Real Estate Due Diligence Checklist: What You Need to Know – Videos 1-3
Video 1 Transcript
Presenter: We are going to talk a little here about doing the due diligence. We’re going to start off with qualifying the neighborhood. What I do when I qualify a neighborhood. In the Pittsburgh market, Pittsburgh is a big city. It’s a small big city, really. There’s a lot of different neighborhoods within Pittsburgh. We are continuously opening up new markets.
It’s like anything else. If you’re satisfied where you’re at, if you think you’re in the perfect location and you don’t have to look for something new, chances are you’re on your way to go out of business. We are constantly looking at new ways to invest, new markets to invest in, different ideas just as you guys are. I speak to many of you and many of you say, “I want to invest in many different markets. I want to invest in Pittsburgh. I want to invest in Cincinnati. I want to invest in Indianapolis.” Because you want to diversify and you don’t want to be all in one location.
With that being said, we start off by looking at the people, we’re going to talk about that more. Then we look at the real estate. Those are the two main factors that we look at. We move on from there to look at the schools, the crime, and the local organization.
To talk about the people, the first point, now under each area we look at we look at several different things. If you have a pen and paper, it would be a good time to take notes [01:40]. There’s a lot of information here. Under income, you want to understand the averages and the extremes. You want to understand what the average incomes in the area are, but you also need to understand the extremes. The extreme on the high end and the extreme on the low end because those are your outliers, they’re going to skew your averages.
For example, if the average income, let’s say it’s $50,000 but there’s a high level of poverty in a specified area, that average income of $50,000 is going to be low. Or if you have $50,000 but there is one neighborhood that fits into that community that’s a really affluent area, then that $50,000 is going to be high. It’s very important that you also understand the extremes and not just the averages.
One of the areas that I use, and write this down, one of the resources that I use to find out a lot of this information about a neighborhood is a website called Neighborhood Scout. There are several others, Street Adviser and citydata.com. For us, we find Neighborhood Scout to be very reliable. I’m not a representative of Neighborhood Scout so if you sign up for them I don’t get paid anything. That’s just what we do, but if you do two out of those three and compare the data, you should come up with some pretty good information on the neighborhood.
For example, I’m going to keep using the same example. There is a house on a road called Curry Hollow Rd. I drew this presentation up about two weeks ago, and when I was drawing this presentation up, I was actually analyzing a property in an area but I hadn’t bought in yet. It was perfect timing. As I was drawing this presentation up, I was doing the same analyzation process on a property I’m going to call a Curry Hollow Rd.
On Curry Hollow Rd, in that area, the median household income is $75,000. Now, why is this so important when you’re analyzing a neighborhood? As far as the extremes, this happens to be a B-plus, A-minus neighborhood in Pittsburgh, believe it or not.
I know here that’s not a lot of money here, but in Pittsburgh a household income of $75,000 is doing pretty well. You have to realize that. The poverty level zero. There’s no skew on that number on the downside; on the upside, there are no super-affluent neighborhoods that are affecting this either.
Now, what we look for and it’s typical lender policy, but I have a mortgage background also, I owned my own mortgage company up until 2008. What I look for is a rental payment to no higher than 40% of the total net income. In this particular situation, the median household income net is $75,000. If you take $75,000 times 40%, that gives you $30,000 a year, when you divide that by 12, that’s $2,500 a month.
In this particular area, the average home can afford $2,500 a month in rental payment. That’s a good place to start when you’re analyzing a neighborhood. You want to know what the average household in that area can afford to pay. That’s going to help you determine the homes you look at and whether the home that you’re looking at fits the neighborhood, not every home fits the neighborhood.
Next, we’re going to talk about occupations. Knowing what people do helps to provide a product that meets their needs. On this Curry Hollow Rd example, 40% of the working population is employed in executive management and professional occupations while the second most common occupation is major sales accounts and working in fast food restaurants. Other residents are manufacturing and labor.
Based off of this information, we’re looking for homes and apartments that either fit single individuals or large families. When you have people in the management field in those type of occupations, they’re usually single people or people when they’re married that have larger families with pets even. You will have people between that, but to cater to the largest pool of potential tenants that’s what you’re looking for.
For example, in this situation, a two bedroom house is not the most ideal. You’re looking at an apartment for an individual, a duplex of two one bedrooms, or you’re looking at a three to four bedroom house that has a nice yard.
Also, what we look at are unemployment rates. Obviously, unemployment rates are very important. You want to try to hammer down the unemployment rates in an area to know if the people in that area can afford to pay you rent. In this particular area, with the Curry Hollow Rd example, the unemployment rate is 2.6% which is phenomenal as anybody knows.
Pittsburgh as a whole our unemployment rate is 5%. This area is even lower than the Pittsburgh but the national unemployment rate is between 7% and 7.5%.Now, just because an area may have above average unemployment rates does not mean that it’s not a good potential area to invest in. You have to take many other factors, you’re taking all of these factors together.
