Real estate investing can yield high returns when opportunities are evaluated correctly based on facts rather than promises or perceptions of potential alone. Due diligence refers to the careful investigation and validation of key investment details that determine viability and likelihood of success or failure. While due diligence adds time and cost upfront, it pales in comparison to losses that can result from taking on deals with hidden issues or unfounded optimism.
Check the numbers.
Review financials, tax returns, bank statements, closing documents and anything else shedding light on key metrics including income, expenses, cash flow, ROI, IRR, cap rates or equity positions. Ensure assumptions and projections seem realistic and conservative relative to industry standards. Favorable numbers alone do not an investment make.
Validate cash flow.
Determine if enough cash flow exits to cover all expenses, debts, capital needs and investor returns. Study bills, contracts, leases, rental incomes and expenses line by line. Make sure no big unknowns remain and that maximum rent is being charged, or that business revenue sufficiently covers costs. Cash flow after expenses must remain positive to support the investment.
Check licenses, permits, and taxes.
Ensure the seller legally owns the underlying real estate investing and assets. Review endless fees, back-taxes or other government liens that could be called or foreclosed on, seizing invested capital. Unpaid taxes or permits cancelled due to non-renewal pose huge risks requiring diligence to find before purchasing.
Analyze risks.
Meet with accountants, attorneys, architects, engineers, contractors, existing landlords or property managers knowledgeable about the opportunity’s biggest risks. Ask hard questions, probe weaknesses and determine potential downsides to evaluate threats versus potential return. Price risk appropriately into any offer or decision to move forward. It’s better to walk away than lose money due to avoidable mishaps.
Get professional guidance.
While the seller’s team likely consists of professionals, benefit from your own. Hire real estate agents, attorneys, accountants, property inspectors or other specialty advisers based on opportunity details. Paying for independent opinions outweighs risks of following misleading seller guidance or making key mistakes through inexperience or lack of proper due diligence. Professional guidance protects invested capital from avoidable error.
Due diligence takes time but costs far less than mishaps arising from lack thereof. Careful examination of numbers, cash flow, legal ownership, risks and professional opinions helps determine whether an opportunity qualifies as an investment or dubious promise of returns too good to be true. When profits depend on losses sustained by others, thorough due diligence protects your own financial security against the perils of real estate risks gone unconsidered until too late. The value of due diligence cannot be overstated within reach for big rewards and major financial stakes. Conducting it thoroughly leads to good decision making and minimized regret or ruin.
