Due diligence is concerned with the investigation of the property being considered for purchase or used for collateral and the assessment and verification of the investment parameters being used to decide whether to invest in a property – either as a direct purchase or a loan. The real estate investor going the solo route will have to do all information gathering, assessment and verification him self.
The investor utilizing the services of a real estate advisor will only have to spot check and verify the due diligence already done by the advisor. As the relationship develops between the investor and his advisor, the investor should be spending less and less time verifying information submitted by the advisor, although the investor should never totally abandon due diligence efforts.
APPRAISAL
The first item to consider when performing due diligence is the appraisal report. We have the appraisal done by an appraiser we know and whose work we are comfortable with. The appraisal is a full appraisal, encompassing market, cost and income approaches to determine value. Although we are most concerned with the comparable sales approach, if the other approaches result in a lower figure we will use the lowest figure to determine value. We insist that at least four comparable properties be used to determine market appraisal, as well as a different four (as rental comps) to determine value by the income approach.
The appraisal report should be fully read to obtain the appraiser’s opinion of the neighborhood and area that the subject property is located in. Appraisals will also have sections pertaining to the growth potential of the property area as well as verification of property demand for rental purposes. All this information must be assimilated by the real estate investor to help determine his degree of interest in investing in the property. The appraiser himself and the appraiser’s work should be familiar to the investor.
The appraiser should be MAI certified, and should have significant experience in appraising and valuing the type of property being considered. Pay particular attention to the comparables being used as a basis for valuing the subject property. These “comp” sales should be recent (one year or less) with few adjustment differentials with the subject property. Especially with residential property appraisals, the comps should be in the same neighborhood as the subject property. Being able to validate the appraisal’s accuracy is an art as much as a science. Specific knowledge of real estate industry procedures and standards are necessary, as well as local knowledge of a particular area. Real estate remains a localized business. If the investor does not have the knowledge to render a reasonable judgment as to real property valuations in a particular location, than outside expertise must be brought in to access the situation.
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