Due diligence is extremely important, regardless of the type of property you’re thinking of buying. In development property and land deals, buyers start the fact-gathering process with their first encounter with the property and it continues until they either bail out of the deal or go to settlement.

Here’s a list of sources of information (people, places & things) that are good starting points if you’re trying to research a property.

Sales & Ownership Data

Tax assessor information is available in several forms. For every piece of data, there is a primary source. The primary source is likeliest to be the most accurate and current source of information. For real estate documents that are recorded, such as deeds, liens, restrictive covenants, easements and subdivision plans, the primary source is the actual record of filings maintained by the applicable governmental department as well as the documents themselves and the recording information shown on them. These are usually kept at the courthouse for the county in which the property is located (Recorder of Deeds or Tax Assessment Dept.). People usually use title insurance companies who send searchers to the various courthouses to look up records. The deed contains the legal description of the property, which sets forth the property’s actual dimensions.

You can also search in free or fee-based databases that allow you to get information on properties nationwide or in a particular geographic area, such as: http://www.searchsystems.net; http://www.realquest.com; http://www.brbpub.com/pubrecsites.asp. These are great tools as long as you remember a couple of things. They should never be used as a substitute for hands-on research and inspection if you need results that are current and absolutely accurate. No database, even a governmental one, is a primary source of information. The governmental database, however, may be the next best thing to the primary source depending on the manner in which it was created and the frequency with which it is updated. When title companies insure property title, they do not rely exclusively on databases. They send people to where the records are maintained to physically search them. Real estate appraisers do not just use databases. They conduct additional due diligence and physically inspect the properties involved.

For several reasons, the farther you move away from the primary source of information, the greater the likelihood that the information may not be current and accurate. There is the time factor. The information has to pass from the primary source down the line through other people or organizations. In addition, there is the “garbage in, garbage out” principle. The integrity of any database, governmental or not, hangs on the thoroughness and competence of the people responsible for compiling and maintaining it. Databases can save you a tremendous amount of time and effort. You can use them most effectively as screening tools and to gather information subject to confirmation and further research if the situation or property warrants it. In addition, they are invaluable in identifying contacts if you need additional details or clarification.

If you want to find out who owns the property but don’t know the address, one way to be able to identify the property is to go to the municipal building and look at the tax maps or tax plats of properties in the municipality. By process of elimination, you should be able to identify the property (thus giving you the owner name, address, parcel identifying number). It’s a good idea to take a copy of the tax map with you when you return to the property since this will help you to pinpoint its location by counting parcels on the map from intersecting streets or other landmarks, particularly if the property is vacant land. Again, be aware that some of the information in the database or on the tax maps may not be accurate, particularly the size & shape of parcel, zoning classification, and whether the property’s serviced by public utilities.

New Construction Communities

If you want to find out who is or will be building in an area, take one municipality at a time and get the list of approved subdivisions and land developments from the municipality (manager’s office, code enforcement or land development offices). Then you can visit the new construction sites, talk with the site agents and get brochures. If the jobs haven’t started yet, you can go to the builders’ websites for preview information.

Municipal Records

You can identify properties that have applied for rezoning or subdivision & land development approval by requesting a list from the municipality of the properties. After you decide which properties you want to investigate further, make an appointment to review the development files and plans at the municipal office. This is public information, and anyone is entitled to review materials relating to actions taken by a municipality in public meetings and hearings. This can be an excellent source of information on owners who may be thinking of selling their properties.

Utility Maps

Checking the street for manhole covers and hydrants won’t necessarily give you correct information about whether a property can be serviced by public water and sewer. Instead, consult the mapping available through the municipal or regional sewer & water authorities, county or regional planning commission and private water companies.

