The Overlooked Component of Due Diligence
Eliminating the Luck Factor in Investment Decisions
By Nicholas DeSumma
Knowledge, timing, and luck are often considered key variables that play into a successful real estate investment. However, those that successfully invest in real estate over long periods of time while adapting to various market cycles often can eliminate “luck” from their equation and substitute it with expanded knowledge.
As an investor, continuously analyzing and refining the key questions — who, what, when, where, why and how — will help expand the knowledge component. The “who”, “when” and “why” are often answered prior to investing in loan or asset pools as they tie to the initial purpose and overall strategy of the endeavor. The remaining components arguably tie more to supporting the investment strategy:
What // What asset type and class should be targeted, with emphasis on condition, level of investment, and overall financial upside in supporting the overall strategy?
Where // Which market(s) should be considered based on determined opportunity, knowledge, and resources?
How // How will the investment be funded? Have funds been raised or will there be a debt structure, such as through a private lender?
Drilling in on the “what” component, and as the “what” is answered, an imperative component to execute on opportunity resides in proper due diligence. Conducting proper due diligence can become an artform as it is not only reliant on coordinating with various vendors, data providers, and relevant third parties, but it requires effectively and efficiently aggregating the obtained information in a method to make a decision in an accurate and timely manner.
The Due Diligence Process
During the due diligence process, there is a tremendous amount of focus tied to a property’s characteristics, such as square footage, bedroom and bathroom count, current value, and current condition, as well as its investment opportunity — renovation scope and cost, repaired value, market conditions between end user buyers and renters based on the strategy. An area that is often overlooked given its diversity and ability to effectively and timely aggregate viable data are a property’s intangibles: title, liens, violations, taxes and delinquencies or dues, such as those associated with a homeowner’s association.
Understanding which loans or assets to acquire, as well as what strategy to implement, will drive the investment opportunity forward. However, an improper understanding of what was formally and legally acquired, as well as what legal obligations the investor is now tied to through the acquisition, can often, and drastically, derail the investment.
Accordingly, Guardian Asset Management has created an unparalleled ecosystem to better support the entire due diligence process, with additional emphasis on the aforementioned property intangibles. Embedded within this ecosystem is the successful marriage of the various service pillars (as well as the various data elements that drive due diligence decisions), including renovation, maintenance, preservation, evaluation, single family rental management, asset disposition, and title services. Title services, inclusive of the various other property intangible components, can be a cost-adverse and lengthy process yet remains crucial to those seeking to invest in loans and assets.
Combatting the Challenges
The expectation for additional delinquent loan and distressed asset trades or acquisitions is prominent given current post-pandemic market conditions. With this expectation should come further consideration towards better understanding the intangibles of a property for various reasons, such as:
» The prevalence of multiple transfers of vested ownership via Quit Claim Deed during the loan servicing and/or foreclosure process can delay or even bar the conveyance of a property due to recording delays at best and missing legal instruments at worst.
» The merger, acquisition, and dissolution of many lending and servicing entities can stall any efforts at resolution should there lack a clear chain of succession and authority to correct essential legal documents.
» Homeowner’s associations, tax collectors, and local code enforcement entities have become more proactive in recording liens and judgments to encumber title and ensure payment collection, even when outside of the bounds of statutory rules.
» Title insurers have taken a more conservative approach on insuring over any encumbrances on title that do not have completely indisputable resolution on record, refusing to insure even with prior insured policies or indemnity from prior insurers.
» Lending institutions have returned to more conventional and stringent requirements regarding clear versus insurable title policies, potentially shrinking the potential buyer pool and negatively affecting investment return, which could pose challenges on an investor’s exit strategy.
» The ability to obtain financing for investors through private or hard money can be jeopardized if title or related issues are not easily resolved through the general investment strategy, such as resolving a violation for overgrown lawns.
As a best practice to combat these increased challenges, partners that leverage product diversity, such as tax, municipal and code searches, will assist in not only ensuring more effective investment decisions, but mitigate risk with potential financing partners. An effective partner is not one that just delivers timely results, but it is one that advises on the diverse products and data available to align the right resources for the decision being made.
Guardian’s philosophy is to not only ensure investors have access to all services, but to also advise on when to leverage each. These include title reports (Ownership & Encumbrance, Current-Owner Search, Two-Owner Search, Full Search, and Foreclosure Search), data tapes with abstracting documents, customizable lien priority flags to triage assets, tax certifications, municipal lien and code searches, homeowner’s association verifications, title clearance and curative services, assignment verification reports, replacement title policies and collateral document preparation and reconciliation services.
A commonality between investors, regardless of the investment, is to create value and discover opportunity to expand. While the “luck” element may factor into being in the “right place at the right time” or “having the stars align,” it is no mistake that those who successfully expand their venture into a long-term operation eliminate luck by refining modeling and layering in tools to better analyze, decision and forecast.
While the intangible side to real estate may be less glamorous, potentially costly to research, and often associated with delays, better understanding these elements, as well as identifying property partners to utilize and when to leverage their diverse suite of offerings, will help solidify decisions regardless of market conditions.
