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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.
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?
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?
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.
RHOL has very extensive and comprehensive
information on Building Codes and Occupancy Standards available to our
supporting members in the
Manage Web. 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.
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.
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.
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 you provide adequate contingencies.
Use any information provided to do the financial analysis. You can obtain
your own data for many expenses.
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 do so after completing this course.
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.
Super Fund Sites
Super Fund sites are specific areas of known contamination that have been
defined by the EPA.
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.
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.
Writing the Offer
General
In all respects, the property checks out as being one
that you want to own - what next? Well, you need to write a purchase contract.
This documents is also sometimes called a purchase agreement or contract to
purchase, but what is in it is a lot more important than its name.
There are a number of elements to a legal contract
to purchase real estate. Basically, they are:
Although you will not usually sit around a conference table negotiating
various terms and conditions of your purchase contract, you should be aware of
negotiation principles when you write your offer. You will almost certainly
negotiate after you have made your offer. Unless your purchase offer is
ridiculously out of line with value or other issue to the degree that it makes
the seller mad, you should expect a counter offer from the seller. It is likely
that you will get a counter offer even if you offered full price because some of
the contingencies or other issues that you included will probably be
objectionable to the seller or his agent. Many of the same principles apply
whether you are sitting across the table from the seller or instead are writing
your original offer or writing a counter offer to his counter offer.
Contract Forms
Most real estate agents who are representing a buyer will utilize a
purchase contract that is (1) their firm's custom form, if a large company or a
franchise such as REMAX or Century 21, or (2) their state's Association of
Realtors form. If you are working without an agent, you have the choice of
obtaining a form of the seller's agent if there is one (and there usually is),
whichever type that is, or obtaining an Association of Realtors form yourself.
One of the potential problems with using the custom form of a large company is
that it may contain a whole lot of references to the company name. Accordingly,
of the two choices, you usually be better off using the state Association of
Realtors' form.
An alternative is a form of a reputable independent publisher such as
California's first tuesday. Unless you are capable of judging the
adequacy of the independent publisher form, assuming there is a good one
available for your state, it is usually safest to use the Association of
Realtors' form because state associations tend to employ competent attorneys for
drafting forms and they are usually kept up to date regarding the latest
statutes and Court decisions.
One potential problem in getting a form from the seller's agent is that
the agent will likely want you to let him help you fill out the form. Remember
that the seller's agent wants badly to make the deal because he will make a lot
of money no matter what price the property sells for and whether it's a good
deal for either the buyer or the seller. Accordingly, if you're not sure that
you can hold your own against the agent and won't let him influence your offer
(probably almost impossible), don't let him work with you on the contract. For
the same reason, you need to hold your own in filling out the form along with
your own agent when you have one.
The form, from whatever source, will have various and sundry boiler plate
clauses regarding financing and other conditions and contingencies. There is
nothing wrong with using these clauses where they meet your own requirements.
However, do not be intimidated into using a clause that does not say exactly
what you want. Do not hesitate to add an addendum that contains the exact
customized clauses that you need. Be sure to line out the boiler plate clauses
and refer to the addendum for each of the clauses that you wish to replace or
modify. Due to limited space on the form and for clarity it is usually best to
write a new clause on the addendum rather than mark up an existing clause except
for very minute changes (e.g., changing the number of days from 7 to 10). Be
sure that both parties initial every single markup on the contract.
Example of an addendum.
Price
When writing the offer, you need to decide what you are willing to pay for
it. As previously stated, a good understanding of valuation is required before
applying the information of this course and the subject is covered in detail by
our Valuing Income
Property e-course.
Almost as important is price is the terms.
The loan terms are, of course, important because interest rate, monthly payment,
and length of loan are all directly related to financial viability and
profitability of property operations. Other terms of the contract are also
important, including those mentioned in the next three paragraphs.
