I’m Buying An Investment Property. What Documents Do I Request From the Seller?
A Beginners Guide to Due Diligence
Aside from his remarkable business success and acumen, Warren Buffet is widely known for his prophetic investor wisdom. One of his most repeated gems is:
The first rule of an investment is don't lose money.
And the second rule of an investment is don't forget the first rule.
This blunt piece of advice should be followed to the letter; but it’s often easier said than done. Because Making money in real estate is far more straightforward than insulating yourself from losing it [money].
However, there are a handful of precautionary measures that can be taken in order to reduce your risk exposure and prevent taking on losses. Market research, an in-depth understanding of the asset type, renovation plans, a sound repositioning and rental strategy; all of these various pieces to the real estate purchase process can be broadly categorized as due diligence. And while they all have equal merit, this article will dive deep into the pre-acquisition component of due diligence. More specifically, what documents and information you should gather from the opposing side of the negotiation table before you close on a deal.
Leases
A copy of the current and expired leases for all residents that are residing at the property will reveal a ton. Aside from the basic information - how much the tenant is paying and when they moved in - you’ll also gather the following:
How much the resident put forth in the form of a security deposit; if anything was collected at all.
Which tenants are longstanding residents, versus those that are new to the property.
Which leases are expired, and which ones will be expiring in the coming months.
Which units have pets.
Any other concessions or clauses that warrant attention.
As an experienced buyer or investor, you can read between the lines of the leases to determine where rents can be increased and how management can be improved.
Rent Roll
The rent roll will help you decipher how dependable and consistent the monthly income is. It will tell you which tenants are current versus those that are behind; and it’ll also show you which residents pay on time, versus those that have a tendency to pay late.
T-18 (or T-12)
The T-18, short for Trailing 18-Months, is an income and expense report that looks back over the last 18 months. It will divulge the asset’s gross earnings, plus lay out any incidental and operational expenses that have recently been incurred, or are covered on a consistent basis.
Maintenance Requests and Work Order Log
For those owners that utilize a property manager, or self-manage but leverage some sort of resident portal and supporting software, they should be able to provide a summary of the various maintenance requests and work orders that have been placed by the tenants of the building. With this information, you can deduce:
What’s been fixed and how.
Which work orders still need attention.
Which units may necessitate further inspection.
Whether or not there are any ongoing or recurring maintenance issues.
Not all owners and managers will be able to provide a thorough report of all repairs that have been carried out, but it’s best practice to ask.
Warranties and Permits
Large repairs such as a roof replacement or updates that have been made to the plumbing, electrical, and HVAC system, should come with a warranty. Not only that, but depending on the scope of the work that was carried out, the owner should be able to provide proof that permits were secured. Without any paperwork to support the high-ticket repairs that have been made, it’s tough to ensure that the work was done correctly and up to code. Furthermore, if any mechanical aspects of the property fail within the first few years, you need to know which technicians to call.
Risk is an inescapable aspect of investing. But although it can’t be completely avoided, it can definitely be mitigated. Having a systematic investigative process that includes a roster of all of the pertinent documents you should request throughout your due diligence is key. By gathering all of the information discussed in this piece, you can confidently pursue an opportunity, knowing that you have a handle on all of the most important material facts.
The Firebrand team owns and operate assets across multiple states, throughout three different regions of the country. If you’re considering purchasing a home or adding an investment property to your portfolio, we’re here to help.