Zoning

Each municipality adopts a zoning ordinance and zoning map for the properties within its borders. This material is available for review or purchase at the municipal office or through private vendors. Always make sure you’re looking at the most current ordinance and map since these are amended periodically. In addition, read the whole ordinance and not just the section on the particular zoning classification because the ordinance contains provisions that apply across the board on issues like definitions of terms used, accessory uses & structures, signage, and minimum frontage requirements.

The zoning officer (a/k/a code enforcement officer) at the municipality is the one to whom you should direct your questions about the zoning ordinance or map or if you want to find out anything about a property that may have happened in the past, like granting of variances, special exceptions or conditional uses.

Proposed Highways & Facilities

Depending on the nature (federal, state, local), you can access information through the municipality, county/regional planning commission, municipal comprehensive or “master plan” and federal or state agencies.

Profile Data of Area or Municipality

Municipalities and county or regional land planning agencies prepare comprehensive or master plans as a primary tool for their land planning. These plans contain a wealth of information pulled from various sources including US Census Bureau, Dept. of Labor, US Dept. of Agriculture soil surveys, FEMA floodplain mapping. In addition, you’ll find data about natural resources, statistical data on housing stock and non-residential developments, existing and proposed roads, transportation facilities, utilities, plants, commercial operations, hospitals and schools. Be sure to check out the proposed land use map and accompanying text. Here you might find clues for future growth areas and even potential for successfully rezoning particular properties. The master plans are available at either the municipal office or the county/regional planning agency.

Floodplain Maps

To determine if the property is in an area subject to flooding, consult floodplain maps. These are available through either the municipality, county/regional land planning agencies, or FEMA (http://www.fema.gov).

New Option in Vacation Home Ownership,
Not Your Typical Vacation Home

What could be more perfect that owning a luxury vacation home at a landmark resort and receiving rent revenue whenever you’re not using it? Condo hotels are the newest trend in vacation home ownership. Live in it when you’re there; rent it when you’re not.

So how do condo hotels differ from owning a traditional vacation apartment or condominium? These are not your typical second homes. They are fabulously-furnished condominium suites in some of the most famous hotels and resorts around the country. The properties are usually large, high-rise, luxury hotels operated by a big name like Four Seasons, Ritz Carlton, Sonesta, Starwood or Hilton. Prices range from $200,000 to over $1 million for prime properties.

Generate Revenue to Defray Mortgage Costs

How do condo hotel owners find renters? This is what makes the program so appealing. When owners are not using their unit, it is put into the rental program of the hotel. By capitalizing on a hotel’s name recognition, advertising, national affiliations, centralized reservation system and management expertise, unit owners typically receive a higher level of rental income than they would from a traditional vacation home. Plus the hotel takes care of dealing with the renters, as well as all housekeeping and maintenance of the condo hotel units. Talk about hassle-free!

The Real Appeal of Condo Hotels Is Appreciation

While it’s nice to receive rental revenue on your vacation home, the more important factor from an investment standpoint is its appreciation. Condo hotel units have been appreciating at a far faster rate than single family homes and condos in the same areas.

Most condo hotels are purchased directly from the developer. With limited inventory, condo hotel units have been moving at lightning speed. In fact, almost all condo hotels sell out in pre-construction, long before even a single spade of dirt has been overturned. And as is the case in any situation where supply is greatly outpaced by demand, condo hotel owners have been seeing tremendous appreciation in their units.

World-Famous Resorts Attract International Attention

Most condo hotels are located in seasonal resort areas. South Florida, particularly Miami Beach and Ft. Lauderdale, is one of the country’s hottest markets with world-famous properties like the Fontainbleau, Canyon Ranch Living and Trump International leading the way. Las Vegas and some of the Caribbean Islands are also popular condo hotel destinations.

Who’s buying? The answer, in a nutshell, is everyone. That is, investors and vacationers who recognize the appreciation potential of a revenue-generating vacation home. That appeal isn’t limited to U.S. buyers. The concept of condo hotels has had international appeal with buyers from Latin America and Europe competing with Americans for the best properties.

