When buying an investment property, you have to do proper due diligence before closing the deal. This real estate due diligence checklist is comprehensive and captures the key things you need to check before signing the dotted line to own the property.
Due diligence is boring, but it’s absolutely critical.
Here we’ll take a deep dive into due diligence to make sure your deal won’t go South down the line if things change.
What is real estate due diligence?
Simply put, real estate due diligence means doing your homework before buying real estate to make sure you’re getting what you’re paying for. It involves reviewing documents, making calculations, inspecting the property, doing appraisal, and generally taking caution.
The due diligence period refers to the period between putting the property under contract to closing the deal. This period is typically negotiable, as agreed by the buyer and seller.
During this time, you can request any changes stipulated in the contract, such as unexpected repairs that were not disclosed. You can also terminate the contract and get your money back if you find things you can’t change (e.g. a noisy train, or sex offenders in the area).
In other words, you can opt out of the contract during the due diligence period without penalty because of anything that changes your mind as a buyer.
Here’s a checklist of due diligence items you need to complete before signing the dotted area to become the next legal owner oft hat real estate.
1: Estimate After Repair Value & Offer Price
The first thing you need to do is to find out if this will be a good investment deal or not. After all, if it’s not, you wouldn’t need to proceed further, would you?
Study comparable sales in the area to determine the best ARV. This will give you rough estimate of your offer based on the information you have for the property.
For example, when you talk to the seller, ask them what repairs are needed. You can then make an educated guess on how much it will cost to fix it.
Note that at this point this is just a guess. Once you visit the property and do an inspection, your numbers will be more accurate.
You can then estimate how much your offer will be based on this info.
For example, if you find a house with an ARV of $150,000 that needs $25,000 in repairs, your number will look like this:
2: Study the neighborhood
You’ll definitely want to make sure your investment sits in the right neighborhood. It’s easy to get drawn to a property and forget what else is out there. You’ll eliminate quick, uneducated decisions by looking at different properties and driving around the area.
Are the houses generally well kept? What demographics of people live there? Young families, college student, older couples? These factors will impact the individual markets and affect the potential for getting a great deal.
Make use of tools like Google maps to tour the area virtually before you visit the property.
Some important factors to consider are:
- Comparable sales
- Medium income
- Occupancy rates
- Population growth
- Crime rate
- School rankings
You’ll want to invest in low-crime areas. Families are particularly sensitive to how good the school district is. You’ll also want to make sure you’ll get tenants when you need them.
3: Evaluate financial value of the property
If you’re buying an investment property to rent out, you’ll want to make sure it will give you a positive cash flow.
This means you’ll need to cater for
- Gross rental income (allow 10-15% lower in a recession)
- Vacancy – allow for longer than normal vacancies in a recession
- Property taxes
- Repairs and maintenance
- General administration
- Contract services
- Capital improvements – Roof, HVAC, etc
So, your cash flow will be
Cash Flow = (Gross Income – Gross Expenses) – Debt Service
Obviously, we’re skimming through the top here, but I won’t go into detail about evaluating properties such as CAP rates.
4: Visit the property and estimate repairs
Don’t fall into the trap of investing in properties you never get to see. If it’s out of reach, don’t buy it. I know some investors will disagree with me on this, however, this will keep you safe from making poor investments.
Visit the property and make sure everything is what the seller says it is. Then, estimate the repairs based on what you see. Again, you’ll be safe by estimating on the higher side.
There are not enough hours in a day to estimate every nail, tile and door handle in a repair for every property you buy. However, you can use some general items that cover most of your repairs.
Our real estate investor websites have in-built basic and advanced repair estimators that will come in handy for this.
I can’t stress this enough – don’t under-estimate repairs. It will easily kill a deal that looks great, or sink you.
It’s better to over-estimate them and stay safe.
5: Get a property inspection done
Part of the due diligence checklist should be to hire a professional inspector to inspect your property. A professional inspection will un-earth things you probably missed in your rehab estimation.
It will point out issues you probably didn’t see like roof, foundation, etc. Also, it would point out issues created by the home owner – such as new rooms that don’t meet building codes. All this could spell trouble for you as the new owner.
Also, an inspection will look at things like Lead, Asbestos and Radon if the property was built before 1978. The property could have termite damage that may not be obvious to you.
This applies whether you’re a new or seasoned investor – do an inspection on every investment property you buy. It’s probably one of the best real estate due diligence steps you can take.
6: Do a formal appraisal
As much as you’ve estimated the ARV and calculated an offer price based on the numbers you’ve crunched, a professional appraisal should be your next step.
It will give you a more accurate value of the property “as-is”. If the inspection un-earthed things you didn’t know about the property, these will be factored in the appraisal.
As a result, you might end up negotiating the buying price lower if the appraisal value is lower than your estimate.
At the very least, you’ll rest well knowing you didn’t pay too much for the property.
7: Get title work done
Don’t under-estimate the importance of getting a proper title work done on the property. Even though you can do most of this research yourself, let this be done by a professional. I know, you can use public records to access most of this information, let professionals do their job. Then you won’t get nasty surprises down the road.
Title work will verify who owns the house, the mortgages and liens on it, legal description and boundaries, usage rights and more.
Similarly, title work will give you access to the most recent land survey. This includes the legal boundaries, any structures on the property, mortgages, easements etc.
Title work will give you a wealth of information that you shouldn’t miss before you buy it.
8: Do an environmental evaluation
Doing an environmental evaluation should also be part of your real estate due diligence checklist. It reveals hazards like gas leaks, wetlands, manufacturing in the past, etc.
This way, you’ll rest easy knowing the property is be safe for the next family without getting nasty surprises in the future.
9: Check out the Home Owners Association (HOA)
If the property is located where there’s a home owners association (HOA), check out their regulations and restrictions.
HOAs are created to maintain the integrity of the neighborhood and properties. Sometimes they have strict rules and regulations that they enforce, and you need to know about them before you close.
For example, the color you paint your house, or parking an RV in the driveway or street may be restricted. Get to know these rules beforehand so you don’t get fines and penalties you can avoid.
10: Get your financing ready
If you’re paying cash for the property, you’ll want to make sure your source of financing is ready for closing.
If you’re using a bank to finance your mortgage, you’ll probably need a longer time for due diligence. Bank lenders will do their own inspections and appraisals, which will take more time.
Even if you’re wholesaling the property, you’ll probably need transactional funding if you’re doing a simultaneous closing.
At the end of the day when everything else has checked out, you’ll want to be ready with cash ready to close your deal before the due diligence period ends.
11: Get title insurance
When buying any property, make sure you get title insurance. It gives you a peace of mind as buyer and protects you if there are issues with the title, such as
- Claims from heirs
- Pending legal action
- Unpaid taxes and old mortgages
Even if you’re wholesaling in a double closing / simultaneous closing, buying title insurance will shield you should anything happen down the line.
12: Confirm your real estate due diligence checklist
Before going to closing, double-check to make sure you din’t miss anything. The process of due diligence is dirty and unpleasant, but it’s well worth it to safeguard your investment. As the potential next owner of the property, you deserve to have all this information to make an informed judgement.
It will save you from making costly mistakes whether you’re a new or seasoned investor. And it will also provide you with opportunities to make better deals.
Follow this real estate due diligence checklist and your next deal won’t have any surprises.