Property investment due diligence
Research is an important part of any potential investment. As part of any investment strategy it is essential that a thorough and comprehensive due diligence process is carried out on the entire product and process prior to committing any funds.
What is due diligence?
The process of researching, evaluating and investigating an investment, investment vehicle or investment company in detail before committing funds. Investors need to take steps to research the investment vehicle, company, the project and any other parties involved as well as looking at all the facts of the investment and ensuring that they are fully understood.
Why carry out due diligence prior to investment?
To highlight risks and expose potential threats to your capital investment. It helps investors to make an informed and educated investment decision by laying out the facts and becoming aware of the risks involved.
Due diligence helps investors to understand the investment so they can ensure that the strategy is suitable to their investment needs and personal investment goals. Investors should feel comfortable with the investment and the company offering the opportunity.
Due diligence is an imperative part of any investment process, in order to ensure peace of mind and reduce risk. The importance of due diligence has increased since the global financial crisis and investor confidence has decreased.
What to include in your due diligence?
The Investment Structure
Each investment requires the investor to follow a certain procedure. It is therefore essential for the investor to understand the entire purchase procedure from start to finish, including exactly what funds are required, at what stage of the purchase, allowing for accurate cash flow analysis and maximum financial leverage.
Return on Investment v Risk Level
Many investments represent a level of risk that is often directly proportional to the potential returns. For example, high potential returns may represent the higher risk categories and vice versa. Investors should always take time to identify the potential risks and returns before assessing if they are acceptably balanced.
Suitability of investment
Careful consideration should be given as to whether the approach and terms of the investment are appropriate for the investor’s personal financial situation and investment targets. One consideration should be the amount of time any capital is likely to be tied up in the investment and whether access to these funds is likely to be required during the investment period. Additionally, for many investors cash flow may be an issue. The investor may determine that an investment that produces positive cash flow may be important as opposed to a back-end profit payout.
This is a major factor with any property investment. The location of an investment is directly linked to the ROI an investor can expect from both capital growth and rental yields. We recommend that investors look at comparable property and rental prices in the direct and surrounding competitive areas of any proposed investment to obtain firsthand knowledge of pricing and, where and when possible, personally visit the property.
Typically, early entry into emerging markets can offer the highest return on investment. However, in many circumstances, this is associated with the highest levels of risk. Whilst distance and accessibility can be key barriers to researching firsthand foreign markets, key assumptions can be made by looking at basic market drivers for the area.
Also keep in mind that different jurisdictions have differing laws of property ownership. The location of the property investment is an important factor that should be discussed for both legal jurisdictional issues as well as tax consequences.
If a market is expected to offer continued growth, it is important that as an investor you understand what the "market drivers" are for this growth. Some common "market drivers" are listed below:
A property purchase is only an investment if it is purchased at the correct price, allowing for its value to appreciate and/or generate solid rental returns in proportion to its cost.
An excellent sign of a future investment property hotspot is when there are considerable infrastructural improvements being made to a specific area. Generally, this includes local attractions, services and amenities, but also, and often most importantly, additional airports, ports and roads. The re-location of corporate companies and other industrial sites are also strong signs.
- Natural Factors
Many locations base their bid to increase tourism and property demand on the fact that the area enjoys excellent weather conditions or can offer features likely to hold strong leisure appeal such as beaches, countryside or mountains.
Tourism is the primary factor that enables many investment locations to create a successful property market. With increasing transport options tourists are visiting a more diverse range of locations both internationally and domestically. Areas that have cultural, natural or recreational appeal and especially those that in invest in their offerings are likely to benefit from inbound tourist activity and hence be a stronger investment proposition
- Local Demand
A key element to successful property investment is to invest in areas that have a strong local demand. This is often not in the aesthetically pleasing beach locations but in the centre of growing towns and cities. By investing in high demand locations such as these the investor is not limiting any potential resale to second home or overseas buyers. Often social housing and workforce housing projects can reduce risk significantly as there is a constant demand for low-cost housing.
- Political Stability
With terrorism around the world on the increase and many political, religious and legal implications to consider it is essential that the stability of an investment location is considered prior to any investment. Political stability of a location can act as a very strong investment market driver.
The Promoter of the Investment Regulation
Ascertain whether the product you are buying should be regulated by the relevant body in the country where the product is being sold and whether the company involved is sufficiently regulated. If they are not this needn’t necessarily be an issue provided the company in question can provide you with a full explanation of why not. Company background
It should be relatively easy to find out key information about the history, background and track record of the company in question. At the very least, searching the internet should reveal any negative postings and make you aware of potential issues.
Establish whether the company has a physical presence in the form of offices you can visit and individuals with whom you can speak on a one-to-one basis; do not simply take the presence of a website as proof that a company is what it purports to be.
Once the above factors have been considered the investor must be sure that the vendor/constructor has a proven track record and is operating legally, ethically and with sufficient funding. As mentioned previously, IPIN commissions independent lawyers to produce a legal review of all our projects prior to making them available to members, and if necessary you should employ a reputable conveyancing solicitor who will cover checks such as:
- Company Registration and Owners Review
- Land Title Confirmation
- Various Construction Licenses
- Developer Background Checks / Track record
- Build Quality Guarantees
- Sales Agreements / Contracts
If you are unsure about any investment, seek professional advice from your financial or legal advisor.
- Thursday 27 January 2011