Investor Awareness: Real Estate
Learn what you need to do to protect your real estate investment.
When purchasing real estate in a Self-Directed IRA (SDIRA), whether it’s a single-family rental house, vacant land, or a 50-unit apartment building, the investor should always perform their due diligence. Due diligence is the step-by-step process of evaluating an investment to protect yourself from investment fraud. This includes performing calculations, reviewing documents, procuring insurance, and walking the property. In other words, doing your homework on the property before you make the purchase could save you from a deal that could potentially be risky. During your real estate due diligence process, there are a few key steps you should take.
Title Review
One of the first things you should examine as part of your due diligence is the title history on the property. All title documents are public records that can be researched and reviewed. A thorough title review will expose whether there is any litigation pending that might threaten the title of the property, whether the seller has title to the property, and whether the seller has any encumbrances or financial obligations attached to the property, such as a mortgage or tax lien.
Contract
Be sure to read the contract and that you fully understand the contract you’re reading. The contract should allow you time to perform due diligence, giving you the option to walk away for any reason and have your earnest money returned in full. This time frame varies, and it could range anywhere from one week to a couple of months, depending on the nature of the investment property. If you need help with the contract, you should always consider seeking the help of a real estate professional or an attorney who has experience with commercial real estate. If a seller vigorously pushes you to shorten your timeframe, this could be a warning sign. Train your mind to be cautious of sellers who want you to make quick decisions.
Inspection
Have a professional inspection performed on the property. A licensed, professional inspector can review the structural integrity of any building on the property and can also point out any potential physical problems with the property.
Appraisal
An appraisal will give you a third-party estimate on the value of the property. This will tell you whether the amount of money you’re about to spend on the property is worth what you think it is. Appraisals are generally necessary if you want to finance the real property purchase with a mortgage loan. Even if you are paying cash and an appraisal is not required, you should still consider getting one, as it will help you evaluate the value of the investment.
Environmental Assessment
If a visual inspection of the property reveals any potential environmental hazards or problems, you should consider ordering an environmental assessment of the entire property. Some of the things that might cause you to order an environmental report include leaking gas or oil containers, possible wetlands or clean water issues associated with water on the land, or former use of the property as a manufacturing or mining facility.
Land Use Controls
The final consideration you should take into account is the zoning of the property. You need to make sure that the property is zoned for the intended use, otherwise you may face legal issues or difficulties in obtaining permits. For example, if you want to use the property to start a business, you need to verify with the local zoning authority that the property is zoned for commercial use or that you have a reasonable chance of having the property rezoned as commercial.
Commercial Real Estate Additional Due Diligence
Commercial real estate requires more in-depth due diligence, and you will want to get information about rental history, vacancy rates, maintenance fees, property management fees (if property management needs to be hired out), taxes, insurance, and leases. Read the leases very carefully! Questions you may ask yourself as you review the lease might include the following:
- Is this a triple net?
- Who pays what?
- Who’s responsible for what?
You’ll want to investigate your financing options and determine your fixed and variable costs in order to see if the return on your investment is in line with what you had in mind.
Investing in real estate with a SDIRA can be a rewarding strategy, but it also comes with some risks and challenges. Conducting the proper due diligence is important so that you are well-informed and prepared before making any purchase decisions. By following the tips shared above, you can avoid common pitfalls and ensure a smooth and successful transaction. Remember, your IRA is a powerful tool for building wealth and securing your future, but it also requires responsibility and care.
