Financial Due Diligence in Property Investing

Investing in real estate is an exciting proposition. A good Property Investment not only provides income and asset growth but also gives an investor the personal satisfaction of investing in the community, providing people with homes to live in and places to do business. A good real estate investment should be a win/ win scenario for all those involved.

The implications of a failed Property Investment are huge and potentially long lasting for an investor. A poor performing mutual fund can be cut loose with a key stroke and transaction fee, cutting investor’s losses and retaining their remaining capital for more promising investments. Property investments on the other hand require capital to maintain and if not profitable can be very difficult to get out from under. A bad investment can consume capital or force a sale at a grievous loss, having a profound effect on your bottom line.

The long term risk is one reason that due diligence in inspections is the most important safe-guard a real estate investor can employ; Inspections of the building and its mechanical components, along with site and environmental inspection, coupled with a legal inspection of title, will go a long way in mitigating the risk involved in Property Investing.

While these critical functions are generally performed by unbiased professionals, the process of financial due diligence, more often than not, dependent on information provided by the seller. Aside from the personal stake, the seller has in the transaction colouring the data, generally the information provide is at best a good faith estimate. You would be hard pressed to find a Real-Estate Investor holding a property that performed as well as the sellers information claimed.

There are a few steps a prudent Property Investor can take to prove the property’s profitability:

  • Ask to look at the lease agreements and inspect them for terms and conditions
  • Verify rent payments through bank deposits and tenant statements. For all intent and purposes you need to verify that the rents are real not just projections.
  • The seller’s income tax returns; look for discrepancies in income and expense write offs between the tax returns and other information provided by the seller.

Should the seller be reluctant or refuse access to these documents, every bone in your body should tell you to run, not walk, RUN away from this prospective deal.

Another area of financial due diligence that is often overlooked is the liability test. It is important to know if there is any; debt obligation, deferred maintenance contract or other debt to outside contractors, attached to the property and how theses future liabilities will affect the property’s performance.

In the area of due diligence and Property Investing, comprehensive and accurate information is the key to risk mitigation and profitability. We here at Custodian are Australia’s source authority in Property Investing, waiting to guide you in a successful investment direction.

*extract from Custodian Millionaire Case Studies magazine printed in 2012.
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