Due Diligence: A Guide for Real Estate Investors

When we talk about due diligence, most people think about a property inspection. And we agree, a property inspection is an absolute must during the conditional period if you have not already completed one prior to putting in your offer. Alternatively, have a qualified General Contractor (GC) complete your inspection so you can also get quotes on the required work. You might also want to book other trades in during your inspection so you can have estimates for all the work needed on the property.

Going beyond the home inspection, we need to talk about financial and legal due diligence. If you skip these parts of your due diligence, you may end up with a poor investment. For your investment to be successful, you need to evaluate it comprehensively by reviewing its income, expenses, service agreements, and legal status among other items. As with any investment, you need to carefully consider the viability of it.

To do this, we need to gather operating information and confirm income and expenses. We also want to review tenants, service agreements, and legality concerns. Let’s get started!

Income Review

We usually start with checking the income information. Ensure that there is a signed lease in every unit and that rental rates from the rent roll match the numbers used to calculate your offer. Look for any discrepancies concerning vacancies (especially if a unit sits vacant for more than a month). Ensure any vacancy loss is accounted for on the income statements.

For any units that are currently under market rent, determine the reason why. These units can be beneficial to you if you are able to increase rents after you purchase the property. Check to see if it is a long-term tenant situation or is the unit in need of serious repair. Take notes and confirm with property inspection to see how you can increase your cash flow after you purchase the property.

Tenant Review

Next, we look into the tenants themselves. Are there background and/or credit checks for each tenant? Do they pay their rent on time or are they consistently late on rent payments? Are there complaints about them from other tenants on the property or nearby neighbours? Bad tenants can cause good tenants to leave which can put you in a precarious situation. Do the work now to find out if any tenants will need to be evicted or encouraged to find alternate living arrangements. Risky tenants can significantly decrease the value of a property.

Service Agreement Review

When confirming expenses, it is important to look at all existing service contracts on the property. You need to verify the numbers you based your offer on were correct and that there are no additional expenses you need to account for. Confirm who is responsible for paying utilities (hydro, gas, water & sewer, hot water tank rental, etc). Verify the utilities by getting the last 12 months’ operating history on each account. Ask about any increases for next year.

You also need to carefully review service agreements to see if any have termination clauses longer than 30 days. If so, you’ll want to vet the service provider to see if you will stay with them. If you choose to go with another service provider, you may need to negotiate termination with the seller as you don’t want to be locked into them.

Service contracts to look for include:

  • Property management contracts
  • Heating, air conditioning and cooling service agreements
  • Landscaping and/or snow removal contracts
  • Coin-operated laundry contracts
  • Garbage/recycling contracts
  • Cable and/or internet contracts
  • Cleaning contracts
  • Alarm and security contracts
  • Parking contracts
  • Advertising contracts

Government Review

One of the final pieces of due diligence is to make sure the property is in compliance with government standards. These include things like confirming the legal status with City, fire code violations, outstanding permit problems, zoning violations, encroachment issues, and environmental concerns (asbestos, mold, lead paint and/or radon). You will also need to ensure there are no existing liens or judgements placed against the property by running a title search.

Due diligence is the time for you to evaluate the property’s viability and document any discrepancies. You may find some things that are positive (under market rent units) as well as some things that are negative (undocumented expenses, consistent late payments, long-termination service agreements). All of the information you collect will help you decide whether you want to go through with the purchase of the property or not. Or you may also choose to try and renegotiate based on your findings. Having everything well-documented is vital to making a case for a further price reduction or request for seller to complete work prior to closing.

Whichever way you decide to go, taking the time to do your due diligence is 100% worth it and can save you a ton of hardship, time and money.

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Michael Murphy, Ottawa Realtor

Hi, I'm Michael

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