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 Sale by Owner (FSBO), a concept few sellers attempt, holds many potential rewards for the savvy seller.  Unfortunately it also holds many perils for the seller solely attempting to cut out a perceived middleman.  With the tactics any investor can learn from this very website, it should be easy to find a realtor worth their 6% fee.  Before an investor decides whether or not this method of selling would work best for them, they should consider the following analysis.Strongly consider the value of your time and the expected cost savings of not using a realtor.  On a $100,000 home, an investor will avoid costs of approximately $6,000 or 6% by not hiring a realtor.  However, the investor will incur numerous additional costs that would be traditionally born by the realtor.  Marketing fees can be substantial.  After printing signs, flyers and putting ads in the paper a seller could be down $500 - $1,000. 

Next, the seller must put an hourly wage on their time.  As an investor, a generous number of $50 per hour is appropriate.  Doing some very simple math, after marketing a seller can afford to spend about 100 hours of their time on the sells process.  While that seems like a lot, its about 12 eight hour work days.  The most basic property will require a minimum of two to four weekends of showings.  After four days (2 weekends) of showings at six hours a day (2hrs. prep time, 4hrs. show time), an investor only has about 76 hours left.  Add 5 -10 off hour showings and the time really starts to add up.  This is before the buyer’s realtor begins requesting documents from you and the banks start calling.  It’s very easy to spend 12.5 eight hour days selling your home.  Most realtors spend the equivalent of that amount of time or more on a transaction.  And remember, they do it for a living so they are much faster and generally better at it than you.

Consider the market you are selling into.  FSBO properties work very well in strong markets when the seller has the upper hand.  Conversely in a buyers market, the negative perception of an FSBO property alone could cost an investor 2-3% of the property value.  Think about it from the prospect of a buyer.  Owners typically know much less about the real estate market, have very little access to current market comparables and have completed far fewer transactions than an experienced realtor.  That’s worth a 2-3% discount in most buyers’ opinions.  Additionally, so many FSBO properties are poorly managed.  Many realtors farm FSBO markets for this very reason. 

Investors should also understand the scope and the value of their network before attempting a FSBO transaction.  Realtors know buyers, sellers, other realtors, investors and other interested parties.  They employ their entire network with the goal of selling this particular property.  If an investor can’t think of at least 10 people to pitch their investment property to it might be time to call a realtor.  Smaller networks mean it will take longer to sell the property.  During this time an investor could be missing numerous investment opportunities. 

FSBO transactions can work, but investors need to understand the risk and rewards.