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- Strategies
-
If using an agent, maintain control of the deal. It is your money,
both cash and what you will owe the bank, that will be at risk. The
agent will be able to spend his commission after closing whether or not
you made a good buy. The success of your investment will depend
upon buying the right property. Do not buy a property because the
agent tells you it's a great deal. Depend upon your own analyses.
- Pre-Offer Property Analysis
-
Once you have found a property that you would like to consider purchasing
- what next? Unfortunately, you can't do all the due diligence
that you'd like until you obtain information that won't be provided
until the seller has accepted your offer. However, there are
a lot of things that can be done before writing an offer and the more
you do the better.
There's no point in spending time writing an offer
for a property that has obvious serious problems. Most importantly, you
need to make a decision about what price you're willing to pay before making
the offer, so you need to determine what the property is worth. Even though
you will include contingencies in your offer, writing an offer and doing further
inspection and analyses is a waste of time and energy for both buyer and seller
(and their agents) if you're not serious about buying the property.
Therefore, you should check out all issues that you
possibly can prior to writing the offer. Issues investigated before writing
the offer should still be included as contingencies in your offer unless you
are absolutely certain that they are not potential problems.
Legal Issues
- Zoning
-
You should verify that the units are legal as
to zoning. If not, is there an existing variance or are they grand-fathered?
- Building Codes & Occupancy
-
Ask seller/agent whether they are aware of any remodeling, additions,
etc. Were improvements done with building permits? Are
electrical, plumbing and heating to code? If not, are they grand-fathered? Does
the local building code have occupancy restrictions?
Having non-code items or conditions in a rental
unit leaves you open to violation citations and/or lawsuits by injured tenants
or their guests.
- Title Report
-
A report showing easements, liens, and other matters
of record is very important, whether it is a preliminary title report from a
title insurance company or a chain of title prepared by an attorney in those
jurisdictions where title insurance is not used.
- Physical Inspection
-
While one should be concerned about physical inspections
when purchasing a personal residence, it is often of even greater importance
when purchasing income property. There are several reasons why this is
so.
First, rentals are often mistreated by tenants. Second,
many landlords do minimal maintenance, only fixing those things that break, and
do little or no preventive maintenance. Third, some income properties,
particularly the larger complexes, have types of equipment and other issues not
found in a single-family home.
Financial Analyses
- General
-
As mentioned above, one of the difficulties in buying income property
is that you must usually come up with the price that you are willing
to pay before writing the purchase contract, but you do not always
have access to all desired information until after you have an accepted
offer. However, you need to do as good an analysis as possible
with what you can get.You can often do a fair analysis using
data (1) provided in the listing, (2) available from the listing agent
and/or the owner, and (4) available from other sources.
If you cannot obtain the information needed, you
shouldn't be making an offer - unless you have nothing better to do with your
time and you provide adequate contingencies.
Use any information provided to do the financial
analysis. You can obtain your own data for many expenses.
LandlordAmerica has an e-course, Valuing
Income Property, that discusses value in considerable detail and shows you
how to value an income property, including both quick preliminary approaches
and detailed complex methods. The Valuing course also includes many related
topics necessary to financial analyses, for example, reserve accounts. If
you have not yet taken that course, you should do so after completing this course.
Environmental
- Danger, hazardous to value
-
 There
are a variety of environmental issues that can seriously impact property
values, including the presence of lead, asbestos, toxic waste, radon,
or other hazards, and potential restrictions on further development.
- Super Fund Sites
-
Super Fund sites are specific areas of known contamination
that have been defined bythe EPA.
- Lead-Based Paint
-
It is easy to determine whether a residential
property was built before 1978, requiring disclosure and concern, or built in
1978 or later, requiring little concern.
- Other
-
Whether you will want to do a pre-offer check
on issues such as radon, depends upon the area of the country and even on the
specific type and location of the property.
