Guide to Real Estate Due Diligence
When it comes to real estate, doing your due diligence can be stressful and intimidating, especially if this is your first time buying or investing in real estate. Due diligence essentially means that you are doing your homework on the property you would like to buy before the sale goes through to help minimize your risk.
These include an inspection and appraisal; however, there is more to due diligence than just those two items. It is highly recommended that investors perform their own due diligence. If you are buying a single-family home or a duplex, due diligence can be a pretty fast and simple process, compared to buying a huge apartment building.
When to Perform Due Diligence
There is some basic due diligence on a property that you should do before you make your offer, as well as more, deeper due diligence once you have placed your offer.
Before Your Offer
Before you decide to put in your offer on the property, you should perform an area analysis where you look into the occupancy rate, median income, crime rate, school rankings, and population growth. The school district the property is in is especially important if you want to attract tenants with families.
The crime rate is important because people do not want to live in an area with a high crime rate if they can avoid it.
You should also determine the after repair value of the property, which is most easily done by looking at comparable sales currently on the market. The pro forma is also important, as it will show you the income and expenses for the property how it is currently.
If you plan to rehab the property, you should also try to come up with an estimate on exactly how much you may need to pay upfront, before you can rent the property out, or sell it if you are flipping it.
After Your Offer
There is even more due diligence to do after your offer has been accepted; this is where it can get more complicated.
The first big thing you need to do after your offer is accepted is the physical inspection. It is recommended that you hire a professional to inspect the property, as well as walk through it yourself. Check every light switch, heater, water faucet, everything! Break down what needs to happen in construction, going into more detail than your pre-offer estimate, and consult with your contractor. This is when you will want to look into any zoning rules regarding the property.
You will also want to have the property appraised. If you are getting a mortgage loan, it may be handled by your lender. However, if you are paying cash for the property, it is up to you to have it done.
Check the title to ensure there are no liens on the property and no one else has any rights to claim it later on. Title insurance is often available in home sales to help protect you from this.
For a commercial property or a multi-unit complex, you should also look deeper into the finances of the property. You will want the following documents:
"T-12 Operating Statement: Minimally for the past 12 months—particularly for apartments—but preferably for the last three years.
“Current Rent Roll
"Aged Receivables Report: A list of who’s behind on their rent and by how much.
"List of Recent Capital Improvements"
For occupied properties, you will also want to look at every lease. Make sure that the rent, utilities, fees, and types of leases the units have, as well as the pet policies and pet rent, if applicable.
Look out for misallocated expenses and bad debts, which "is an expense that a business incurs once the repayment of credit previously extended to a customer is estimated to be uncollectible. Bad debt is a contingency that must be accounted for by all businesses who extend credit to customers, as there is always a risk that payment will not be received."
Another piece of your due diligence is the homeowner association (HOA), which has become common in many neighborhoods, and condos always have them. You will want to review their bylaws and fees, along with any other pertinent information.
References
Christensen, Kate. “Due Diligence in Real Estate - 9 Tips for Smart Buyers.” RealWealth, 13 Dec. 2019, www.realwealthnetwork.com/learn/due-diligence-real-estate/.
Syrios, Andrew. “Due Diligence: The Ultimate Guide for Real Estate Investors: Blog.” Due Diligence: The Ultimate Guide for Real Estate Investors | Blog, BiggerPockets, 10 Apr. 2020, www.biggerpockets.com/blog/due-diligence-ultimate-guide.
Tuovila, Alicia. “Bad Debt Definition.” Investopedia, Investopedia, 5 Feb. 2020, www.investopedia.com/terms/b/baddebt.asp.
Vandenboss, Kevin. “Real Estate Due Diligence: What You Need to Look For.” Millionacres, Millionacres, 11 Feb. 2020, www.fool.com/millionacres/real-estate-basics/investing-basics/real-estate-due-diligence-what-you-need-look/.