Learn More About Condo Hotels

Condo hotels have tremendous investment appeal in today’s market because of low interest rates and a tumultuous stock market that has investors looking for safer alternatives. Investors who take the condo hotel plunge can enjoy all the amenities of vacationing in a first-class resort while watching their units appreciate exponentially.

A Look at the Big Picture in Vacation Home Ownership

Condo hotels are one of the hottest products in today’s real estate market. New properties are cropping up in different parts of the country and new buyers are entering the market daily. Things have been moving so quickly in terms of condo hotels, but sometimes it’s worth taking a moment to step back and look at the big picture.

Condo Hotels In General

There is a spreading enthusiasm about the condo hotel concept. More people are recognizing its potential and therefore creating demand for more inventory.

Condo Hotel Buyers

The average buyer is 35-50 years old. Buyers for Florida properties, where condo hotels are most prevalent, come from all over the U.S. On the international front, most foreign buyers interested in U.S. property are from South America and Europe.

The vast majority of buyers want condo hotel units primarily as investments and are focused on the potential for appreciation with the side benefit of hassle-free ownership. They see the ability to actually use their condo hotel unit as a vacation home as important but secondary to their goal of investment diversification.

Condo Hotel Market

Virtually every single property that has come on the market to date has sold out in pre-construction. Most of these properties are mega high-rise buildings with on average 200-500 units, and with some in excess of 1,000 units.

The speed with which these properties sell out is often as surprising to buyers as it is to the developers themselves. For example, the MGM Grand in Las Vegas, a 576-unit condo hotel, was expected to sell out in two years. It sold out in two months! The Platinum, a 255-unit property in Las Vegas, also sold out in just a matter of a couple months.

Hot Areas

South Florida continues to be an extremely popular area and one that has shown strong and steady appreciation. As already mentioned, the condo hotel trend which began in South Florida has now spread out west. Las Vegas is leading the pack with many new condo and condo hotel developments in all price ranges being built.

Growth in Florida

Looking at South Florida, it’s easy to see what is happening. Miami Beach, the hottest area, is all built up. There just isn’t any undeveloped land. That’s causing a couple of things to happen. Developers are heading to the northern end of Miami Beach (North Beach) and areas still further north such as to Sunny Isles and Ft. Lauderdale.

A new trend is developers buying existing structures in Miami Beach and either upgrading them, as in the case of The Mimosa which was the former Brazil Motel, or knocking them down and starting over, as in the case of One Bal Harbour in which a multi-family, high-rise building (Harbour House) was demolished and a five-star condo hotel built in its place.

Finally, some properties are beginning to crop up inland. These condo hotels may not have oceanfront views; however, they’re within a few short blocks of a beach. Because they’re not on the ocean, these properties tend to be priced more economically.

Properties

The most popular properties continue to be those with a franchise name, one that brings a reputation for four- to five-star quality or a name that is already well-known. A prime example is Canyon Ranch Living in Miami Beach. People recognize the Canyon Ranch name and feel confident that this property will be of the same five-star caliber as its Arizona counterpart. Of course, it doesn’t hurt that this property will have a 60,000 sq. ft. rooftop spa and fitness center.

The Selling Process

A lot of properties take reservations of more than half the total project long before they’ve even prepared their purchase contracts. This means that many of the best units are reserved months before any money changes hands and often before even the first spade of ground has been turned over. Those early investors are seeing some amazing appreciation on their investments.

Prices

Like anything for which there is more demand than supply, prices keep going up, up, up. Developers often raise their prices 3-5 times from when they start selling until they sell out.

Developers are no longer discounting prices at the beginning of the selling process when they are anxious to get a few sales under their belt. This used to be common practice; it is no more because demand is so great.

There are sometimes, however, some price adjustments made at the very tail end of the sellout phase when developers want to close out their property and move on to their next project. Generally speaking, with regard to price, the best time to get in is usually early on in the first pre-construction offering.

