Investing in real estate offers an incredible path to building long-term wealth. This is why I’ve been doing it for so long! But, buying an investment property also comes with some major risks. As such, new and experienced investors alike should ask certain questions when buying a property.
Personally, before buying a property, I like to break down the questions I ask into four categories: questions I ask 1) myself, 2) a real estate agent, 3) the seller, and 4) the inspector or GC. With the answers from these questions, I can decide whether or not a particular deal makes sense for me.
In the rest of the article, I’ll dive into the major questions in each of these four categories. Specifically, I’ll cover the following topics:
- The Benefits to Buying Investment Properties
- The Importance of Due Diligence
- Category 1: Questions to Ask Yourself
- Category 2: Questions to Ask a Real Estate Agent
- Category 3: Questions to Ask a Seller
- Category 4: Questions to Ask the Home Inspector or General Contractor
- Final Thoughts
The Benefits to Buying Investment Properties
Before getting into the nuts and bolts of different real estate purchase questions, I want to first provide a broad overview of different real estate profit paths. When investors understand how real estate creates wealth, they gain a more thorough appreciation for its potential value. And, related to this potential value, understanding these wealth-building avenues should force any new investor to stop and think: am I doing this correctly?
In other words, buying real estate can have huge consequences. Invest wisely with appropriate strategies, and you can build tremendous wealth. Conversely, make the wrong moves, and you can dig yourself into pretty significant financial and legal trouble in the blink of an eye. With that said, here are the major ways that investing in real estate builds wealth:
Property Investment Profit Paths
- Value-add appreciation: When investors, particularly ones pursuing a fix & flip strategy, improve a home, they add value to it. By repairing a roof, repainting an exterior, renovating a kitchen, or any other of a countless number of improvements, investors increase the value of a home. And, if done correctly, the increase in value due to an improvement will be greater than the cost of the improvement itself. Investors who sell a property shortly after these renovations realize that value in the sale.
- Cash flow from rent: With a properly analyzed deal, investors will collect excess cash flow from a rental property every month. Depending on your wealth-building priorities, you can use this excess cash flow multiple ways. For example, to build your rental property portfolio, you can set this money aside every month until you have enough for another down payment. Alternatively, you may want to diversify your savings and use this cash to invest in stocks, bonds, and mutual funds.
- Loan amortization: When investment property tenants pay rent, that money pays your mortgage. With an amortizing loan like a mortgage, a portion of every payment reduces your loan balance. As your loan balance decreases, your equity – or ownership – in the property increases, building your overall wealth.
- Property appreciation: As the above chart demonstrates, property investors also benefit from long-term property appreciation. While home values may fluctuate in the short-term, if you hold for an extended period, you’ll likely benefit from property appreciation, or increases in value. As the values of your property investments increase overtime, your net worth builds with them. This relates directly to a wise saying related to property investments: don’t wait to buy real estate; buy real estate and wait.
Now that I’ve outlined these profit paths, I’ll turn to the central focus of this article: due diligence and the questions investors should ask when buying real estate.
The Importance of Due Diligence
Generally speaking, due diligence means investigating the background and condition of a house. More specifically, investors want to know about a property’s physical condition, its financial issues (e.g. unpaid property taxes), and its location (e.g. the state of the local market).
In other words, think of due diligence as “doing your homework” before buying a property. Would you buy a car without taking it for a test drive and examining its accident history? Absolutely not. And, you shouldn’t think about buying a property – a far larger investment than a car – without doing some in-depth research on the home. If you don’t do your due diligence before buying a property, a seemingly good deal can become a nightmare pretty quickly.
For example, say the seller has done some DIY improvements. If you don’t confirm that those repairs are up to code, you’ll be on the hook for fixing any code violations before reselling the property – potentially costing tens of thousands of dollars and turning a profitable deal into a loss.
But, investors shouldn’t view due diligence solely in terms of the property itself. Rather, savvy investors consider due diligence through the lens of all questions they should ask. More precisely, I recommend breaking down due diligence into four different categories of questions: ones you ask 1) yourself, 2) the real estate agent, 3) the seller, and 4) the home inspector.