For example, some of the areas we invest in do have unemployment rates around 10% to 12%. However, we know in those areas that we are going to be renting to tenants who have subsidized housing which means they have Section 8. We are not against Section 8. Section 8 is another form of income; if you do the proper tenant screening, then Section 8 can work very well. Some of our best tenants are Section 8 tenants and some are not.
Another thing we look at is household types. What I mean when I say household types is, there are different studies and different documentation you can get out there to give you an idea of the household structure. Whether it’s a single individual, or it’s a one parent with a child or it’s two parents with multiple children. Once again, this is all important to make sure the investment that you’re buying is catering to the area.
In this neighborhood, as we said a few slides back, the majority of the population is a single individual living on their own, or a husband and wife with multiple kids and a pet. We make sure in this area that we are catering towards that.
When looking into people, we also look at home ownership versus rent ratio. Kathy stated that in the United States overall, that ratio is 60/40 of which I agree. In this particular area, the ratio is a 86/14. 86% ownership to 14 % tenants.
Looking from a landlord standpoint, that tells me that my property’s probably going to take a little bit longer to rent because I have a much smaller pool. In our C to C-plus neighborhoods, the ratio is that 60/40 ratio. In the B-neighborhoods that ratio is normally about 75/25. As you can see this is a B-plus, A-minus area. 86/14.
That’s something you want to take into consideration when you’re thinking about, “Hey, how long is my property going to sit vacant?” If I’m in a B-plus, A-minus neighborhood, I have less of a tenant pool so there’s a chance my property may sit vacant for a little bit longer.
Video 2 Transcript
Presenter: We’re talking about rental rates. Will your property provide enough return on your investment? There’s a lot of different ways to research rental rates. In this Curry Hollow Road example, the average rate for a three bedroom home is between $950 to $1,050. You obviously need to do this when analyzing your numbers. You need to be able to figure out how much the rents are in that area. Three bedrooms are $950 to $1,050, two bedroom homes are $750 to $850.
In addition to knowing what your rental amounts going to be, you also want to try to get an idea of the average rent increase in the area. For example, in this particular area, the average rent increase is 2.7%. That gives you an idea of what’s going to happen for you as time goes on.
We do several things, we dig really deep. We believe that if you’re going to invest in real estate, and you’re not willing to treat it like a full time business or connect yourself with a team that is, then you should not do real estate. Because you’re going to be one of those individuals who goes to meet somebody and when you’re watching a game or something, you say, “I tried that real estate investing and that doesn’t work,” and that’s not true.
It’s if you don’t either hook up with the team that this is when they do full time or you don’t make it a full-time business, it will not work. What we do is we use Craigslist. Now there’s different websites out there for determining rents. One of them is– does anybody know of any?
Audience Member: Rentometer.
Presenter: Rentometer? I’ve seen that, I’ve looked at that.
Audience Member: Zillow.
Presenter: Yes, Zillow. I’m always wary of Zillow. Have you used Rentometer, Rory?
Rory: Yes, I compare to that with Zillow just to get a benchmark.
Presenter: How do you find that works?
Rory: It’s pretty good actually.
Presenter: Okay, so Rory recommends using Zillow and Rentometer combined; we do look at those. What we do requires a little bit more work, but we find it to be fairly accurate. Here’s the two things that we do.
We go on Craigslist and we look at everything that is for rent in the area that’s comparable to what we’re looking to buy in that area. Then we look at all the pictures, and then we map it with Google maps to where the property we’re looking to buy is. Then we call those property managers, or listing agents, or owners and we talk to them about their property, ask them how long their property has been on the market, and different things like that.
The other thing we do is we look up all the property managers we can find in an area, and we call them up and we ask them, “How much do you think a three bedroom house is? Rents for in this area? How much do you think a two bedroom house rents for in this area?”After you call three or four property managers, you compare the data you find on Craigslist, you compare the data that those property managers gave you. You get a pretty good idea of what you’re looking to rent property for in the area. Yes, sir?
Audience Member: There is a Padmapper I think it’s called. It does Craigslist mapping over laying on Google Maps so you can see the neighborhood, the pricing. Do you use that?
Presenter: I like that. I’ve never seen that. You would save us some time. There’s always a new tip and I love that. There’s always something new to learn. That would be so awesome. Any other comments questions in regards to rental rates? Yes, Rory?
Rory: It’s similar with you mentioned calling property managers. Some states I know like Arizona, there are property managers that have massive websites that list their property for rent. That’s a real good source that I go and look at two or three of those, and I already know the areas.
Presenter: That’s very good. Rory just made a good suggestion, property manager websites. A lot of property manager websites have properties listed that they have for rent. You can use that in conjunction with Craigslist and the other things.
One of the reasons I do like calling the property managers is because they’ll start to tell you, they’ll say, “Yes, I just rented a property on this street for this much. I just rented a property on this street for this much.” That’s like having a sold comparable when doing a CMA. One of the good reasons for calling the landlords and calling the property managers is that they tell you what they just recently rented on what street and how much for.
