What is Due Diligence in Real Estate?

Ashley:
That is Actual Property Rookie, episode 190. My title is Ashley Kehr, and I’m right here with my co-host Tony Robinson.

Tony:
Welcome to the Actual Property Rookie podcast, the place each week, twice every week, we provide the inspiration, info and superb tales it is advisable to hear to kickstart your actual property investing journey. My co-host, Ashley Kehr, what’s occurring? What’s new in western New York as of late?

Ashley:
Nicely, it’s per standard. My flight will get delayed and/or canceled, and so getting back from the Rookie Weekend in Denver, flight received delayed in our layover in Detroit, and I didn’t get house until about 2:00 a.m., and so, working on fumes immediately. The children already missed three days of faculty to come back to the occasion with me, in order that they needed to rise up at 6:30 this morning and prepare for varsity, and I’m positive they’ll crash tonight. Nevertheless it was very nice getting to have the ability to have them include me. However, yeah, we’re all fairly drained immediately.

Tony:
Yeah. However what’s distinctive about this delay, truly, is that it wasn’t climate. It wasn’t the dangerous climate in Michigan. It wasn’t the dangerous climate in New York. It was as a result of they didn’t have a pilot.

Ashley:
Yeah.

Tony:
How do you e book an entire airplane crammed with individuals, however overlook that you simply want a pilot?

Ashley:
Yeah. I don’t know if perhaps the pilot canceled or what. I don’t even know the individual that stands on the gate, the gate attendant, perhaps, is named. I don’t know. However they stored making bulletins updating us saying, “We’re simply in search of a pilot. We’re very brief staffed.” Then they had been like, “We discovered a pilot who’s speculated to be having break day, however he’s going to come back, and he’s about 10 minutes out.” After which he got here, and everyone clapped.

Tony:
You simply must pack up and transfer to California with me. I by no means get my flights delayed. I’m by no means snowed in. My web connection is fairly sturdy. It’s similar to all indicators factors to Ashley coming to California.

Ashley:
Yeah. Nicely, we had been attempting to-

Tony:
And there’s dairy farms right here.

Ashley:
Yeah. Nicely, we had been speaking about what number of instances we’ve been delayed, and Daryl was saying, my enterprise accomplice, was saying the way it’s at all times these two airports. I’m like, “Nicely, yeah, as a result of there’s no different direct flights. There’s actually two or three airports you’ll be able to fly direct to out of Buffalo.” So, sure, our layovers are at all times the identical airport.

Tony:
All the time right here.

Ashley:
However, yeah. So, what’s new with you?

Tony:
What’s new? We’re nonetheless busy engaged on the resort out in Massive Bear. As of proper now, we’re speculated to be closing in about seven weeks.

Ashley:
Oh.

Tony:
We’re up towards the gun. Issues are transferring quick. However fingers crossed that we type of get the whole lot carried out we have to. However I’m tremendous, tremendous excited for this venture, and I nonetheless suppose there’s lots of upside there, so me and the Alpha Geek Capital group are simply arduous at work attempting to place that collectively.

Ashley:
Is your due diligence interval over with?

Tony:
We now have, I feel, 10 days left in our due diligence. However we’ve gotten just about all of our inspections carried out. We did our section one. We did the property inspection. We did the appraisal, termite inspection. So just about all of the due diligence we wished to do, we’ve we’ve just about accomplished. Fortunately, no main pink flags have come again but.

Ashley:
Yeah. That’s what I wished to type of speak about on this Rookie Reply episode is due diligence in properties. Since you’re doing due diligence in your property in New York, too. Do you need to clarify that one a bit?

Tony:
Yeah. We truly pulled out of it due to our due diligence.

Ashley:
Oh, you probably did?

Tony:
I can share type of what we-

Ashley:
Oh, I didn’t know that.

Tony:
Yeah.

Ashley:
Yeah.

Tony:
Yeah, we truly pulled out of it. We had a property underneath contract in western New York. Is that western New York or is that upstate New York, the place we [inaudible 00:03:50] that property is at? What would you name that?

Ashley:
It relies upon the place you reside, as a result of should you stay in New York Metropolis, the entire state is named upstate New York. However I might say that was extra central New York. Central New York is what I might say.

