Summary: In this article, we’ll discuss the following: what is due diligence in real estate, different types of due diligence (residential, commercial and land), buyer rights, due diligence time period and essential action items to ensure a smart and smooth buying or investing experience.
Many home buyers or investors struggle with the real estate due diligence process. It can be intimidating and stressful (especially if you’ve never done it before), to know where to start, what information to review and how to gather the right information to help you decide whether or not the property you’re looking at is a smart investment or not. We’re here to make that process a lot less intimidating by explaining essential due diligence to-do’s including 9 helpful tips for smart buyers.
What is Due Diligence In Home Buying?
Due diligence basically means, doing your homework before buying real estate. Whether you are looking at a single-family home, duplex, or multi-unit rental property, there are several due diligence items to perform in order to minimize risk and potential cost upon purchase. Ordering an inspection and appraisal of a property is standard due diligence procedure, and should always be performed. But smart real estate investors don’t stop there. In addition to a standard inspection and appraisal, buyers should always do their own investigation of the property. We’ll dive deeper into exactly what that involves, how much time you have to perform your own due diligence and share nine essential due diligence tips for all real estate transactions.
Why Do I Need to do My Own Due Diligence?
While real estate investment companies, like RealWealth, uses its best efforts and proven protocols to screen, review and understand the operations of each of its “property teams” or investment properties, it’s always recommended that investors perform his or her own due diligence prior to purchasing. The performance of an investment property is never guaranteed, which is why it’s so important to do your own due diligence. RealWealth requires investors to perform two due diligence items before purchasing a property: (1) order an inspection from a licensed home inspector, and (2) order an appraisal (if financing, the lender will automatically order one, if you are paying all cash then it’s your responsibility to order one).
Real Estate Due Diligence Documents & Checklist
If you are new to real estate investing and unsure where to start with your own due diligence, there are several free resources available. Property Metrics offers a comprehensive due diligence checklist, along with hundreds of documents available to download. Becoming familiar with real estate due diligence documents may seem overwhelming, however, having a general understanding of their specific purpose will only help the buying process go as smoothly as possible.
9 Essential Due Diligence Items for All Real Estate Transactions
1 – Shop the Marketplace
Many first-time buyers look at just a few properties before putting in an offer and purchasing real estate. The pitfall here is that you have no idea what else is out there because your sample size is so small. Looking at different properties and spending several months shopping around to see what the market has to offer before you buy will eliminate a quick, uneducated, and emotional decision.
Get to know the areas you’re considering buying in. Drive around the neighborhoods, look at other houses (are they generally rundown or well-kept?), people who live there (are they generally young families, college students, or older couples), and talk to residents to gain insight on if home values are going up or down. It’s also a good idea to check out crime rates in the areas you’re looking to buy. These factors can greatly impact which markets to buy in and which markets to avoid. All of these tasks are part of doing your own due diligence, even before making an offer on a property. RealWealth performs all of these due diligence items, plus several more, which we talk about at the end of the article.
2 – Do Your Homework
As defined at the beginning of this article, due diligence simply means, doing your homework. If you’ve found a property you’re interested in buying and make an offer, the first two items on your due diligence checklist is to order an inspection and appraisal. We will go into more detail on types of inspections and appraisals in #4 below and why they should ALWAYS be performed upon making a purchase offer.
Next, we do our own homework. Due diligence also involves walking the property, reviewing documents (before signing), calculating insurance and other out-of-pocket costs, market values and trends in the area, etc. Essentially, doing everything you possibly can to ensure you are purchasing real estate that is a good deal and will produce a positive return on your investment. Be thorough and meticulous as you weigh the pros and cons of each potential investment. When it comes to due diligence, no detail is too small.
3 – Get Multiple Bids for Your Mortgage Financing
If you’re financing a property, apply the same idea discussed in tip #1 and compare multiple interest rates. As few as 20 percent of buyers get just two bids for financing and have no idea if competitors could offer a better deal. By taking a little extra time on your due diligence and getting multiple bids for mortgage financing, you’ll know you’re getting the best deal out there.
