Vetting your real estate investment

Editor’s note: This article is reposted with permission of Zillow. View the original item: "How to Vet an Investment Property."

By Leonard Baron

Lower home prices and mortgage rates are causing many people to consider taking the real estate investment plunge. But as with any big financial investment, what may be a good strategy for some may be harmful for others.

If you are planning on trading cash in lower-risk certificates of deposit (CDs) or bonds for real estate, you are trading into a dramatically higher-risk asset.

However, if you do decide to jump into the investment property game, you should make sure to vet the property investments you plan to acquire to better increase the chances that the real estate you buy will increase your net wealth, not decrease it.

This is, of course, assuming you already understand the most important item in investing: making sure the property you are buying is cash flow positive based on conservative estimates, and that it provides you a fair rate of return on your investment. (Read more about estimating cash flow on properties.)

What other items and issues does a buyer need to review when buying an investment property?

Home inspection

Most people know to always have a home inspection done when they are buying property. While a competent home inspector will note all the items working or not, the inspector is not pricing out the costs to get all those items repaired, nor other items like painting, flooring, etc., that you might plan to have done.

It’s your job to put together a list of all the work and get with your contractor to price them out. Put that number into your financial analysis and note that properties in poor condition rarely sell at a large enough discount to compensate for all rehabilitation work that needs to be done!

Title abstract and insurance

When you buy property, a title policy protects you in case there is a title problem, like the seller’s ex-fiancé was a part owner in the property but didn’t sign off on the sale. In this case, it is the title insurer’s problem and the title insurer will cover costs to defend you and settle any dispute, up to the policy maximum limit, unless the title issue was "excluded" from the title policy.

The Schedule of Exclusions will note issues the title insurance policy will not cover, like recorded easements. It is vital to review the information there as well as in the title abstract. If there is a title issue that was "excluded" from coverage, it is your problem, not theirs.

Survey, plats, legal description

Your land, lot or condominium — plus parking spaces and storage — will also have a defined legal description of what you own. There may be a county plat showing it and/or you might want to have a survey done of the lot lines.

Either way, you should walk the property and compare what you physically see to what is on the plat/survey to make sure you are comfortable that no neighbors’ fences, driveways, etc., are encroaching on your lot.

If it is a condominium, make sure you review the recorded rights to your interior space, patios, parking spaces, storage, etc.

Homeowners association

If you are buying a property in a common interest development like a condo or townhome, you are not only buying your individual unit, you are buying into the larger entity. Thus, you are responsible for your share of the cost to pay for those, via homeowner association (HOA) fees.

There are many many risks related to HOAs; a few range from unfunded reserves for repairs and replacements to litigation and water issues.

You can do analysis to better reduce your risk of buying into an HOA that is in a disastrous state, but you have to do the hard work of doing the proper due diligence.

Financing

You also need to make sure you are getting a fair deal on your mortgage financing. Just getting a bid from one lender is not good enough. Shop around to get pricing from at least two lenders and carefully compare those mortgage bids to determine which one gives you the best fees vs. interest rate.

It’s not easy to do, as the good faith estimate (GFE) forms are quite complicated, but that’s no excuse for not doing the proper analysis.

Insurance

Lastly, do you have the proper type and amount of insurance coverage in place? Make sure to sit down with your insurance agent and determine what you need to be adequately covered. Look into umbrella policies as well as earthquake, interior condominium HO-6 insurance policies and any other coverage you need.

Pick your real estate agent’s brain so you have the proper coverage for your risks.

A real estate investment, whether rental property or a home, is the largest, most complicated and riskiest purchase you will ever make. Experienced investors know how to better reduce their exposure with the proper due diligence; you need to make sure you know how to do the proper steps, too!

It’s your money, and your retirement, at risk. You don’t want to find out, after disaster strikes, that you could have reviewed, analyzed, researched and done the hard work upfront to have protected yourself and avoided that issue from ever happening in the first place.

Leonard Baron, MBA, CPA, is a San Diego State University lecturer; a Zillow blogger; the author of several books, including "Real Estate Ownership, Investment and Due Diligence 101 — A Smarter Way to Buy Real Estate"; and loves kicking the tires of a good piece of dirt! See more at ProfessorBaron.com.

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