If you’ve asked the right questions, how many bedrooms? How many bathrooms? How nice was the kitchen? These are things you have to take into consideration. Did it have a garage? Did they have an air conditioner? Was the kitchen granite? Did the kitchen have a backsplash or was it regular laminate countertop? Those are different things that you take into consideration.
Now to talk about the real estate. You’ve evaluated the people, you have a good idea what’s going on with the people. Now you need to evaluate the real estate in that neighborhood. You want to understand the vacancy rate in that neighborhood. How many homes are vacant in that neighborhood?
In the Curry Hollow road example, the vacancy rate is only 2.6%, that’s extremely low. That’s what you get when you get up into a B plus, A minus type of situation. The average vacancy rate in all of Allegheny County, which is the county that Pittsburgh is in is only 3%.
Our economy is really strong right now, we have a thriving situation. I would say, in a normal neighborhood, you’d be okay with a 4% or 5% vacancy ratio. When you start to see vacancy ratios up over 6%, 7%, 8% what’s happening in that area? If it’s an area that’s on the rise that’s really good, but if it’s supposed to be an established neighborhood and you have vacancy rates around the 8% or the 9% area then you just want to figure out why and what’s happening in that area.
Video 3 Transcript
Presenter: You want to know your appreciation rates in the area. All these different websites can give you that idea. For us, we’re looking for an area that’s growing and not declining, we’re looking for areas on the upswing not areas on the downswing, of course. We’re not investing for appreciation gains, our primary focus with investing is cash flow, but we do want to invest in an area that is growing and not declining.
Real estate, you need to know your expenses, because when you’re figuring out if a particular deal makes sense, what you’re doing is you’re taking your rent minus your expenses to give you your positive cash flow. Then you’re going to analyze that and you’re going to do a formula where you divide it by your total investment to decide what your return is.
We on an average provide returns between 11% to 12%. If we’re operating in a stronger neighborhood, we’ll go down to 9% but in Pittsburgh you’re going to find 11% to 12% is our average. You need to determine what return you need on your investment then you’ll be able to figure that out once you have your rental amount, you know about the neighborhood and you have your expenses.
The schools, that’s very important. A lot of these websites tell you what the actual school district is and the school district rating, then you need to talk to somebody more to understand about the schools in the area but be aware that in some areas there are multiple school districts. You need to understand exactly which school district your property is in, in that area then how does that school district compare with the other school district in that area? Are you in the better school district?
Some of our best investments, we go in to say a B-neighborhood, but there’s an area of that B-neighborhood that is less desirable. It’s a C-plus area in a B-neighborhood, but that C-plus area is still in that B-neighborhood school district. You have a B-neighborhood school district, a C-plus area, you could find some great deals in that area and it’s very attractive because of the school district.
That’s just one of the ways we find really good deals. For example, an area where we own a ton of property, one of the areas where Kathy bought, that’s a C-plus neighborhood. The rankings for that school district aren’t great. But, I grew up in that area, I grew up in that school district.
What I know about it, is that people in that area, people in that C to C-plus class, they sometimes put more of a value on sports than they do on education. In that particular area, the sports program is phenomenal. The football team is always very competitive, the basketball team is always very competitive, so the people who are going to live in that area right now desire that school district because of its sports program more than its education.
When you look up the ranking for the school it’s going to be low, but what I know is people come there just for the sports. Those are insights if you find out you could uncover a lot of good opportunity.
You want to find out the crime rate; in the Curry Hollow example, the crime index is 85, this is by Neighborhood Scout. The higher the crime index the better, so 100 is the best you can get. Then when you look at that crime rate, the breakdown of crimes is 3.8% are violent crimes and 27.3% are property crimes.
That’s the breakdown of the crime ratio that was given on Neighborhood Scout. Even if the crime index was say 50 which is in between, not the best, not the worst, but you see a low violent crime rating. That tells you that you’re going to have some property crime but it’s not a dangerous area to live.
Community organizations, I place personally, our company places a huge emphasis on community organizations. For example, when you Google this area, the Curry Hollow Rd example area, I googled it and I found Landlords Association and Community Development Corporation. This means, people in that area really care about the area.
What you’re looking for on Google. A lot of times if an area has a website, that means that there’s people in the area that are really proactive about the area. If you find an area where the area has a website, that’s a good thing. You’re looking for Community Development Corporation, Landlords Association, Historic Organizations. An area that has historical organizations is normally an area on the rise because homes have to be renovated to a certain standard.
For example, there’s one area we buy in where if we remove the windows, we have to put wood windows in because that’s what was there in the 1920s. Four years ago that area was a D-neighborhood, today it’s a B-neighborhood. That’s one thing that we really look at.
You also want to look at community events. You want to look at community watch organizations, and when you have all of that or some portion of that in an area, it tells you that the community is very involved. That’s usually a good area to invest in.
For example, on the Curry Hollow one, we located the date. If you go to the website for this area, which is called Baldwin, you’re going to find they have all kind of stuff. They have an Easter egg hunt going on, coming up. They have a Community Development Corporation. They have just so much fun stuff to do. They want to bring it together as a community.