- Writing the Offer
-
General
In all respects, the property checks out as
being one that you want to own - what next? Well, you need to write a purchase
contract. This documents is also sometimes called a purchase agreement
or contract to purchase, but what is in it is a lot more important than its name.
There are a number of elements to a legal contract to purchase real estate. Basically,
they are:
Although you will not usually sit around a conference table negotiating
various terms and conditions of your purchase contract, you should be
aware of negotiation principles when you write your offer. You
will almost certainly negotiate after you have made your offer. Unless
your purchase offer is ridiculously out of line with value or other issue
to the degree that it makes the seller mad, you should expect a counter
offer from the seller. It is likely that you will get a counter
offer even if you offered full price because some of the contingencies
or other issues that you included will probably be objectionable
to the seller or his agent. Many of the same principles apply whether
you are sitting across the table from the seller or instead are writing
your original offer or writing a counter offer to his counter offer.
- Contract Forms
-
Most real estate agents who are representing a buyer
will utilize a purchase contract that is (1) their firm's custom form, if a large
company or a franchise such as REMAX or Century 21, or (2) their state's Association
of Realtors form. If you are working without an agent, you have the choice
of obtaining a form of the seller's agent if there is one (and there usually
is), whichever type that is, or obtaining an Association of Realtors form yourself. One
of the potential problems with using the custom form of a large company is that
it may contain a whole lot of references to the company name. Accordingly,
of the two choices, you usually be better off using the state Association of
Realtors' form.
An alternative is a form of a reputable independent
publisher such as California's first tuesday. Unless you
are capable of judging the adequacy of the independent publisher form, assuming
there is a good one available for your state, it is usually safest to use the
Association of Realtors' form because state associations tend to employ competent
attorneys for drafting forms and they are usually kept up to date regarding the
latest statutes and Court decisions.
One potential problem in getting a form from the
seller's agent is that the agent will likely want you to let him help you fill
out the form. Remember that the seller's agent wants badly to make the
deal because he will make a lot of money no matter what price the property sells
for and whether it's a good deal for either the buyer or the seller. Accordingly,
if you're not sure that you can hold your own against the agent and won't let
him influence your offer (probably almost impossible), don't let him work with
you on the contract. For the same reason, you need to hold your own in
filling out the form along with your own agent when you have one.
The form, from whatever source, will have various and
sundry boiler plate clauses regarding financing and other conditions and contingencies. There
is nothing wrong with using these clauses where they meet your own requirements. However,
do not be intimidated into using a clause that does not say exactly what you
want. Do not hesitate to add an addendum that contains the exact customized
clauses that you need. Be sure to line out the boiler plate clauses and
refer to the addendum for each of the clauses that you wish to replace or modify. Due
to limited space on the form and for clarity it is usually best to write a new
clause on the addendum rather than mark up an existing clause except for very
minute changes (e.g., changing the number of days from 7 to 10). Be
sure that both parties initial every single markup on the contract. Example
of an addendum.
- Price
-
When writing the offer, you need to decide what
you are willing to pay for it. As previously stated, a good understanding
of valuation is required before applying the information of this course and the
subject is covered in detail by our Valuing
Income Property e-course.
Almost as important is price is the terms. The
loan terms are, of course, important because interest rate, monthly payment,
and length of loan are all directly related to financial viability and profitability
of property operations. Other terms of the contract are also important,
including those mentioned in the next three paragraphs.
- Deposit
-
Cash deposits are customary, but smart buyers don't have to operate according
to custom. The seller wants the buyer to put up a cash deposit to keep
him from backing out of the deal, because when a contract for purchase
has been negotiated and signed, the seller is actually granting the
buyer an exclusive option to purchase the property, subject to the
terms and conditions contained in the agreement. So, the buyer
is getting a lien on the property subject to those conditions. The
seller needs something in return, right? Sure, but why should
it have to be cash? There are reasons to avoid cash deposits,
if possible.
