It happens all the time when you engage in acquiring a new property through contract, there is not much information about the property known at that stage.  All you may know is the details of the financial statement and rent payroll or you've visually inspected the place by driving around the block.  This is more than enough details to make a solid educated offer on the place but it does not by any mean represent the actual value.  There's a lot more information you'll need to know to determine the real value.

Really this is the job of the Due Diligence process.  What is the purpose of this process?  Due Diligence is an analysis by which your risk is assessed.  Much like discovery in a court case, you will have at least 30 days to figure out what exactly the property entails and what owning the property requires you to be responsible for.  Finally, also what kind of benefit you will receive as a result of purchasing the property.  What will be your cost benefit and profit?

There are four ways risk can ruin this success and by you knowing the potential risk involved, you can steer clear of these situations.  The following potential risks for these transactions are: Market, Financial, Tenant, and Physical. 

Much like pillars in a building, these four potential risk elements connect and overlap with each other.  By having a four-part Due Diligence plan in place covers all aspects and the weakest links of the pillars of the deal.  You can analyze risk from different points of view. 

The process of Due Diligence analysis is contingent on the order of the analysis.  Each step of the process is independent of each other and over lap, as you cannot pass one step and not another step.  You must pass the first, in order to go onto the second.  There are not allowances. 

A good example of this procedure is let's say you have found out the market risk is much too high.  So as a result it does not matter if the financial aspect of the analysis comes out good or that the physical details ring true, you cannot not have a failing element because all of the elements must be balanced.  Here are the four parts revealed in depth.

Market Due Diligence:

You must have an understanding of the market in which the property is located.  Ask yourself some questions that may seem logical or not.  What is the area like? Is it up and coming?  Growing?  Are there jobs near by or is it a bedroom community? What are the comparables of the area in rent and turn around in tenant occupancies?  Will the rent potential grow over time?  At what point in the market lifecycle is this market where the property is located?  Is there going to be new construction projects in the area for competition with this property?

Finally after answering those questions, you need to be sure if you really want to own property in this market and if so, please continue.

Financial Due Diligence:

It is a must to request at least three years of profit and loss statements and rental records because this will give you an accurate depiction of the income potential.  You should sit down with the resident property manager or your accountant to create potential expense projections for which to base your future experience.  You will want to plug in the income, vacancy and expected rental conditions from the first step in the Due Diligence process.  You will also want to get projected loan costs and payments from your mortgage broker or figure them out yourself.  From this you can write up an Investors Proforma for at least three years if not five.  The most important question you should ask at this point is: when will you see a return on the investment at the price you are paying to have the property? And what will it take to get there?  Is it realistic and if so, you can go onto step three.

Tenant Due Diligence:

This step we have found can be most important in deals relating to industrial, office and retail related properties.  You will want to ask the following questions before moving onto the physical analysis.  What are the strengths of your current tenants and the current leases?  Each strength, especially where business potential is concerned will need to be analyzed separately.  It will be important to understand in detail the existing leases but also to continue this analysis with Estoppel letters to confirm the details of the leases.  Another question at the heart of this is rather or not the leases are accurate and portray the tenant income realistically.  Will these businesses and tenants still be around, five years, ten years, and fifteen years from now? If so, you can continue.

Physical Due Diligence:

A proper inspection of the property should be carried out by a professional but still it is an excellent idea for you as the property owner should do a complete walk through of every square foot of the building.  At this time, please make note of any repairs and proposed costs of such repairs in order to include these in the analysis.  It should be taken into account the amount of funds needed to complete these repairs but also the amount of time needed so that you will have an accurate idea of what is in store to get a short-term return on the investment, rather this be accepting possible in tenants or just beautification.  The final concern here is will you be able to make the repairs but still see an ROI in your numbers during the Proforma analysis.  It is important to note here that this step in the Due Diligence is always last for obvious reasons.  Really it will not matter if the property is not in good, bad or top-notch condition if there parts of the process are bad.  I mean a good-looking property in a lousy market will see a return on investment or allow you to reach your goals.  It is also true if the financials do not add up, the numbers just won't fly.  It won't be realistic.

By performing the four-part Due Diligence process by passing each step until the last is reached, allow you to have a realistic impression of what your future will offer.  Not only this fact but also what steps are needed to make this a profitable situation for you.  This allows for your pillars to be stronger in the long run but also have a clear picture of risk and what is involved in reducing these for you.  As always, too much risk leads to upside down investments and therefore the advice to look for options.