Quality

Most condo hotels being built are of four- to five-star quality. The reason is two-fold: 1) There is demand for the types of services provided by four- and five-star properties, and 2) Oceanfront land is so costly that it makes more sense for the developer to put in a luxury property with units that he can sell at a premium price rather than lower priced units.

Financing

It’s getting a little easier to get condo hotel financing. There was a time when most banks and mortgage companies weren’t even familiar with the term condo hotels. They now know it and also recognize the viability of these properties. They are more accommodating in expediting these loans.

Contracts

Contracts that allow assignability have become rare. In the past, at some properties buyers could place a deposit on a unit in the pre-construction phase and then flip their unit prior to when they had to close. Developers now want to be sure that they don’t compete to sell their last few units with investors who purchased early at pre-construction prices and are now re-selling them at below the developer’s current prices.

Resales

Some condo hotel unit resales come on the market. Of course, this is to be expected. Some of the earliest buyers now want to move on to something or somewhere else. However, the resale market is still relatively small, and it’s hard to find a bargain.

Advice to New Buyers

How can buyers choose a condo hotel unit that will be a good investment? It’s best if they can work with a real estate broker who specializes in condo hotels and can make them aware of all products on the market. Aside from that, they should look for the following elements:

* Location: Real estate is all about location. Beachfront properties in South Florida have done exceptionally well in recent years. Their appreciation has been significant. If you prefer a property that is not on the ocean, it’s a good idea to select one in an area where you can expect to have business driven to your property, such as near a major convention center or in Downtown Miami near the financial district.

* Franchise: It’s always safest to go with a major company, well-known internationally. Four Seasons, Hilton, Starwood, Rosewood, Setai and Trump are excellent examples. Ask yourself, would you likely stay in a Holiday Inn for $69 or the independent hotel across the street for $62? Many investors or hotel guests will pay a little more for the comfort level they get with a well-known, well-respected franchise.

* Management Company: Compare the management companies and their rental sharing program. You will likely feel more comfortable investing your money in a condo hotel with an experienced, top-notch management company vs. an independent operator. Also, it’s worth noting that an established management company does worldwide marketing and likely has a state-of-the-art reservation system that will help ensure your unit is rented as much as possible.

In a commercial real estate (CRE) discussion you will likely hear the term Capitalization Rate (Cap Rate). You will see that buyers, sellers and lenders use this term to determine the value of a property. You need to know that making an investment decision solely on Cap Rate can mislead you into purchasing the wrong property.

Cap Rate can be considered the percentage return earned during the first year of operations. It is calculated by dividing the first year Net Operating Income (NOI) by the value of the real estate which is usually expressed as the price of the property.

Net Operating Income
Divided By
Value of Property
Equals
Cap Rate

Cap Rate considers the first year NOI in a property. In the same property, the higher the Cap Rate, the greater the NOI from the property will be relative to the price of the property. The greater the NOI a property produces, the less money you need for a down payment. This is because lenders base their lending decisions by looking at the NOI a property produces because it is the NOI that is the source of the cash flow that the borrow has available with which to make the payments on the loan.

In other words, when a property produces $100,000 of NOI, if the price for that property is $1,000,000, based on a 10% Cap Rate, your payment will be lower than if you had paid $2,000,000 for that property, based on a 5% Cap Rate, right? That’s easy.

Here, NOI is the same, but the payment will differ based on price. So, for simplicity, the higher the Cap Rate, the greater the cash flows.

Cap Rates can be used as a cursory evaluation of a commercial property. Experienced investors often look at the cap rate to screen out properties with low NOI relative to the price, as those properties may not produce enough cash flow to make the mortgage payment.

Sellers will quote Cap Rates differently and investors must determine which type of Cap Rate is being advertised by the seller. There is the actual Cap Rate which is based on the current NOI of the property. That means that the Cap Rate is based on actual NOI the property is currently experiencing and assumes that no changes to that number will occur.

