Real estate deals are the lifeblood of both cash flow and asset appreciation. Real estate is everywhere you look. The potential to find real estate deals are all around. However, not all real estate deals are the same. Not all real estate deals are well-located. Not all real estate deals offer great risk-adjusted returns. On the positive side, there are lots of deals that you can analyze in the market to determine whether the deals fit your investment criteria. I look at dozens of deals on a weekly basis. I offer on very few deals although I initially get excited about more. And on the deals I offer on, often times the price desired by the seller and the price that I am willing to offer is too great. Sometimes there are other competing offers that are marginally better that I lose out to, and sometimes we win the deal.
In order to get to the stage of winning a deal, there are many things that need to happen in order to move forward with a given deal. The steps that we take to analyze a deal are listed below:
Step 1 – Find deals that fit your criteria
In order to find deals that fit your criteria, you need to know your criteria.
- What market or markets do you want to invest in?
- What types of properties do you want to invest in?
- What are your return expectations?
- Will you do the property management or do you need a 3rd party manager?
While there are methods and systems that you can develop to find deals on your own, it is imperative to engage multiple brokers in the market or markets that you are involved in. Brokers are in the business of knowing real estate owners and in understanding which owners may have an interest in selling at some point. The point is that you need to talk to brokers and tell them what you are looking for. Tell them what kinds of deals to keep you in mind for. Let them know what kinds of assets you are seeking. Give them your back story so that they know you are someone that is serious about moving forward on deals. In addition to brokers, you should also utilize various resources – both offline and online. Not all online resources provide current or relevant deal information, but you should use these sources nonetheless. When it comes to brokers, trust but verify. Brokers are salespeople selling high ticket items. While the vast majority of brokers are good at understanding the asset and the market, too many brokers oversell the future upside. Do your own analysis and come to your own conclusions.
Step 2 – Analyze the deal financials
It comes as a surprise to many beginner investors, but you will look at way more deals than you will analyze, and you will analyze way more deals than you will end up writing offers on. When I started in residential real estate, I offered on properties much more quickly. I would look at 5 properties, offer on 2 and get 1 of the deals. The hit ratio was 20% of what I looked at and 50% of what I offered on.
When I moved into multifamily and commercial properties, I would look at 5 deals per week. I would analyze 1 deal every other week, which means that I would only analyze 1 out of every 10 deals I looked at. And I would only write an offer every three months or so. Over three months, I would look at nearly 60 deals, I would analyze 6 deals, and I would write an offer on 1 of those deals. Over the year, I would look at around 240 deals, I would analyze 24 deals (10% of the deals that I looked at), and I would offer on 4 deals (1.67% of the deals that I looked at). The hit ratio ended up that I would win 1 deal out of every 2 or 3 offers, which means that I was doing 1 to 2 deals per year initially. Nowadays, I do more deals per year, but my success ratio has increased as I have fine-tuned my model. I now do a mix of multifamily and commercial properties in a number of markets. I also invest indirectly with other Sponsors who I know, like, and trust.
Step 3 – Write a non-binding Letter of Intent (LOI)
When writing an LOI, it is important that you do the basics of a business letter. You should include your contact information at the top of the letter and you should include the information of the person that you are sending the letter to whether that is the seller or the seller’s broker.
You then need to put in the details of the offer including price, earnest money, deposits, due diligence time periods, contingencies, responsibilities for a Purchase Agreement, title, and closing conditions. We have an example of a non-binding Letter of Intent that we use on YouTube in a video title Understanding Letters of Intent.
Step 4 – Negotiate the Purchase Agreement
Once you have a fully executed LOI, you will either wait for the Purchase Agreement from the seller or you will draft the Purchase Agreement for the seller depending on whose responsibility it is from the Letter of Intent. Purchase Agreements are highly detailed and legalistic. You should get comfortable with the major points and understand that everything in these contracts is up for negotiation prior to when they are signed.
The things that you should include or ensure are included in the Purchase Agreement are the following:
- Property Description
- Any and all transfer documents (Deeds, Assignments, Bill of Sale, etc.)
- Earnest Money
- Purchase Price
- Due Diligence
- Title Review
- Financing
- Tenant Files & Lease Reviews
- Contingencies
- Inspections
- Default Provisions
- Seller Representation and Warranties
- Closing
- Post-Closing Requirements
Step 5 – Conduct your due diligence
After the execution of the Purchase Agreement, you will be involved in multiple activities in parallel. You will be arranging financing, obtaining insurance quotes, conducting title review, and doing your property level due diligence. Listed below are the primary due diligence activities that you should conduct after negotiating and obtaining a fully executed Purchase Agreement:
- Review Title and make objections if necessary
- Do a deep Market Analysis where the property is located
- Analyze Job Growth
- Analyze Population Growth
- Research the area Rent to Income ratio
- Analyze Actual Rents versus In-Place Rents
- Understand Market Vacancy
- Review historical Real Estate Taxes versus expected Real Estate Taxes
- Analyze the Rent Roll
- Compare the Leases to the Rent Roll
- Calculate the Property’s Performance Using the Trailing 12-month Financials
- Evaluate in-place Insurance compared with Insurance quotes from your insurance broker
- Review all Utility bills and compare to your projections
- Review Historical Repairs & Maintenance
- Do a Contract Review
- Look at Historical Capital Expenditures to determine what work has been completed on-site
Step 6 – Arrange financing
Send your underwriting, the Offering Memorandum, and any due diligence to your mortgage broker or directly to your direct lender. If you need assistance with obtaining quotes for your commercial real estate financing deals, please feel free to reach out to Guardrail Finance. We can obtain a range a quotes from various lenders that we have worked with over the years and we can run the process through our technology-drive mortgage banking platform.
Step 7 – Close the transaction
When your due diligence is completed and your lender is ready to close the transaction, get your cash equity prepped for the closing and send the money to escrow. Sign the transfer docs, loan docs, and title docs with escrow. Then take title to the property.
Step 8 – Post-Closing Property Operations
Once you have taken title to the property, get the utilities and service contracts assigned over to you. Ensure that you send out a letter to your tenants letting them know who to send rent checks to and where to send the checks.
You have now gone through the stages of a real estate deal. You are now the proud owner of a cash-flowing property. Congratulations!
Until next time, happy investing and let’s continue growing both our passive cash flow and net worth together!
Robert Newstead