Ben Said It Best
Ben Franklin once said, "Diligence is the mother of good luck." In real estate, thorough due diligence is the barometer of success. Ignore it and you might strike out in the first inning. Excel at it and you might hit a grand slam.
Real estate investors understand the importance of due diligence. However, even with hard work and good intentions, life doesn't always go your way. Markets change. Partnerships fail. Pro-forma statements over promise. And issues are overlooked.
Currently, my partners and I are working through a due diligence miss that is going to be a pricey fix.
Follow The Rules
My business partner and I first got interested in the asset class in July 2015. For over a year, we networked, read, spoke to brokers and industry professionals. We even purchased an educational information package for $1,000 with a detailed due diligence manual. We put in more effort than most new people I had spoken to. For our first acquisition, we partnered with a reputable mobile home park operator. One of the benefits of doing so was that we assisted them with their due diligence process.
Shortly after, we connected with an absentee owner that was getting sickly. She owned the property for over 10 years and she wasn't able to give the property the attention it deserved. The numbers were attractive, and the strategy was crystal clear. Raise rents and cut expenses to increase cash flow. We raised the necessary capital and closed on the property in January 2017.
Something Is Wrong
Operations were going better than expected. Rent increases went smoothly. We experienced few collection issues. In the second month, we rented a unit for $50 per month higher than we underwrote the deal.
Then one day we got a call from the state water utility commission. They mentioned that the water bills seemed extremely high for the number of units. It was running close to three times the normal limit. We immediately called the manager and asked to look around the property for leaks. He found one. We fixed it, but the problem persisted. We conducted a water audit, and the engineers noted that this problem has been going on for at least three years. The problem still exists.
How did we miss this? We followed seasoned investors' advice. We went through the process before. Why wasn't this evident when I looked through the documents the first fifteen times?
After talking with our property manager, leak detection experts, city water officials, water engineers, and multiple plumbing companies, the collective group hasn't been able to come up with a definite plan to reduce water consumption. At this point, we are guessing until we dig into the ground. All of this could have been avoided if we dug deeper in due diligence. We didn't do the math on the water usage on a per unit basis. Honestly, we didn't even know how much water a mobile home usually used in a month before this happened. What you don't know can sink you.
One way to mitigate this situation is to partner with an experienced investor for multiple deals to see the common mistakes.
The Saving Grace
We learned that even though we felt we had prepared thoroughly, we will still make mistakes. As Mike Tyson once said, "Everyone has a plan 'till they get punched in the mouth". All investors take jabs. They are unavoidable. Some you can't control while others will alter your approach to purchasing real estate. In all deals going forward, we will tighten up our due diligence process. We probably won't make that mistake again, but we will most likely make another one in a different area. Real estate isn't about not making mistakes. It is bound to happen. It is about reducing your downside risk and buying low enough will help weather any storm you might inadvertently put yourself in.
Luckily, we purchased this cheap enough that we should still make money after all the repairs have been made.