Updated: Nov 18, 2021
By Dan Werry, JD, MBA
As capital continues to pour into real estate nationwide, the due diligence required for entry varies. Common business sense says that basic and structured due diligence will provide a protective tarpaulin over each investment, but sadly, this attention to detail is often found to be lacking.
Conducting transactions, assuming ownership, speculating on growth or evaluating potential should be systemized, much as it is for an investment banker managing a merger or a lawyer protecting a client’s interest. But more often than one would hope, real estate investing has resembled the Wild Wild West, where overly expeditious land grabs, ego-driven purchases and developments are not uncommon and financially risky duels rage, providing a maverick free reign.
For the passive investor, a maverick is the nemesis.
Though challenges exist with every deal, overcoming these challenges is often the difference between business successes or a bust. The positives and negatives of each transaction must be weighed carefully and thoroughly to determine possible outcomes. While the processes for evaluating positives and negatives can be tedious, it is common – as it is with stockbrokers and attorneys – to seek professional guidance from somebody familiar with critical real estate, finance and related industry market information.
In general, investment grade real estate should pass several due diligence standards before it is considered worthy of potential investment. Some of these standards include:
Sponsor/Management: Who is managing the property or investment? Who oversees its day-to-day operations? What are their capabilities and what services do they offer? Are they truly a full service organization, capable of providing all of the necessary services needed to be successful? Do they have an efficient client services department, available to answer and respond to your requests promptly? Do they send out your annual investment summaries on a timely basis so you can complete your tax returns on time without extending?
Market: Location, location, location… how is the real estate supported by demographics? Is it in a business-friendly environment? How is the local economy? What is the recent property absorption rate? It is important to go beyond the numbers/statistics and come away with a better understanding of market dynamics and economic drivers.
Valuation: What are the property comparables? Do they really provide an apples-to-apples comparison? How is or are the lease(s)? What are the relative costs per square foot? What are the replacement costs for the building? Do preexisting formulas produce healthy numbers?
Tenants: Who are the tenants? What industry are they in? How is that industry projected to perform? What are the financial strengths of the tenant(s)? What is there credit rating? Are they local, national or international? Have they been in the building for a while? Is this their headquarters? How is their space configured?
Lease(s): Are there Net Lease terms? Upon examination of each individual tenant lease, how many of them blend and extend? What renewal options are there? Are there any early outs? Who from the company signed the lease? Is that person still with the company? How far does that person live from the asset or how knowledgeable are they on the immediate market?
Financing: Again, what’s the loan to value? Is it fixed and Non-recourse? What is the term?
Asking these questions for each real estate investment of those conducting the due diligence is imperative for anyone investing in today’s real estate market. This will give you a basis to compare your options. Ask for a detailed conference call to go through these critical factors!!
Due Diligence Call
A due diligence call as referenced above is even more important for those who are flush with financial resources and otherwise not having some of the helpful real estate experience. We live in a world that seeks instant gratification—and results—from investments; where real estate is king and investing in it looks easy and filled with rewards. Yet there are risks associated with any type of investment, including real estate.
Having formulas to plug the data into, and knowing how to predict a potential outcomes based on the results of these formulas, is but one benefit of working with a registered representative who specializes in passive income real estate.
About the Author
Dan Werry began his real estate career in Southern California in the late 1980’s when the market was considered to be potentially overvalued. With proper due diligence Dan successfully worked with real estate investors as they built their portfolio’s purchasing rental real estate. In the early 90’s Dan complete law school and an MBA while continuing to work with builder/developers constructing high-rise condominiums where created mortgage products for a national bank. Following graduate school Dan established one of the larger national offices working with real estate investors completing 1031 Exchanges and providing advisory services for replacement properties.
JRW Investments recognizes the importance of due diligence, and the value of specialized expertise. The role of due diligence by individuals or firms with demonstrated expertise won’t completely eliminate risk. It can, however, greatly reduce risk and help make investment choices much clearer, paving the way for sound investment decisions.