Due Diligence Fundamentals - How to tell which investment will be profitable for your risk profile

Often the investor gets caught up in the emotional hype of the marketing pitch. I have seen many investors get hooked by the emotion of property purchases, resulting in poorly performing portfolios. Ask yourself 'Am I buying for profit or Prestige?'

There is no doubt that the prospect of a new purchase and the potential of future capital gain is alluring.

However, for the profitable property investor emotion is small part of the equation. A profitable property investor examines many aspects of the purchase, not limiting the examination to the property alone.

This is called �Due Diligence� and is carried out before any decision is made.

We could say that due diligence is a risk management process that is carried out by the purchaser of an investment designed to provide a calculated and predetermined outcome given market factors.

Due Diligence is an answer to the question: �How to tell which investment will be profitable within my risk profile?�

What does this mean?

Many articles and books have been written about Due Diligence and have summarised what they see as the key factors in obtaining profitable portfolios. They generally take the approach listing the obvious things to look for; location, location, location etc., however, this is only part of the equation.

New properties look good and can be great purchases but the purchase will depend on your current financial requirements for cash flow, the ensuing taxation benefits, finance requirements and the type of structure that you would use to purchase the property.

Due Diligence then is the risk management process that encompasses the above considerations and is outlined as follows:

Valuation

o Professional valuations will provide realistic parameters for price expectancy. They may not be accurate but will be unemotionally calculated from sales history in the area. Valuations from Real Estate agents can subject to the inconsistencies of the agents local or in-house economics.

Environmental

o This is where not only location comes into the equation but, aspect, surroundings, pollution, views, streetscape, local council plans, community facilities, transport, weather etc.,

Accounting and Taxation

o Every individual has different requirements for investment whether it be negative gearing, positive gearing short term tax advantages, wealth creation, wealth retention, cash flow or long term equity.

Finance

o What are the finance requirements for the investment? Do you qualify for a no-doc or a low-doc home or investment loan? What kind of investments can be safely geared and how? What investments require no or little deposit?

Structure

o There are numerous ways that an investment can be structured from single ownership to joint ventures to creative ways of financing a purchase. The structure of the purchase can make the difference between an opportunity or not.

Legal

o The way the sales contract is written can enhance the security of the opportunity or provide for enhancement of the investment.

Building Services

o Who built the investment and how well built is it? What is the history of the developer, architect and builder? What capital growth has developments by this developer, builder and architect experienced?

Market

o Market reports, demographics, history of sales and rentals in the area, migration and infrastructure information provide valuable information needed to asses the potential profitability of the investment.

Without addressing each of these topics investors are - exposed to unknown risk - only guessing at the opportunity in a potential investment.

The PIAA has developed a 5 Star Rating System for property investments that assists in the Due Diligence process.

The system provides comprehensive Due Diligence information about the investment opportunity and presents it in a way that the investor can better assess whether the investment is suitable for their level of risk or involvement.

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