Real Estate 027: All About Home Inspections (Rental Property Edition)
/A critical step in the home purchasing process is due diligence. Assuming that you have done your market research, found a deal, and negotiated it under contract, its time to conduct a home inspection to ensure that there are no surprises that significantly change your cash flow numbers. As Ronald Reagan infamously said, "Trust, but verify." Home inspections are a great way for a buyer to hire an objective third party professional to be your eyes and ears, especially if you are unable to physically visit the subject property.
The first step in home inspections is to find the right inspector. For investors, this means finding a team that is investor friendly and understand where you are coming from. There may be "add-ons" to the inspection package that an investor may not need as they are not occupying the property. Further, you may come across a conflict of interest when inspectors also perform repair/rehab services as they may be incentivized to recommend repairs and attempt to perform the work themselves. Hiring an inspector who's sole job is to find issues without being the remediator will allow you to have an objective helper.
Below are a couple ways that I have found my property inspectors when investing in a new market:
Property Manager
Real Estate Broker/Agent
Google (Yelp/Facebook Groups/Bigger Pockets)
Fellow investors
Local Real Estate Investment Association (REIA)
Once you have created a short list of inspectors, make sure you have a phone call w/ them to set expectations, check if they are properly licensed and bonded, request sample inspection reports, and understand costs involved (e.g. Single Family Residence, Duplex, Quads, Radon, Termite, and Sewer Scoping). Although inspectors will have disclaimers stating that they are generalists and not experts when it comes to specific issues such as the foundation, electrical, and plumbing, etc. their experience inspecting homes will allow them to help identify patterns and trends when it comes to issues they have seen in the past. For example, an inspector who has seen a hundred homes in a certain zip code will understand the nuances of that neighborhood and will be able to advise the buyer in a more specific manner. In my experience, I have been able to find an investor friendly inspector who knows I will be a repeat customer, offer special pricing, take additional reference photos (not in the report) as well as walkthrough the inspection report with concerning areas.
Once the home inspection has been scheduled, be sure to coordinate with your Broker or Property Manger to make sure utilities are turned on so that the inspector can test lighting, appliances, and other CapEx items. Upon successful completion of the inspection, its time to assess remedial costs. Generally, your property manager, handyman, or General Contractor should be able to put together a "high level" bid for you to take to the seller and negotiate a credit at closing, reduction in sales price, or seller repairs. Of the three aforementioned scenarios, I prefer a credit at closing as I would like my own team to perform the work and control the output. Sellers may opt to use cheaper materials or put "lipstick on a pig" that may result in reperformance of the work down the road. Further, I do not have my rehab crew put together a detailed scope of work at this stage, as I do not know if the seller and I will be able to reach an agreement. Reason being, if market conditions do not allow for us to reach a deal, I do not want my team to have spent to much time on this project.
Some of the red flag issues that may cause serious concern relate to:
Significant termite damage
Mold
Radon
CapEx (Roof, Wiring/Electrical, Plumbing, HVAC, Structural)
Asbestos
Lead Paint (Generally found in homes older than 1978, highly toxic and a health hazard)
Flood Zone
Please note that if you are financing your property, your lender may request many if not all of these above items to be remediated before closing. Further, your lender will typically require an "A" grade insurance plan to cover liability of the property, and your insurance company may deem these issues to be uninsurable. These are real problems that you need to consider before moving forward in the purchasing process. Be sure to differentiate the "must repair" items with the "nice to have/value add" repair list. The seller will generally list the house taking deferred maintenance into consideration (e.g. old carpet, cabinets, touch up paint, fixtures, windows, etc.).
Refer to my previous blogs on negotiating real estate (e.g. Never Split the Difference book review, and buying real estate through seller financing) for tips and tricks on how to speak with the seller. Bottom line, remember you are not trying to squeeze ever dollar out of the seller, but you are simply trying to hit your pre-defined cash flow numbers and renegotiating the deal based on newly discovered facts. Remember to use your Real Estate Broker as a sounding board when negotiating as an experienced Broker will have a good idea on the After Repair Value (ARV) and local market cap rates that typically drive the selling price. In addition, be strategic when negotiating issues with the buyer and make sure you highlight the high dollar value items and not make a long list of minor repairs. Show the seller you are a reasonable buyer who has identified these issues, but am willing to give up the smaller things (e.g. cosmetic repairs below $100) in order to close the deal.
In addition to the inspection report, its always good practice to perform an inquiry with the seller or their representative agent to understand their motivation for selling, which may sometimes uncover issues the owner is currently facing or have faced in the past (e.g. high vacancies, vandalism, wet basement, or roof damage due to high winds/hail). Further, you will be able to get a sense of whether or not the seller is trying to hide or conceal issues from you as you begin to ask probing questions.
As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.
Good luck!