Sellers will sometimes quote pro-forma or potential Cap Rate to reflect what the purchaser will receive during their first year of operations after certain changes have been made. What this means is that after purchase, with certain changes made (increase in rents or decrease in expenses in some manner) the property could potentially yield a greater NOI. When the seller has quoted a pro-forma or potential Cap Rate and it is on that potential NOI that price is being determined.

Let’s say that a property could potentially generate $100,000 NOI with zero vacancy (100% leased). If the asking price is $1,000,000 for those cash flows (NOI) then the Cap Rate is 10%.

On the other hand, let’s assume that the property is actually only 80% leased and therefore only generating $80,000 NOI. If the asking price is still the same $1,000,000 for these lesser cash flows (NOI), the Cap Rate or return is only 8%.

The debt service on the $1,000,000 is the same in both examples, but the amount of NOI from which to pay that debt is less in the second example. Again, the higher the cap rate, the greater the cash flow. The greater the cash flow, the more likely the lender will make the loan.

Let’s look at it another way:

A property is listed for $1,000,000 and is currently 80% leased and generates $80,000 NOI. Rents are $120,000 and expenses are $40,000. Assume that the pro forma income is $100,000 per year when it’s 100 %t leased at current rental rates and that, if rents are increased, the NOI could be $140,000. The seller could display three different Cap Rates for the same property:

1. The seller could use NOI of $80,000 per year making the Cap Rate 8%. This is the correct way to calculate the current Cap Rate.

2. The seller could use NOI of $100,000 and advertise a 10% Cap Rate.

3. The sellers could use the pro forma NOI of $140,000 and advertise a Cap Rate of 14%. Although this takes NOI into consideration, it is not actual NOI but potential NOI.

As an investor, you must know which Cap Rate the seller is quoting.

The returns of a CRE property come from: appreciation, cash flow, depreciation (tax write-offs), and principal reduction and the use of leverage.

Despite all of this analysis of cash flow, often, the biggest chunk of your investment return comes from appreciation. This is in addition to positive cash flows! That’s what makes commercial real estate so attractive.

Often properties with the greatest potential for strong appreciation are newer or in good locations and are offered at lower Cap Rates. In other words, they are priced higher. On the other hand, properties that are in poor condition, or have ground leases, are much harder to sell. As a result, a seller may try to attract buyers by advertising a higher Cap Rate. Buyer beware!

The calculation of Cap Rate only considers the first year of NOI. It considers the upcoming year and either bases it on actual or pro-forma NOI. But what if you own the property for longer than 1 year?

The Cap Rate should not be the only factor considered to determine whether to buy and how much to pay for a property but it is a good way to quickly weed out investments not meeting the investor’s criteria or to quickly qualify investments that warrant further analysis.

All markets are cyclical including real estate cycles. As the old adage goes, “What goes up, must come down” and vice versa. Knowing that, if investors had a crystal ball and could time the market so that they were always buying when the market is depressed and selling when things are hot, imagine the money which could be made.

We are all hearing on the news about how the economy is slowing and the housing market is depressed and people are losing their jobs. But that generalized viewpoint is too macro. Real estate is local and it is better analyzed from a microeconomic viewpoint. That sounds like a simple statement but it is important to understand. While it is true that many markets are depressed, other markets are bustling with activity and appreciating.

What is true in Los Angeles is not necessarily true in Oklahoma City. And what is true in apartments in Chicago may not hold true for retail property in Chicago. It is important to look not only at the “metro” but also the property type. It is important to forecast not only the demand for real estate but supply as well, both of which effect vacancy, pricing and value.

