Residential Real Estate Investing Requires a Risk Mitigation Review and Return Proposal Analysis

Investors approach to analyzing investments is often irregular and not protected by experience and a disinterested view. This often leads to unnecessary investment risk and if included could actually make good investments much more attractive to qualified investors. This article attempts to layout a plan that provides this disinterested view and pro active risk management approach.

We believe that prudent investors need to distance themselves somewhat from the project. Banks attempt to accomplish this through the use of the appraisal, property condtion reports, environmental studies, surveys, and collecting other information on the principals. This is not an ineffective approach, but the approach fails to consider the investment in the context of the plan and the total financial strength of the proposed investment. The investor needs to remain connected to the context of the investment, but achieve an unemotional decision based on merits and issues.

Conceptually, achieving this goal requires the following actions:

1. The information from the standard reports needs to be collected. From this, the investor needs to extract: 1) property taxes, 2) immediate improvements, and 3) improvements for the upcoming 5 years, and 4) any other actions that require funded work. Also, the investor should look for structural issues such as lack of central air conditioning, aluminum wiring, lead paint, or other items that may require financial planning into the project. Ideally, the investor should estimate the cost of these items.
2. The investor needs to review the intended improvements planned by the principal or for the project. The cost of these items needs to be measured for accuracy.
3. Financing terms and conditions must be clearly defined prior to the investment. The terms need to be certain at closing. They must allow for timely refinancing if the exit does not develop. The potential requirement for additional capital should be understood should any assumptions fail.
4. The operating income and expenses need to be measured against local projects. The expectations need to be judged for their reasonableness and likelihood. Occupancy should be verifiable for similar projects with similar traffic.
5. Accounting and cash management plans and capacity needs to be proven, must provide for critical accruals especially payroll tax, property tax, insurance, and reasonable capital reserves.
6. Reserve accounts must be fully funded at closing for capital reserves, taxes, and insurance. Additionally, reserves for exit and wind up are prudent. Also, an initial operating reserve post closing should be budgeted and detailed. Finally, a contingency reserve is prudent.
7. Finally, a review of the operating agreement should confirm that assets cannot be sold out of the investment without reasonable approval of the investors and that the investor has adequate involvement should additional funds and support be required.

Investors probably are well advised to engage resources to answer these questions prior to closing as part of their diligence and either influence the principal to add these to the project if not provided or forego the investment.

Blake Ratcliff (US Naval Academy Graduate & Marine Officer, Serial startup entrepreneur, COO/CEO, multifamily / residential investment founder, and property manager).

Blake’s crafted 100+ business plans, prepared and delivered 1000+ investor presentations, and is an expert financial modeler. A deeply experienced real estate business person and startup business expert, Blake hones your Business plans, reports, and presentations.

Visit http://internationalresidentialrealestateinvestorsassociation.org/real-estate-project-services-due-diligence-reports-business-plans.