By asking the below questions to these four individuals, you’ll have a solid answer to the most important question: should I buy this property?
Category 1: Questions to Ask Yourself
- How much investment risk am I willing to accept?
Every real estate investment includes some level of risk. And, as with all investments, real estate risk typically relates directly to returns. In other words, the more risk you assume, the more reward potential in a deal. For instance, commercial real estate development from the ground up offers some of the highest returns in the industry. But, successfully taking a property from a patch of dirt to a stabilized commercial property comes with massive risks, as well.
On the other hand, you can limit your risk (not eliminate) by purchasing a turnkey rental property. With these deals, you buy a ready-to-occupy home – typically at retail – and a management company handles all aspects of the deal (placing tenants, operating the property, maintenance, etc.). But, this approach also significantly cuts into your returns, both due to the retail purchase price and monthly management fees.
Recognizing this risk-reward spectrum, investors should ask themselves how much risk they’re personally willing to accept prior to purchasing any property.
- What real estate investing strategy do I want to pursue?
Real investing strategies relate directly to risk. As stated above, some strategies simply entail more risk than others (and, in theory, reward). While not an all-inclusive list, here are three of the more popular investing strategies among residential real estate investors:
- Fix & flip: With this approach, investors buy distressed properties in need of significant repairs – typically at a deep discount. Due to this level of disrepair, these properties generally do not qualify for the traditional financing that a primary homebuyer would use. As such, the house flipper renovates the property so that it will qualify for traditional mortgages, sells it to a primary homebuyer, and collects a profit on the difference between total costs and the sales price.
- BRRR: This stands for buy, rehab, rent, and refinance. Similar to house flippers, BRRR investors buy and rehab distressed properties. But, rather than sell them post-rehab, they rent the renovated homes to long-term tenants. Once they’ve placed these tenants, the investor then refinances the short-term, high-interest hard money loan used to finance the purchase and rehab into a long-term, low-interest permanent mortgage. After this refinance, BRRR properties function like any other long-term rental properties.
- Turnkey buy and hold: Investors using this strategy seek to minimize rehab and maintenance work. Rather than buy a distressed property to renovate, they buy move-in ready homes – typically at retail price. As a result, these investors tend to have smaller margins, but this strategy also requires far less work.
While fix & flip and BRRR target properties look more or less the same, turnkey ones are move-in ready. This reality illustrates why it’s so important to define your investing strategy before purchasing a home.
- How do I want to finance a home purchase?
A saying exists in real estate: financing is king. The best deal in the world doesn’t matter if you can’t figure out how to pay for it. Accordingly, before purchasing any property, you’ll want to confirm how you’re going to pay for that property. Many residential real estate investors use hard money loans due to their A) speed, and B) ease of approval. But, other options include putting your own cash into a deal, bringing on business partners, borrowing from family, or any other number of financing strategies. Regardless of how you plan on financing a purchase, make sure you answer this question before trying to buy a property. Otherwise, you’ll end up missing out on a deal when your funding falls apart.
- How much day-to-day involvement do I want to have with the property?
In some respect, this question revolves around your investment strategy. For instance, assume you want to pursue a fix & flip or BRRR deal. If so, someone will need to supervise the day-to-day renovation work. Will that be you, or do you have a general contractor you trust? Similarly, for BRRR deals, will you manage the tenants personally, or will you hire a property management company?
There aren’t any “right” answers to these questions. But, investors should consider this level of involvement before purchasing a property, as this will allow you to solidify the necessary professional relationships.
NOTE: As a rule of thumb, time commitment and profit are directly related. The more time and effort you put into a job, the more profit you’ll earn. Conversely, by paying other people (e.g. contractors and property managers) to work, you’ll save time, but these expenses will also cut into your profits. Once again, the answer to this question comes down to your unique life situation and investment objectives.
Category 2: Questions to Ask a Real Estate Agent
- Do you have experience working with investors, and do you have a plan for off-market strategies?
