The difference between a successful Real Estate IRA investor and a not-so-successful one often comes down to due diligence. The investor who understands what goes into valuing a property, to include historic and expected cash flows coming in and out as well as risk – is able to make better decisions than a less skilled investor. If you’ve been blindsided by the unexpected as an investor – or if you believe you could be – here are some tips from experienced professionals to improve your due diligence and help you avoid getting caught unawares by the unexpected ever again.
- Don’t rely on pro forma financial statements and projections that you get from the seller. This is a common rookie mistake. But most of the experienced and successful investors we speak to have never seen a case where the actual cash flows from a real estate investment were better than the pro formae. Any such information you get from the seller should be considered, at best, a wildly optimistic scenario. You want to pay a fair price for the property’s actual performance, not the best-case but highly-unlikely scenario.
- Verify everything. You want to physically see proof of existing rental/lease agreements for rental properties and multi-family dwellings. Compare claimed rental income to bank account deposits. Are they reasonably close? Chances are they aren’t what the pro formas project!
- Dig through liability estimates. These are the expected liabilities, or the ‘negative cash flow’ events you can expect once you own the property in your Real Estate IRA. State law may require the seller to disclose all known liability issues to you prior to closing. But don’t rely on this. Always do your own digging. How old is the roof? The HVAC unit or units? The furnace? Are there issues with plumbing? Wiring? The septic tank?
- Don’t skip the title search. You don’t want to get hung up by a competing ownership claim on a property, nor an outstanding tax liability issue that makes it too difficult or time consuming to close, reducing or eliminating the profitability of your investment. You also want to identify any liens on the property that have to be paid off at the time of transfer.
If possible, take a look at the relevant tax returns. Look at the expenses and repairs that the sellers are claiming on their own tax returns. This helps ensure that the expenses claimed in the pro formas are reasonably correct.
This also helps flush out encumbrances and debts on the property that are not publicly recorded, but could bite you in the tail once you own the property.
- Query the current property manager, if any. Is there any money they owe outstanding to the property management firm?
- Look at interest expense deductions. Is the amount claimed under interest expense accounted for by the debts they’ve disclosed to you? If they are paying much more in interest than you can account for in their disclosures of outstanding debts, it could indicate some significant debts they’ve left out. Follow up.
If you are interested in exploring the many advantages of owning real estate within the tax-advantaged structure of an IRA or other self-directed retirement account, call us today at 866-7500-IRA. Or visit our website at www.americanira.com.