How To Do Due Diligence

How To Do Due Diligence

Jason Hartman uses this episode to discuss due diligence. He hosts investment counselor Adam Schroeder to go into the due diligence. They go through key aspects of income property investing including checking home prices with Zillow and contacting the Tax Assessor. Then they discuss working with lenders and the importance of home inspection and re-inspection.

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Welcome to the young wealth show where you’ll truly learn how to make, spend and invest money for an awesome life. Get the real life stuff that wasn’t part of your school curriculum. Young will gives you innovative new ways of dealing with your finances, as well as the skills and tools you’re going to need to survive and be successful out on your own. Let the young wealth show be your GPS to take you from clueless to clued in. here’s your host, Jason Hartman dunwell

Jason Hartman 0:51
glad you could join us today as we talk about a very important aspect of income property investing and that is none other than Due diligence, okay, due diligence, you got to do your due diligence, right. And Adam is here with me. He wanted to bring up this topic. Of course, we’ve talked about it many times over the last 14 years or so. And we’re going to talk about it again. Maybe we’ll go into a little more depth This time, we’ll add some different ideas to it. And just go ahead and approach that subject because it is all important. Many investors have been hurt and had financial penalties. It’s like getting a traffic ticket, you know, you’re going to have more expenses. A little more expensive. Yes. Well, I don’t know if you’re in California, that traffic ticket can be really expensive. But But you know, if you’re speeding on the on the highway, right, and you’re going too fast, you get a traffic ticket. If you’re going too fast in your income property purchases, you might get a ticket too. Now, I do want to say that the biggest flaw of most people, most investors They shoot themselves in the foot or as Sarah would like to say shoot themselves in the shoe. Because she takes every old saying or investment counselor Sarah and sort of revises it for her own liking. And most people go too slowly. Okay, so this is not the problem most people have going too fast. Most people are suffering from the paralysis of analysis. And what we want to do is find a balance between the two. Don’t go too fast. Don’t go too slow. Be in the Goldilocks zone, right? It’s not too hot. Not too cold. It’s right where it should be. Adam, what do you have on tap for our due diligence discussion today?

Adam Schroeder 2:39
Well, first off, it made me think of the old Mountain Dew commercial, we got to do the do I don’t know if that’s a reference that you’ll get but so I think we should start with pricing because that’s

Jason Hartman 2:48
that commercial. But I do know that Mountain Dew is like soft drinks are terrible. And Mountain Dew is one of the most terrible because it has a massive amount of sugar. It has has a massive amount of caffeine. And it is really bad. In fact, I saw a documentary once about these dentists that were going into Kentucky. Oddly, Kentucky is the big place for Mountain Dew. Apparently it’s really popular there. And they were treating people and they talked about all these terrible oral diseases and all this stuff. Just Mountain Dew is just wreaking havoc on people’s teeth in their mouth, and it’s just bad stuff. So stay away from Mountain Dew. But do your due diligence.

Adam Schroeder 3:32
Go ahead. So we figured I figured we’d start with price because that’s the first thing people look at whenever they’re looking for an investment property. There are a couple different places you can find pricing and we’ll go over those and the first and biggest one is you can go to the MLS. Now there are important tidbits that we have to say about this. And that is that your property is likely to be on the higher end of the area because of the fact that you’re actually getting a renovated property. Most of the other ones on the block, you know, don’t have a new roof don’t have a new age spec system, don’t have new flooring, potentially, and they don’t have new paint jobs, new everything. So you’re likely going to be looking at properties that are a little bit less than what you’re paying, but you want to be sure that you’re in the same ballpark.

Jason Hartman 4:21
Yeah, okay, so so you’re not always getting the best house on the block, though, we do want to make that disclaimer, and you’re not always getting a renovated house. Occasionally, people through our network buy non renovated properties. However, we don’t recommend that, you know, it happens once in a blue moon. So it’s very rare, but on the occasion that you do, then those comps will become more meaningful. Go ahead.

Adam Schroeder 4:47
And one of the important things whenever you’re starting this also, your first part of due diligence is asking the provider for their scope of work. Okay,

Jason Hartman 4:57
good. Good point. Yeah, you can do so our Local megahertz specialists can provide you with her scope of work that they’ve done on the property. But remember, each property is starting at a different place. So that scope of work may be larger or smaller, depending on what they’re starting with. Right? If they’re starting with a real disaster, then it’s a money pit for them. And the scope of work is huge. If not, then it’s it’s not not so much that way. Right? It might be a small scope of work where it’s just a cosmetic upgrade sometimes. Also, the scope of works vary in detail. You know, I wish there was some standardization for this. contractor estimates quotes scope of work, it’s just all over the board. Okay. Don’t let them give you a scope of work that says renovate house, okay. You know, it needs to have a degree of detail to it. How much detail Well, that’s all debatable and I don’t think we can even go there without having visual aids, but just make sure you’re comfortable with the level of detail. And if it’s not detailed enough, ask for more.