4 – If You’re Financing, Expect an Appraisal
An appraisal determines the value of a property. If you’re planning on taking out a mortgage, lenders will require an appraisal be performed to ensure the property is worth what it’s selling for. Following an appraisal, if a property is not worth the sale price, the loan will not be approved unless the seller reduces the price to its value.
An appraiser and home inspector will both inspect the property, however the appraiser considers things like property size, lot size and location, upgrades, overall condition and compare other similar properties (“comps”) in the neighborhood. Having an appraisal done keeps sellers from attempting to inflate costs without value.
5 – Have the Property Inspected
There are several different types of inspections that can and should be performed on a property you may potentially purchase. We will discuss types of inspections and why it could be worth paying some of your own money to have have certain inspections done prior to buying.
Please note: it’s always a good idea to be present for the inspection, as this will give you a good idea of the condition of the property, along with the opportunity to ask any questions that may arise.
General Home Inspection
This type of inspection should always be performed before moving forward with the purchasing process of a house. It’s also required by most lenders if you are using financing to buy the property. Most commonly, a certified home inspector or licensed contractor will inspect the overall condition of the house. This includes a full report on the condition of: roof, plumbing, electrical, heating and cooling, kitchen appliances and water heater. The inspector or contractor will provide a full report on any issues found and how severe the issues may be.
Following an inspection, it’s not uncommon to find extensive necessary repairs (new roof, old or deteriorating plumbing and pipes, electrical issues, etc.), that present potential risk and cost. Sometimes the cost of these necessary repairs is enough to cause the buyer to cancel their offer and continue looking for a lower risk property. Make sure your purchase agreement uses language and stipulations that allow you to cancel your offer following an inspection, without losing any money you may have put down as a deposit.
Wood-Destroying Organisms (WDO) Inspection
Many lenders also require a WDO inspection of a property. This inspection checks for wood rot in the structure of a property. Wood rot can be caused by termites or water damage. Inspectors will look for wood rot on exterior siding and interior walls (including baseboards), as well as the garage (if applicable). Extensive wood rot can cause severe structural damage to a home. The inspectors report will outline how extensive or minimal the wood rot is, in turn, providing additional information to help you decide if the risk outweighs the reward.
Lead-Based Paint Inspection
This inspection is legally required for any house built before 1978. If the seller is already aware that lead-based paint is present in or outside of the home, federal law requires that they disclose this information to potential buyers. Buyers can also perform their own lead-based paint test as part of their due diligence process. Paint containing lead is a health hazard and will require additional costs to extract before you or tenants inhabit the property.
Radon Gas Inspection
A lesser-known inspection, radon is a radioactive gas that is present in homes all over the United States. Long-term exposure to radon gas has proven to contribute to thousands of lung cancer deaths every year, according to the EPA and Surgeon General.
Defective Drywall Inspection
Also a lesser-known and fairly new inspection that tests for defective Chinese drywall. Found mostly in properties built in Florida, between 2001 and 2009, this type of drywall corrodes building materials and wiring over time and produces a strong sulfur smell. Additionally, it has been known to cause certain health problems.
6 – Is the Property Eligible for Insurance?
The only reason a property may be ineligible for insurance is if it doesn’t meet minimum standards required by the insurance company. When searching for insurance, make sure your home or property meets minimum requirements.
Which type of insurance do I need? Next, we’ll discuss the different types of insurance you may be eligible for to protect your assets.
If you are planning on living in the home you purchase, you’ll need homeowners insurance. This type of insurance covers major losses such as, liability, natural disasters (like floods or earthquakes), private property losses, fire and theft. Be sure to compare several insurers to get the best deal possible. How much insurance will cost depends on several factors. For instance, if your property is in a “flood zone” or “tornado-prone” area, insurance rates will be much higher or even difficult to get coverage at all. Make sure you have an idea of how much insurance on your property will cost every month before purchasing.
Planning on renting out the home or property you purchase? You’ll need dwelling insurance to cover liability and protect the landlord’s (that’s you!) assets. This insurance does not cover the renter’s belongings, thus it will be a good idea for tenants to purchase rental insurance to protect their belongings.
Empty or Vacant Property Insurance
If you are planning on buying a property and then reselling or “flipping” within a short timeframe, you’ll want to buy this insurance to protect your assets. Because nobody is living in the home and renovations may be in progress, there is more risk of theft, vandalism or fire, causing this type of insurance to be more expensive than others.