- Personal Property
-
 If
there is any personal property included in the sale or that you want
included in the sale, be sure that the contract includes it. It
is sometimes best to have a separate agreement in every offer that
covers any and all personal property, but make it an intrinsic part
of the real estate transaction, in order to prevent a lender from subtracting
the value from their loan commitment. Also, insist that you receive
a bill of sale for all the personal property listed in an inventory.
- Contingencies
-
Contingencies are very important and it is important
that they be properly written. There are a number of general and specific
principles that you should follow when writing contingencies into your offer
and these are covered in LandlordAmerica's Buying
Income Property e-Course.
- Financing
-
Unless you're paying cash and the money is in
your bank account, a financing contingency is very important. Be specific regarding
the maximum acceptable interest rate, discount points, and other costs as well
as the minimum number of years of the loan that you are willing to accept. Also,
specify that it will be a loan from a legitimate lender (no loan sharks) and
specify a fixed interest rate if you are unwilling to take a variable rate loan. Finally,
be sure it is clear that your inability to obtain financing meeting your criteria
is a complete failure of the contingency.
- Title Report & Title Insurance
-
Require delivery of a preliminary title report
or chain of title report as soon as possible. You as buyer usually have
the right to choose the title company or attorney and should do so. You
can ask ahead of time what the maximum period will be required for provision
of the report.
If in a jurisdiction where title insurance is
available, require that extended coverage be provided, rather than the basic,
even if you must pay for the coverage yourself. Basic coverage only protects
against things that are a matter of public record and fraud and does not protect
against encroachmentsor certain other matters. The extra cost is
relatively low. See our Title
Insurance page for additional discussion about title insurance.
- Financial Records
-
The value of the property and the amount that
you should be willing to pay for it are entirely dependent upon the income and
expenses. Accordingly, you must be sure to require adequate documentation
needed to verify both income and expenses.
- Lease Documentation
-
Leases and related documents are exceedingly important
for two reasons. First, they verify the income information that is being
provided in the financial records. Second, they disclose (1) how long tenants
have been there (indicating the stability of their business), (2) the expiration
date of tenancy and possible extension options (indicating when you can raise
rents), (3) the future rent increases already built in (indicating future automatic
income increases and therefore value increase), and (4) all sorts of other important
information that has an impact on the current and future value of the property.
- The Tenants
-
Existing tenants in investment property can be either assets or liabilities.
Whenever you buy the tenants with the real estate, protect yourself
by requiring adequate documentation.
Lead-based Paint Disclosures For Tenants
For a residential property built before 1978,
require the seller to provide copies of executed lead-based paint disclosure
forms for all tenants. In addition to the federal regulations, some states
(e.g., Massachusetts and Maryland) have imposed additional and more onerous regulations
and penalties, so investors in pre-1978 residential income property should be
sure to understand the lead paint laws of the state in which they invest.. The
required federal pamphlets and forms are available on the members-only Forms
Web.
The LandlordAmerica web site has considerable
information regarding lead
paint issues.
- Insurance Policy
-
While you will not be depending upon the cost
of the sellers insurance when doing your analyses, you still want to obtain a
copy of his policy or at least of the sheet showing coverage because it will
be of use in obtaining your own insurance.
- Physical Inspections Structure & Components
-
While one should be concerned about physical inspections
when purchasing a personal residence, it is usually of greater importance when
purchasing income property. There are several reasons why this is so.
First, rentals are often mistreated by tenants. Second,
many landlords do minimal maintenance, often for only things that break, and
do little or no preventive maintenance. Third, some income properties,
particularly commercial properties and the larger residential complexes, often
have types of equipment and potential problems not found in a single-family home.
Be sure that your purchase contract makes contingencies
out of all inspections and allows adequate time to get the results of the inspections,
taking into account inspector scheduling, holidays, weekends, weather; time to
analyze the reports; and time to exercise a contingency if necessary.
- Survey
-
A boundary survey is not often needed, but it is worth including as a
contingency in case some reason to have one comes to light during the
contingency period or if the lender requires one.