Adam Schroeder 6:08
Yeah, they should know. That’s right. Hopefully, if they don’t know what they’re doing to the property, that’s a big red flag at least.

Jason Hartman 6:15
Right? Right. And what this scope of work does though, is it provides you with something to come back with later. If you have a maintenance problem or repair problem on that property later, you can just say to them, Look, this was in the scope of work. So if you agreed to give me a six month or a one year warranty on all the work you’ve done to the property, okay, they’re not gonna want things they didn’t touch, right and that renovation, then this should be your responsibility. That’s what you’re saying to the local market specialist, maybe three or six months after you own the property, because now you’ve got that scope of work. You can look back on it and you say, hey, you said you replaced this, this toilet or You did the HV AC system. So you should take care of any problems with that now, and they should not be my responsibility as the new buyer from you.

Adam Schroeder 7:08
Okay, go ahead. Absolutely. And then there’s another site you can go to which probably everybody here knows about and that’s Zillow. Now we have to throw in the fact that they gives us

Jason Hartman 7:17
never heard of it. Never heard of it.

Adam Schroeder 7:21
The thing that gives estimates and nobody, I don’t think anybody knows how exactly the zestimate is figured. But it can give you a good idea of what other people are listing their homes for in the area that may or may not be on the MLS. So it’s a good place to go to get a general idea for what the neighborhood is selling.

Jason Hartman 7:42
Right right now, you know, Zillow, it’s the Wild West bit. Okay, there’s a lot of trash on Zillow. And I don’t mean bad properties, I mean, trashed listings, there are fake listings. There are properties that have ease They’re sold or rented a long time ago and they’re still up. It’s really a bit of a mess. But, and the zestimate is a complex algorithm. It’s their secret sauce. You know, nobody knows exactly how it works, except the two people that know the formula for Coca Cola. Okay, it’s kind of like that. And it’s kind of like Google’s search algorithm, right? And the thing you have to realize is that it’s, it’s a mess, right? However, compared to what, right compared to what we had before Zillow, we had really nothing like that we had other things, of course, but we had nothing like that. So it’s better than than it used to be. Right? It gives you a guideline, but it requires you to obviously use your intelligence and your reasoning skills to understand the accuracy or inaccuracy is one of the things I’ve also noticed about Zillow is that the pictures can be insanely misleading. Sometimes the pictures aren’t even the same house, they literally aren’t. This happens a lot in where you have a builder that may be built an ETL project. And they built, you know, four or five houses in a neighborhood. And they’ll list the property at you know, 123 Elm Street, and they’ll put pictures of 675 Elm Street, and they’ll just to show you like a sample of their work, or their construction quality, and it’s not even the same house. I mean, this is really, really dangerous. Okay, it’s very misleading. So you got to be really careful. You know, it’s kind of like the old saying, Don’t believe everything you read online. Well, that’s for sure. That same same idea goes with a platform Listing Service, or a forum or a you know, anything I mean, you’ve got a you’ve got to sift through this and really use some more reasoning power, but but it’s better than what we had before.

Adam Schroeder 10:02
So very good, good. And then the other place you can go and this is going to be the values are going to be off on this just because the way that all communities do it, but you can go to the county assessor and look at the property tax values. Now, most likely, there’s some sort of at least in Texas, there’s some sort of homestead exemption or in California, you know, you have a requirement of that can only go up what is it 1% or just a couple percent a year because of 13. And so it’s not necessarily the best way but if you can find out in general, what homes are being valued for in that neighborhood and don’t look at the property tax value of your property, because obviously your property was purchased for less than it could have been by the market specialist if it had been updated in been a good home. Right. So look at the surrounding areas and just get a feel for especially if you can find one that sold recently. You can usually see You know what they’re valuing that? Right? Right good place to go to get a general idea