Tony:
Okay. All proper. There you go. We had this stunning property in central New York. It was a mattress and breakfast, and it was inbuilt 1922, so a really historic property in that city. We had it underneath contract. Our plan was to go in there, purchase it, renovate it, flip it into an Airbnb. However, throughout our due diligence course of, we flew out to New York, and we noticed the property in individual, talked to lots of native individuals. We determined to drag out of it, and I’ll type of clarify why.
First was that we realized that we had been already shopping for type of on the max ARV, and our authentic aim was to buy that property with both non-public cash or arduous cash, do our renovations to type of carry it as much as 2022 requirements, as a result of it was very dated inside, and we simply felt prefer it wouldn’t work tremendous effectively as an Airbnb. Our aim was to purchase it and renovate it after which refinance into some type of long-term debt, however BRRRRs solely work you probably have sufficient unfold between your buy value and the after-repair worth.
However this property was so distinctive, as a result of it was a seven bed room, eight bathtub property, and there simply weren’t very many comps surrounding that property in that space. There have been some that had been type of additional away, however after we met with the realtors in individual, they instructed us like, “Hey, truthfully, the place you’re at might be the best you’re going to have the ability to go.” In order that was the primary strike, was that we didn’t have any room to actually push the ARV up.
The second factor we had been saying, “Okay, even when we depart some cash within the deal, it’d nonetheless make sense.” However the different problem was discovering good labor. In all places, all over the place, all over the place, proper now, it’s actually arduous to seek out individuals to type of take these initiatives on. We received a few suggestions. All of them stated, “Hey, come again to us in 12 to 24 months when all of our different initiatives have type of cleared up.” After which they had been saying like, “When you do discover anyone that’s out there proper now, it’s best to run away, as a result of all the nice contracting crews are fairly busy.”
So it was these two issues, after which we discovered another stuff within the inspection report. We tried to barter with the vendor, and he or she wasn’t keen to barter. So there was simply type of all these items that received stacked on high of one another that we had been type of discovering out throughout that due diligence course of that made us notice that, “Okay, we like this space. We undoubtedly need to transfer into that space with the property, however that particular home, we predict it is smart to go on.”

Ashley:
Are you going to do any type of unsolicited mail or something in that space to search for it, or simply have a look at stuff that’s listed available on the market, on MLS?

Tony:
We simply began a unsolicited mail marketing campaign for right here in California, the place our Joshua Tree properties are, so we’re testing on the market first. I feel if we are able to actually nail it on this native market, then we’re going to start out utilizing that very same course of to some outdoors markets, as effectively.
I used to be going to say, Ryan Dossey, who’s been on the podcast, proper? I feel he did a pair episodes earlier than I got here on. He’s received an organization referred to as Ballpoint Advertising and marketing, and he’s not paying me to say this, nevertheless it’s actually, actually an amazing product, as a result of most postcards you ship out, they’re typed, or you’ll be able to inform that it got here from a pc, however Ballpoint Advertising and marketing, he’s received some type of robotic that hand writes the whole lot, so it appears like a handwritten letter. And our response price on the primary few postcards we despatched out has been a lot increased than what we had been doing with our different unsolicited mail, so it’s labored out effectively for therefore far.

Ashley:
That’s what I take advantage of, too, and I used to be simply pondering we must always do an episode, perhaps get him on once more and stroll by means of that course of once more. Yeah, we did ours proper earlier than Christmas. We did it for a lake home round two lakes that we need to get a short-term rental at for a lake home, and, in fact, private use. However we did it two days earlier than Christmas, I feel, and we had been getting calls the day earlier than Christmas Eve, when it hit everyone’s mailboxes.

Tony:
Loopy, proper?

Ashley:
We had been overwhelmed by it. However, yeah, it labored nice. We ended up, truly, proper now we’re negotiating on two properties from that marketing campaign that was again in December of simply us following up. After which that very same spherical we did a spherical to campgrounds within the space, too. And that one we’re negotiating on a campground proper now that got here from that mail marketing campaign. So yeah, we must always undoubtedly do a Rookie Reply or a full episode on unsolicited mail.

Tony:
Unsolicited mail works.

Ashley:
Yeah.

Tony:
Completely.

Ashley:
However, yeah, let’s do due diligence immediately, as a result of I’ve a property, too, that additionally fell out of contract as a result of it didn’t go inspections, and we received out of the contract earlier than our due diligence interval was up.

Tony:
It’s a must to inform us about it.

Ashley:
The property for me was 700 acres, two stunning ponds, two lodges for marriage ceremony venues, a Barton restaurant, 80 RV hookups, 18 cabins. I imply, simply superb, one-of-a-kind property.

Tony:
So it was a very small property.

