Hi, it’s Dan Witherington of American Wealth Builders
It’s highly advised that every investor, before every investment – does proper due diligence.
Due diligence has two benefits:
First, it helps you find investments that are compelling and reveals their benefits and risks so you know whether it’s the right investment… and so you also know perhaps when and how to buy, and when and how to sell.
Second, it answers your questions and give you peace of mind. That way, if the market or your stock does move in an unexpected way, you can go back to your due diligence and say, “okay, this was solid. The research was correct. I just need to hold the line and stick with my decision.”
Due diligence gives you two-fold benefits of investigating the investment and answering your own questions.
But if you’re thinking about investing in real estate, what should you do?
I did an informal poll of investors I know and asked them what kind of due diligence they did before investing in real estate.
I asked a couple dozen people in my very unscientific survey and I got basically a couple dozen responses. Plus a lot of head scratching and “ummm” and “uhhhhh.”
Here’s what I think: people know about due diligence and embrace it as a key step in stock market investing. But when it comes to doing due diligence in real estate, they just don’t know what to do and how to do it.
Well, that’s why I’m writing this email to help you out. What I’m sharing here isn’t going to be the full answer, but it should give you a bit of a framework to help you get started thinking about the things you need to thnk about.
It’s a series of simple questions that you should find the answer for. Apply these questions next time you’re thinking about buying a rehab project, becoming a landlord, or buying turnkey notes.
#1. What is the total investment to acquire the property?
#2. What additional expenses are needed to upgrade/maintain the property? In the case of a flip, what expenses are required to get it into a sellable condition and what carrying costs will you incur? In the case of a rental property, what expenses are required to maintain the property in a rentable condition and what ongoing expenses (such as property taxes) will there be?
#3. What is the income you expect to earn from this property? Estimate the annual income and the lifetime income (since that may be different, depending on what kind of deal you’re doing).
#4. When does the income come to you? If you sell a house to a homeowner who needs to get a mortgage, you may complete the transaction then potentially wait a couple weeks before the banks finally get the paperwork pushed through and the money is in your account. With a rental property, you might have monthly or quarterly cash-flow, depending on how it’s set up.
#5. How long until you get your investment back? Add up the answers from #1 and #2 and then compare it to your answers for #3 and #4. A flip that costs you $50,000 to acquire and another $25,000 in repairs and carrying costs, and sells for $100,000 in 8 months, means that you get your investment back (plus your profit) in 8 months. A turnkey property that you acquire for $40,000, that generates $700 a month, means that you get your investment back in about 4 years, 9 months.
Note: I like this question because it tells me how quickly I can start generating a profit.
#6. What happens to your access to capital during the investment period? Ask this question to give you some insight into your liquidity. With a flip, your money is locked up and you may need to spend even more to fix up the house. With a rental, your capital is used to acquire the property and although it might seem at first like it takes longer to get your investment back, it’s critical to note that you have access to capital (your cash-flowing returns) right away.
#7. What’s the profit ceiling on the deal? You may have read question #5 and asked yourself, “Why wouldn’t I just do flips if I can get my money back sooner?” and this question will address that. Because, with a flip, you have a profit ceiling, since you can only sell that house once. So, in the flip example above, you get $25,000 in profit in 8 months, which sounds great. But in the turnkey rental property example above, everything after 4 years and 9 months is profit. So, what if you hold the property for another 5 years or 10 years or 20 years?
#8. How much work is required? Another key question that many investors forget to ask. They look at the fast pops of cash they get from a flip and focus on that but totally overlook the time and effort intensity required to get that money. In my example above, does $25k in 8 months sound amazing? Sure it does. But I’d rather enjoy cash flow and no cap on a lifetime of profitability if it meant no work at all. Don’t just focus on the one number but how all the numbers work together.
#9. Where should I invest? This next question should guide you to think about the best markets to be in. Avoid the common default to invest in your own market simply because you happen to live there.
#10. What capital should I invest? This is an important question that often gets overlooked. The reason is: investors who want to do real estate deals may think only in terms of mortgages (since that’s how most people acquire their personal homes) or perhaps in terms of a huge lump sum of money that they have to save up. But there are other ways to invest – and one of the most powerful ways to invest is with an IRA or 401k in some situations. (Note: this works for turnkey properties but it doesn’t work for every type of flip/rehab – especially if you’re staying the property while you fix it up.)
These 10 questions are a starting point – a simple framework to get you thinking about what the right investment is for your situation. Perhaps you’ll go through these questions and realize that a specific rehab is a great deal for your immediate situation so you’ll pick it up; perhaps you’ll go through these questions and discover that a turnkey property is best for your portfolio. Use these questions to start your due diligence process.
And be sure to give us a call here at American Wealth Builders because when you’re looking at turnkey properties, we can help you figure out your answers to some of these questions.
Here’s how to contact me…
Senior Wealth Strategist
American Wealth Builders
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