Jason Hartman 11:04
it is and just realize that your taxes will be reassessed upon closing of the property. So that also brings us to another point, Adam, that does relate to due diligence. When you look at the performer, that the local market specialist posted on our platform, you’ve got to make sure that you verify those numbers with them to areas where they commonly understate, maybe it’s intentional, maybe it’s not, that varies, but our taxes and insurance, okay, now, now the rent the rental value, and we’re going to talk about that in a moment. If you’re used to looking at properties through our network, and you you start to have an understanding of it. And then of course, there are some rent sites that I’m sure will mention in a moment that can help you but again, they’re kind of like Brazil. thing it’s Same, same concept, you can get an idea if the rent is overstated. Okay? you’ll you’ll have a sense of that after a while of looking at properties. But the taxes and insurance can be also understated. And those will affect your bottom line your net operating income or noi. So you really want to verify those things. And especially if you are in a disaster prone area, say a hurricane area, insurance can vary greatly, depending on which side of the highway you’re on. In other words, how close you are to the coastline or not. That can vary quite a bit. That type of construction of that home can make the insurance prices vary quite a bit. Also be mindful of flood insurance, whether or not that is required. And so that’s another part of due diligence, you really want to know and those tax values, especially on new construction properties, where maybe the tax assessor has assessed a vacant lot then there Assessing an improved lot, and most of the values in the improvement, you know about the Hartman risk evaluator that can help you dramatically reduce your downside risk when investing. If you’re not aware of that, go to Jason Type Hartman risk evaluator. We’ve done quite a few podcasts on that over the years, and just learn how that works. And understand what we call the El TI ratio, not to be confused with LTV, that’s loan to value ratio, this is the land to improvement ratio. So that tax assessor if they’re assessing a vacant lot, that tax rate, and that comparable value is going to look very low, and it will be reassessed when you buy it, and those taxes will go up significantly. Now that may already be reflected on the performer. It may not. But that’s why we want you to do your due diligence. Hopefully it is already reflected and you’re just confirming their number as that estimate but we Want you to be careful.

Adam Schroeder 14:01
So let’s go into the since you were just talking about it, we can go into the property taxes a little bit more. That’s one area we were going to cover. And that is if you go and check on the values in the county tax assessor, you can also see most of the time what the tax bill was for that property. And then if you really want to know, you can actually call them I’ve done this on a couple properties. You just call them and you don’t have to ask what that property will be. You say, hey, in the county, so you’re buying a property for $100,000. in that county, in general, for $100,000 house, how much will you be paying in property taxes, and they can give you a ballpark figure. So if they come back and say, usually $100,000 house has $1,000 in property taxes, and you look on our site, and you see that it’s roughly $1,000 a year, then they’re probably giving you a good estimate. If you see that it’s $400 a year well then that might be because they put down what They’re paying in property tax, which will vary greatly from what you’re paying. So you can just call them up. Most people don’t call it county tax assessor. So their wait time is very short. Yeah,

Jason Hartman 15:10
yeah. You know, I gotta say that has surprised me. Many times they just pick up the phone. Yeah, it’s really great. You know, in the old days, it used to be a 45 minute wait. Somebody thing I called.

Adam Schroeder 15:22
I called one office for the assessor and the assessor was the one who answered the phone. It wasn’t even receptionist. He answered the phone. And I was like, Yeah, can I talk to somebody about this? He’s like, I’m the assessor. Oh, okay. Wow. So you love what I would have gotten here in Travis County? tech. Yeah,

Jason Hartman 15:39
like I remember when I lived in Orange County, California. You know, the assessor was john T. Morlock. So you know, that’s the name written on the envelope, which is kind of weird how our government puts the name of a person on there, like personal branding. It’s sort of weird for a government position, but, but whatever. It’s like he answered the phone himself. We’ll just call the right President Trump’s speaking Can I help you?

Adam Schroeder 16:05
Just walking by and the phone rang so picked

Jason Hartman 16:07
it up. Yeah, that’s customer service. I tell you, that’s great. Okay, good. What else?

Adam Schroeder 16:12
Alright, so let’s go into we, you know, we’ve done price we’ve done property taxes, why don’t we go into the first thing you’re going to want to do, potentially even before you get looking at properties, and that’s lenders. We have several lenders in our network that do nationwide lending for investors, and that’s their bread and butter. They know it, they can help you get a loan really quickly. But you can also go out into each individual market and look for local banks and credit unions. The one problem I’ve run into whenever I’ve tried to do this for our properties and for other people’s properties is that most smaller banks, most local banks and credit unions won’t give you an investment property loan until the loan size is over. $100,000 once it gets over that there interested in and they’ll give you an estimate. But until that point, a lot of them just won’t do it. They don’t think it’s worth their time. They’d rather give loans for owner occupied properties and other things. So that’s one problem you might run into when you go outside of our network. Okay, so that means loan amount range over 100,000 means you

Jason Hartman 17:22
have to have $20,000 property. Yeah, right. Right. Right. And that’s not always true. That’s just one lender that you happen to talk to. Right. It’s

Adam Schroeder 17:30
been it’s been a couple of them that I’ve talked to that seems to be a number that a lot of them go with. And I’m not saying if your loan value isn’t $100,000 don’t try. I’m just saying that’s a problem you may run into.

