Making sure you’re not buying property that will fail

We owe it to ourselves to make sure that any property we buy actually has the potential to make us money. Otherwise, what’s the point? Here are three things that every savvy investor will look at before he or she seals the deal on investment real estate.
This property shows real promise. The price is right, the rents are up to market (none of this ‘rents should be higher’ in the advertising), and it’s in a good part of town. So what’s wrong?
Maybe nothing is wrong. Or maybe everything’s wrong. Due diligence will tell. With it, you’ll know for sure you want to buy this place. But you don’t want somebody else’s trouble.
Three things can affect whether or not a property really does have promise: the tenants, the condition of the property and what’s going on around the property.
Bad tenants
The January 2009 issue discussed estoppel certificates, documents designed to confirm the claims the seller has made about his or her tenants and agreements with them. That goes a long way toward telling you what you need to know about whether or not tenants are paid up with their rents, they actually are paying the rent the seller claims and that there are no ‘side deals’ with tenants, such as promises to make huge modifications or to buy new appliances.
What an estoppel certificate won’t tell you is what kind of tenants actually live in the property. And that is something you need to know. You need to know, for example, if they have a history of late rent payments, of disputes with other tenants or neighbors, if they have been the cause of an inordinate number of visits from the police, and if they meet the standards for renting from you. It could be that the reason the seller is selling is that he is sick and tired of the tenant hassles and wants to dump them on somebody else. If that’s the case, you may not want the person dumped to be you.
To find out, look at each current tenant’s file.
There may be no need to look at past tenants’ records, since you won’t be dealing with them, unless there is a history that would put the property on a watch or problem property list with the police force. Some cities have ‘problem property’ ordinances that provide for the closing down of properties with a large number of ‘bad-neighbor’ type calls to the city or the police. In that case you want to look carefully at past tenants. If you find a record of tenants who have been police problems, run up the red flag.
If you were to buy a property with a ‘problem property’ label, you can expect hassles from bureaucrats and having to spend a lot of time straightening out the mess. Yes, the city would probably start all over with you, but a considerable amount of time and stress would be wasted trying to make bureaucrats understand common sense.
One of the things you will need to do in your due diligence, then, is check with police to find out if they have had any persistent problems with the investment you have in mind. (That is only if your city has an ordinance which allows the closure of properties that have a history of problems.) Finding out should be simple. Just call the police department and tell them that you are considering buying the property at 1234 Main St and want to know if it is on a list of properties that get special attention. If the property is okay, continue with due diligence.
Now you need to look at individual tenant records. Before you begin your examination, you first need to create appropriate rental policies and standards for the new property. You don?t care what standards the seller used. Possibly his standards, or lack of them, resulted in unqualified tenants renting from him.
You are looking for the red flags in rental histories mentioned above. Sure everybody might be paid up now, but what about six months ago? You don’t know what the seller has done to see that all the tenants look paid up on the books. He could have made special arrangements; he could have forgiven past unpaid rent. You need to know.
What happens if you find out that you have a problem tenant? You know, someone with extra roommates, paying late rent, making excessive noise, or who otherwise is not meeting your rental standards. Address it in the addendum to the sales agreement that you write after you complete your due diligence. You have a couple of options: one, to require that the tenant be out of the property before closing, or, two, to lower the price you are willing to pay for the property. In most cases, you simply will want the tenant out. If there is a lease in place, that is probably not an option, so you would have to offer less for the property. But a month-to-month tenant would simply have to go.
‘Seller will terminate the tenancy and cause the tenant in Apartment 5 to vacate before closing.’
Major repairs
Anyone who buys a piece of real property without having it inspected by a professional inspector deserves whatever he gets. All kinds of things hide on roofs, under floors, in basements and walls, and around the property. Even if you are an old hand at inspecting properties, you still want someone else to look at the property you have in mind to buy just to get a more objective eye.
Professional home inspectors almost always have another inspector look at properties they are considering purchasing, so emotion won?t cloud their judgment making a defect seem less/more of a problem than it actually is.
When should a major problem disqualify a property from your consideration? This answer may not satisfy you, since it is not cut and dried. In fact, it is depends on a couple of factors, such as price and how long you plan to keep the property.
