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.