This is always the first question I ask a potential real estate agent. If agents don’t have experience working with investors – and understand what investors are looking for in a property – why use them? I can pull my own information from the MLS (or one of its data aggregators like our Investor’s Edge).
Normally, I want to work with an agent who also invests on the side, as this means he or she likely has a very clear understanding of what sort of properties I want to buy. And, directly related to this, investors usually don’t find successful deals on the MLS. Instead, we look to off-market properties with less competition and better prices. Any investor-friendly agent worth his or her salt will have a clear and executable plan for going after these sorts of off-market properties on your behalf.
- Are there any municipal zoning restrictions?
Some municipalities severely restrict home improvements that change the current layout of a property. Before diving into a deal, you’ll want to consider what is and isn’t allowed with local zoning laws.
A homeowner may or may not know the answer to this question. But, a real estate agent – especially one used to working with investors – will absolutely know how to track down this information.
- Are there any tax liens on the house?
Similar to title issues, tax liens mean someone else has a claim to a property – in this case, the local government. While this may not be a dealbreaker, you’ll want to absolutely know about any tax liens and incorporate those payments into your deal analysis before buying a home.
Once again, you can – and should – ask the homeowner about this. But, if someone’s trying to quickly offload a property, he or she may be less than forthcoming about potential issues. Instead, a real estate agent can help walk you through the public records to confirm no liens exist on a given property.
- What school district is the house in, and how is it rated?
This can make a huge difference for potential buyers and renters, and it will certainly factor into the pricing decisions for both fix & flip and BRRR strategies. Real estate agents have very specific non-discrimination rules about what they can and can’t say about the quality of a local area. But, they also have in-depth understanding of local markets and will likely provide you a more honest answer than the seller.
- What is the current tax-assessed value, and what is the local property tax rate?
This proves particularly relevant to BRRR investors. Property taxes represent a major operating expense for a rental property, so you’ll need to clearly understand these amounts to accurately project future cash flows.
And, you certainly don’t need to ask a real estate agent this information. Tax values are publicly available, and a couple minutes of digging in a municipality’s online database will pull up the records on a given property. But, for new investors unfamiliar with this process, it helps to have an experienced real estate agent guide you through the process.
Category 3: Questions to Ask When Buying a Property
- Is there anything special about the home I should know about?
Some houses have that extra “something” that makes them more appealing to potential buyers. It could be proximity to a great playground, or some intricate carpentry that really brings out the features over the living room fireplace. Bottom line, some homes have neat characteristics that may not jump out to casual viewers. Current homeowners can help explain these little perks to you.
- Why are you selling the home?
This provides you two key pieces of information. First, if it pertains to issues with the home, you’ll gain more insight into the repair needs that the place needs. Second, when you learn someone’s motivation for selling, you can better craft your purchase offer. As real estate investors, we’re problem solvers. Helping a home seller solve his or her problem can be a win-win: get the homeowner cash and find a great deal.
- How long have you owned the home?
Normally (though not always), the longer someone has owned a home, the more equity he or she has in that property. When people have equity in a property, they typically have more incentive to sell, as they can convert that equity into cash. Conversely, it can be more challenging finding motivated sellers among homeowners with little to no equity.
- How long have you been trying to get rid of the house?
This informs your approach to negotiation. If a homeowner has been trying to sell a place for a year, he or she will likely accept lower offers or more concessions. Alternatively, a homeowner who listed a property a week ago is probably willing to hold out and test the market for a while.
- When do you need to move/sell?
Once again, this information can inform your negotiating position. If a homeowner absolutely has to move/sell by a certain date, he or she will likely accept a lower offer in order to meet that deadline. Additionally, investors have an inherent speed advantage. Using cash or hard money loans, we can close on homes far more quickly than people using traditional financing. We can use this fact for negotiating leverage, as well.
- When is the earliest you can move?
This information provides you more fidelity on seller motivation – or lack thereof. If a seller responds with something along the lines of “I’ll give you the keys now!” he or she likely has tremendous motivation to make a deal happen. On the other hand, someone in no rush to move may not have the same level of motivation, meaning you may struggle to negotiate a good deal.
