The single most important aspect in real estate investing is due diligence.

What is due diligence? Due diligence is a focused attention given to research and study about a specific investment property being considered for acquisition or sale by a real estate investor—due diligence is the free-look phase of a purchase built around questions that have to be answered about the property. In short, due diligence is about discovery.

The breath and scope of due diligence depends on the investor’s goals, and its intent is really to answer the question: “Does this transaction move me closer to my investing goals?”

Okay, when does a real estate investor conduct a due diligence? Simple, the complex nature of real estate has made it imperative that the due diligence process be completed prior to making any final decisions to buy or sell.

When making a real estate acquisition, be sure that your offer includes contingencies for a due diligence that clearly put the seller on notice that you will be researching specific items about the property and you will be making your final decision to buy based on that research. For example,

1. Physical inspection of the property, including the interior of all units
2. Reviewing financial details of the property, including expense statements and profit and loss statements
3. Inspection of all rental agreements and rental applications of existing tenants
4. Securing financing
5. Obtaining clear title

Real estate investing is a business; due diligence is simply a logical process that helps insure that the real estate investor is a prudent business person and makes wise real estate investment decisions.

The correct calculation for a rental property’s operating expenses are crucial to real estate investment analysis, and play a vital part in real estate investment decisions.

That seems obvious, and almost redundant to restate, but truthfully, even with quality real estate investment software, many do present APODs (annual property operating data) and proforma income statements with operating expenses commonly skewed in three areas.

1. Vacancy rate – the tendency for many is to show a vacancy rate based on the past performance of a rental property—sometimes even at zero percent! This is not realistic, however, because market conditions, property wear and tear, rent increases, and even a change of ownership can, and often do, cause vacancies. It is always prudent in real estate investment analysis, therefore, to include an allowance for vacancies characteristic to the local market.
2. Maintenance and repairs – it is a mistake to show the amount actually spent over the past several years. It is helpful for a real estate investor to know what an owner has done to upkeep the property, but past expenditures are not necessarily relevant to what a new owner might spend in the future. The current owner, for example, might be a repair-person capable of keeping maintenance and repair costs reduced, whereas the new owner might be required to contract it all out at top dollar.
3. Replacement reserves – most tend to ignore this altogether because reserves for replacements are not a fixed reoccurring expenditure like property taxes, utilities, or trash. It is, however, wise to include an allowance for reserves in a real estate investment analysis because it provides for future replacement of worn out items an owner must eventually pay for and therefore plan to spend.

If you are doing a real estate investment analysis, and uncertain what allowances to include for vacancy, repairs, and reserves, ask a local appraiser, or perhaps a local real estate professional who understands rental property.

The important thing is not to make real estate investment decisions based on incomplete operating expense data. It might easily result in your dream investment property becoming your worst nightmare.

There are certainly reasons why it would be wrong for you to purchase a rental property.

Just because a rental property is beautiful, for example, is not a prudent reason to for you to become a real estate investor, nor should you invest in real estate simply because it is located in the same neighborhood where you grew up.

On the other hand, there are good reasons to consider becoming a landlord and sound reasons why you would get involved with rental property ownership. Let’s look:

1. You want to take advantage of the IRS depreciation factors made available through property ownership to help write-off money you earn at your regular job.
2. You are planning for retirement and are looking to add to your nest egg when you someday sell the rental property for a profit.
3. You are planning your children’s college tuition and would like to set up a property account to act as a savings account.
4. You want to earn some extra income to provide a more steady base income.
5. You want to beef up your net worth with a portfolio of properties to make yourself more attractive to lenders and subsequently better qualified to borrow more money—perhaps so you can invest in a business venture.
6. You relish the idea that real estate property values are increasing, and would like to cash in on rental property appreciation.
7. You see an opportunity to purchase the building your business is located in to help reduce the overall cost of operating the business and thus, enhance your profits.
8. You want to own real estate in order to diversify your investment portfolio.
9. You simply want to make money.

It should not surprise you that the good reasons for investing in real estate concern money– rental property ownership is a business, after all!

The important thing is not to mix business with pleasure.

Do your homework. Learn the value of income property in your area; watch the for-sale ads in the paper, speak with appraisers, bankers, and real estate investment professionals.

Most importantly, after you locate a rental property, be sure to run the cash flow, rate of return, and profitability numbers. Not in your head, plan to invest in a good real estate investing software program–remember, real estate investing is a business you want to manage like a CEO.