Deposit
Cash deposits are customary, but smart buyers don't have
to operate according to custom. The seller wants the
buyer to put up a cash deposit to keep him from backing out of the deal, because
when a contract for purchase has been negotiated and signed, the seller is
actually granting the buyer an exclusive option to purchase the property,
subject to the terms and conditions contained in the agreement. So, the buyer
is getting a lien on the property subject to those conditions. The seller needs
something in return, right? Sure, but why should it have to be cash? There are
reasons to avoid cash deposits, if possible.
Personal Property
If there is any personal property included in the sale or that
you want included in the sale, be sure that the contract includes it. It is
sometimes best to have a separate agreement in every offer that covers any and
all personal property, but make it an intrinsic part of the real estate
transaction, in order to prevent a lender from subtracting the value from their
loan commitment. Also, insist that you receive a bill of sale for all the
personal property listed in an inventory.
Contingencies
Contingencies are very important and it is
important that they be properly written. There are a number of general and specific
principles that you should follow when writing contingencies into your offer and
these are covered in RHOL's Buying Income
Property e-Course.
Financing
Unless you're paying cash and the money is in your bank account, a
financing contingency is very important. Be specific regarding the maximum
acceptable interest rate, discount points, and other costs as well as the
minimum number of years of the loan that you are willing to accept. Also,
specify that it will be a loan from a legitimate lender (no loan sharks) and
specify a fixed interest rate if you are unwilling to take a variable rate
loan. Finally, be sure it is clear that your inability to obtain financing
meeting your criteria is a complete failure of the contingency.
Title Report & Title Insurance
Require delivery of a preliminary title report or
chain of title report as soon as possible. You as buyer usually have the
right to choose the title company or attorney and should do so. You can
ask ahead of time what the maximum period will be required for provision of the
report.
If in a jurisdiction where title insurance is available, require that
extended coverage be provided, rather than the basic, even if you must pay for
the coverage yourself. Basic coverage only protects against things that are a
matter of public record and fraud and does not protect against encroachments or
certain other matters. The extra cost is relatively low. See our
Title Insurance page for additional discussion about title insurance.
Financial Records
The value of the property and the amount that you should be willing to pay
for it are entirely dependent upon the income and expenses. Accordingly,
you must be sure to require adequate documentation needed to verify both income
and expenses.
Lease Documentation
Leases and related documents are exceedingly important for two reasons.
First, they verify the income information that is being provided in the
financial records. Second, they disclose (1) how long tenants have been there
(indicating the stability of their business), (2) the expiration date of tenancy
and possible extension options (indicating when you can raise rents), (3) the
future rent increases already built in (indicating future automatic income
increases and therefore value increase), and (4) all sorts of other important
information that has an impact on the current and future value of the property.
The Tenants
Existing tenants in investment property can be
either assets or liabilities. Whenever you buy the tenants with the real estate,
protect yourself by requiring adequate documentation.
Lead-based Paint Disclosures For Tenants
For a residential property built before 1978, require the seller to
provide copies of executed lead-based paint disclosure forms for all tenants. In addition to the federal regulations, some states (e.g.,
Massachusetts and Maryland) have imposed additional and more onerous regulations
and penalties, so investors in pre-1978 residential income property should be
sure to understand the lead paint laws of the state in which they invest..
The required federal pamphlets and forms are available on the members-only
Forms Web.
The RHOL web site has considerable information regarding
lead
paint issues.
Insurance Policy
While you will not be depending upon the cost of the sellers insurance
when doing your analyses, you still want to obtain a copy of his policy or at
least of the sheet showing coverage because it will be of use in obtaining your
own insurance.
Physical Inspections
Structure & Components
While one should be concerned about physical inspections when purchasing a
personal residence, it is usually of 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, often for only things that break, and do little or no
preventive maintenance. Third, some income properties, particularly commercial
properties and the larger residential complexes, often have types of equipment
and potential problems not found in a single-family home.
Be sure that your purchase contract makes
contingencies out of all inspections and allows adequate time to get the results
of the inspections, taking into account inspector scheduling, holidays,
weekends, weather; time to analyze the reports; and time to exercise a
contingency if necessary.
