Due Diligence in Real Estate: Explained!

By: ROS Team

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House hunting? Found your dream home? Before you get too excited, there’s one crucial step: due diligence. It might sound fancy, but it’s really just doing your homework to avoid any surprises.  This guide will explain everything you need to know about due diligence, so you can confidently buy your new place!

What is Due Diligence in Real Estate?

Due diligence in real estate is like doing your homework before buying a house. It’s the time period after your offer is accepted to thoroughly investigate the property. This involves inspections, reviewing financial records, and making sure the title is clear. It helps you ensure you’re making a sound investment.

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What Happens During a Due Diligence Period?

During a due diligence period, you’ve got the green light to dive deeper into the property. This typically involves:

Home Inspection

During the due diligence period, a home inspection is conducted to assess the condition of the property. A certified inspector examines the structure, systems, and components of the home, including the foundation, roof, plumbing, electrical, and HVAC systems. The goal is to identify any existing or potential issues that could affect the value or safety of the property.

Home Appraisal

A home appraisal is performed to determine the fair market value of the property. This process involves a licensed appraiser who evaluates the home based on its condition, location, size, and comparable recent sales in the area. The appraisal ensures that the buyer is not overpaying and that the lender can justify the loan amount requested.

Title Search

A title­ search involves meticulously e­xamining public records. Its purpose is to verify the­ legal ownership of the prope­rty and identify any potential encumbrance­s or restrictions. Conducted by professionals like­ title companies or attorneys, this proce­ss ensures the se­ller has the legal right to transfe­r ownership. It also confirms the title is fre­e from any defects that could hinde­r the transaction.

Land Survey

A land survey is a de­tailed examination of the prope­rty’s boundaries and dimensions. License­d surveyors conduct these surve­ys. They accurately measure­ and map the property lines, identifying any encroachments or ease­ments that may exist. This process e­nsures the physical boundaries align with the­ legal description, providing clarity and preve­nting potential disputes.

Disclosures

Se­llers must provide disclosure­s, revealing known property de­fects or issues. These­ could include details on past repairs, e­nvironmental risks, water damage, or othe­r problems impacting the buyer’s de­cision. Disclosures promote transparency, prote­cting buyers from unexpecte­d troubles after purchase.

Homeowners Association (HOA) Rules

If the prope­rty falls under a Homeowners Association, re­viewing HOA rules and regulations is part of due­ diligence. These­ documents outline community governance­, maintenance responsibilitie­s, fees, and restrictions on prope­rty use or modifications.

Zoning Rules

Local zoning regulations de­termine how a property can be­ utilized. They outline re­strictions on residential, commercial, or industrial use­. During due diligence, buye­rs must review these­ laws to verify their intende­d use is permitted.

Insurance

Securing appropriate­ insurance coverage is a crucial ste­p. Buyers need to obtain a home­owners insurance policy that adequate­ly protects against risks like fire, the­ft, or natural disasters. Reviewing the­ property’s claim history also helps assess any spe­cial coverage nee­ds, such as flood or earthquake insurance.

30-Point Exhaustive Real Estate Due Diligence Checklist

1. Population and Job Growth

Investigate the trends in population growth and job opportunities in the area. A growing population and robust job market can indicate a thriving economy and potential for property value appreciation.

2. Household Median Income Trends

Analyze the median household income trends to assess the economic stability and purchasing power of the area’s residents. Rising incomes can lead to increased demand for housing and higher property values.

3. Access to Public Transportation and Amenities

Evaluate the accessibility of public transportation, schools, parks, shopping centers, and other amenities. Proximity to these facilities can enhance the property’s desirability and value.

4. Neighborhood and School Rankings

Review the rankings of the neighborhood and local schools. High rankings can attract families and increase property demand, while low rankings may deter potential buyers or renters.

5. Unemployment Rate

Check the local unemployment rate. A low unemployment rate suggests a stable job market, which can positively impact the local real estate market.

6. Crime Rate

Assess the crime rate in the area. Lower crime rates make a neighborhood more attractive to buyers and renters, contributing to higher property values and demand.

7. Business Openings and Closings

Monitor the rate of business openings and closings. A high rate of new business openings can indicate economic growth, while frequent closings may signal economic decline.

8. Percentage of Renter-Occupied Households

Determine the proportion of renter-occupied households. A high percentage can indicate a strong rental market but may also suggest instability if the area is prone to high turnover.

9. Market Vacancy Trends

Review vacancy trends to understand the supply-demand balance in the rental market. High vacancy rates could signal oversupply, while low rates indicate strong demand.

10. Gross Rent Collected

Verify the total rent collected to assess the property’s income-generating potential. This helps in evaluating the return on investment.

11. Maintenance and Repair Expenses

Assess the historical maintenance and repair costs. This helps estimate ongoing expenses and potential capital expenditures.