7 – Search the Title History and Get Owner’s Title Insurance
Performing a title search before the final purchase of a property is essential to ensure you will receive the title free and clear of any defects in ownership. If the previous owner had work done on the house and failed to pay the contractor the full amount, there could be a lien attached to the property that must be paid before it can be sold. If the buyer isn’t aware of this lien, they could end up paying for the amount owed before the title can be released free and clear in your name.
After doing a title search, buyers should get the owner’s title insurance to protect from issues that may not have been discovered during the title search. Such issues may include, omissions in deeds, undisclosed heirs, forgery, or mistakes in records. Owner’s title insurance protects buyers from any unknown liens on the property that may arise after closing, in which the insurance company is responsible to pay.
8 – Check Out the Homeowners Association Covenants & Restrictions
If you’re buying a condo, apartment, townhome or single-family home in certain communities, expect to adhere to HOA requirements. HOA’s often have strict rules and covenants that owner’s must follow. These covenants are made and enforced in order to protect the appearance and values of the neighborhood. For instance, the color you paint the outside of your property or parking an RV in your driveway or on the street, may be limited or prohibited. If these covenants are broken, property owners are subject to fines paid to the HOA. Covenants and restrictions of the HOA can and should be reviewed before final closing of the property.
9 – Consider an Experienced Real Estate Attorney, if You’re a Beginner
The process of buying property, especially if you’re a beginner, can seem overwhelming and stressful. With so many different factors to look at and consider before purchase, it’s wise to consider using an experienced real estate attorney to ensure all necessary due diligence is performed and no detail is overlooked. When in doubt, ask for help from an experienced professional.
Due Diligence Real Estate Contracts
How Long is Due Diligence Period?
Buyers and sellers work together to negotiate a contract that should include a defined real estate due diligence period. While a 17 day due diligence period is the default length of time in California, both parties can customize how long this period lasts, typically between one and 30 days. If a buyer or seller wants to move the deal through quickly, or requests more time, then this should be clearly stated in the contract. Once a purchase offer is accepted by the seller, the defined due diligence period generally starts within 24 hours. The seller is then required to disclose any necessary repairs or problems with the property.
Buyer Rights During Due Diligence
Let’s say you are under contract for a property in California, meaning your offer has been accepted by the seller. You then have (hypothetically) 17 days to complete your due diligence or complete evaluation of the property. In the contract, the buyer can request that any changes or necessary repairs they find during the due diligence period, be made or credited for the cost during escrow. Changes or addendum’s can be made to the contract as long as both parties agree. If a buyer finds something in the due diligence process that can’t be fixed or changed, like loud trains passing nearby, sex offenders in the area, or a high crime rate, they can legally terminate the purchase contract. Basically, anything that “fundamentally alters” wanting to buy the property, qualifies the buyer to opt out, without losing their initial deposit.
Due Diligence in Commercial Real Estate
Commercial real estate due diligence works a little bit differently than residential or land. The first step, is to clearly define your objectives for buying commercial property. In other words, what are you planning on using it for? Three common objectives or types of investors include: (1) investment purposes, (2) real estate development, or (3) business operations (occupied by buyers organization). Each objective requires more or less in-depth due diligence than others, so it’s important to understand why you are buying the property it will lay out your due diligence checklist.
Documents You Should Analyze in Commercial Property Purchase
If you’re purchasing commercial real estate, such as an income-producing apartment building, several documents should be analyzed closely beforehand. For example, examining current tenant leases and tenant payment history will give you an idea of expected monthly cash flow. In other words, will the property produce positive, stable cash flow every month, or will you be losing money because of current tenant leases and/or unreliable tenant payments.
Along with tenant leases, buyers should also research and analyze title, zoning regulations, tax certificates, and seller’s financial records and operating statements. What to look for in these documents will be explained in the sections below.
Title & Property Descriptions
Order a preliminary title report that offers information about previous owners, property liens or easements (legal right to use the property). Once all the title information has been gathered, it’s always good practice to have a professional survey the property (i.e. lot size, access roads, soil conditions, improvements or changes made, etc.), to confirm the accuracy of the title.