Survey
A boundary survey is not often
needed, but it is worth including as a contingency in case some reason to have
one comes to light during the contingency period or if the lender requires one.
Environmental
This is another subject that is seldom of much concern for a personal
residence except for lead and, occasionally, radon issues. The subject can be
much more important for income properties, particularly commercial properties.
Items that might be of concern include Super Fund Sites, soil & groundwater
contamination, lead paint, asbestos, and radon.
Estoppel Certificates
Although often not utilized unless required by the lender, as they usually
are for larger properties, Estoppel Certificates should be used for every
purchase of a tenant occupied property. An Estoppel Certificate is a document
signed by a tenant that, among other things (1) affirms the lease documents
(attached to Certificate) and the deposit/rent amounts; (2) confirms that there
are no agreements outside of the attached documents; and (3) confirms the amount
of security deposit, the current rent, and the date to which rent has been
paid. The document is sometimes called a Certificate of No Defense. A sample
basic Certificate is available in our members-only
Forms Web.
Escrow Period
You, as buyer, will usually want a long
escrow because you want to minimize the pressure to get everything done. The
seller will usually want a short escrow because the longer the escrow the more
chance that it never closes and he doesn't get his money until closing. If the
tax year is not an issue, pick a realistic closing date based upon the time
required to complete all contingencies including financing.
Possession Before or After Closing
If the seller will retain possession of the property or any part thereof
after the close of escrow or if the buyer will get possession of the property or
any part thereof before the close of escrow, the parties should execute a formal
lease agreement covering the subject period of time.
Final Check
Before you sign the contract, read it carefully and then
read it again. A signed real estate contract is a legally
binding agreement. The BIG print
giveth, and the small print taketh away.
Post-Acceptance Analysis & Inspections
Legal Issues
Although you should have checked into as many issues as possible prior to even
writing the offer, you must now do some serious investigation.
Title Insurance Report
If not available prior to writing the offer, obtain the preliminary title report or chain of
title report as soon as possible. Also obtain legible copies of all documents
referred to in the report. Title reports often contain errors, so question any
items that weren't expected or don't make sense.
Zoning & Building Codes
If not done prior to writing the offer as previously recommended,
you should now check into zoning and Building Code & Permit matters.
Licenses & Permits
Depending upon the city, county, and/or state in which the property is
located, it is possible that a variety of licenses, permits, and/or inspections
might be required for rental properties.
Documentation
Financial
Your purchase contract should have required that the seller provide
financial records that show income and expenses for at least the past 12 months
and the records must be such that verification of accuracy is possible. You can
also determine realistic expenses on your own.
NOTE: Property taxes may be increased
substantially based on your purchase price. Make sure you understand the
local tax assessment policy and use the likely new tax amount for your
proformas.
You should also take a look at the conditions of the roofs, parking
lot, heating/cooling systems, and any other major components to determine (1)
whether there is deferred maintenance that will need immediate attention (lender
may even require it) and (2) what type of annual reserve payment you need to
include in your analysis (lender may do so).
Although you came up with the price that you were willing to pay when you
wrote the offer, you have to re-analyze the value, using the same procedures
with perhaps more complete and accurate data. Also, if you structured your
contingency periods properly, you will have the results of whatever inspections
you performed.
If you now come up with a value of less than you offered, it should only
be because of (1) information from full documentation was different than from
that originally provided before writing the offer or (2) previously unknown
and/or undisclosed
physical or environmental defects were uncovered during inspections. In either
case, you can exercise the appropriate contingencies and try to negotiate a
lower price or, if the seller is unwilling to renegotiate, cancel the deal.
Leases
You should be sure that you are
provided copies of all leases and related documents, including amendments,
guaranties, checklists, and house rules.
One reason lease documents are important is to verify rent income. This
is particularly important regarding unique commercial properties for which it is
difficult to independently determine market rents. For commercial
properties, there are a number of additional issues that must be considered
compared to residential property.
