When a bargain isn’t a bargain

Factors to consider when purchasing property

Even though today’s real estate market has improved, you can still find investment properties at bargain prices. But, as with any real estate investment, the price may be too good to be true. Therefore, you’ll need to consider more than just the purchase price.

Who are the tenants?

What may seem like a bargain property can come with a high vacancy rate. Finding new tenants can be time consuming and costly, especially if you need to first renovate the vacant space. Even if the property has a relatively low vacancy rate, examine existing leases for any troublesome terms and evaluate the financial standing of every tenant.

Before purchasing a multitenant property, review existing leases. Then compile a current rent roll that summarizes key details for every tenant, including move-in date, security deposit, escalation clause, expiration date, outstanding rent balance, and options to extend or purchase. Watch for tenants who are behind on their payments, leases nearing expiration and rent rolls that differ greatly from the seller’s income statement.

How about zoning?

Most lenders won’t extend a property loan unless it’s zoned for your intended use. Check to see if zoning authority records suggest any plans to change the property’s permitted uses, and if existing approvals and permits are transferable. If not, it could be difficult to obtain any required variances or permits.

Property located in special public financing or redevelopment zoning areas may be subject to land-use restrictions. On the upside, these properties may be eligible for property tax abatements and income tax credits for rehabilitation.

What are the maintenance and carrying costs?

If the property is distressed, it’s likely that routine maintenance and repairs have been neglected. If so, you’ll need sufficient capital to bring the property up to speed, possibly leaving you unable to market vacancies for some time.

Regardless of the property’s vacancy rate, you must pay its carrying costs — property taxes, mortgage payments, insurance and so forth. If a building is off the market because it needs maintenance or code compliance work, you may have to shoulder carrying costs without offsetting rental income for a while.

Are there judgments, claims or liens?

The seller of a bargain-priced property may have fallen behind on obligations to contractors and other third parties. In such cases, you may incur costs to locate lien holders and obtain releases. Code enforcement fines could also come into play.

Verify certain contractual obligations of third parties, too. Check to see if the warranties, guarantees, indemnities and rights under the original construction contracts are assignable.

What about environmental issues?

Cleanup costs and liability for lurking environmental issues can pile up quickly. Often anyone who’s owned the property may be jointly or severally liable for cleanup. Determine the applicable federal, state and local environmental regulations, including those that could limit future uses. Review any environmental reports, notices of violations and pending litigation.

Lenders typically require a Phase I Environmental Site Assessment, which requires an analysis of a property’s past and current uses, looking for environmental conditions that could create liability for the buyer. The assessment generally covers underlying land and any physical improvements to property.

Take it slow

Finally, remember to check the crime rate, median income of tenants, rental rates of comparable properties and unemployment rate for the past few years to help estimate the neighborhood’s future property values. With the improved real estate market, you may have the urge to act quickly when you come across a bargain-priced property. But take the time to review all the factors discussed and perform thorough due diligence. Failure to do so could result in that bargain price evaporating and costing you more in the long run.