real estate investments carry inherent risk that is only compounded by limited experience in real estate investing.  Being honest and regularly providing information to financial backers helps the novice investor stay abreast of the market and their investment.

Friends, family, investment clubs, etc. offer great opportunities to connect with other real estate investors and secure additional investment funds.  This No Money Down strategy provides capital and important relationships to help grow a successful real estate investment business.