Lead-based Paint Disclosures For Tenant
For residential property constructed before 1978, verify that the lead
paint issues are fully covered, as previously discussed.
Other Tenant Info
Since the value of leases is dependant upon the financial strength of the
tenant and/or guarantor, it is of value to obtain copies of applications, credit
reports, financial statements, and/or other documentation upon which the
decision to lease was based.
Estoppel Certificates
Although often not utilized unless required by the lender, as they usually
are for larger properties, estoppel certificates should be used for every
purchase of a tenant occupied property. An estoppel certificate is a statement
signed by a tenant (1) affirming his lease documents (attached to Certificate)
and the deposit/rent amounts; (2) confirming that there are no agreements
outside of the attached documents; and (3) confirming the date to which rent has
been paid. The document is sometimes called a Certificate of No Defense. A
sample basic Certificate is available in our members-only
Forms Web.
Without an estoppel certificate, you may find out after closing that (1) a
tenant had a first right of refusal or option to purchase that he'd not been
given opportunity to exercise or (2) there is a lease amendment that the seller
had neglected to provide which extends the lease for 3 years of the unit that
you planned to move into after close of escrow.
Inspections
Every offer to purchase real estate should be contingent upon a thorough
inspection of the property. Whether you need the inspection performed by
someone other than yourself depends upon your knowledge and experience as well
as the type of property. If you are new to real estate investing, and/or
building construction, DO NOT try to do an inspection on your own. Even
experienced investors usually take some qualified, but disinterested, third
party along when they check out a property before purchase.
While one should be concerned about physical inspections when purchasing a
personal residence, it is usually of 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, often for only things that break, and do little or no
preventive maintenance. Third, some income properties, particularly the larger
complexes, have types of equipment not found in a single-family home.
Be sure that your purchase contract makes contingencies out of all
inspections and allows adequate time to get the results of the inspections
taking into account inspector scheduling, holidays, weekends, weather, time to
analyze the reports, and time to utilize a contingency if necessary.
Physical
Hopefully, you have written a good contingency clause regarding physical
inspections into your purchase contract. Now you have to decide how to use it.
There are a lot of things that are candidates for close inspection, and what is
important depends upon the type and size of the property as well as the
complexity of some of the systems. The ones that are often of concern are roof,
heating/cooling systems, electrical, plumbing, gas, and pests.
You can either hire individual specialized contractors for
each component or hire a property inspection service to cover the entire
property. Whether you hire a single property
inspector or a separate inspector for each of various components depends upon
the type and complexity of property. Read RHOL's
Selecting a Property Inspector page. Having independent inspections by
professionals can sometimes give you more leverage in re-negotiating the deal
when problem are found.
How can a buyer check to see whether a contractor is properly licensed?
You should determine if any complaints have been filed against the contractor,
current license status, and the "qualifying party" to whom the license was
issued. You should make sure the qualifying party contractually responsible for
constructing your home matches the license number on the building permit. For
additional information, visit our
Selecting a Contractor page.
Environmental
This is another subject that is seldom of much concern for a personal
residence, except for lead-based paint and radon issues, but can be important
for income properties, particularly commercial properties.
Soil & Ground Water Contamination
Although you should have checked whether the property is in a super-fund
site before writing the offer, if you didn't, do it now. While this is not
necessarily a reason to eliminate it from consideration, you should be sure that
you understand the ramifications, if any.
For commercial properties in particular, you need to be concerned about
potential contamination issues. For commercial locations, the lender will
usually require a Phase One Report, but you should have made the Report a
contingency in your purchase anyway.
Lead-Based Paint
For pre-1978 residential properties, you, as buyer, must be provided with
the legally required lead paint pamphlet and disclosure form. This is in
addition to receiving copies of the tenant-signed forms mentioned in the earlier
paragraph. If the form indicates that the seller has had a lead paint
inspection or has had remedial work performed, be sure to get copies of the
reports and/or certificates.
Asbestos
If applicable, have the property inspected for asbestos.
Radon
If applicable, have the property tested for radon.
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