The Key to Real Estate Investment Due Diligence

by Rob Phillips, CPA

Some real estate investors prefer to avoid the operational difficulties involved with running and leasing residential and commercial buildings. Instead, they opt to combine their financial wits with the capabilities of hands-on property operators and fund managers. Partnering with individuals who have varying credentials is a great way to capitalize on each other’s strengths and build lucrative assets. Passive investors avoid communication with large banks and arduous loan applications by relying on highly-skilled professionals to manage their investments and the investment process.

The lack of active participation allows passive investors to fund multiple projects at once, rather than putting all efforts into one property. Simultaneously financing multiple properties creates diversified portfolios in short periods of time.

While passive real estate investing offers expedited experience, it has potential drawbacks like all other ventures. Namely, financiers have little-to-no say in the operational aspects of properties. They lack control over rental prices, building upgrades or any active decisions surrounding their investments. Primarily, passive investors fund properties and collect their profits from rent and property appreciation (usually at sale or refinance) but don’t have management or operational control.

Luckily, some strategies prevent passive investors from falling into potentially bad investments without having to transition into active roles.

Review the Basics and Choose a Platform

Real estate investment trusts (REIT) have strong reputations and large, diverse portfolios. However., publicly-traded REITs are vulnerable to stock market fluctuations, which can have negative (or positive) impacts on investments. The equity-loss risks are highly dependent on the economy, so keeping up with market trends is essential for success.

Direct investments through limited partnerships, on the other hand, allow individuals to put their money right into pieces of real estate, rather than funding corporations who invest in properties for the individuals. Direct investments offer higher leverage, more stability and more control – three qualities many passive investors miss out on when involved in REITs.

Limited partnerships allow appreciation and tax deductions while keeping liabilities low. Also, limited partners can intervene if gross negligence or willful misconduct on the part of the Manager (or Sponsor) is involved. While investors retain some control here, it still falls short of traditional, active investments.

Get to Know Potential Partners

Before deciding on which companies or partners to invest with, consider the types of properties they specialize in and how those categories fare in local markets. For instance, there may be high demand for retail space in downtown Atlanta but not throughout the surrounding suburbs.

Rather than switching investment categories, consider new geographic locations for more profitable endeavors. Although historically investing in a new geography was difficult if not impossible for most passive investors, crowdfunding for real estate platforms are making the process much simpler and accessible.

Additionally, analyze the professionalism and business practices of prospective organizations. Real estate investors might consider contacting previous renters to gauge the approval rate of real estate firms. Since passive investors have little control over operation of properties themselves, they should make sure their potential active participants are reputable.

Look at real estate firms’ reviews online prior to investing in their rental properties to make sure they maintain good rapport with past tenants. To get first-hand knowledge, ask to walk through buildings or units to avoid firms that run neglected or unkempt properties.

Many crowdfunding platforms use an extensive screening process to weed out bad investments and unqualified sponsors. This process of elimination saves investors the work of assessing each individual real estate company, as the website or service evaluates companies before listing them.

However, investors should still conduct their own due diligence and review all investment details carefully when choosing to invest in direct real estate through a crowdfunding platform.

Select the Right Property

Investors looking to generate short-term profits might find better luck investing in modern, multi-unit buildings to immediately generate steady rental income. Conversely, small-scale investors might keep future profits in mind by opting for more inexpensive properties requiring structural or other work. The best fit varies, depending mostly on individual wealth and investment goals.

Passive investing, crowdfunding and equity sharing don’t have to be risky ventures, even though they present some disadvantages. In reality, they can be lucrative equity generators for investors who want to avoid the active, hands-on duties of real estate ownership.

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