Proper real estate due diligence is key to making a good investment return. There are so many things one needs to look for in order to make the right real estate investment.
As someone who has been investing in real estate since 2003, I've seen my fair share of wins and losses. There are many types of things to watch out for as I've written many times in the past.
Sometimes, black swan events happen, like the global pandemic which shut down hospitality and retail. These random exogenous variables is why diversification in real estate is also important.
The Rise of Real Estate Crowdfunding Since 2012
Since the passage of the 2012 JOBS Act, an excellent new way to invest in real estate is through real estate crowdfunding platforms. These platforms allow you to invest as little as $100 – $1,000 in commercial real estate deals that were once only available to institutional investors or ultra-high net worth investors.
The real estate platforms are marketplaces that first screen the best deals possible to then allow its members to choose. The platforms also actively manage each deal once fully funded for their fee. Just be aware that there is also platform risk as well.
Due to the importance of due diligence in the real estate investing process, I asked Jilliene Hellman, the CEO and Co-Founder of RealtyMogul to share her thoughts on the due diligence process.
How Real Estate Crowdfunding Platforms Perform Their Due Diligence
As the CEO at RealtyMogul, I have approved over 300 property investments ranging from debt and equity and multifamily, retail, industrial, office, hospitality, self-storage and mobile home parks. Since 2012, we have continued to refine our due diligence process and learn from our prior investments.
General Overview Of Due Diligence
The start of our due diligence process is a gut check.
Is this a market we want to invest in, with an operating partner we trust and are impressed with, in a property where we think there is an opportunity to make a strong risk-adjusted return?
In about 98% of the deals we see, the answer to this gut check is “no.” For starters, we automatically decline any requests for financing that are ground-up development, land, international real estate, or hospitality. Those are simply not areas where I am willing to take the risk required.
Assign A Due Diligence Team
Once we have a deal that passes our gut check, the next step is to assign a team to dive in more deeply. We have a talented team of underwriters and asset managers at RealtyMogul that I am incredibly proud of.
Our head of asset management has been with the company nearly five years. He has seen almost every deal we have ever invested in. He helps us to continuously modify our underwriting assumptions based on the actual results of our portfolio.
We use an underwriting process that we have internally dubbed “zero-based underwriting.” We put aside the financial model from our operating partners and re-build it from scratch.
We use industry data from CoStar and Axiometrics (two of the largest data providers in commercial real estate) to build our forward-looking projections. We review the actual results of the property over the last few years in addition to reviewing each line item.
For example, are expenses where we expect them to be? Will there be a new tax assessment after we acquire the property that we need to bake into the financial model? Are we properly accounting for replacement reserves to continue to maintain the building over time?
We also prepare revenue assumptions – given the market, do we expect there to be rental growth, and are there other areas where we can generate revenue? (i.e. laundry income or parking income or billing back utilities to the tenants).
Much of this is about financial data, but we are also digging deep into that market. How has the market performed over the last two decades? Where were cap rates in the market during the 2008 recession and immediately thereafter, and what are our expectations of vacancy in the event of a downturn? Understanding the state of jobs in the market is also critical – who are the major employers? Where do our tenants work and what enables them to pay us rent on time?
Reviewing The Operating Partner (Sponsor)
Once we have a financial model that we believe is rational and we like the results from a risk adjusted return perspective, the next step is to dig into the operating partner and the property management company.
What is their education and experience? Have they had success investing in this market using a similar business plan? Do they have the financial wherewithal to be able to secure competitive debt? How are their reporting capabilities? Are they responsive to our requests for diligence in a timely manner? Are they generally somebody that we want to associate ourselves with?
In addition to these questions, we run background, criminal, and credit reports on our operating partners. We are looking for any adverse items to get a decent read of their character based on their history.
Once our underwriting and asset management team has performed their deep dive, they draft an underwriting memo and present it to our Chief Investment Officer, Chris Fraley, and me.
Chris has been in commercial real estate for over 20 years. He was formerly a partner at Rockwood Capital, which manages over $8 billion in assets. I feel so grateful to have him by my side analyzing real estate investments. He helps determine if the potential risk adjusted returns of each deal are appropriate for our platform. He is my due diligence partner.
Regular Investment Committee Meetings
At our investment committee meetings, Chris and I drill into the specifics of the transaction. We ask dozens of questions to ensure we understand the risks, potential mitigants of the deal, and the history and track record of the operating partner.
In many instances, Chris and I will meet with the operating partner or will have already met with them in the past. We believe it is critical to get to know our partners on a personal level.
If Chris and I approve the transaction at investment committee, it is a considered a contingent approval which can still be overturned by the results of the site visit. Our due diligence has multiple phases.
Visit Each Property In Person
At RealtyMogul, we step foot on every single property that we invest in. This may be different than our competitors, but we cannot fathom putting a deal up on our platform that somebody from our team has not inspected in person.
There are so many unknowns when you analyze real estate from an Excel file and a PDF. You must see and touch and feel real estate to really understand the intricacies of it.
Related: Learn Why RealtyMogul Is Investing In Gateway Cities
Final Approval By Committee
Once the site visit is done, the lead underwriter will re-present the deal for formal investment committee approval. Our investment committee is unanimous – Chris and I both must agree that a deal will move forward. If a deal is going to be invested in out of one of our MogulREITs, there are additional team members who then get involved in the approval process.
In the case of MogulREIT I, our Portfolio Manager must approve and in the case of MogulREIT II, our independent Board of Directors must approve. After the proposed deal passes this rigorous due diligence process, it is exclusively listed on our platform for our members to invest in.
Investor Protection Is Our Goal
RealtyMogul was founded in 2012. While I wish I could say that all 300+ investments we have made have performed as expected, some transactions have exceeded projections, others have trailed projections, with the rest performing as expected.
While this is the nature of investing in real estate, we actively manage every investment through our asset management team to help operators mitigate problems and communicate to the investors important information about the deal during its hold period.
Prior to the close of any investment, we negotiate collectively on behalf of our investors for certain controls and rights that enable us to step in and point an investment in the right direction if things are going awry.
In some instances, we may have the right to force a sale of an investment if we think that is in the best interest of investors. But some transactions simply get off to a slow start – one of the things we have noticed, particularly in multifamily investing, is that it can take a bit longer for our operating partners project to start renovations.
It is unrealistic to assume that you may be able to renovate and re-lease a unit very soon after you acquire the property. Given our accumulated experience from prior deals, this is now one of many learnings informing how we underwrite new deals.
Related: How Is CRE Affected By COVID-19?
Invest With Confidence
Investor Protection is our top goal at RealtyMogul and I believe that our rigorous due diligence process facilitates this. Through our platform, we can finally level the real estate investment playing field by providing commercial real estate investment opportunities to everyone, instead of just to those with specialized knowledge, the right connections, or access to large amounts of capital.
Our members have direct access to our exclusive list of institutional-quality real estate offerings, and I am extremely proud of our team’s investment track record.
My other two favorite platforms that are free to sign up and explore are Fundrise for their eREITs and CrowdStreet for their 18-hour city investments. Both are excellent. I've personally invested $810,000 in real estate crowdfunding to diversify my holdings and earn income passively.
Disclaimer: Financial Samurai is an affiliate for RealtyMogul and RealtyMogul compensates Financial Samurai for generating leads. Securities are offered through North Capital Private Securities, member FINRA/SIPC.
Check out my Real Estate Crowdfunding Resource Page for more information.