I was trading messages last week with Richard Bowser, editor of this publication. We decided that an article on developer due diligence (DD) would make sense given current market conditions. I thought the topic was a great one and that it would not be hard work but then I thought further about how to shape what you are about to read below. It was not such a simple topic…
It turns out there is a large gap between what a professional investment analyst does and what a typical investor looking at backing a developer’s project considers. There are university degrees and professional associations which certify that someone is qualified as an analyst. Certified Financial Analyst (CFA) might be considered at the top of the heap. Testing and years of work are required before someone can use the CFA designation. How many CFAs invest with developers? How many developers would know what CFA means? Would the developer know what should be shared with a CFA so a deal is funded? Does a developer know that there are financial regulations that heavily constrain what the developer can say or do when raising money for their project? This knowledge gap is scary when you start to dig into the details.
I then thought about the people that I know who represent what I would label ‘best practice’ for property investing DD. There is a lawyer, an ex-fund manager, one or two developers who build at scale and a few others. They all tend to have a more serious background, are not afraid of spread-sheets and they research very carefully the people that they get involved with. They do not agree to deals in pubs or otherwise seek funding exclusively from a close set of mates. A few have degrees in some form of real estate from a reputable UK university.
On the other side of the gap, the chasm is the wider community of people who have grown their knowledge, very often through weekend seminars. The seminar focus is on creating wealth through property. Get rich by using Other People’s Money (OPM). The core foundation of the training is using leverage to magnify results. I started with a USA based seminar called ‘Nothing Down’ in 1983. So, this is not a bad starting point. It is a starting point that can create a blindness to what good investment DD really is about.
Just about anyone can buy a house. Many of us have parents who did buy a property or we have done so ourselves. The process is not that complex and the analysis is trivial if we are being polite. Mostly because it works for the typical home owner so why make it any more complex. Whatever they might believe, they are not investing with a true investment mindset.