- Environmental
-
This is another subject that is seldom of much
concern for a personal residence except for lead and, occasionally, radon issues. The
subject can be much more important for income properties, particularly commercial
properties. Items that might be of concern include Super Fund Sites, soil & groundwater
contamination, lead paint, asbestos, and radon.
- Estoppel Certificates
-
Although often not utilized unless required by
the lender, as they usually are for larger properties, Estoppel Certificates
should be used for every purchase of a tenant occupied property. An Estoppel
Certificate is a document signed by a tenant that, among other things (1) affirms
the lease documents (attached to Certificate) and the deposit/rent amounts; (2)
confirms that there are no agreements outside of the attached documents; and
(3) confirms the amount of security deposit, the current rent, and the
date to which rent has been paid. The document is sometimes called
a Certificate of No Defense.
- Escrow Period
-
You, as buyer, will usually want a long escrow
because you want to minimize the pressure to get everything done. The seller
will usually want a short escrow because the longer the escrow the more chance
that it never closes and he doesn't get his money until closing. If the
tax year is not an issue, pick a realistic closing date based upon the time required
to complete all contingencies including financing.
- Possession Before or After Closing
-
If the seller will retain possession of the property
or any part thereof after the close of escrow or if the buyer will get possession
of the property or any part thereof before the close of escrow, the parties should
execute a formal lease agreement covering the subject period of time.
- Final Check
-
Before you sign the contract, read it carefully
and then read it again. A signed real estate contract is a legally binding agreement.The
BIG print giveth, and the small print taketh away.
Post-Acceptance Analysis & Inspections
- Legal Issues
-
 Although
you should have checked into as many issues as possible prior to even
writing the offer, you must now do some serious investigation.
- Title Insurance Report
-
If not available prior to writing the offer, obtain
the preliminary title report or chain of title report as soon as possible. Also
obtain legible copies of all documents referred to in the report. Title
reports often contain errors, so question any items that weren't expected or
don't make sense.
- Zoning & Building Codes
-
If not done prior to writing the offer as previously
recommended, you should now check into zoning and Building Code & Permit
matters.
Licenses & Permits
Depending upon the city, county, and/or state
in which the property is located, it is possible that a variety of licenses,
permits, and/or inspections might be required for rental properties.
Documentation
- Financial
-
Your purchase contract should have required that
the seller provide financial records that show income and expenses for at least
the past 12 months and the records must be such that verification of accuracy
is possible. You can also determine realistic expenses on your own.
NOTE: Property taxes may be increased substantially based on your
purchase price. Make sure you understand the local tax assessment
policy and use the likely new tax amount for your proformas.
You should also take a look at the conditions of the roofs, parking
lot, heating/cooling systems, and any other major components to determine
(1) whether there is deferred maintenance that will need immediate attention
(lender may even require it) and (2) what type of annual reserve payment
you need to include in your analysis (lender may do so).
Although you came up with the price that you were
willing to pay when you wrote the offer, you have to re-analyze the value, using
the same procedures with perhaps more complete and accurate data. Also,
if you structured your contingency periods properly, you will have the results
of whatever inspections you performed.
If you now come up with a value of less than you
offered, it should only be because of (1) information from full documentation
was different than from that originally provided before writing the offer or
(2) previously unknown and/or undisclosed physical or environmental defects were
uncovered during inspections. In either case, you can exercise the appropriate
contingencies and try to negotiate a lower price or, if the seller is unwilling
to renegotiate, cancel the deal.
- Leases
-
You should be sure that you are provided copies of all leases and related
documents, including amendments, guaranties, checklists, and house
rules.
One reason lease documents are important is to
verify rent income. This is particularly important regarding unique commercial
properties for which it is difficult to independently determine market rents. For
commercial properties, there are a number of additional issues that must be considered
compared to residential property.
Lead-based Paint Disclosures For Tenant
For residential property constructed before 1978,
verify that the lead paint issues are fully covered, as previously discussed.
