If you are not careful, you can really lose a lot of money if you buy the wrong property, in the wrong area, at the wrong price. This is why you need to know how real estate due diligence is performed by homeowners and investors alike.
Real estate due diligence is like doing your homework on a property to make sure the property is:
- In good condition (or in the condition you expect it to be)
- Is not going to be a money pit where you spend every penny you have fixing it
- Does not belong to someone else and your money is being stolen
- What the seller is telling you about the property is true
- Is the right property at the right price
I have personally bought and sold over 35 properties as an investor and currently own over 30 of them as rental properties.
In all my investing and buying of real estate, it was the due diligence (homework) that I did before I bought any of them, that saved me from buying the bad ones.
Actually, I have passed on hundreds of properties because I did my homework and made sure I did the real estate due diligence to know it was a good property.
So, What is due diligence on real estate investing?
The due diligence on real estate investing is researching and verifying the details about the acquisition of property before any offers are made.
Although every investment in real estate may seem risky, the due diligence allows us to minimize the risk with the proper research before jumping into the purchasing decision.
Due diligence on real estate brings together all the information that is useful for the buyer to know about the property before proceeding to purchase it. It is critical step in the acquisition process.
Why do you need due diligence on a property you are buying?
Due diligence allows you to feel more comfortable and assists you in meeting the expectations regarding the property. It ensures the correctness of all the transactions incurred in the process of acquisition of property.
If you are a business entity and you are in a position of mergers and acquisitions (M&A), purchasing a business without having due diligence increases the risk.
There are various reasons why due diligence is important for you while buying any property. Such reasonings and importance are discussed as follows:
- To confirm and verify information about the property that was brought up during the deal
- To identify potential errors in the deal and thus avoid a bad business transaction in a good investment opportunity
- To gather all the necessary information that would be valuable in the deal
- To ensure that the deal complies with all the investment criteria
Due diligence on real estate helps you to understand the nature of a deal, the risks involved, and whether or not the deal fits your portfolio before investing in any property.
Due diligence is like undergoing “homework” on a potential deal and is essential in investment or purchasing decisions.
How long is the due diligence period in a real estate purchase?
A normal due diligence period in real estate may be 10 days or 30 days, depending on how you deal with your decision of the purchase. The real estate sales, laws, and customs duty from state to state can also differ the due diligence time.
- Ten days usually include the inspections of the property and other information regarding the deal.
- Thirty days include the inspections and the mortgage process.
The due diligence period in the real estate purchase is the time that you start with inspecting the property and settling the mortgage and end with the deal.
Here are some of the key points to remember when you are undergoing a due diligence period:
- Any period of time can be managed between the buyer and seller, depending on the nature of property—shorter for a single property and longer for land, commercial buildings, and multi-properties.
- As a buyer, remember that a seller is keeping the property off the market during this time and has an interest in moving things along.
- As a buyer, you can always demand a reasonable amount of time to make your decision before laying out the money.
- As a buyer, do not put off critical inspection to the last minute of the deal. You will need enough time to address all of your concerns (if any) without the need for the termination of the deal.
The due diligence period gives you sufficient time to inspect the property. The time begins when both parties sign the contract and ends when all contingencies are resolved.
You should start by learning the due diligence procedure in your area before you begin to search for property.
Can sellers back out during the due diligence period?
Yes, a seller can back out during the diligence period, but it is rare for sellers to back out from the contract.
Let us find out some reasonable reasons that sellers can have:
They cannot find another property.
As soon as the seller gets a great offer, they might want to search for another property in the due diligence period. If they cannot find the property they need, they might have to back out from the sales contract.
Life circumstances change.
Sometimes an unexpected life event may happen in the seller’s life. This could be a sudden death of a family member or something else bad happen in their life.
In this case, as a buyer, you must understand the situation and respect the decision of the seller.
The offer came back low.
This is one of the biggest reasons why sellers back out during the diligence period.
