Performing Psychological Due Diligence on the Seller

Performing Psychological Due Diligence on the Seller

“Performing Psychological Due Diligence on the Seller”

By: Sam Liebman

{4 minutes to read} 

• Sam Liebman
• December 11, 2021

Congratulations, you finished analyzing the offering memorandum, obtained an accepted letter of intent (LOI), and have signed a contract to purchase the property. You’re on the way to acquiring a property but you haven’t yet crossed the finish line.

 

The contract gives you only thirty days to perform all your due diligence on the property. At that point you must make a decision to close or have your contract deposit returned. Thirty days is not a lot of time so you must have all your ducks in order. Performing due diligence is the most important action step to take before you close and take title to the property. Remember that once you close, there is no turning back. The property is now yours, along with any warts you didn’t uncover. You made your bed, now sleep in it.

The primary goals of performing due diligence is to:

• Verify the information contained in the offering memorandum by a thorough investigation of the property’s books and records (analytical due diligence procedures).
• Uncover the inside story of both the property and the property owner to uncover both hidden value and potential problems (psychological due diligence).
• Gain as much leverage as possible to be in the best negotiating position to purchase the property.
• Fully understand whether the prospective investment fits your personal economic objectives and risk tolerance requirements.

In my world, performing analytical due diligence is just the beginning. There is another type of due diligence that I refer to as psychological due diligence that must also be performed. Generally, this refers to performing an in-depth investigation of not just the property, but the seller as well. Performing psychological due diligence is an extremely effective way to uncover hidden value and existing and potential problems overlooked by others. This is where the golden opportunities lie and riches can be found.  Every property has not one, but two, separate and distinct personalities; one for the property and one for its owner.

To perform psychological due diligence you must have the mindset of an undercover detective. The first thing detectives do is pull the file of potential suspects. They examine the suspect’s rap sheet, prior arrest record, and psychological information in an attempt to create a profile of the suspect. What are the suspect’s tendencies and behavior patterns?

In real estate your suspect is the seller. The same detective mindset should apply while performing your due diligence on a property. What are the seller’s tendencies and behavior patterns? Why is the property for sale? Is the owner in financial trouble? How flexible were they in past dealings? Was the seller a pro? Do they drain all the potential out of the building before they sell?

Nine out of ten purchasers are guilty of gross negligence and incompetence because they fail to perform an in-depth investigation of the seller. Big mistake! If you neglect to learn what makes a seller tick, you will never uncover the seller’s reasons for selling. There is no better way, absent a shot of truth serum, to achieve this goal than by creating and analyzing a comprehensive profile of the seller. Mastering this skill will give you a tremendous advantage in the acquisition process of purchasing real estate. Creating a profile of the seller is the tool that will enable you to uncover untapped potential and expose existing and potential problems overlooked by others.

The seller profile will reveal a treasure-trove of information, if it’s performed correctly. The seller profile should overflow with insider information about the seller. A property’s operations are often a mirror image of its owner.

The seller profile should include detailed questions about the owners: (i) Personal Situation, (ii) Financial Situation, and (iii) Professional Reputation.

A great way of getting information about a seller is to establish a network of contacts that include, but are not limited to; brokers, attorneys, banks, construction workers, title companies, etc. My favorite way is to find employees that were recently fired and ask them some questions. Believe me they will have a lot to say about the owner.

Real Life Example

In the early 1990’s we purchased many properties that were in a state of foreclosure. I discovered that many property owners attempted to convince their bank that the property wasn’t even worth the principal amount of the mortgage. To achieve this deception, the property owner would enter into fictitious leases at below-market rents with family members, friends, and acquaintances. While negotiating with the bank to restructure the debt on more favorable terms, the property owner would submit to the bank a very low rent roll to support their claim that the net operating income generated by the property could not possibly support the existing debt service. Rather than foreclose, the bank would often cut a deal with the property owner for both a lower interest rate and forgiveness of part of the debt. As soon as the ink was dry on the restructured documents, the property owner would have his buddies vacate their apartments and re-rent them at the much higher market rents. I once asked a property owner how his office building was doing for which he replied, with a laugh, “The first or second time around?” Many banks played hardball, refusing to negotiate with the property owners, and commenced a foreclosure action.

Through our network of contacts, we were aware of the game the property owners were playing and who they were. As a result, we gained a tremendous advantage while negotiating with the bank to purchase certain properties. We had the insider information, not the bank. As soon as we closed, we immediately started eviction proceedings, successfully evicting over 50 illegal tenants, dramatically increasing the cash flow and the market value of the property. We were able to purchase about 15 properties for a fraction of their market value. In fact, we increased the property’s value by millions of dollars while we were in contract before closing on the property.

 

Our success was directly attributable to obtaining insider information about the property owners that were notorious for installing fictitious tenants in their buildings and matching them to the properties in foreclosure.

Too many times, I have heard sellers, brokers, and others say, “There’s no time to perform such detailed due diligence. You’ll lose the deal.” I say, “So I’ll lose the deal!” It’s a giant mistake to believe that you must have a hairline trigger, or you’ll lose a deal.

I cannot stress enough the importance of performing extensive due diligence on both the property and the property owner. It’s not only common sense, but it’s your duty to yourself, your partners, and your investors.

My book, Harvard Can’t Teach What You Learn from the Streets devotes an entire chapter to Performing Psychological Due Diligence.

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Sam Liebman is founder and CEO of WealthWay Equity Group LLC, a New  York-based private equity and real estate development company. He has owned substantial interests in over 70 properties during the past 30 years, ranging from multifamily communities, office buildings and shopping centers, to the ground up construction of a luxury 21-story condominium development in Manhattan. He is also CEO of Rolling Cash Realty, Inc., a real estate management company, as well as a partner in Tepper & Co., a certified public accounting firm. His new book is Harvard Can’t Teach What You Learn from the Streets: The Street Success Guide to Building Wealth through Multi-Family Real Estate (Made for Success Publishing, Jan. 11, 2022). Learn more at samliebman.com.