As you might already be aware, our primary focus is buy-rehab-hold. Many times over the years, deals have looked great on the first walk through, and the numbers have come up solid, but upon further inspection, we have found issues that caused us to change our minds about the deal.
It’s important to do a thorough physical and financial inspection of a deal to make sure the deal will meet (and even exceed) your expectations. You also want to make sure that the data the seller gives you to evaluate the deal is correct. This includes everything from the rent tenants are paying, the utility expenses and even what use the property is zoned for.
Discovering that a piece of data you used to evaluate the deal is incorrect can kill a deal. Discovering it too late can be much worse.
When we buy a property, every one of our agreement of sales includes two clauses around inspections. One clause allows us a phase called the Due Diligence phase. This phase typically takes 15 to 30 days and is the time period when you can do all inspections. The second clause allows us to ask the seller to make repairs, request a discount in price (called a re-trade) or exit from the deal altogether as a result of what is found during the inspections.
Related: The Importance of Doing Your Due Diligence: A True (and Almost Disastrous) Story
This article is dedicated to the Due Diligence phase and what we typically do to make sure the deal will meet our expectations.
The level of detail you will go into during due diligence will vary depending on the size of the property. You should do some level of all the inspections below, even for a single family home.
3 Crucial Inspections to Make During Due Diligence
1. Document Inspection
This is the first and typically the most straight forward part of due diligence.
In the agreement of sale, we ask for specific documents to review. Most of these are readily accessible by the seller, and we just want to make sure they have them on hand. Some of the easy ones include the deed to the property, a copy of their insurance policy, copies of all tenants’ leases and a recent real estate tax bill.
If the seller can’t produce one of these things, it’s a red flag that deserves further examination and may uncover more data. Perhaps the tenants living in the building don’t actually have written leases. Perhaps the property is in a flood zone, which would become evident on their insurance policy.
Another document that the seller may or may not have on hand is a land survey of the property. If the owner doesn’t have a survey, you should consider having one performed on your own to confirm that things like fences, driveways and utility poles don’t cause a boundary issue between you and a neighboring property.
The last stop on your document inspection should be to the local municipality. There, you want to confirm that the property is zoned for its current use, that it is registered as a rental property (if that’s required in your area), and that there are no violations filed on the property.
Document inspection/review should take you no more than a day once you have everything in hand.
2. Physical Inspection
Just like a homeowner’s inspection, when you purchase a home, the physical inspection of a rental property is dedicated to uncovering things that may become a problem down the road.
For every deal we do, we perform a detailed walk through of the building.
We look for two things: upgrades we want to make and safety concerns. Upgrades usually include the things that make a unit rent easily, like new kitchens and baths, new light fixtures and appliances. Safety concerns include things like missing smoke detectors and undersized electrical breakers. In New Jersey and Pennsylvania, the local township performs a Certificate of Occupancy inspection on every sale, which focuses on safety.We typically rely on their inspection to uncover safety code violations.
We do all of the above for just about every purchase. As the deals have gotten larger, we’ve implemented some of the following additional physical inspections:
Roof inspection: For mixed use or multifamily buildings, we have a roofing contractor come out and give us a full assessment of the roof condition for a very reasonable fee of $100. The report includes pictures and a brief written report. He also includes an estimate to repair any damage.
Structural inspection: Structural repairs can be expensive, but they can be remediated. If we see something that looks suspicious with the building foundation or the framing (typically in the basement), we bring in an engineer. For a small fee, he will do an inspection and write a report of his findings.
Boiler inspection: For multifamily buildings with one boiler heating multiple units, we will have a heating contractor inspect the heating system to determine its current health and life expectancy beyond closing.
Fire inspection: When there are hardwired smoke detectors or fire extinguishers in the common area of the building, we have a contractor inspect them to make sure they are working properly. Most municipalities will require this to get a clean certificate of occupancy actually.
Environmental inspection: This sometimes comes up for properties larger than a single family home and will just about always come up if you are getting financing from a local bank. It involves making sure there are no environmental hazards on the property. These hazards are a threat to the local environment and include things like an abandoned underground heating oil tank or asbestos insulation on heating lines or lead based paint.
The inspection needs to be done by a third party company hired by you (the buyer). It can be a very light inspection called an Environmental Analysis Survey or a full blown analysis called a Phase 1 Study. If any issues arise, the seller is obligated to remediate them, and the inspector is obligated to report …read more