How to Invest in Commercial Real Estate

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Episode #022 - Underwriting Commercial Real Estate - Free Underwriting / Due Diligence Checklist!

by Criterion, Braden Cheek, Brian Duck
February 19th 2021
Description - Download our FREE Due Diligence Checklist Today!

How to understand due diligence from both an Investors Pers... More

we have, we have a lot of people who are probably house flippers who like to use their hands to fix everything, manage everything. You need to stop doing that. We need to stop doing that. Guys hire a property management company. Your tenants will thank you, Your investors will, thank you. Bank will. Thank you. Everyone will thank you. Your spouse will thank you, master. What's up? Welcome back to head to invest in commercial real estate. Welcome back Today. It's all about underwriting and underwriting is is quite honestly, could be terrifying. So today is the idea of getting you from contract to close with peace of mind. Okay, so the biggest thing right, is we're going to give away our due diligence checklist. And and this is kind of like the bible, so to speak of underwriting, it will give you confidence. Um it'll help you out and it'll get him to a lot of the weeds that we might not get into on the show, but make sure you download it at um d d checklist, how to invest in CRE dot com. It seems like it could be a little intimidating to make sure you've got everything covered.

Absolutely terrifying. Um You know, I don't know about you guys the first time I was going through it. You feel like you're constantly forgetting something constantly because there's I mean, this list is what four pages and we have, we have over 40 three items you've just entered or you're trying to enter into some contract or some asset that's worth millions of dollars. And if you miss one thing, you're thinking that could cost me hundreds of thousands, you're buying real property. I mean that can be complicated, just entitled and abstracting and making sure you own it. You have to ensure it, you have to make sure it's occupied with tenants that are hopefully paying you money. You've got to get a massive loan on it, which you may have never done and might not even be your own money for the down payment, may be your friends and family, family's money and that's gonna keep you up at night. Um So you know, we'll go through some of the high level things traps um stories, stuff like that. But at the end of the day, you gotta go download the checklist dd checklist at how to invest the CRE dot com. Yeah. So you know a lot of people, we've been talking about what's going to keep people from investing in commercial real estate. And I think a couple shows ago we talked about is it's the fear of losing money and it's the fear of taking a risk and failing.

Uh So that is what is gonna keep most people, people might listen to the show, people might dabble and get a red house, but when it comes to buying a multimillion dollar commercial deal, it's fear that's gonna keep doing that. So today we just we're gonna give away the d D checklist, but like you said, getting someone from the time that they get assigned purchase and sale agreement to the closing is arguably the most scariest time because that's when you can make mistakes, you can miss something and then you've got this property with a huge loan and it's not what you thought. Uh that's why the D. D. Is really important. And I'll say I'm not an expert at D. D. I. Have I have a really good list and I have a really good professionals that we hire to walk us through that list and to make sure that we don't mess up. So who's on that list of professionals that you need? Because I I know I'm not an expert either. So I I feel like I'd have a lot more confidence if I had um some people who are going to help me, so who can who can help you with uh making sure you've got everything covered. Yeah. I think there's gonna be a ton of people on that team, but real quick before we dive too far.

And I think there's gonna be two viewpoints of this episode and it's going to be people who want to invest in in commercial real estate. And you need to understand due diligence. So you can know what questions to ask whoever you're investing in, right. Like you need to understand some of the things so you can trust that person enough to give them money, then there's gonna be another group of people who actually want to go out and buy these shopping centers or apartment complexes or that, that commercial deal themselves and they obviously need to understand because they're buying it. But going back to your question, who's on the team? Um, yeah, first, um, closer. Uh, so we, you know, title company will handle the closing, but what I would suggest is find a closing company with a person, a closer at that company that you get to know and you get to use on all of your deals. Uh, so that's number one free plug. I've used Megan Arnold at Oklahoma title and escrow and and that is the perfect example of who you want as a commercial closer because you get this person, you get this liaison to transfer stuff. You have no idea. Might as well be a different language on, on title work and then you get a person, hey, is everything good? Yeah, it's going great. Thanks Megan.

Okay, let me ask you so the title company can, they can use the same person no matter where the asset is. Yeah, yeah. You can, you can hire the closer, you would have to engage them specifically through the law firm, but like he's referring to theirs closers out there who just closed deals and a lot of times they can be associated with title companies. I think that's what you're saying. Yes. And I'm not sure. I don't think the title company we use can close deals in every state or they may be can't even write title insurance in each state. But from our perspective for a fee, they can handle our side of the closing, reviewing the title work, making sure the title insurance is there and everything else that goes into building that closing statement and and making sure the money is all going where it needs to go and that's good. That sounds complicated and expensive goal that's gonna cost a fortune. Uh a few $100 should get you there man, A few $100. Yeah, that sounds like money well spent. So if you have no idea on title insurance are closing commercial property. Just that right there a few $100 that's so cheap that money.

