LOS ANGELES—Real estate has long held a place in wealthy investors' portfolios as an asset that can both produce regular income while experiencing capital appreciation. These investors have had access to those “in the know” about these deals and were able to reach the high minimum investment amounts for real estate investment groups. However, with the emergence of crowdfinance and sophisticated online investment portals, the world of real estate investing is now changing.

Since the JOBS Act passed in April 2012 that allows for securities-based crowdfunding and general solicitation of investors, there has been a growing movement to open up previously closed-door investment opportunities to other accredited investors (those who make more than $200,000 annually) and, eventually, to everyday, non-accredited investors. The real estate industry is already seeing the effects of this, with online investment platforms like AssetAvenue, offering high-quality deals, often at much lower minimum investment levels that can attract a broader swath of investors.

For those new to real estate investing, a key element to successfully investing in commercial real estate is performing a thorough due diligence analysis prior to investing in a property. Due diligence is something that seasoned investors know is important, but many first-time investors get excited about acquiring their first investment property and lose sight of the mechanics of knowing what they're buying.

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

1. Weak Local Market Conditions

There are two major factors to underwriting a real estate deal—the market and the property. Of these two, the local market conditions always trumps everything else. A great property in a declining market can be a bad investment. Analyzing the demographic trends of population growth, income, and employment in the local market will tell you where opportunity or risk lies. It will also show which property types are in demand or oversupply.

2. Misleading Financials

Anyone who has ever prepared a projection of property operations knows that by tweaking the assumptions, the bottom line can be manipulated into whatever will make the deal work. Many sellers will overestimate revenue and/or underestimate expenses, thereby asking for a higher sales price because the property appears more profitable than it really is.

That's why it is critical to get the real operating numbers, not a projection of potential rent and estimated expenses. Confirm and verify every element of income and expense, and make sure your offer is based on the actual financial performance of the property.

3. Poor Quality Tenants

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

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

The same screening mechanism takes place with tenants in shopping centers or office buildings - examination of rent rolls, payment histories, and credit files of existing tenants can be very enlightening in quantifying the risk quotient of each tenant. Is the tenant a stable, healthy company or are they on the verge of bankruptcy? Recognize that your expectation in receiving your rental income is driven by the health of your tenants' business operations.

4. Hidden Property Conditions

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

Part of your due diligence checklist involves inspecting the property condition, including physical items such as building systems, environmental matters and structural components. Hire the right professionals to give you estimates on the maintenance costs of these items, their lifespan, and how much it will cost to replace them when needed.

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

5. Legal Challenges

Just as important as the physical condition of the property are the intangible items, such as title, survey, zoning and land-use regulations. Is the current land use and zoning consistent with your plans for the property? 

Many times, a seller will market their property indicating that it can be zoned for another use and has the development potential to add additional square footage. As a buyer, know that the burden of diligence is on you—do your research and check to see if there are any legal restrictions to your use of the property as planned or proposed. Because zoning and land use regulations change with time, do not assume that the proposed use of the site will be permitted as advertised by the broker or seller. 

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

Finally, when it comes to facilitating your investment activities 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 real estate investing
• Has a team that is available to answer any questions you may have
• Provides educational tools on their site
• Strongly vets their deals and sets realistic expectations
• Has a track record in delivering solid returns for investors

The Bottom Line:

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

David Manshoory is the founder of Asset Avenue—a crowdfunding real estate investment platform. The views expressed in this column are the author's own.