What’s the #1 difference between professional investors and just investors? Professional investors do not “get married” to the property they are about to buy. The biggest mistake a buyer could make is to not be objective about the asset, to use emotions instead of facts to guide the final purchasing decision. To avoid this mistake, the process of due diligence is employed – research, evaluation and analysis of the information about the property, both financial, legal and general, to make sure the buyer sees the whole picture, not just carefully curated favorable pieces.
Depending on your intended use of the property, one or two changes in the initial assumptions could make the investment completely useless. A doctor wouldn’t invest in a building that won’t meet the minimum parking requirements. A cash-flow investor wouldn’t buy an asset that intentionally or otherwise understates the expenses and overstates the income, making it financially unsuitable to meet the buyer’s debt obligations. Due diligence gives the buyer a confidence that once the acquisition is complete, there won’t be any hidden surprises that would undermine the value of the investment.
A few questions that the buyer needs answered before signing the purchase contract include the following. Will the future use of the property violate the local zoning laws? Do you have enough parking for your intended use? Does the income from the property support the purchase price? Will the change of ownership affect the leases in place? Does the income statement show any red flags? Do the expenses correspond to the average expenses in the given industry? Are any of the crucial expenses understated? Is the information reported truthfully, without omissions or misrepresentations? How are expenses and passthroughs treated?
Imagine discovering that the seller has been supplementing tenants’ payments of property taxes in the NN building. The new owner probably wouldn’t want or even be able to afford this practice. The payment of taxes would revert back to the tenants, who would complain, try to renegotiate their leases, or even leave. Supplementing tenants’ payments is not illegal, but it makes it questionable whether the current tenants could afford their leases under the new ownership. This is one example of a red flag. It might or might not serve as a deterrent for the buyer, yet it would surely make one more prepared for what’s to come.
On the other hand, due diligence might reveal positive surprises, like hidden profit potential, or a quality of the asset that has been overlooked by the seller, but would benefit the new owner, like the value of a cell phone tower lease, that could be sold for good profit.
Due diligence by Moschetti Group includes the review of all items in the PSA, leases abstracts, review and analysis of the operating statement, zoning and use, potential problems and pitfalls.
Please contact Mr. Moschetti to start the process of due diligence on your property.