Inner Circle Lesson: Pre-Appointment Due Diligence

Pre-Appointment Due Diligence

Thanks to killer marketing and a system for getting it out without my involvement, my office deals with somewhere in the vicinity of 20-30 property leads each week. And since the majority of the time invested in evaluating a property is in the process of driving to, looking at, and creating a repair cost estimate for it, we’ve discovered that it’s a big time-saver to know as much as possible about whether that property is a likely deal BEFORE anyone wastes 2 hours looking at it.

That’s why we have a “pre-inspection” due diligence system for leads that’s run BEFORE we spend time on the time-consuming part.

Since you probably ALSO don’t have all the time in the world to waste on deals that aren’t going to go anywhere, I thought I’d share that system with you so that you can adapt it to your own needs.

1. Whenever possible, we want to know what the seller’s bottom dollar and terms are before we inspect. I say “whenever possible”, because finding this out requires direct contact with the seller. While 90% of our leads these days are directly from owners, there are still a smattering of MLS listed properties and bulk packages—both cases where all you can really do is go see the property, make an offer in writing, and negotiate from there.

However, when a seller calls us directly, we positively will not set an appointment to look at a property unless he’s told us that he’ll accept a price (or terms) that LOOK as if they might work.

How do we know before examining the property that the price “might work”? Because, before we’ve seen the property, we’ve always done this:

2. Run comps on the property. Once you get a decent comping system (I use Haines Cross Cross + Real Estate or REIBlackbook) and get good at using it, it takes less than 5 minutes to generate and evaluate comparable sales for any given property. We do this on ALL prospective deals, no matter what the source, to get a handle on:
   1. What fixed-up properties are selling for (if there are any)
   2. What distressed properties are selling for (roughly)
   3. How many sales are happening in the area

3. Tried to determine the general condition of the property. Again, I say “tried to”, because sometimes we simply can’t get a lot of direct information from the seller about this.

Out of town owners often tell us they’ve never set foot in the home; bulk sellers usually don’t know and don’t care what kind of shape their properties are in; agents don’t want to waste time on the phone describing the property condition, and even when they do, their information isn’t always reliable.

So when we’re talking directly to a seller who lives in or at least in the vicinity of the lead, we ask them, item by item, about the age and condition of the various components.

When we can’t do this, we rely on other data:

• Current and old listing information from MLS. If the current listing says “needs TLC” and the last listing—from 2006—says “newer roof, kitchen, water heater, and furnace”, we know that we’re dealing with a 10 year old roof, kitchen, water heater, and furnace.
• Permit and code violation information from the city. A simple call to the building department will tell us if any permits have been pulled for work on the property, and when; it will also tell us if the property has a barricade order or other code violations that would indicate poor or extremely poor condition.

4. Used the public record to determine who the owner is and confirm other information about the property. This takes just seconds, and is really a way of insuring that there’s nothing else we need to ask the seller before seeing the property.

Things we’ll take a quick look at include:

• The owner of record; we’re checking both to see if the person we talked to was the actual owner (for some reason, local wholesalers have gotten into the bad, misleading habit of claiming they’re the owner or a partner when they’re not on title at all) and whether they’re the ONLY owner (if there’s a co-owner, I’ll need their signatures on the purchase agreement; if that co-owner is deceased, which happens pretty often, I’ll need to know whether probate has been opened)
• The property details; if the owner claims that the property has 4 bedrooms and the county data says it only has 3, I want to know what the discrepancy is before I comp it. Sometimes the county is wrong, sometimes the seller counting a partially finished room in the basement as a bedroom, even though it’s not legally or practically one.
• Unpaid real estate taxes; I want to be careful when there are unpaid tax bills to set the seller’s expectation that those will be deducted from his proceeds at closing. For whatever reason, my students and I have had a spate of sellers recently who thought that we’d pay them IN ADDITION TO the purchase price, or that they didn’t have to be paid at all—a misconception I want to head off at the pass. Also, I want to make sure a tax lien hasn’t been issued against the property.

It’s actually a combination of the results of these steps that determine whether or not a particular lead is worth inspecting. I ran across a case this weekend that exemplifies the difference between a probable BFWOT (that’s Big Fat Waste of Time) and a possible deal. It went like this:

An out of town bulk seller called me with a tape of 9 properties for sale in my area. Bulk properties are notorious for being, with some exceptions, in terrible condition—so bad, in fact, that the offer that you come up with when you run through the ARV x .7 – repair costs formula is often a negative number.

But this was a “pick and choose” tape, which means that I can buy one, several, or all of them. Had it been a “take one, take all” package, I would have looked at each property, but under the circumstances, I wanted to inspect only the ones that looked like possible deals.

Property “A” was a 2 bedroom house in a purely rental area—there are no sales to homeowners in the neighborhood, and very few sales of properties that were not distressed at the time of the sale. Using the due diligence process above, I quickly discovered that:

• The property had had a fire. Based on the orders against it, it was a fairly significant fire, requiring the roof and an addition to be torn off.
• The property was subject to $6300 in back taxes—important, because most offers to bulk sellers are net to the seller; in other words, you are responsible for paying any back taxes.

This quickly left me with an understanding that:

• The repair costs would be massive
• The property is almost certainly not one that I could sell for even $6300

Thus I neither bothered to do any further due diligence nor inspect the house.

Property “B”, on the other hand, is a 5 bedroom house in a similar, mostly-rental area. In about 10 minutes, I found out that:

• Based on an MLS listing from 3 years ago, it had new replacement windows
• Distressed properties in the area (again, there are no sales of fixed-up properties) are selling for $5,000-$11,000
• There are no building orders against the property
• The seller paid $789 for the house
• The back taxes are only $158

So I DID look at this house, because a rough guesstimate tells me that I could sell this house to another investor for roughly $7,000 and my research tells me that the seller CAN sell for much less than that—although whether or not it will remains to be seen.

Doing this pre-inspection due diligence won’t always keep you from being dragged into a BFWOT; sometimes there are no city orders on a property because it’s already been torn down, and what you and your seller thought was a 3 bedroom house is, in fact, a vacant lot. Sometimes (and this also happened to me this weekend), a 3 year old MLS listing does not reveal the fact that a subsequent owner has gutted the property back to the studs, and you’re looking at a shell that needs $45,000 in renovations and will be worth $45,000 fixed up.

But it does help you make some intelligent decisions about where to spend your time, and it’s worth creating your own system for.

One final, and very important, piece of advice: do NOT do this level of due diligence on a property that you “found”, or that “came up on a list”. You can waste gigantic amounts of time over-researching houses that you don’t even know are for sale yet.

Until you’ve actually talked to a seller, or seen a property listed, don’t “get curious” to the point of spending all this time tracking down the history of a property that the seller may not even want to sell. It’s a waste of time that you could be using to get actual motivated sellers to call you.