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Lesson 5
Pre-Offer Property Analysis
Once you have found a property that you would like to consider
purchasing
- what next? Unfortunately, you can't do all the due diligence that you'd like
until you obtain
information that won't be provided until the seller has accepted your
offer. However, there are a lot of things that can be done before writing an
offer and the more you do the better.
There's no point in spending time writing an offer
for a property that has obvious serious problems. Most importantly, you need to make a decision about
what price you're willing to pay before making the offer, so you need to determine what the property is
worth. Even though you will include contingencies in your offer, writing
an offer and doing further inspection and analyses is a waste of time and energy for both buyer and seller (and their
agents) if you're not
serious about buying the property. Therefore, you should check out all issues that you
possibly can
prior to writing the offer. Issues investigated before writing the offer
should still be included as contingencies in your offer unless you are
absolutely certain that they are not potential problems.
Legal Issues
Zoning
You should verify that the units
are legal as to zoning. If not, is there an existing variance or are they grand-fathered?
This is one of those pieces of advice that can be ignored in many cases.
For example, a duplex building in a block of duplexes requires little
investigation regarding proper zoning. However, an apartment in a house
among a neighborhood of single-family homes warrants scrutiny.
Likewise, a relatively new office building in an area of several other office
buildings probably has no zoning issue, whereas a single-family home converted
to office use and being sold for more than it's worth as a single-family home should be
thoroughly checked out.
RHOL has very
extensive and comprehensive zoning information available to our members in
our Real Estate Investors Web
at: http://rhol.org/invest If you have
any doubt about how zoning may effect the value of a property please take
the time to read the relevant information.
Building Codes &
Occupancy
Ask
seller/agent whether they are aware of any remodeling, additions, etc. Were improvements done
with building permits? Are electrical, plumbing and heating to code? If not,
are they grand-fathered? Does the local building code have occupancy
restrictions? Many codes restrict the number of occupants based on the size of
bedrooms and the number of rentable units based on common areas and parking.
Having non-code items or conditions in a rental unit leaves you
open to violation citations and/or lawsuits by injured tenants or their
guests. Keep in mind that a disgruntled tenant can file a complaint
that results in a special inspection of your property which might uncover zoning
and/or code violations that could require expensive repairs, remodeling or even
limit the use of your building.
RHOL has very extensive
and comprehensive information on Building Codes and Occupancy Standards
available to our supporting members in our
Property Management Web
at: http://rhol.org/manage If you have
any doubt about how building codes may effect the value of a property please
take the time to read the relevant information.
Title Report
A report showing easements, liens, and other
matters of record is very important, whether it is a preliminary title report
from a title insurance company or a chain of title prepared by an attorney in
those jurisdictions where title insurance is not used. Although not often
available prior to acceptance of the purchase contract, it is worth asking for. Also obtain legible copies of all documents referred to in the
report. This subject will be covered more thoroughly in the next lesson.
Holding Title
It is extremely important to give serious
thought to the potential liabilities associated with owning rental properties
and to take the necessary steps to minimize your risks. There are dozens of ways
in which it is possible to lose your entire net worth if ownership is not
properly vested.
Investors should research the subject themselves
and/or seek competent legal advice regarding the tax and legal implications of
the various vesting options. For many investors, it is currently
recommended that the Limited Liability Company (LLC) provides the best tax
benefits and risk management, with a separate LLC used for each separate
property.
Insurance
Before committing to purchasing a property, be
sure that you will be able to obtain the required insurance. Premiums can
easily turn out to be a significant operating expense and need to be taken into
consideration when analyzing the property. Worse yet, it is possible that a
particular property and/or landlord
will turn out to be uninsurable.
A property may be rejected for a variety of
reasons. As examples, the building is sitting on an earthquake fault line, near
a toxic waste dump or in an area subject to flash floods, hurricanes or fires.
The physical condition of a building might make it uninsurable.
Similarly, investors might be turned down for
insurance if they have a history of making too many insurance claims on a
homeowner's policy or even for having a bad credit record.
The types and amounts of insurance coverages the
landlord buys must also be based on the requirements of the lender.
The more tenants, the more insurance must be
purchased to cover the risks. The best insurance package for a landlord is
usually the commercial liability policy, or a scaled-down version of that for
smaller buildings.
Such a policy covers damage to the building and
to tenants' personal property, injured residents and guests, any kind of
equipment used to maintain or heat the building, workman's compensation for
anyone doing upkeep and storm or earthquake coverage in areas prone to such
disasters.
