Updated: Aug 17, 2022
When buying a new rental property, we need to take care of a few things.
To ensure we are buying a good property, we need to follow the steps.
To ensure we are ready for whatever comes, we need to collect the supporting documents.
I divided the checklist into phases: before purchase, while in escrow, on the day of closing, and after purchasing.
Make sure that the deal makes sense
While this is an obvious step, it is also the most important.
Even in the buy & hold niche, there are different strategies for different strategic goals. One strategy can be "cash flow at all costs," regardless of equity. Another strategy is to get all the invested money back after refinance and some cash flow. Any combination of equity and cash flow is also a possibility.
In the chart: Buy and Hold different strategies.
Whatever strategy you are implementing, make sure that the specific deal makes sense.
Note: Some savvy investors have other strategies that a specific deal might not make sense without understanding their complete picture.
Running comps ("comps" is an abbreviation for comparables) means extracting your property's value based on similar properties recently sold. The property's value is referred to as ARV or After Repair Value.
Things to note:
The properties we use for comps must be sold and not for sale.
Properties used in comps analysis should be of the same type - if you buy a duplex, i.e., a valid comp will be another duplex.
You should have ten properties to have a good comps analysis.
You can ask a valid question - why should I run my comps? I can get comps from the real estate agent and Zillow's estimated price.
For that, I answer that it is true, but not enough:
The realtor can also pull a CMA (comparative market analysis) from the MLS. I don't use this method often, as the realtor chooses the specific properties for comps and will lose commission if the deal falls through.
Zillow's estimate (AKA Zestimate) is as good as the comps the algorithm automatically pulls, and sometimes they are not good. I.e., two adjacent properties can belong to different property classes. Lastly, savvy investors can manipulate Zestimate (remember that some savvy investors will buy deals that don't make sense? Well, this is one of the reasons for that).
I have a thorough comps process to uncover the property's ARV that I will share in another article.
Note: If you can't find good comps, ask yourself why? Why is this property so different than whatever is sold? Why are no properties being sold in this area? It might be okay - i.e., an area with a high percentage of owner-occupied properties or a rural area, but be aware.
Put an offer
At this stage, you should go ahead and put the property under contract - we already know that the deal makes sense, and we have time to complete our due diligence while the property is under contract.
Note: I don't recommend you to put under contract properties you don't intend to purchase eventually.
The contract will include the closing date and what kind of contingencies you require - the most common contingencies are inspection and financing. The contract will include additional disclosures from the seller, i.e., tenant's rents, disclosure of details on the property, etc.
Your offer should include proof of funds, and if your offer requires financing, you should be preapproved and show the doc proving it.
Once you have an executed contract, you can proceed with the due diligence process.
Inspecting your property before buying is one of the best value-for-money investments you can make while purchasing a property. Inspectors see dozens of properties in your market and can point out whatever stands out and can check things that an untrained eye can miss.
For a relatively small amount of money (anywhere between $200 - $1,000 for a 1-4 unit property), the inspector will provide the inspection results, which will be very detailed. Most of the things in the report can be easily fixed and are nice to know rather than must fix. The best thing to do at this stage is to call the inspector and have a 10-15 minutes discussion on the property. Some things are better explained verbally, some things are forgotten, and you can ask whatever you want.
If you found things that change the deal, i.e., additional renovation costs, you can either renegotiate the price or back out of the deal.
Now is the time to transfer the earnest money deposit to the leasing agent/title company (depending on the deal). Make sure you have the correct details of wiring.
Before purchase - summary
Now that we covered the steps we need to take before purchasing a property, let's summarize and see the docs we have
Who Should Provide It
What is it?
The contract binds you and the seller to execute the deal.
Confirmation you paid (and therefore business expense) for inspection
List all things that are not okay with the property.
Tenant's details, leases, are they current on rent?
Agent / Lawyer
Understanding the occupancy status, if you inherit problems, etc.
Signed doc that you waive the inspection and agree with whatever was found. If you want a discount following the inspection, this doc will mention it.
Title / Lawyer / Agent
Instructions on where to transfer the earnest money.
Earnest Money deposit confirmation
Confirmation you wired the earnest money.
Now that we covered what should be done before the purchase, let's proceed to the next step - while the property is in escrow.