In the context of real estate investing, due diligence is the process of confirming that the information presented about a potential investment is true. Generally speaking, interested individuals can expect due diligence to be a laborious and time-consuming process, but it is nonetheless so important that people should never make real estate investments without running through the relevant steps. Why is due diligence so important when it comes to real estate investing?
Simply put, people can’t make good investments without being able to trust the information that is presented about their investment options. As a result, there are various ways that interested individuals use to ensure the truthfulness of such information for various kinds of information. One excellent example would be the financial statements of corporations that have their stocks traded on stock exchanges, which have to be looked over by auditors so that potential investors can trust in them being faithful representations of financial realities.
Unfortunately, real estate investments are nowhere near as convenient as stock investments in this regard. Primarily, this is because there isn’t the same kind of interest that can be found for a potential real estate investment compared to a potential stock investment. As a result, interested individuals need to confirm the information presented about the potential real estate investment using their own resources instead of being able to find such information confirmed for them.
Moreover, due diligence is even more important in the context of real estate investing because of the sums of money that are involved in such transactions. It isn’t uncommon for real estate transactions to involve hundreds of thousands of dollars, which has a corresponding effect on the potential losses of such investments. In the meantime, a bad stock investment will hurt, but unless interested individuals have been making the cardinal mistake of dumping all of their money into a single stock, chances are good that their losses will be much more limited in nature.
A full list of the factors that real estate investors need to check when investigating a potential real estate investment is too long to be presented here. However, interested individuals might find some examples to be useful for their purposes:
A real estate investment cannot be examined on its own. Instead, it needs to be examined in the context of its neighborhood, which has a huge impact on its marketability. Generally speaking, someone running a neighborhood analysis will look at a wide range of factors. Some of these factors will be quantitative in nature, with examples ranging from crime rates and population growth rates. Other factors will be more qualitative but no less important, as shown by local schools as well as access to other amenities. Real estate investors can be interested in just about all of the segments of the real estate market, but at the very least, they need to make sure that they know what they are getting into beforehand.
Cash Flow Analysis
Most people understand the need to make sure that the real estate investment is profitable. However, a positive income is not the same as a positive cash flow, which is too often overlooked. For those who are unfamiliar with the concept, operations will see cash coming in as well as cash going out, which are not 100 percent correlated with revenues and expenses. As a result, it is possible for a set of operations to have negative cash flow, which is a huge problem because they can’t sustain themselves without sufficient cash to make necessary payments. Due to this, when real estate investors are looking over a real estate investment’s revenues and expenses, they need to look at its cash inflows and cash outflows as well.
Real estate investors should never carry out a real estate transaction without performing a physical inspection. Moreover, if they are looking into rental properties, they should make sure to inspect all of the units that are under consideration. Otherwise, if they just look into a small number of them, chances are good that the sellers are going to direct them towards the best units, which can give them a very misleading impression of the state of the building. Physical inspections often involve looking at things that real estate investors might not have the expertise and experience to handle on their own. In which case, they should never hesitate to call in professional help.