Also, you need to keep your insurance agent up to
date on the value of the property to make sure you're covered. Insurance
policies coverages are generally automatically adjusted annually to insure that
they keep up with replacement costs. In other words, as your properties
increases in value, so do your premiums.
Physical Inspection
While one should be concerned about physical
inspections when purchasing a personal residence, it is often of even greater
importance when purchasing income property. There are several reasons why
this is so.
First, rentals are often mistreated by tenants.
Second, many landlords do minimal maintenance, only fixing those things that break,
and do little or no preventive maintenance. Third, some income properties,
particularly the larger complexes, have types of equipment and other issues not found in a
single-family home.
You may be able to obtain a lot of
information prior to writing an offer even without access to the property. Landscaping, exterior painting,
parking surfaces, and fences are visible from the street, as is sometimes the roof. You may even be able to view
the inside of a vacant unit, in which case you should look at the electrical
panel (check for aluminum wire), plumbing and plumbing fixtures, and
appliances. Make notes of all defects and/or questionable items so that
you will remember to include them in contingencies if and when you write a
purchase offer.
Financial Analyses
General
 As mentioned above, one of the difficulties in buying income property is
that you must usually come up with the price that you are willing to pay before
writing the purchase contract, but you do not always have access to
all desired information until after you have an accepted offer. However, you need to
do as good an analysis as possible with what you can get.
You can often do a fair analysis using data (1) provided in the
listing, (2) available from the listing agent and/or the owner, and (4) available
from other sources.
The detail of information required to do an
adequate analysis depends on the type of property under consideration.
This varies from perhaps nothing for an owner-occupied single-family home,
where you can obtain the needed information yourself, to a large amount of
detail required for a large shopping mall. Generally, the more complex
the property, the more sophisticated the owner and/or agent, and the more
likely that you would have received what you needed to do the analysis.
Larger properties often have document packages containing very detailed
information that is available to legitimate potential buyers.
If you cannot obtain the information needed, you shouldn't be making an offer
- unless you have nothing better to do with your time and provide adequate
contingencies.
Use any information provided to do the financial analysis. You can obtain your own data for many
expenses. Property tax is of public record; insurance and landscape
maintenance quotes are easily gotten; fences, landscaping, parking areas, and exterior
painting are visible from the street, as is sometimes the roof, so you can
have some idea of items of possible deferred maintenance. Don't hesitate
to badger the owner or listing agent for information beyond what they originally
provide.
RHOL has an e-course, Valuing
Income Property, that discusses value in considerable detail and shows you
how to value an income property, including both quick preliminary approaches
and detailed complex methods. The Valuing course also includes many
related topics necessary to financial analyses, for example, reserve
accounts. If you have not yet taken that course,
you should.
While you will not have to complete that course prior to finishing this one,
you will have to understand how to determine value prior to applying the
information of this course to an actual purchase or sale.
Strategies
If using an agent, maintain control of the deal. It is your money, both
cash and what you will owe the bank, that will be at risk. The agent will
be able to spend his commission after closing whether or not you made a good
buy. The success of your investment will depend upon buying the right
property. Do not buy a property because the agent tells you it's a great
deal. Depend upon your own analyses.
Environmental
Danger, hazardous to value
 There are a variety of environmental issues that can seriously impact property values, including the
presence of lead, asbestos, toxic waste, radon, or other hazards,
and potential restrictions on further development. Before completing a
purchase of some properties, prospective buyers should obtain a Phase One Report which consists of researching the past uses of the property.
If
there is any chance that a previous use could have contaminated the property
in any way, obtain the services of a qualified environmental engineer to
inspect the property. See our environment
web page for a additional discussions of issues relating to real estate.
Super Fund Sites
Super Fund sites are specific areas of known
contamination that have been defined by the EPA. Determining whether
or not a property you're trying to buy is in a super-fund site is relatively easy,
as maps are readily available, and should be
done before writing an offer on a
property. While being within a Super Fund site is not necessarily a reason to eliminate
a property from consideration, you
should be sure that you understand the ramifications, if any, and it might be
reason to significantly lower the offered price.
Lead-Based Paint
It is easy to determine whether a residential property was
built before 1978, requiring disclosure and concern, or built in 1978 or later,
requiring little concern. Although the year of construction is usually
provided in the listing and/or directly by the seller, it is recommended that
this be personally verified by a call to the county (or visit to the web site of those
counties that provide this information) if it is not otherwise known that the
property is newer than 1977 (e.g., you personally know when the specific property was
built or when the subdivision was developed).
Other
Whether you will want to do a pre-offer check on
issues such as radon, depends upon the area of the country and even on the specific
type and location of the property.
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