LOS ANGELES—Real estate has long held a place in wealthyinvestors' portfolios as an asset that can both produce regularincome while experiencing capital appreciation. These investorshave had access to those “in the know” about these deals and wereable to reach the high minimum investment amounts for real estateinvestment groups. However, with the emergence ofcrowdfinance and sophisticated onlineinvestment portals, the world of realestate investing is now changing.

|

Since the JOBS Act passed in April 2012 thatallows for securities-based crowdfunding and general solicitationof investors, there has been a growing movement to open uppreviously closed-door investment opportunities to other accreditedinvestors (those who make more than $200,000 annually) and,eventually, to everyday, non-accredited investors. The real estateindustry is already seeing the effects of this, with onlineinvestment platforms like AssetAvenue, offeringhigh-quality deals, often at much lower minimum investment levelsthat can attract a broader swath of investors.

|

For those new to real estate investing, a key element tosuccessfully investing in commercial real estate is performing athorough due diligence analysis prior to investing in a property.Due diligence is something that seasoned investors know isimportant, but many first-time investors get excited aboutacquiring their first investment property and lose sight of themechanics of knowing what they're buying.

|

As a first-time investor, here are five tips on how to spota bad real estate deal:

|

1. Weak Local Market Conditions

|

There are two major factors to underwriting a real estatedeal—the market and the property. Of these two, the local marketconditions always trumps everything else. A great property in adeclining market can be a bad investment. Analyzing the demographictrends of population growth, income, and employment in the localmarket will tell you where opportunity or risk lies. It will alsoshow which property types are in demand or oversupply.

|

2. Misleading Financials

|

Anyone who has ever prepared a projection of property operationsknows that by tweaking the assumptions, the bottom line can bemanipulated into whatever will make the deal work. Many sellerswill overestimate revenue and/or underestimate expenses, therebyasking for a higher sales price because the property appears moreprofitable than it really is.

|

That's why it is critical to get the real operating numbers, nota projection of potential rent and estimated expenses. Confirm andverify every element of income and expense, and make sure youroffer is based on the actual financial performance of theproperty.

|

3. Poor Quality Tenants

|

Leases are the most important documents that attach to an incomeproperty. The existing leases produce the income, so it is criticalto review every lease and understand the financial strength of thetenant behind each lease.

|

In an apartment building, tenant files with poor or non-existentcredit reports and lack of references are a red flag. If thebuilding is filled with tenants who have a history of making latepayments or being evicted, your vacancy, as well management andlegal expenses will be higher than anticipated.

|

The same screening mechanism takes place with tenants inshopping centers or office buildings - examination of rent rolls,payment histories, and credit files of existing tenants can be veryenlightening in quantifying the risk quotient of each tenant. Isthe tenant a stable, healthy company or are they on the verge ofbankruptcy? Recognize that your expectation in receiving yourrental income is driven by the health of your tenants' businessoperations.

|

4. Hidden Property Conditions

|

In commercial real estate, it's important toremember that the seller always knows more about the property thanyou do. As a buyer, your job is to dig for the information theseller may not want to volunteer, or perhaps isn't aware of, inorder to make an intelligent decision about the deal.

|

Part of your due diligence checklist involvesinspecting the property condition, including physical items such asbuilding systems, environmental matters and structural components.Hire the right professionals to give you estimates on themaintenance costs of these items, their lifespan, and how much itwill cost to replace them when needed.

|

The condition of the property will determine how efficiently youwill be able to manage the property. If a building is 40 years oldand has old plumbing or a roof that is falling apart, it willrequire more maintenance and upkeep than a recently constructedbuilding. These numbers need to be accounted for in your financialanalysis of the property, and should be reflected in the purchaseprice you offer the seller today.

|

5. Legal Challenges

|

Just as important as the physical condition of the property arethe intangible items, such as title, survey, zoning and land-useregulations. Is the current land use and zoning consistent withyour plans for the property?

|

Many times, a seller will market their property indicating thatit can be zoned for another use and has the development potentialto add additional square footage. As a buyer, know that the burdenof diligence is on you—do your research and check to see if thereare any legal restrictions to your use of the property as plannedor proposed. Because zoning and land use regulations change withtime, do not assume that the proposed use of the site will bepermitted as advertised by the broker or seller.

|

Knowledge of contract law, insurance, finance, accounting, andtax law is also critical to doing things right at the beginning toinsure a successful outcome on your investment.

|

Finally, when it comes to facilitating your investmentactivities online, be sure that you choose a platform that:

  • Is credible and only specializes in real estate deals
  • Is backed by a team who has years of deep experience in realestate investing
  • Has a team that is available to answer any questions you mayhave
  • Provides educational tools on their site
  • Strongly vets their deals and sets realistic expectations
  • Has a track record in delivering solid returns forinvestors

The Bottom Line:

|

Following these simple rules and recommendations can prevent youfrom making a poor real estate investment decision on your firstdeal. Don't let the excitement of your first investment cloud yourjudgment and make you rush through the due diligence process, orcause you to invest on the wrong crowdfunding platform.

|

David Manshoory is the founder ofAsset Avenue—a crowdfunding real estate investment platform. Theviews expressed in this column are the author's own.

Want to continue reading?
Become a Free ALM Digital Reader.

  • Unlimited access to GlobeSt and other free ALM publications
  • Access to 15 years of GlobeSt archives
  • Your choice of GlobeSt digital newsletters and over 70 others from popular sister publications
  • 1 free article* every 30 days across the ALM subscription network
  • Exclusive discounts on ALM events and publications
NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.