Every experienced CRE investor has one lesson they learned the hard way whether it was a lease issue, hidden maintenance, financing, zoning, environmental concerns, or something else.
If you could give new investors one due diligence tip, what would it be?
We bought a duplex years ago that was a true fixer-upper. When I did my due diligenceand talked to the neighbors, it was clearthe current tenants had to vacate before I’d agree to close escrow and take possession of the property. Ladies of the evening in the front unit, and an unlicensed street drug pharmacy in the back unit.
I should have stipulated that they not only vacate the property, but that I could do a walk-through after they left to make sure they hadn’t damaged the units further on the way out.
The druggists painted a huge orange-and-red pagan religious figure on the back bedroom wall. It was an evil spirit to indigenous peoples, and I had to replace the drywall to remove it.
The “ladies” in the front unit scattered red Jell-O powder on the floors of the unit so the cockroaches would flourish and multiply. When I opened the door, a sea of insects covered the floor and clung to the walls. Millions of them. I went to the local hardware store and bought two bug bombs, returned to the property, and threw them in the front door. I locked the door and didn’t return for two days. I had to use a 2-foot-wide push broom to sweep the piles of cockroaches out the front door, and then replace all the carpet in the unit.
Silly me.
Why didn’t I do a walk-through AFTER they changed the locks?
The good news is: I had several lienholders on the property in 2nd, 3rd, and 4th position. I discounted those liens and refinanced to pay them off. It cash-flowed as a duplex once we invested in upgrades.
Two years later, we converted it into a 3-bedroom house with a 1-bedroom "mother-in-law setup with a separate entrance, carport, yard, and utilities. We spent 2k on the conversion and doubled the property’s market value. We sold it for a tidy sum and made a good profit.
One thing I would never skip is verifying the rent roll against the actual leases and payment history.
A spreadsheet can make a building look fully occupied and performing well, but that doesn’t tell you whether everyone is actually paying, how many tenants are behind, what deposits are really being held, or whether there are side agreements that never made it onto the rent roll.
I also want to see the actual operating bills, especially water, insurance and recent maintenance. Those are the numbers that can surprise you after closing.
A property can look great based on the seller’s summary and look very different once you start operating it yourself.
For rentals, I think the tenant files and actual collections deserve just as much due diligence as the physical building.