- Other Tenant Info
-
Since the value of leases is dependant upon the
financial strength of the tenant and/or guarantor, it is of value to obtain copies
of applications, credit reports, financial statements, and/or other documentation
upon which the decision to lease was based.
Estoppel Certificates
Although often not utilized unless required by
the lender, as they usually are for larger properties, estoppel certificates
should be used for every purchase of a tenant occupied property. An estoppel
certificate is a statement signed by a tenant (1) affirming his lease documents
(attached to Certificate) and the deposit/rent amounts; (2) confirming that there
are no agreements outside of the attached documents; and (3) confirming the date
to which rent has been paid. The document is sometimes called a Certificate
of No Defense.
Without an estoppel certificate, you may find
out after closing that (1) a tenant had a first right of refusal or option to
purchase that he'd not been given opportunity to exercise or (2) there is a lease
amendment that the seller had neglected to provide which extends the lease for
3 years of the unit that you planned to move into after close of escrow.
- Inspections
-
 Every
offer to purchase real estate should be contingent upon a thorough
inspection of the property. Whether you need the inspection performed
by someone other than yourself depends upon your knowledge and experience
as well as the type of property. If you are new to real estate
investing, and/or building construction, DO NOT try to do an inspection
on your own. Even experienced investors usually take some qualified,
but disinterested, third party along when they check out a property
before purchase.
While one should be concerned about physical inspections
when purchasing a personal residence, it is usually of greater importance when
purchasing income property. There are several reasons why this is so.
First, rentals are often mistreated by tenants. Second,
many landlords do minimal maintenance, often for only things that break, and
do little or no preventive maintenance. Third, some income properties,
particularly the larger complexes, have types of equipment not found in a single-family
home.
Be sure that your purchase contract makes contingencies
out of all inspections and allows adequate time to get the results of the inspections
taking into account inspector scheduling, holidays, weekends, weather, time to
analyze the reports, and time to utilize a contingency if necessary.
- Physical
-
Hopefully, you have written a good contingency
clause regarding physical inspections into your purchase contract. Now
you have to decide how to use it. There are a lot of things that are candidates
for close inspection, and what is important depends upon the type and size of
the property as well as the complexity of some of the systems. The ones
that are often of concern are roof, heating/cooling systems, electrical, plumbing,
gas, and pests.
You can either hire individual specialized contractors
for each component or hire a property inspection service to cover the entire
property. Whether you hire a single property inspector or a separate inspector
for each of various components depends upon the type and complexity of property. Read
LandlordAmerica's
Selecting a Property Inspector
page. Having independent inspections by professionals can sometimes
give you more leverage in re-negotiating the deal when problem are found.
How can a buyer check to see whether a contractor
is properly licensed? You should determine if any complaints have been
filed against the contractor, current license status, and the "qualifying
party" to
whom the license was issued. You should make sure the qualifying party
contractually responsible for constructing your home matches the license
number on the building permit.
- Environmental
-
This is another subject that is seldom of much
concern for a personal residence, except for lead-based paint and radon issues,
but can be important for income properties, particularly commercial properties.
Soil & Ground Water Contamination
Although you should have checked whether the property
is in a super-fund site before writing the offer, if you didn't, do it now. While
this is not necessarily a reason to eliminate it from consideration, you should
be sure that you understand the ramifications, if any.
For commercial properties in particular, you need
to be concerned about potential contamination issues. For commercial locations,
the lender will usually require a Phase One Report, but you should have made
the Report a contingency in your purchase anyway.
- Lead-Based Paint
-
For pre-1978 residential properties, you, as buyer,
must be provided with the legally required lead paint pamphlet and disclosure
form. This is in addition to receiving copies of the tenant-signed forms
mentioned in the earlier paragraph. If the form indicates that the seller
has had a lead paint inspection or has had remedial work performed, be sure to
get copies of the reports and/or certificates.
- Asbestos
-
If applicable, have the property inspected for
asbestos.
- Radon
-
If applicable, have the property tested for
radon.
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