Due Diligence - Property, Paper Work & People

1. Property – The property is your collateral. If the deal goes bad and you do not get

your capital returned, you will receive the property. You need to understand the value,repairs needed and what it is truly worth.

1.1 Value: The ARV is After Repair Value. This is the value of the property once

all value-add renovations are completed. This needs to be verified with either an

appraisal or real comps or nearby property, with roughly the same square

footage and beds/bathrooms. The comps used should be less than 6 months

old, close to the target property and similar housing configurations. Investors can

be overly optimistic on their ARV value and that can lead to false hope of how

good the deal really is.

1.2 Repairs – What is the scope of work needed to take the property from fixer

upper to the top comps used in the calculation of the After Repair Value (ARV).

The repairs should be itemized and include the following as a minimum:

Demo (and haul away with dumpsters)

Trades – HVAC, electrical, plumbing

Exteriors – Siding, windows, roof, foundation/crawl space, masonry, etc.

Interiors – Framing, drywall, trim, kitchens, baths, paint, lighting, flooring, etc.

Environmental – Is there asbestos, underground oil tanks, mold, etc. that need to

be remediated

Permits – What permits need to be filed?

Zoning – Confirm the end use of the property will be zoned correctly and if there

is any need for updated certificate of occupancy.

How are the repairs going to be funded? Experienced investors like to be

funded at closing for all the repairs, but it is safer for the lender to fund them on

draws where repairs are funded as the work progresses and is verified preferably

in person. You can have an independent person verify repairs for you or rely on

facetime, photos and video.

Equity and Cash Flow:

The equity is your safety net. You should have 20 – 40% of equity as calculated

below

ARV * .8 – Repairs = 20% equity

ARV * .7 – Repairs = 30% equity

If your plan is to rent it and joint venture, what is the market rent, how much are

taxes and insurance? What will be your net monthly income that leads to your

ROI on the net cash flow?

2. People – This is more oriented to what to watch for if you are the private money lender, but applies in general terms to everyone you work with.

The people you choose to invest with are critical. How do you really measure their character? How well do they communicate? Sometimes investors will communicate well when all is going well and go dark when things hit the fan. The

people component needs to be validated multiple times. When we rent to new tenants,

we screen extensively to fully understand who is renting from us. When you are

investing you should have a similar approach and take every precaution possible to

protect yourself.

2.1 Credit check - Ask them for a copy of their current credit report. Review it

carefully.

2.2 Experience – How long have they been investing? Ask for a copy of their

settlement statements from recent investments they have made. Review

them carefully to see when they bought them, ask for a copy of the leases if

they rented and for the sales settlement statement if they flipped them.

2.3 Cash reserves – Ask them about their cash reserves.

All of this is done not to invade privacy, but to help prevent issues later, and

create a successful investment.

2.4. Social media check - How do they appear online? Do they post about the

houses they are working on? Are they constantly on exotic trips (this could be a

red-flag).

2.5. Contracting team – Is the investor subcontracting everything or is there a

general contractor. Are the contractors licensed and insured? How long have

they been working together and how do you know the contractors are getting

paid by the investor? You may want to use a lien release waiver to be 100%

sure.

2.6. Legal team – Who is their attorney/title company and ask them for a

reference. How long have they working together? When you do the deal be

sure you always wire funds to the lawyer/title company and not direct to the

investor.

2.7 Partnerships and LLC’s - If you are creating a partnership LLC be sure to

have your own personal lawyer review everything for you including who the

members are, the registered agent, address on file and the extreme details of the entire operating agreement.

2.8 Payments – How is the investor going to pay you, how often and how will you be 100% sure

3. Paperwork – The documentation for your investment is crucial. It needs to

be properly created and carefully reviewed.

3.1. What - What documents are needed to keep the deal safe? Typically it is

combination of promissory note, deed of trust/mortgage, title insurance and home

owners insurance.

You should avoid making loans and investments “unsecured” and always know where

the money is being sent. Avoid sending it directly to an investors checking account. It

should wire to a settlement agent, title company or Lawyer and they will disburse it for

you. The best position to be in is 1st position, if you lend in 2nd position your risk goes

up if the 1st position mortgage needs to foreclose. Never lend in 3rd position and avoid

unsecured loans in all cases. Your position should be secured at the courthouse with a

mortgage or deed of trust. You should be named as additional insured on the home

owners insurance polity and you should consider receiving a lenders title policy when

making private money loans.

3.2. Who – Who prepared the documents? They should be prepared by a

Lawyer and carefully reviewed for interest rates or equity terms, terms, who is involved

(individual, LLC or trust), joint venture agreement, title insurance, etc. Do you have a

working understanding of the documents and which ones get recorded at the

courthouse to protect your interest? Does the documentation match your agreement on

how you will you be paid your interest and when your capital will be returned?

3.3. Where - Where is the investment closing? What is the wiring for the settlement agent?

Closing thoughts – You should be able to easily explain your investment to your spouse or a friend. Can you summarize who you are investing with, the property and what is being done to it, how you manage the risk and keep it safe, and how your capital will be returned?