Well obviously there the title company will provide other services that cost more than that. I'm just talking about the fee to kind of handle the transaction in the paperwork. Yeah. And there's lots of closers out. There's lots of title company's title companies. Um you know, there's big national companies, we happen to be in Oklahoma which is this nice little gym of abstracting. So there's two out of the 50 states that still use the paper abstract and we, each state's different. You're not gonna wanna need to learn all that. The next person on your team will be an attorney and you know, there's a couple different ways you can go about the attorney. You know, there are, if you have a lot of money or a bigger client, they tend to hire really experience expensive attorneys that handle everything with the, the contracts and the closing and it's done professional. They're not going to miss anything. And that's kind of the primo, I would say Primo service to getting your deal closed again, going back to cost. How do you, how do you gauge that? I mean, what are you, what are you seeing out there? That's probably what, 2030 grand on a transaction that could be. Um, and on the high end and high end.

That's if an attorney kind of handles handles everything. Uh, we, we have done that on a couple of occasions, but I would say if you have an attorney that you can, uh, have at your disposal to, to review the purchase and sale contract and to make sure that you're covered there and then to handle any issues that come up during the due diligence, you don't need them to handle all of the, the entire process so that I would just recommend having one as part of your team that you can connect with but not having them do everything. Okay. Yeah. So attorneys are magical because they billed by the hour and they can work a lot of hours in today. Um, so what you want to do is make sure you're monitoring your attorney closely because if you go in with a very specific set of, of uh, you know, requirements, a very specific niche set of work that you're gonna go in and say, hey I need you to review this purchase and sale agreement. You're not engaging them a $30,000 team to say, Hey I need you and all of your colleagues to review every step in this transaction. You can buy that. But then right, you get under contract, you had them review the PSA and then the next thing you may need is maybe an amendment, you know, maybe 30 45 days later they're starting to get involved in.

Entitle in raising money or operating documents, stuff like that. But if you engage them on very specific things over the period of time, you can take that, you know, 15 to 30 grand maybe from your premium legal team and you may be able to get it for a few a few $1000 maybe total. Yeah, I was gonna say 35 on the low end. Yeah. Which is pretty affordable to get somebody who is licensed in law does real estate transactions. They're gonna protect you with with stupid little things that you can like force majeure, I guarantee you the first time you read it can't pronounce it guarantee 100% chance and you need to turn to explain that. And anyway, next one. Yeah. So uh management company I would say is is the next one. Property management, property management. So if you're not gonna do it in house. Uh Which may be a lot of guys. Girls starting out would not have that management and house is to get a local management company that's highly recommended by real estate professionals in the market. So let's pause there because I feel like this is a controversial subject. We have, we have a lot of people who are probably house flippers who like to use their hands to fix everything, manage everything.

You know that you need to stop doing that. We need to stop doing that. Guys hire a property management company. Your tenants will thank you. Your your investors will thank you. Bank will thank you. Everyone will thank you. Your spouse will thank you. Oh God, I want to say this about doing things yourself. I know we've probably said it before. I'm gonna say it again, is everything can be hired in this life. And so if you're doing work that can be hired, just figure out what it costs to do that work when it's all said and done. I mean the drive time fixing The toilet are handling a maintenance issue or delivering a lease. And if that's $10 an hour, that's $20 an hour, even $40 an hour. Is that really your goal? Because if it isn't, you have to be spending your time buying deals, I'm not sure that times measurable right at that time that you do that vs if you found another deal during the four hours that it took or eight hours that it took here and there or whatever, you just don't want to be doing yourself, we don't have to get into that too much. But the property management company, uh they will put together a budget for you, uh analyzing the leases and help get you ready on day one.