Let’s review a concept with which we are all familiar, namely supply and demand. Obviously when demand is greater than supply, prices go up. Here’s an illustration. Imagine there are two of you in the middle of the desert and you are both dying for a drink of water and I have the only glass of sparkling cold H20. If I offer to sell it to you for $1.00 and the other person wants it bad enough, he will offer me $1.25 for that same glass. Seeing that you will lose out on that much desired glass of water for your parched body, you will be inclined to offer me $1.50 for example. And so the bidding goes until one of you simply can’t afford to increase the price further. So again, when demand is greater than supply, prices go up. That is true not only for property values but rents and occupancy as well.

Conversely, as we know, when supply is greater than demand, prices go down. Using our example, let’s say that I and another person are in the arctic and we are both selling ice cold drinks. Now this other person and I must sell our drinks in order to earn enough money to feed our family. Here you come along all bundled up and not very thirsty. I offer to sell you my drinks for $1.00 each.

Realizing that he is about to lose a sale, this other person offers you the drinks for $.75 and I reduce my price to $.50. Now remember that you aren’t very thirsty so despite the falling prices, you’re still not enticed to buy. We reduce our prices further until at some point you say to yourself, “Wow, I’m not very thirsty but these prices are so low I just can’t pass up a bargain. Maybe I won’t drink them now but I’ll buy them at these low prices and stock up for summer. At some point, when price is low enough it will create demand and a sale will be made.

Obviously I incorporated both supply and demand in this example. Your demand for a cold drink wasn’t very high since you weren’t thirsty and the supply was more than you needed even if you were. But at some point, you bought anyway. When price gets low enough demand increases causing supplies to shrink again. And this is what causes those market swings.

Now you may be wondering why I am repeating a concept with which you are already familiar. The reason is this. Because cash flow is so critical in commercial real estate, it is not enough to only forecast current cash flows but also to forecast cash flows into the future with as much accuracy as possible. To do this, we must forecast supply and demand now only in the present but also into the future. In commercial real estate we use concepts like gap analysis and location quotient along with forecasting basic employment to assist us with these forecasts. We use these advanced tools to determine at what point supply and demand shift.

As an example, if you decided to buy a piece of land now and build a 35 unit apartment complex, you need to know the demand for those units when those units are going “online”. In other words, by the time you go through design, the Planning Commission and the construction phase it could be 2 years into the future before your units are ready to be rented.

What if in the interim a large REIT with multimillions (and often billions) came in and built 500 units just around the corner from your building. And what if the demand indicated that only 200 units would be absorbed (rented) per year. When there were only going to be 35 new units in the area, your new construction was only going to serve a small percentage of the demand and your units (if priced reasonably or even slightly aggressively) would be easily and quickly absorbed (rented). But now that there are 535 new units for these 200 people to choose from, imagine the scenario. Think arctic because it’s going to feel like a very cold market!

With only 200 units being absorbed per year, assuming all things equal (supply and demand don’t change), it will take a little more than 2 ½ years after construction has finished to rent all 535 units. Obviously this could devastate your cash flow and if you haven’t planned for this, you could lose your shirt.

Similarly, if you buy a C-Class Building in an area where a new Class A building is being built, what is going to happen to your rents? Why would someone rent a unit in your Class C building when for the same price they could live in a luxurious Class A building? You will have to lower your price to entice renters. Again, if you hadn’t planned for this in your cash flow projections, this could be devastating.

By now you may be saying to yourself “I can’t plan for everything, especially if I don’t know about it.” One way to combat this concern is to invest where economies are expanding and therefore demand is increasing and of course to do your due diligence. One strategy is to “Follow the Big Boxes.” This means where major retailers go, you go. If WalMart is expanding into an area and building a new store it is because their staff of highly paid experts have determined that population is growing and there is growing demand in that area. Rather than hire your own highly paid experts, just piggy back on their expertise and go where they go.

Now I’m sure that all you engineers, scientists and accountants are squirming in your chairs. After all this is not very scientific. There is no complicated formula. And so it is for you that I will follow up with Part 2 of this article as there are some scientific methods by which to measure the market both presently and in the future with a great degree of precision. Now breathe.