Is this bargain-priced property a diamond in the rough?

With real estate values holding fairly steady over the past several years, investors are quick to jump on a perceived bargain. While getting rock bottom pricing isn’t a bad idea, investors need to be careful about doing their homework before closing. A bargain can quickly turn into a problem if you fail to consider more than just the price. Here are five other factors to consider.

Zoning

Check zoning authority records to determine if there are any plans to change the property’s permitted uses, and if existing approvals and permits are transferable. If not, it could be difficult to obtain any required variances or permits. Remember, most lenders won’t extend a property loan unless it’s zoned for your intended use.

If you’re purchasing property located in special public financing or redevelopment zoning areas, it may be subject to land-use restrictions. However, these properties may be eligible for property tax abatements and income tax credits for rehabilitation.

Tenants

A high vacancy rate can doom a bargain property. Spending time finding new tenants can be consuming and costly, especially if you need to first renovate the vacant space. If the property has a relatively low vacancy rate, review existing leases for any unfavorable terms and evaluate the financial standing of every tenant.

Before purchasing a multitenant property, compile a current rent roll summarizing key details for every tenant, including:

  • Move-in date,
  • Security deposit,
  • Escalation clause,
  • Expiration date,
  • Outstanding rent balance, and
  • Options to extend or purchase.

Make a note of tenants who are behind on their payments, leases nearing expiration and rent rolls that differ significantly from the seller’s income statement.

Maintenance and carrying costs

Some bargain-priced properties are distressed. If so, it’s likely that routine maintenance and repairs have been neglected. In that case, you’ll need sufficient capital to bring the property up to rentable standards, possibly leaving you unable to market vacancies for some time.

Remember, if a building is off the market because it needs maintenance or code compliance work, you’ll have to shoulder carrying costs without offsetting rental income for a while. This includes property taxes, mortgage payments, insurance and so forth.

Environmental concerns

Your lenders will most likely require a Phase I Environmental Site Assessment. This looks for environmental conditions that could create potential liability for the buyer by analyzing the property’s past and current uses. The assessment generally covers both the underlying land and any physical improvements to the property.

A note of caution: Cleanup costs and liability for lurking environmental issues can pile up quickly. Often anyone who’s owned the property may be jointly or severally liable for cleanup. Have your real estate advisors and attorneys review applicable federal, state and local environmental regulations, including any that could limit future uses. Review any environmental reports, notices of violations and pending litigation.

Legal issues

Sellers of bargain-priced property may have fallen behind on obligations to contractors and other third parties. If so, you may incur costs to locate lien holders and obtain releases. Code enforcement fines may also come into play.

Verify certain contractual obligations of third parties, too. Find out if the warranties, guarantees, indemnities and rights under the original construction contracts are assignable.

Look at the big picture

Risks and threats also may lurk outside of a bargain-priced property. To help estimate the neighborhood’s future property values, research the crime rate, median income of tenants, rental rates of comparable properties and unemployment rates for the past few years.

Most real estate investors will want to act quickly when presented with a bargain-priced property. But be sure to take the time to perform thorough due diligence, because some bargains may just be too good to be true.

We can help

Contact an Elliott Davis advisor to see how we can help.