They're also going to look at all the service contracts from all the vendors that you're going to use the property, whether it's trash or a lot sweep or maintenance, things like that, they're gonna be able to put those together. So they brought you engaging them. I mean, how soon on? I probably engage them when I uh go non refundable with marinus money maybe. Okay, so we're, you know, maybe a month. And you're touching base of the property management company and it may be soon that if it's out of your market because you engage them for feedback. I, okay, that's a good point. So if you're going into a market, looking at a property maybe before you make the offer or you go under contract, you may ask, ask a couple different property management companies. Hey, I'm looking at this asset. Tell me about the area. Tell me about this asset. What do you know about it? They're going to provide really good feedback. Oh, that apartment complex. It's in a pretty good area. It's growing. The school district is great. Uh things are moving up or that that area that the town is really moving east of there and you're really on kind of the older side of town. Those are such valuable insights.

Uh and probably management's gonna be really good at giving you that info. Okay. And Real Quick, How is the best way to find 1? Uh Hold on, I got this, I got, this is my favorite google plus effort equals knowledge. And I say that sarcastically. But 100% of the time when I find a property management company in Newmarket, I'm googling property management companies because first of all, I want a property management company that's sophisticated enough to build a website in 2020 one and advertised. And I mean if you can't show up on google and the market then you're probably not big enough, right? And there's exceptions that super local, most likely old exceptions. But generally speaking, if you can't find them on google man, okay, I agree with that. You can find them on google. Other other avenues to find management companies are uh the local brokers who are the power, who are the power brokers because they will be advertising their name and you'll call them up and say, hey, here are the three best property management companies for this asset in your market, whether it's a multi family C class, whether it's in a class because the a class management company will be different than the C.

Class management company and the retail management company be different as well. So there's ways I think um make some calls a free plug you guys manage some property, don't you? You have if you have property in Tulsa Oklahoma multifamily or retail, we think we're really good at it. All right. So just closing up with manager Manager is a valuable asset uh to engage them before closing, they're gonna have to on board. You want them ready the day of closing, You wanna make sure security deposits lined up, You wanna make sure prepaid rent and taxes? Um I've had property management companies really saved my tail and free advice right until you start having them after they After the closing never paid an onboarding fee for management ever in my life. I don't intend to. Um yeah, management fees are charged after the day of closing, you know, 3-5% of revenue depending on your market and what you're managing, I would say. But yeah, really good. Really good partners. So I would I would spend some time picking, picking a good one. Um But that's definitely got to be on your team. All right. Another one you're probably going to engage pretty early is your lender. This may be one of the most important relationships on your deal, mainly because they're the majority of the capital stack.

So the capital stack, if you look at where the funds are coming from. If you have 100% of where the funds are coming from to buy the property, we've established that we're getting debt for, you know, 70-80% of the purchase price. So that means 70-80% of the money is coming from that lender. That's a super important relationship. They're gonna have a lot of stipulations and documents and so they're they're very interested in the property. So we're talking about underwriting, what is the lender, where does he help you with underwriting? Yeah. So where does he help you? Um I'll get into that. But the biggest thing that the lender is trying to make sure of is that they've got to make sure that loan is good. They need to make sure somebody's paying the loan and if you there's not a personal guarantee at first they want to underwrite the property, right? So I don't want to get too in the weeds, but they need to make sure that property can sustain the debt by itself without the guarantor. Anyway. They're going to help you because they're going to ask a ton of questions to protect their, their massive investment they're making in you. And some of those questions you may not have asked yourself or found out the answer to those, they're gonna be leases, They're gonna be title work. They're gonna be surveys, property condition reports, they want to know everything about this asset that you do.

So they're probably more interested in the overall than any of these other partners, right? These others might have some specifics, but to me, a lender would be interested in all this, All the underwriting. I'm not I'm not sure. Maybe I disagree a little bit lenders. I'm sure that they're going to provide better or more expertise than these other people are, agree, I agree with that because lenders are all over the board I find. Yeah, they, I've been told no on a really good property, I've been told yes on a questionable property but they are invested, they are going to be invested and so they are a good partner. You do need to know the lenders um have relationships with them and there's different lenders for different properties. So you're gonna need multiple uh multiple relationships on that front. Yeah, it can be super complicated. Like if you're getting cmbs or or life insurance debt, the lenders, attorneys teams that you get the pleasure of paying for are going to be so ridiculously cumbersome and they're gonna ask you to fill out documents that, I mean it's it's insane. Um But anyway the lender is going to require a bunch of stuff that's going to make you ask good questions or at least you have to answer them.