The market of real estate is always climbing, and potential buyers are outbidding other buyers. Sellers often back out from a deal if they get a higher offer from another buyer.
How do you do due diligence on real estate?
Due diligence is a critical process when you are in the real estate business. Preparing yourself with the proper homework can help you avoid unexpected moments and minimize the risk.
Here are the steps to be taken by a buyer during the due diligence process:
Study the market
Before you begin your hunt for the purchase of a real estate entity, study the real estate market of the desired location.
Calling a real estate agent, talking to landlords, and doing online research are some ways you can try to understand the market.
Visit the property
Never blindly believe the seller describing the condition of the property. Avoid buying a defected property by conducting your own investigation. Visit the property by yourself, talk to the neighbors, and walk the property to see if everything is as the seller described.
Hire an investigator
You must have an investigator inspect the property you are going to invest in or purchase.
A professional investigator will help you assess all the information regarding the property and ensure that the seller did not misuse the property in such a way that could create problems for you.
Checking zonal laws
This is a common issue that may arise when purchasing a new property. Confirming the zonal designation of your prospective property ensures that it complies with all of the rules.
Public use agreements and growth management regulations are some of the agreements that may affect the future of the property you are willing to buy.
Study the assumptions
There is more than just inspecting the property. You must do the math to determine if it is a worthy investment.
Make sure cash flow and the return on your investment meet your expectations. Check the hikes in future insurance rates and tax rates.
Local agents, landlords, property managers, and census data can provide you the information you need.
Study the potential environmental hazards
Make sure you check all of the environmental hazards, including gas leaks, oil containers, and drainage systems surrounding the property. The assessment of these hazards ensures the property remains safe for the foreseeable future.
Remember, the process might look intensive, but it is well worth making an effort to safeguard your investment.
The due diligence process is a vital part of your property buying experience, allowing you to have the inspection, investigation of the possible neighborhood downfalls, and work with the seller to access all the information.
What do you need to do during your due diligence period?
During the diligence period, the home inspection is the most important task to do, and it involves the following:
- Checking the physical condition of the property
- Checking for hazardous substances and environmental issues
- Verifying the acreage or square footage of the land and property
- Assessing the building’s foundation and the condition of the plumbing, electrical, mechanical, and drainage system
- Checking the surroundings and location of the property
- Checking the availability of insurances
- Checking any other matters that may hamper the buyer’s decision to purchase the property
Get financing for the real estate purchase
Once you have verified all the required information about the property, it’s time to get your financing done. One of the easiest ways to purchase a property is lender financing.
Research multiple lenders to make sure you get fair terms and interest rates. Consider all of the options and compare them for the best choice that matches your expectations.
Get property appraisal for bank financing
Obtain a reliable appraisal and real estate evaluation that ensures you don’t purchase a property at an unreasonable price.
Hire a professional appraiser, and he or she will help you to finance the property or even get you a mortgage loan for purchasing.
Even if you are paying full cash, getting a property appraisal for bank financing is a smart move.
Make sure the appraisal gives you an unbiased, third-party estimation of the true value of the property before you purchase.
Acquire homeowner’s insurance
Acquire all insurance by checking if insurance is available for the property’s title or not.
You need to purchase homeowner’s insurance. This guarantees your ownership.
Avoid these problems when you acquire homeowner’s insurance:
- Unpaid taxes
- Pending legal actions
- Old loans and mortgages
- Claims from heirs of the owner
Get roof, plumbing, and electrical inspections
You might be careful to get inspections for things like the roof, plumbing, and electrical foundation. The inspection will identify any red flags that may lead you to reconsider the investment.
A licensed inspector will tell you if the electric wiring is working or not and check whether there are any foundation problems like damaged floors and beams.
In a nutshell, due diligence on real estate helps investors and buyers like you understand the nature of a deal and the risks involved. It will help you evaluate whether or not the deal and risks match your expectations.
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