Sometimes, being a real estate investor is like being a detective. You need to investigate the facts, uncover the truth, and work out the best course of action. If you don’t, you could make a costly mistake. Due diligence means taking care and caution when investing in a new property. That includes carrying out a review or audit and discovering whether that property is a good investment or a bad one. So, you put your detective’s hat on and search for clues.
You’ve heard the horror stories in the news. Someone purchases the property of their dreams and, a year later, discovers the house is sinking into the ground. Carrying out due diligence can prevent bad things from happening and protect your hard-earned cash when making investments in real estate.
So, what does due diligence involve? You investigate the facts about a property to ensure it’s a good purchase. Here are some of the most common due diligence items for investors:
Examining legal documents
- Occupational licenses (for commercial properties)
- Zoning restrictions
- Power of attorney documents
- Tax registration documents
Financial matters
- Checking median household income for other properties in the neighborhood
- Checking vacancy rates
- Talking with insurance companies
- Comparing property expenses with other buildings in the area
Physical property inspections
- Reviewing the structure of the property
- Reviewing energy usage
- Checking for repairs
- Executing an environmental suitability assessment
- Viewing site plans
One of the most important steps of the due diligence process is reviewing any seller disclosures that might detail the financial or physical state of a property. In a state that doesn’t require the seller to make disclosures, you can ask the homeowner questions about the property or get your real estate agent to do it for you. Leave no stone unturned!
Most real estate contracts allow for a period of due diligence, and that period can last range from 10 days to a few weeks, depending on the state. The process starts when an investor opens escrow and finishes at closing. Some investors use a due diligence checklist when auditing a property. You might want to create one of your own.
Due diligence case study
An investor is interested in purchasing a property and expanding her investment portfolio. Before signing any contract, she carries out due diligence checks on the property. (Wise!) That includes physical inspections, researching the neighborhood, assessing potential rental income, and obtaining insurance and loan quotes. After completing her checks, the investor can review her financials and decide whether the investment will prove to be a lucrative one.
The bottom line
Due diligence means reviewing a property before you invest in it. It’s your chance to learn if a property provides you with value for your money. The list of due diligence checks is exhaustive but might include physical inspections, reviewing leases for terms, and surveying a property for its environmental impact. Investors should always carry out due diligence checks before committing to purchase a property