After the title has been proven to be accurate, the buyer should acquire title insurance in case unexpected issues arise, in which the insurance company will be held liable for any financial loss.
Is Your Property in Florida? Order a Municipal Lien Search
Unlike most U.S. states, Florida attaches any liens, fees or permit violations to a property rather than an individual. Therefore, all properties purchased in Florida should have a municipal lien search conducted, in addition to a conventional title search.
Complying with Zoning & Property Codes
Zoning regulations and property codes are unique to each city or municipal. Properties must be compliant in meeting current rules and regulations. Request documentation from the city to ensure that the property is compliant with existing zoning regulations and land use classifications. This information will also ensure that your intended use of the property meets compliance standards.
Please note: consider using an independent zoning specialist to survey the property confirm information is up-to-date.
State-Specific ADA Compliance Standards
Determine if the property you intend to purchase is compliant with the Americans with Disabilities Act (ADA). ADA regulations and requirements vary from state-to-state along with supporting documents needed in order to prove compliance. The ADA and federal government offers a checklist to help commercial property owners make any necessary changes or improvements to become ADA compliant or maintain compliance moving forward.
Do Your Due Diligence on the Seller
In addition to performing extensive due diligence on a property, commercial buyers should also investigate the sellers reputation and track record. Examining relevant documents like tax returns, prior use of property, past litigation, loans, and service contracts, will provide insight on the sellers integrity and help determine if this is someone you want to buy from.
Land Due Diligence
Just as buying commercial property requires certain additional due diligence, the same goes for purchasing land. It usually takes more time and work to perform due diligence on vacant land than an existing home. Below, we will cover a list of important due diligence items unique to buying land.
Search the Title
When searching the title to ensure that the land is free and clear to purchase, it is generally advised to trace back 30 years. Locate relevant documents like, the sale deed and property tax receipts, to confirm ownership of the title.
Post a Public Notice for Land Purchase
Another due diligence item to confirm that a title or piece of land is free and clear for sale, is to post a public notice either online or in the newspaper. This provides an opportunity for anyone to come forward if there are any liens, encumbrances or restrictions attached to the title that may not have showed up in the title search.
Verify Original Documents of Purchase
A deed may be the single most important document to locate and review. If the seller doesn’t provide a deed, oftentimes deeds can be found online and downloaded for a small fee. If the deed isn’t available online, inquire with the town or county registry. The deed is such an important document because it states what exactly is for sale, where it’s located, and any encumbrances that may be tied to the title.
Have Land Surveyed by a Professional
You’ll want to have a land inspection before purchase of a property. If there isn’t physical evidence or legal documents showing the boundary lines and measurement of the land, spending a little extra money on a professional to survey the property is well worth it. A surveyor will not only measure the land you intend to purchase, he or she will also provide a detailed legal description including, marking property boundaries zoning status, any issues with protected land or flood plains, etc.
Ensure Property Taxes are Up-to-Date
Make sure all property taxes have been paid by the current owner and are up-to-date. Request original receipts of all property taxes paid to prevent having to back-pay on unpaid property taxes.
How Does RealWealth Help Me Buy Property?
We Perform Extensive Due Diligence For You
- Look at Comps
- Compare Price per sq/ft with cost to build
- Look at Historic Prices in the Area
- Type of Neighborhood
- Tenant/Buyer Profile of the Neighborhood
- Employers Nearby
- Transportation & Traffic Nearby
- School Ratings
IMPORTANT: You must still do your own due diligence. As described earlier in this article, while RealWealth does most of the due diligence legwork, investors are still required to perform two due diligence items before purchasing a property: (1) order an inspection from a licensed home inspector, and (2) order an appraisal (if financing, the lender will automatically order one, if you are paying all cash then it’s your responsibility to order one). Any additional due diligence items should also be conducted by the buyer, to ensure it’s the best investment for you.
Hopefully, after reading this article you feel better equipped to perform your own due diligence on a residential, commercial or land purchase. The purpose of due diligence in real estate is to collect enough information on the property to make the smartest buying decision possible. Due diligence is intended to hold sellers accountable as well as save buyers from making a bad purchase. So get out there and do your due diligence!