Ashley:
Yeah. We ended up getting it underneath contract for $3 million. With that underneath contract, it was mainly “as is”. They weren’t going to make any repairs, however we nonetheless put in a due diligence interval. I had used a dealer on this deal. That they had introduced me the deal. However I’ve to say that-

Tony:
Ashley, can I cease you actually fast?

Ashley:
Yeah.

Tony:
As a result of I need to spotlight one thing, proper? If you say “as is”, let’s break down what which means for the listeners. So once you conform to “as is”, what does that imply? What are the constraints you may have as the customer?

Ashley:
Principally, if I discover something within the inspection, they’re not going to repair it. I bumped into this with the campground, proper now, I’m attempting to barter. When he countered me for a better supply, I accepted that counteroffer, however I put that I now need a longer due diligence interval.
He was like, “Nicely, this property is ‘as is’. If an outlet’s not working, I’m not going to repair it.” Blah, blah, blah. I needed to clarify, “I fully perceive, however I can’t go into this property blind, after which swiftly I get a invoice for $100,000 of repairs that wanted to be carried out. I simply must be sure that there aren’t a ton of points that aren’t developing.” And I stated, “On the cheaper price, I used to be keen to take that danger.” As a result of then I had much more capital to play with and will add in a big capital enchancment in there.
So, yeah, simply keep in mind that if somebody says “as is”, that doesn’t imply you need to purchase it “as is”. You possibly can go and do your due diligence on it and see what sort of prices are going to be related to buying that property.

Tony:
Truthfully, even “as is”, though they received’t restore it, you’ll be able to nonetheless ask for a credit score. As a result of, I’ve had it carried out each methods, proper? Some individuals they are saying, “‘As is’. I’m not going to repair something. Don’t ask me for any extra money.” However I’ve had different affords the place though it’s “as is”, I’ve nonetheless been capable of negotiate credit to say, “Hey, it is a a lot larger expense than what we had been anticipating, so we want some type of discount within the buy value. I don’t want you to repair it, however I simply want a bit little bit of break there.” I simply wished to pause on that, as a result of I do know that time period will get thrown round lots, so we might break it down for the rookies.

Ashley:
Yeah, it undoubtedly doesn’t harm to ask to get that negotiated, even when they’re saying “as is”, I might nonetheless … perhaps they’re not even conscious of the problem, and should you pull out of that contract and so they go to a different purchaser, one other purchaser might be going to seek out the identical problem, after which it’s simply going to occur once more. That’s nice recommendation to undoubtedly attempt to ask for them to present you a reduction on the worth.
Okay, so this property, among the issues that we came upon first going into it, first, it was a foreclosures property and there was again taxes owed on it. The county ended up taking possession of the property first, earlier than the financial institution foreclosed on it, and it went up for tax public sale. So the county bought it at tax public sale, and the financial institution was the one which ended up shopping for the property. As a result of what another person was bidding at, it wouldn’t even cowl their complete mortgage that was owed to them, plus the again taxes, so the financial institution ended up shopping for the property.
Now they’re promoting it by means of a dealer, and so they don’t know something in regards to the property. There’s no financials on the property, so already moving into this, this was a really, very blind deal to enter. There was actually no steering. We truly employed a advisor who truly helped us construct the monetary pitch deck and the proforma for the property primarily based off comps within the space as to what we might do with it, as a result of there was no actually monetary historical past. In order that was type of an enormous pink flag for us.
So, with that, type of ties within the financing piece. If you buy a property and there’s no monetary historical past or background on the property, it’s going to be very arduous to have a financial institution finance it for you. A financial institution goes to need to see that this property has been producing income. Nicely, this property hadn’t been producing income for 2 years. It sat vacant. So, no financial institution wished to the touch it. We had been going to have a non-public cash lender after which elevate the remainder of the capital wanted.
The second problem that got here up was that we couldn’t get title insurance coverage on the property. This was one thing that our lawyer came upon for us through the due diligence interval, that as a result of it went up for public sale and there was no title insurance coverage bought at that time limit, there was a three-year redemption interval. We ended up having to go to a title lawyer, an lawyer who makes a speciality of title points, and he was the one which type of found that for us, that it wouldn’t be till three years after the public sale date that you can truly get title insurance coverage on it. Meaning there’s nonetheless two extra years earlier than a financial institution would finance the property if we wished to go and refinance.
But additionally, it, what investor desires to put money into a property because the non-public lender or as a restricted accomplice in a syndication deal the place there’s no title insurance coverage on the property? Particularly when it was a really messy of a deal the place the county took it over, the financial institution then purchased it, and the financial institution was within the strategy of foreclosing. So, these had been type of the massive points.