You can't just say, I don't know, you know, and you get turned down through this dichotomy of them asking questions and you answering them, you either get approved or not. It's pretty simple. So I don't know if this next one is has to be like a member of the of a team. A closing team but property uh condition assessment. You know companies where they provide a report on the physical condition of the property. So I don't know if they're a team because you may you may hire different ones but that's definitely something that you're going to need to do. They do what electrical plumbing structural. Maybe even it's it's just think they'll do as much as you want to pay them. Okay. They can do H. V. A. C. They could do roof if you wanted them to. They can do a general on on the roof or you can pay a little extra and and have a roof for make make a full blown report parking lot. H. V. A. C. Plumbing is one that we we've screwed up in the past. We didn't have the plumbing. Uh We didn't know to inspect the plumbing underneath this retail building and it all collapsed on us a couple years later.

And it was pretty expensive miss. And not only did we miss it on the the inspection side but we had our insurance agent that didn't get us. It wasn't our like our agent, it was an agent in the state of the property was in, didn't have us covered sufficiently for it. So it We missed it on two fronts. So I don't know if anybody's listening. Hopefully they don't make that mistake. Yeah and the beauty about this. I know we talked about that in a previous episode, but what do we do every single time now and we like I know I do it every single time. You guys are precision are probably doing it every single time. You know You're snaking the plumbing lines right? Because you got caught and it's like man we didn't snake the lines we got burned. You know, it was probably a $10 $20,000 mistake that it wasn't really big in the grand scheme of things. It was probably recovered. You know there's probably an insurance claim, not that big of a deal. It probably sucked in the moment. But now you know to snake the I mean snake it. Yeah, well we got sued by a couple of the tenants because the plumbing filled their space. So it ended up being a decent little problem for us.

Um But yeah, I think we've covered most of the people that need to be on your team once again, going back to the psychology of it is we're trying to get people in a position where they can take advantage of commercial real estate and getting them through the due diligence, which is the scariest time, which is the time that you're gonna make the most mistakes uh and getting them the confidence to close on their first deal is important. So that's why we're going to give this d d checklist away. Uh And it's not, don't don't think it's the end all be all uh it's a good comprehensive list you can add to it. But you've got to start with the list and start with the team members that we talked about you. And I was I was keeping track of the estimated costs. I know we didn't hit the property condition report. So going back to that estimated cost of property condition report is gonna be depending on what you inspect, how big the property is. There's a lot of variables but generally speaking a few 1000 Bucks a few $1,000, right? So we have a closer A few 100 bucks. We have an attorney 3-5 grand managers working for free and due diligence, right? Because you're not closed your property condition reports, your physical inspections are gonna be $3-$5,000.

So you'll have a you'll have a survey. But sometimes the seller pays for the survey, sometimes the buyer does that that can be a couple grand. You'll have a phase one report environmental um that that can be you know 1000 $2000. Um You Know, we're in for like 10 grand or less to go inspect this. Go and figure it out. Go and test it. And if the deal falls apart. Or if you find something that you can't live with your walking away from all that money and you need to be prepared for that. That that's a good that's a good point. And uh when when new people are underwriting they need to understand what these costs are gonna be because that will factor into their returns. So this this chocolate maybe when we give the D. D. Checklist we give a range of cost on a column next to these items. So that way uh they can know okay this is what a good due diligence costs me on a on a normal $5 million deal. And that way they can say okay I need to raise this much money and this is gonna be my my closing costs or this is some of the money I'm gonna spend from the time I go under contract to the time I close I'd say that's probably a big beginner mistake is underestimating or way overestimating due diligence costs but in general just missing that mark.

And uh I'm getting pretty damn close myself. I can I can typically dial that in um just estimation wise but anyway um it's D. D. Checklist, how to invest in C. R. E. Dot com. D. D. Checklist how to invest in sierra dot com. It's pretty easy. Go there download it felt your name, email super easy. It's absolutely free. Like Joel said it's not the end all be all but it's a really good starting point. Um And if you add some stuff feel free to let us know make sure you are liking and subscribing and then there's this tiny little button, it looks like, you know, there's waves over a bell. And then if you hit that, you actually get notifications when we drop an episode, which is every Tuesday and friday. And I gotta say We're pretty damn good about keeping that schedule because right now it's like 5° outside and we can't even park in the driveway because solid sheet of ice and we're still here to get the episode out on Tuesday and friday. So hit the thing, get the notifications. It'll make us happy. Anyway. We'll be back in a few days. Thanks guys. Thanks. Mm hmm.

Episode #022 - Underwriting Commercial Real Estate - Free Underwriting / Due Diligence Checklist!
Episode #022 - Underwriting Commercial Real Estate - Free Underwriting / Due Diligence Checklist!
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