- How much were you hoping to get?
A saying exists in real estate price negotiations: those who state a price first, lose. As an investor, you never want to be the first party to float a price. Let the seller make this decision, and you can use that as the basis of your negotiations.
- How did you decide on that amount?
After sellers state a target price, ask them to explain how they came up with that number. If they can justify the price, it may tell you something about the quality of the deal. If they can’t, you can use that inability to negotiate for a lower price.
- What’s the least you would take for all cash and a quick closing?
After a homeowner states an initial target price, I like to follow-up with this question. Psychologically, it seems like I’m offering a benefit, so the homeowner will feel obliged to provide an associated benefit. For example, if a homeowner initially asks for $150,000, and I then ask this, he or she will often want to reciprocate, potentially knocking $5,000 or $10,000 off the asking price on a quick, all-cash closing.
- Is there a homeowner’s association (HOA)? If so, what does it cover, and what are the fees?
HOAs can be a blessing and a curse. On the one hand, they often handle exterior maintenance, common area upkeep, and landscaping. On the other hand, you need to pay HOA fees, and these associations can be compliance nightmares, making every little thing you do to a home a complete pain. Before buying a home, you’ll want to confirm exactly what a HOA does and how much it charges.
- What are the included utilities, and what are the average monthly bills?
Does the house have gas, or is it just electric? This is just one utility-specific piece of information that will affect a future rehab. Additionally, if you plan on leasing the property with a BRRR strategy, you’ll want to have a solid estimate of monthly utility bills, as this will impact your bottom line with renters (unless you pass-through utility responsibility to tenants).
Category 4: Questions to Ask the Home Inspector or General Contractor
- What are the general home characteristics (e.g. bedrooms, bathrooms, square footage, etc)?
Before buying any home, you’ll want to confirm its general layout and characteristics. As an investor, this information will prove critical to developing accurate comps, both for valuation and rental purposes.
For example, if a home has two bedrooms, one and a half bathrooms, a one-car garage, and is 1,200 square feet, you’ll use that information to determine local rents and values for similar properties. Without this comps data, you cannot reliably analyze a deal, regardless of whether you plan on flipping it or taking a BRRR approach.
While your real estate agent will pull this information from the MLS, you’ll verify it on the home inspector’s report.
- Does the home have central heat and air?
Central heat and air – especially in climates experiencing temperature extremes – can make a huge difference in a home. For house flippers, if you buy an old house without central HVAC, you’ll need to closely examine the local renovated homes. If the other rehabbed properties do have central HVAC, you’ll need to install it during your rehab process. Otherwise, your home simply won’t be competitive when you list it for sale. And, this sort of addition can cost tens of thousands of dollars, making this a critical piece of information to consider before buying a home.
- Has the homeowner done any major repairs? If so, are they up to code?
Unfortunately, when people take a DIY approach to repairs, they often take shortcuts. This may include quality issues, or, more concerning, the repairs may not be up to code. As an investor, you become responsible for these code violations if you purchase a home with them.
NOTE: This is a question you’ll likely ask of the homeowner, as well. But, you’ll want to ensure your home inspector or a general contractor verifies that any improvements are to code.
- What repairs are needed on the home?
Both house flippers and BRRR investors buy properties with the intention of renovating them. But, there’s a huge difference between “sprucing up” a place and needing to repair damaged foundations, holes in the roof, busted plumbing, etc. These major repairs can cost a ton of money, and before moving forward with a deal, investors need to account for these repair costs in the deal analysis.
As with prior repairs, I recommend asking the homeowner about this info. But, you’ll still need to verify repairs during an in-depth walkthrough with your general contractor – not just your home inspector. Unfortunately, home inspectors typically don’t look beneath the surface, so they may not pick up on structural, plumbing, or electrical repair needs that aren’t clearly visible.
I firmly believe in the long-term wealth-building value of real estate. It’s why I’ve been in the industry for so long! But, before blindly diving into buying your first investment property, you need to do your due diligence. If you ask the above questions, you’ll be able to confidently answer the most important one: should I buy this property?