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? This
is one of those pieces of advice that can be ignored in many cases. For
example, a duplex building in a block of duplexes requires little investigation
regarding proper zoning. However, an apartment in a house among a neighborhood
of single-family homes warrants scrutiny. Likewise, a relatively new office
building in an area of several other office buildings probably has no zoning
issue, whereas a single-family home converted to office use and being sold for
more than it's worth as a single-family home should be thoroughly checked out.
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? Many codes restrict
the number of occupants based on the size of bedrooms and the number
of rentable units based on common areas and parking.
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. Keep in mind that a disgruntled tenant can file a complaint
that results in a special inspection of your property which might uncover zoning
and/or code violations that could require expensive repairs, remodeling or even
limit the use of your building.
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. Although not often available
prior to acceptance of the purchase contract, it is worth asking for. Also
obtain legible copies of all documents referred to in the report. This
subject will be covered more thoroughly in the next lesson.
Holding Title
It is extremely important to give serious
thought to the potential liabilities associated with owning rental properties
and to take the necessary steps to minimize your risks. There are dozens of ways
in which it is possible to lose your entire net worth if ownership is not properly
vested.
Investors should research the subject themselves
and/or seek competent legal advice regarding the tax and legal implications of
the various vesting options. For many investors, it is currently recommended
that the Limited Liability Company (LLC) provides the best tax benefits and risk
management, with a separate LLC used for each separate property.
Insurance
Before committing to purchasing a property, be
sure that you will be able to obtain the required insurance. Premiums can
easily turn out to be a significant operating expense and need to be taken into
consideration when analyzing the property. Worse yet, it is possible that a particular
property and/or landlord will turn
out to be uninsurable.
A property may be rejected for a variety of reasons.
As examples, the building is sitting on an earthquake fault line, near a toxic
waste dump or in an area subject to flash floods, hurricanes or fires. The
physical condition of a building might make it uninsurable.
Similarly, investors might be turned down for
insurance if they have a history of making too many insurance claims on a homeowner's
policy or even for having a bad credit record.
The types and amounts of insurance coverages the
landlord buys must also be based on the requirements of the lender.
The more tenants, the more insurance must be purchased
to cover the risks. The best insurance package for a landlord is usually the
commercial liability policy, or a scaled-down version of that for smaller buildings.
Such a policy covers damage to the building and
to tenants' personal property, injured residents and guests, any kind of equipment
used to maintain or heat the building, workman's compensation for anyone doing
upkeep and storm or earthquake coverage in areas prone to such disasters.
Also, you need to keep your insurance agent up
to date on the value of the property to make sure you're covered. Insurance
policies coverages are generally automatically adjusted annually to insure that
they keep up with replacement costs. In other words, as your properties increases
in value, so do your premiums.
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.
You may be able to obtain a lot of information
prior to writing an offer even without access to the property. Landscaping,
exterior painting, parking surfaces, and fences are visible from the street,
as is sometimes the roof. You may even be able to view the inside of a
vacant unit, in which case you should look at the electrical panel (check for
aluminum wire), plumbing and plumbing fixtures, and appliances. Make notes
of all defects and/or questionable items so that you will remember to include
them in contingencies if and when you write a purchase offer.
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.
The detail of information required to do an adequate
analysis depends on the type of property under consideration. This varies
from perhaps nothing for an owner-occupied single-family home, where you can
obtain the needed information yourself, to a large amount of detail required
for a large shopping mall. Generally, the more complex the property, the
more sophisticated the owner and/or agent, and the more likely that you would
have received what you needed to do the analysis. Larger properties often
have document packages containing very detailed information that is available
to legitimate potential buyers. 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 provide adequate contingencies.
Use any information provided to do the financial
analysis. You can obtain your own data for many expenses. Property
tax is of public record; insurance and landscape maintenance quotes are easily
gotten; fences, landscaping, parking areas, and exterior painting are visible
from the street, as is sometimes the roof, so you can have some idea of items
of possible deferred maintenance. Don't hesitate to badger the owner or
listing agent for information beyond what they originally provide.
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. While you will not have
to complete that course prior to finishing this one, you will have to understand
how to determine value prior to applying the information of this course to an
actual purchase or sale.
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.
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.
Before completing a purchase of some properties, prospective buyers should
obtain a Phase One Report which consists of researching the
past uses of the property. If there is any chance that a previous
use could have contaminated the property in any way, obtain the services
of a qualified environmental engineer to inspect the property.
Super
Fund Sites
Super Fund sites are specific areas of known contamination
that have been defined by the EPA. Determining whether or not a property
you're trying to buy is in a super-fund site is relatively easy, as maps are
readily available, and should be done before writing an offer on a property. While
being within a Super Fund site is not necessarily a reason to eliminate a property
from consideration, you should be sure that you understand the ramifications,
if any, and it might be reason to significantly lower the offered price.
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. Although the year of construction
is usually provided in the listing and/or directly by the seller, it is recommended
that this be personally verified by a call to the county (or visit to the web
site of those counties that provide this information) if it is not otherwise
known that the property is newer than 1977 (e.g., you personally know when the
specific property was built or when the subdivision was developed).
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.