Tony:
Yeah. Simply to interrupt down, the danger of that property not with the ability to get title insurance coverage signifies that, say that another person was on title or has some type of stake in that property, after you buy it, they may return and say, “Hey, I truly owned 50% of this, and I want my cash, or I want possession, or X, Y, Z.” Now it turns into a really dicey state of affairs. However you probably have title insurance coverage and somebody says, “Hey, I used to be truly on title,” it’ll be the title, insurance coverage coverage that may pay that individual out, versus you, as the brand new proprietor.

Ashley:
Yeah. Yeah. Thanks for explaining that.

Tony:
Yeah, so lots of danger should you don’t-

Ashley:
You’re doing a means higher job of breaking issues down for me.

Tony:
Nicely, I’m simply saying, it’s lots of danger there, proper, should you had been to purchase that and also you didn’t have that in place?

Ashley:
Yeah. That was type of like the very first thing for us. The second factor got here up through the due diligence interval. I need to spotlight first is, once you’re doing the due diligence interval, just remember to’re your financing choices. What’s going to work for the property and might you get financing on them? And never even for a way you’re going to amass the deal, the way you’re going to buy it, however should you plan on refinancing down the highway, just remember to can refinance. Go and begin speaking to banks and say, “What’s going to you want from me to place a mortgage on this property in two years or so?” They could say, “Two years of tax returns on the property.” Meaning, truly, it’ll be over two years that you can truly go and refinance by the point your tax returns are carried out. So, go and ask all these questions. Additionally, what’s the mortgage to worth? Various things like that. Simply type of get an concept of what it will be prefer to finance, so you’ll be able to type of work that into your deal.
The second factor apart from the financing is speaking to people who problem the permits that regulate the property, particularly industrial property. You need to discuss to the code enforcement officer. With this property, it had its personal sewer therapy facility on it, and that was regulated by the DEC, the Division of Environmental Conservation, and so they’re those that oversaw that.
Earlier than we even contacted the code enforcement officer, he truly referred to as my lawyer and stated, “I’ve heard a rumor this was promoting, and I tracked it down. If it’s okay, I wish to have the purchaser name me.” He stated, “I’m simply curious what you’re doing with this property.” I stated, “I’m going to show it again right into a campground and function it.” He stated, “Okay, effectively, I must inform you some issues about it.” I feel this was very good that he took the initiative earlier than we even reached out to him.
However he simply stated that fifty of the RV websites which have full water, sewer hook-up to them, and electrical, had been by no means permitted. Meaning for the city, the county, to come back again and problem me a constructing allow, if one thing doesn’t look proper, they should dig up all that infrastructure. There’s no website plans, no engineering plans had been even handed in to the city or the county to place in all of this new infrastructure for these new RV website hookups. In order that proper there, I’m like, at 50 RV websites that aren’t permitted out of 80, that may be an enormous expense for us if we did have to return and redo it if there was one thing flawed and it wasn’t together with code or one thing like that. So, that was type of like our second flag.
If you end up speaking with the DEC or with a code enforcement officer or no matter allow issuing company is, we came upon that in New York State, you’ll be able to truly request a foil, F-O-I-L. And what it’s, is you may get all of their info, all of their data on that property. I imply, this one for this campground website was, I imply, this large thick folder. He truly stated, “Why don’t you come into my workplace, as a result of that may truly be quicker than me simply scanning all this in and emailing it, or copying each web page and mailing it to you.” So try what sort of choices you may have and what sort of info you may get, too, from the federal government businesses which have regulated and permitted these properties.

Tony:
Yeah, Ashley, I feel going into the native city corridor or wherever and get info on the property is tremendous vital. We did that for our Massive Bear property. We had been simply up there final week, and a part of our cease was going into metropolis corridor and simply saying, “Hey, we’re looking to buy this property. What are you able to inform us about it?”
After we had been in New York, similar factor. We went into the city corridor there and stated, “Hey, we’re looking to buy this property. Inform us what we have to do, what the steps are, et cetera.”
You get to go straight to the supply and perceive type of what the potential dangers are, what it is advisable to do as a brand new purchaser to just remember to’re working in a authorized means, et cetera, et cetera. Yeah, there’s a lot worth that comes from simply in individual, speaking to individuals, and getting info straight from the supply.