Say, for example, that you discover there is major dry rot in a couple of the bathrooms. Estimates are that you are looking at $10,000 to make the repairs (these are really serious and require a whole new floor). But let’s also say that you are paying $25,000 below market for the property. Now you have to calculate the lost rent and the costs for re-renting for the units that need repair. You are probably still ahead of the game financially.
But what if you didn?t want to have to make those repairs, you had something else planned, or you don?t want to throw $10,000 in cash at the property over and above your down payment and closing costs? In that case, you would probably reject this one and go on to a property that wouldn?t require all that work.
But wait! There’s still another option. You could have the seller make the repairs before closing. The seller can get the work done and have the repairs taken out of the proceeds of the sale, thus taking no money out of his pocket and no money out of yours. You will have to add language to the addendum after your due diligence requiring the seller to make those repairs. Then all you have to do is re-rent the two apartments in question after you take possession.
‘Seller to repair dry rot in bathroom floors of Apartments 2 and 7 before closing.’
But what if it isn’t a ‘major repair’? Many times buyers and sellers get hung up on things that really don’t matter.
One investor, who specializes in single-family rentals, saw an ad for a three bedroom home in a good neighborhood for $89,900. He knew that looked like a good price for the area. He called his agent to find out more.
After some investigation the agent got back to him. He had talked to the listing agent, who had told him that she had just presented a fullprice offer to the sellers that afternoon. But the sellers wanted to think about it.
That had immediately sent up a red flag to the agent. Why would a seller have to think about a full price offer? With some more digging the agent had discovered that the price wasn’t the seller’s biggest concern. There were some repairs that the other offer asked for.
The offer wanted the sellers to paint the kitchen, fix a dripping faucet in the bathroom, polish the hardwood floor in the dining room and clean the rug in the master bedroom.
The sellers were balking at the offer because the husband had to be on his new job (an important promotion) in 10 days in another city. He was training his replacement at the time, and that demanded that he spend even more time at work. His wife was leaving in 48 hours for the new city to look for housing.
It was quickly apparent to the agent, and to the investor when he heard it, what the real problem was.
The investor looked at the house. Saw that it was in good condition and a good value. He immediately wrote a full price offer, but without the contingencies for cleaning and repair.
His agent presented the offer. The sellers accepted on the spot.
The investor wasn’t concerned about the minor things such as dripping faucets and scuffed floors. Every time he had a vacancy, he had to fix those.
Demanding concessions that really don’t matter from a seller, is just stupid. As an investment property buyer, your concern needs to be rather with things that will affect your investment and bottom line, not things that you have to fix all the time anyway.
The investor won on this sale because he focused on buying the property, not worrying about the small stuff. The reason the people who made the first offer lost is that they wanted everything to be perfect. That is despite the fact that all the repairs they demanded could have been taken care of in a few hours over a weekend.
The losing buyers were buying the home on emotion. The investor was making an investment. He knew that the real profit was in owning the house, not over quibbling over a dripping faucet.
And it paid off for the investor. The appraiser said the house was worth $109,000, and the investor was able to rent the property with a positive cash flow.
A major repair is one that could be considered a capital improvement, such as a roof, new heating or cooling system, carpet replacement, new appliances, and such. Those things you have to be concerned about because they are going to be money out of your pocket first thing.
Those might not be a concern if you have plans to hold onto the property for 20 years. During that time chances are you would have to spend money to replace a roof or heating system anyway. If you spend it now, you might consider it spending un-inflated dollars. However, at the same time, you won?t have the chance to budget for the capital improvements and set up a fund for them.
See, the answer isn’t easy, is it? It is not cut and dried and involves a host of factors that weigh in at more or less importance depending on the investor and the property.
Things around the property While you are looking at a rental property to buy, you notice that next door there is a large vacant lot that has surveyor’s stakes planted in it. You immediately wrack your brain and remember the article you read in the local business newspaper about the new Safeway shopping mall going in in the area. You hadn’t thought about it since you read it, since it was really no concern of yours. Now it is.
Is it good or bad that a Safeway, and probably several other businesses are opening right next to a piece of rental property? Both and either.
Depending on the property it could be a real boon. If it is a multiunit property, it is probably a real plus. Often people who live in apartment complexes like to be close to shopping.
On the other hand, if the property you are looking at is a single-family home, it is probably a drawback. The type of people who tend to rent single-family homes like to live in quiet and peaceful neighborhoods. A business parking lot next door will not lend itself to being quiet and peaceful.