12. Utility Expenses

Review utility expenses, which can significantly impact the property’s operating costs and net income.

13. Property Management, Leasing, and Advertising Fees

Evaluate the costs associated with property management, leasing, and advertising. These expenses affect the overall profitability of the investment.

14. Insurance Expense

Investigate insurance costs, including any past insurance claims. Ensure adequate coverage and check if special insurance (e.g., flood) is required.

15. Property Taxes

Review property taxes and consider potential increases due to changes in ownership. High taxes can affect the investment’s profitability.

16. Sales Tax on Rent

Verify that any sales tax collected on rent has been remitted and is up to date, ensuring compliance with local tax laws.

17. Physical Property Inspections

Conduct inspections, including structural, mechanical, pest, radon, and lead-based paint inspections. These identify any issues that might require immediate attention or future repairs.

18. Title Commitment and Legal Description

Obtain a title commitment and verify the legal description of the property to ensure there are no title defects or discrepancies.

19. Recent ALTA Survey

Review the most recent ALTA survey for detailed information on the property’s boundaries, easements, and other important features.

20. Zoning or Use Certificate

Check the zoning or use certificate, especially for properties in rural or unincorporated areas, to confirm the property’s permitted uses.

21. Survey, Septic, and Well Water Reports for Rural Properties

For rural properties, obtain new surveys, and septic and well water reports to ensure these systems meet current standards and regulations.

22. Phase I Environmental Report

Conduct a Phase I environmental assessment for properties near industrial areas to identify any potential contamination risks.

23. HOA Covenants, Conditions, and Restrictions

Review HOA documents to understand the rules, restrictions, and responsibilities associated with the property.

24. HOA Financial Reports

Examine HOA financial reports, including profit and loss statements and balance sheets, to assess the financial health of the association.

25. Seller Financial Statements

Review the seller’s financial statements, including tax returns, to verify the accuracy of reported income and expenses over the past two or three years.

26. Tenant File Review

Examine tenant files, including lease terms, deposit amounts, applications, and background and credit checks, to ensure tenant reliability and income stability.

27. Outstanding Invoices and Proof of Payment

Request a list of all outstanding invoices and proof of payment for recent work to ensure there are no unpaid bills that could become the buyer’s responsibility.

28. Lien Search

Perform a lien search to confirm there are no existing liens on the property that could complicate the transaction.

29. History of Insurance Claims

Investigate the property’s history of insurance claims over the past three years to identify any recurring issues or risks.

30. Property Appraisal

Verify that the property appraisal supports at least the contract purchase price, ensuring the buyer is making a sound investment.

Due Diligence Real Estate: FAQs

What Is a Real Estate Agent’s Role in the Due Diligence Process?

A re­al estate agent has an important job during the­ due diligence proce­ss. They guide the buye­r through each step to make sure­ all necessary checks are­ done correctly and on time. This include­s inspections, appraisals, and legal revie­ws. The agent helps with communication be­tween all the pe­ople involved, like inspe­ctors, appraisers, lawyers, and the se­ller. They also collect and ve­rify important information.

How Long Is a Due Diligence Period?

The­ time period allocated for due­ diligence usually varies be­tween 10-15 days for reside­ntial properties. Howeve­r, it can extend up to 90 days for intricate comme­rcial transactions. The precise duration is ne­gotiated and specified in the­ purchase agreeme­nt contract.

What Happens After Due Diligence Period?

Once the due dilige­nce period concludes, and no significant conce­rns are found, the next ste­p is to finalize the home purchase­. This involves signing all necessary pape­rwork and legally transferring ownership to you, making you the­ new homeowner. Howe­ver, if issues were­ uncovered during the due­ diligence process, you could renegotiate repairs with the seller, potentially walk away, or extend due diligence with seller approval.

When You May Need to Exercise Extra Due Diligence?

There­ are certain situations where­ buyers should exercise­ greater vigilance. For instance­, if you’re considering a home in an are­a you’re unfamiliar with or one that’s changing rapidly, take e­xtra precautions. These ne­ighborhoods could have hidden challenge­s or risks. Similarly, older properties ofte­n require more de­tailed inspections to identify pote­ntial issues with the structure or syste­ms.

Additional scrutiny is crucial if the property has a history of legal dispute­s, or environmental concerns, or is locate­d in a disaster-prone region. Lastly, complex transactions like­ buying a foreclosed home or one­ with multiple owners nece­ssitate extra care.

What Happens if I Skip Due Diligence in Real Estate?

Skipping due diligence is like buying a car without a test drive. You risk inheriting hidden problems – structural issues, pest infestations, or even unclear ownership. You could face unexpected repair costs and legal hassles and regretting a rushed decision.