Jason Hartman 17:41
Right, right. Okay, go ahead.

Adam Schroeder 17:43
Get but the lenders that we will point you to to contact for our network, they are used to writing loans for less than $100,000. So you don’t need to have $100,000 loan size to buy an investment property. That’s

Jason Hartman 17:56
right. I remember

Adam Schroeder 17:57
cuz I had a client asked me said so if I go under Do I have to pay cash? No, no, you do not.

Jason Hartman 18:02
Right? Right. But if you go for a really cheap property, which is a problem you’re not going to have, because we don’t have any really cheap properties. You know, those properties that just don’t really work and bombed out Detroit, okay? Or something like that. You can get lenders that will turn those down to really low prices, but with the market appreciating so much over the last several years, that’s this is a problem that is happening less and less, so don’t worry too terribly much about it.

Adam Schroeder 18:32
Yeah. And if you’re getting a cheap property as well, even if they’ll give you the loan, a lot of times they give it at a higher slightly higher interest rate. So they can actually make some money on the deal.

Jason Hartman 18:41
Right, right. You know, it’s not worth it to them to bother with really small deals, you have to understand that they they want to, you know, the loan size needs to be worth it for the lender to make the loan. Okay, go ahead. Oh, one more thing I want to say on that though, is remember something even with any lender With the entire financing environment, and with the lenders in our network, where you might receive a couple of referrals from one of our investment counselors, like Adam or the others, just understand that, you know, many of our clients are buying multiple properties, repeat clients buying over and over, which was great, thank you for your business. We, we appreciate that, of course, and understand that if you went through one lender that we recommended to you, six months ago, and then you’re purchasing a property today, six months later, another property, maybe that lender doesn’t have as good a deal for you. This is a dynamic thing. They move in and out of certain markets. And I don’t just mean geographical markets. I mean, market segmentations, mortgage product types, price ranges, all sorts of things. Just know it’s a dynamic market. And the same is true with our local market specialists in the network. Some of them are are very good for a while they’ve got very good inventory, they’re giving very good customer service. And then they go bad. And you know, we’re just not that hot to work with them, you know, and we’re more interested in working with a different local market specialist. So understand that, like any marketplace, all of these things are dynamic, they’re constantly changing. And that’s why you have a human to help you, you have our investment counselor team, who will help you and guide you to the right resources that you need.

Adam Schroeder 20:32
Because we our lenders are constantly reevaluating their fees as well to see you know, they need to compete better with their fees. So one property, they might have high fees, and then they realize, Oh, wait, we’re not getting any loans. They’re going to everybody else. And so we’ve had several of our lenders reevaluate their fees and adjust accordingly. So you know, that’s always something to look at. So next, why don’t we move on to home inspections, you want to move on there?

Jason Hartman 20:55
Alright, sounds good to me.

Adam Schroeder 20:57
Alright. So the first thing you’re going to want to do is Check the state that you’re purchasing in and see if they’re required to be licensed. Because that can route out a whole lot of people with your Google search. So there are multiple states that have licensing boards. Mississippi has a licensing board, Arkansas has a licensing board, I’m sure others do. Those are just the two that I know of off the top of my head. So you can go on to the website for the licensing board, and just look up the county that you’re purchasing in. And it’ll give you a huge list of home inspectors that you can call. And then just pick three, four or five, six of them, however many you want to call and call around and get pricing and see you know, who’s willing to do what and if they can do it in the timeline that you need, and make your plans off there. What I like to do whenever I call them and talk to them, is I’ll say how much does it cost? How much is your reinspection fee if you have one? And also Are you willing to go around and take a video of the property for me so that I can get a walkthrough idea and willing to do that because some of them, no offense to ageism, some of the older ones have no interest in doing that. They’re like, I don’t know how to do it. I don’t want to do it. And then sometimes they’ll talk to a slightly younger person. And they’ll say, Oh, yeah, no problem. I’ll have my phone there. Anyway, I’ll record a video for you upload it, no problem.

Jason Hartman 22:18
Here is millennial Adam saying, hey, Boomer age discrimination. Boy, that’s mean, I tell you, but it’s not completely that stereotype is not completely without truth.