The point is that you need to know about the area where you own or are thinking about owning rental property. You do that by paying attention, by reading the business section of the newspaper and the business newspaper in your city. Your apartment, landlord or rental owners association also will often present speakers at monthly meetings who give landlords the inside track on what is going on around the city. All will tell you all kinds of things that will affect the value of investment property. That way when you look at rental property to buy, you may know what’s going on around it. You can also have a heads up on where expansion is taking place and so where property will appreciate the fastest.
Will you always? Of course not. Part of due diligence is to do detective work about the neighborhood of the property you are interested in buying.
Suppose you had read nothing about the activity in the area of the investment property. You would need to check ownership and/or call the planning depart?ment to ask about it.
A vacant building or lot next to a property should be cause for concern. Vacant lots don’t stay vacant forever. Vacant buildings have a way of getting torn down and replaced with something else. Your concerns should be about what that something else might be. Think what a freeway on- or off-ramp would do to the value of a property; or a bar or nightclub; how about an industrial plant; or, possibly worst of all, subsidized, low-income apartments.
Therefore, always find out who owns vacant property and call and ask what, if anything, the owner has in mind for it. Many counties have tax records online. Just go onto the assessor’s website and look it up. If county tax records are not online, a call to the assessor’s office will get the information. Property ownership is public record.
The only time you might have trouble finding out plans for a property is if the owner is a large corporation. Your first problem would be finding the right person to ask. The second problem would be, once you find the right person, actually getting him or her to tell you anything, even up to admitting the company actually owns the property. Large companies are hesitant to broadcast their plans lest their competition find out and do something to bollix the project or the neighbors find out and create a problem with local government over the development. Of course, the type of corporation you are talking to may be a dead giveaway for the building it would build.
Sometimes, though, a corporation is simply a dummy corporation for a larger one, whose real intent would be obvious if you knew who it was.
If they won’t tell you anything, what they build there will be a surprise. And don’t count on that being a good surprise.
A huge, commanding concern is crime. Many cities publish crime statistics for neighborhoods. That needs to be a concern when you buy property. Good tenants don?t like to live in crime-ridden neighborhoods. Of course, if the property you are looking at is the one whose tenants are responsible for the criminal activity, you could have a real opportunity to turn the neighborhood around and thus make that property more valuable.
A few years ago I was looking at rental property in Mesa, Arizona. To find the one advertised for sale, we drove down a street where the buildings were entirely four-plexes. First thing I noticed was the number of For Rent signs on the street. We came to the building for sale, wan?dered around it, and wrote down the phone numbers on the For Rent signs.
When we got back to our Realtor’s office, I called the numbers on the signs. I reached one of the landlords, who told me that the building that was for sale was the reason there were so many vacancies. The tenants in that four-plex were the problem.
It would have been a tremendous opportunity. It turned out, however, the owner had taken the property off the market the day before.
The other problem would be that I would have had to boot out the current tenants or have the seller do it, thus being stuck with a vacant building on a street where it was tough to get places rented anyway.
That should be your concern with anything you find out about what is going on around a property you are considering buying: how will that affect first, the amount of rent you can get, and second, how hard will it be to rent?
One other trick for finding out what is happening around a property is to visit the area at night. Who is hanging out on the streets? Are they people you want as neighbors? Are they people you want as tenants? Do they look like they’re up to any good at all?
Also look for junker cars. Are they left on the street? If they are, that means city government and the neighbors don’t pay much attention to, particularly care about, or have much invested in the neighbor?hood. It is a sign of a neighborhood going downhill. If you bought a property there, you have to ask yourself, ‘Would I be buying at the bottom and the neighborhood will start to come back’? Possibly. But possibly not, too. It may be just in the middle of a downward spiral, and buying in that neighborhood would lose you a lot of money.
No matter what is going on, it could be good or bad, depending on the type of rental property, its price, and the amount of control you will have over what does go on in the area.
Presumably you’re in the rental property business to make some money. The best part of investing in rental property is that you have real control over your investment, not some officer of a corporation, who can help run the company into the ground, sell his own stock right before the deluge hits and watch the stockholders be wiped out.
Don’t ever give up that control. When you invest in rental property, always check the things that can and will affect how much you earn, both in the short term with rents and in the long term with appreciation for sale.