Ashley:
Yeah. I feel the one different factor that I might add to that’s simply speaking to an lawyer, too, in regards to the property, particularly if it’s a industrial property, and seeing, what offers have you ever carried out like this? That was once I picked my lawyer for this deal was an lawyer I’d used earlier than, however earlier than I made a decision I used to be going with him on this deal, I stated, “What’s your expertise with properties like these?” He was capable of inform me related offers he had carried out, and capable of information me and assist me within the due diligence interval because the issues I ought to search for, and issues he had observed with different properties that got here up that he had helped shut on, too, which was very useful. After which, simply type of like Tony stated, he had contractors come out, inspectors, and I feel lining these all up and actually understanding what you’re entering into and placing a greenback quantity to it is rather vital.
And examine the utilities. You probably have effectively, you may have septic, is it public utilities? One property I simply bought has propane tanks. Truly, there’s two buildings on it. One constructing has a propane tank and the opposite one doesn’t. It’s all wired, all connected, it has all of the plumbing and the whole lot for the gasoline, however there’s not truly a propane tank within the floor. Which isn’t an enormous deal for us. That’s one thing we simply can deal with. However think about should you went into there not understanding that, and also you’re like, “Oh, right here we go. That is virtually prepared. I simply have to complete this little cabin off a bit bit, however oh, there’s no propane. I want a propane tank.” So, checking your utilities and ensuring they’re all operational, or what you need to do to repair them.

Tony:
And simply asking, “Hey, is that this on septic or is it on metropolis sewer? Is it on metropolis water, or is it on effectively?” My thoughts remains to be blown by the effectively water idea, just like the property in New York. They had been like, “Yeah, there’s a effectively underneath right here.” I used to be like, “So there’s simply water underground, and that’s simply coming into the property?” And he was like, “Yeah.” I used to be like, “So is it ever going to expire?” He was like, “In all probability not.” Simply understanding these issues, I feel, are tremendous vital, as effectively.

Ashley:
I can’t wait so that you can come go to me someday and have your first style of effectively water at my home.

Tony:
Nicely water. Blow my thoughts.

Ashley:
Okay. Nicely, the rest you wished so as to add to that?

Tony:
I feel these are all the massive issues, Ash. I feel that’s the whole lot. I suppose the very last thing is simply perceive that the aim of due diligence is to uncover as a lot in regards to the property as you doubtlessly can, in order that means you can also make an knowledgeable determination. You’re going to should rise up within the vendor’s enterprise generally. Proper? You may must ask for info that they’re not tremendous eager on sharing. However on the finish of the day, you may have an obligation to your self and to your enterprise to show over as many stones as you probably can. And if it is advisable to stroll away, be ready to stroll away. As a result of the very last thing you need to do is uncover one thing throughout your due diligence that may be a main pink flag, however you’ve turn out to be so emotionally concerned within the deal that you simply make the dangerous determination of transferring ahead anyway. Work along with your information, work with the arduous info, and never a lot your feelings, and that’s the way you get essentially the most out of your due diligence.

Ashley:
Tony, that hits house to me a lot. The display saver on my cellphone was the view from this property. My passcode on my cellphone, I ought to most likely change it now, after this episode airs, was the handle, the home quantity to this property. And that was simply, I wished this property so dangerous.
However, you recognize what? The chance price of all that point wasted, even cash wasted, I nonetheless should pay my lawyer. I nonetheless should pay for, I had a drone footage carried out of it. I paid the upkeep man to come back. Simply lots of money and time wasted, nevertheless it’s a possibility price, as a result of, or else I might have ended up with … we had already, I feel had $300,000 of cap ex that wanted to enter this property, and it might have been as much as half one million as we began to seek out out extra issues. So, consider that as a possibility price as a substitute of cash wasted, however that emotional detachment is essential on a property, too.

Tony:
Cool. Nicely, glad you had the braveness to stroll away from it, Ash. Yeah.

Ashley:
You already know what? The silver lining to it’s this different property, this different campground we’re going after now, truthfully, appears really easy after going by means of the due diligence of this different property. Simply taking it over. It’s already operational. So I feel it was an excellent just-

Tony:
A stepping stone?

Ashley:
… studying curve for us, too. Yeah. And stepping stone. It’s making us take over this different campground, hopefully, if we are able to get a signed contract this week, lots simpler. However, okay.
Nicely, thanks guys a lot for becoming a member of us. We shall be again on Wednesday with a visitor, and should you guys are loving the present and you’ve got taken worth, please depart us a evaluation in your favourite podcast platform, and tell us how this podcast has impacted your life. I’m Ashley, @WealthFromRentals. He’s Tony, @TonyJRobinson. We’ll see you guys subsequent time.