Adam Schroeder 22:29
And I mean, some of the older ones, they’ll tell you yes. Because they understand. It’s just it depends on if they’re afraid of technology, or not young or old. Yeah, they’re just some people who don’t, they don’t want to deal with Google Drive or Dropbox or something like that. So sometimes they’ll do it. Sometimes they won’t. Yeah. And then another thing you can do

Jason Hartman 22:46
outside. Yeah. Hang on a second. I want to say a couple things about what you said. So first of all, let’s talk about what a reinspection is, and when you need it. Okay. So Adam said First of all, check and see if they’re licensed. There is a home inspector Association. We did a show on it. We had two great home inspector speakers at the last meet the Masters last spring of 2019 in Newport Beach, California. And one of them was on stage with all his gear on, you know, he looked like a paramilitary Commando. commando operation, right. So they later came on the podcast, we did an episode with them, you can go to Jason and just use our search engine there type home inspection. You’ll see all kinds of episodes on that. But that one particular episode, they gave a resource and I forgive me, I don’t have a link offhand. To the national home inspectors Association. Don’t quote me on the name but you know, the Association for home inspectors, and it has a map of all the states that require licensing versus the ones who don’t right and in some states don’t require licensing for contractors also. So keep that in mind to the licensing law. vary from state to state, of course, and maybe even from county to county or city to city, sometimes on a more micro level, and then you have a home inspection, they go out, they do the detailed inspection probably takes somewhere in the neighborhood of three hours, give or take, and they give you this report. And if the report calls out a bunch of items are issues with the property and need to be fixed. If you’re buying a renovated property, you want to make sure the seller or the local market specialist has done that work. So you need to have a re inspection. So you might pay one fee for the home inspection. You know, maybe you’ll pay $350 just as an example prices vary greatly to Okay, so understand that. And then you might pay $75 for a re inspection or $50 for a re inspection or whatever it is, where they’ll go out and they’ll look again at those particular issues. And make sure that have been resolved. So you want to make sure you don’t close on the property before those re inspection items have been checked off that they’re done and they’re to your satisfaction. Now, what if you’re under pressure to close and say you have a interest rate lock on your loan, and that interest rate lock is expiring, and the rates are higher. If you don’t close the deal in a certain amount of time. This is the real world this happens. You want to have the seller give you a credit. In other words, money, okay, where you get an A comfortable estimate of the cost of those items. And they literally at closing as part of the instructions before the deal can close. They have to credit you $1,000 or $2,000, or whatever that number is before closing. Now. If they don’t want to credit it to you, they at least have to leave that money in the escrow account so that they don’t get it from their proceeds of the sale. And you don’t get it either. It stays with a neutral third party, the title or escrow company or closing attorney in their trust account, pending resolution of that issue. And then joint instructions will be required to release those funds. For example, say there’s $1,000 that’s held in that trust account, and the seller fixes the item. Well, then you would sign instructions, just releasing the thousand back to them. Okay, say they don’t fix the item, then you would demand from that account that they release the money to you. Well, what if the seller doesn’t cooperate and says no, I don’t have to release it to I fixed it. Right. Well, then you have a dispute, obviously, right. And usually it’ll get worked out at least they don’t have the money, right. It’s harder to get it from them than it is to get it out of an accountability. neutral third party. So just understand that the best thing is not even go there. It’s to get it fixed before closing.

Adam Schroeder 27:08
Yeah, and one thing you can also do is if you’re, you know, your rate lock is coming up to expire, you can tell them, hey, if you can’t get all of this fixed before closing, you’re gonna pay for a rate lock extension. And they’re willing to do that, then they can pay the hundred or 200 or $300 to get that rate lock extension and they can get the property fixed in that amount of time, as well. So that’s another thing you can come back with.

Jason Hartman 27:32
Good, good, Adam. We have covered a lot of stuff today and I think we are running a little bit long. So why don’t we continue this conversation tomorrow so that we’re not rushed? And we can really make sure we give enough time to cover this all important subject of due diligence. listeners. We will be back tomorrow with more on this subject of due diligence, very important subject until tomorrow.

Thanks for listening and happy investing. See you on Part Two tomorrow. Thank you so much for listening. Please be sure to subscribe so that you don’t miss any episodes. Be sure to check out the show’s specific website and our general website Hartman. Mediacom for appropriate disclaimers and Terms of Service. Remember that guest opinions are their own. And if you require specific legal or tax advice, or advice and any other specialized area, please consult an appropriate professional. And we also very much appreciate you reviewing the show. Please go to iTunes or Stitcher Radio or whatever platform you’re using and write a review for the show we would very much appreciate that. And be sure to make it official and subscribe so you do not miss any episodes. We look forward to seeing you on the next episode.