Due diligence is making sure to maintain and uphold responsible and lawful business when entering into a business agreement with another party. Due diligence in real estate also means doing the appropriate amount of research before entering into a business deal with another party. It can be the difference between making a profit on an investment or making a loss.
One of the ways to practice due diligence is to accurately estimate the potential rehab costs of an investment. However, due diligence does not only involve estimating rehab costs, but also making sure that you fill out the right forms and fill them out correctly. It means paying tax, understanding code violations, and paying utility fees. Due diligence is there to make sure that everything runs smoothly and legally and that you don’t get caught off guard by any mistakes that can occur in the investing process.
On a legal note, due diligence refers to a period that allows investors and buyers to inspect the property and check that every‐ thing is in order before committing to investing in the property. The due diligence period typically lasts between 7 and 30 days. This period is so important because it allows buyers to cancel a contract if they are no longer interested in the property and get all their money back.
For example, a property might seem profitable at first, but you may discover in the due diligence period that there is major structural damage or that there is a problem with the lease agreement. In these cases, you can cancel the contract and walk away unscathed from the investment.
However, the due diligence period isn’t something you should sleep on as an investor. This period should be used productively. Contact home inspectors, contractors, lenders, and real estate lawyers that you will be working with to determine whether the property is worth investing in. This is also a great time to set up a cost estimate of the potential rehab costs of the project. This can help you determine what the return on investment looks like if you decide to invest in the property.
Things go wrong all the time. Especially if there are as many variables to consider as with real estate investing. If you want to make sure that the project runs smoothly, insurance is a great way to check that your investment is protected. Yes, paying insurance might decrease profit margins, and maybe nothing terrible happens that requires you to use the insurance, but the cost of insurance is marginal in comparison to potentializes‐ ter. If you are flipping a house, there are two types of insurance that can be valuable to the project.
The first type is builder’s risk insurance. This type of insurance is used for flipping houses and protects the property, materials, and equipment during the period of construction. This type of insurance is especially useful when the property requires structural renovations because these repairs are riskier. If the property only requires cosmetic repairs, then builders risk insurance may not be worthwhile. Vacant property insurance is also an option if you are flipping houses. The property will most likely be vacant, apart from construction, and it can be used to protect the investment against damages caused by vandalism, fire, theft, or natural disaster. This type of insurance is especially useful for a long-term project.
This tends to happen when homeowners fail to pay property taxes, utility bills, or mortgage loans and can lead to them losing their property. However, this is a great way for investors to find properties. The properties are usually sold on auction. As a beginner, you must know that doing your due diligence requires you to understand the situation of a particular property. Yes, it might be a good deal, but if the property has unpaid taxes, the investor must pay the lien.
An appraisal allows you to determine how much the property should be selling for. This information can be useful for several different factors during the due diligence period. For example, the price of the property may be too high for the condition of the property. Acquiring a professional real estate appraisal is useful because it can be used to negotiate with potential sellers.
It can also give you a good idea of how much you should be paying for the investment. If you don’t get an appraisal, you could risk spending too much money on a property and decreasing the potential profit of the investment.
During the due diligence period, make sure to inspect the property thoroughly. You want to ensure that there is no structural damage like foundational issues or pest infestations because those could drive up the costs of the project and leave you with a lower return on investment. When you are viewing the house, be sure to bring a property inspector with you. They will be able to tell you if there are any code violations that you need to be aware of, and whether these violations are quick fixes or expensive undertakings. If you are going to invest in a house, you must understand the extent of the damages in the house, otherwise, you won’t be able to tell if the property is worth investing in or not.
5. Title History
During the due diligence period, make sure you have all the information regarding the title history and insurance history of the property. You want to check that there are no discrepancies regarding the ownership of the property. For example, if someone sells you a house, but they are not the legitimate owners of the property, then you are not eligible to buy the property. If you don’t double-check this information, you could end up buying a house and losing all the money you used to pay for it. In addition, if the property owner has liens to pay, then they will have to pay those before the property can be put in your name.
6. HOA Fees
The HOA stands for the Homeowners Association. If you own a house in an estate or closed area, then you will be required to join the HOA and pay any fees or levies that are required. These fees are usually paid monthly and contribute towards the main‐ tenancy of the common area or neighborhood. If the property you have invested in is in a closed-off area or estate, then you must check the rates of the HOA fees. These fees can contribute to the overall expenses and carrying costs of a project.
7. Zoning Changes
Zoning refers to the type of property and its function. Properties can be divided into different categories including residential, agricultural, and industrial. If you are not aware of the zoning laws and regulations in your area, then you may encounter some challenges along the way. If you are attempting to buy a property for residential purposes, but it falls under a commercial zone, then you may struggle to take out the right insurance or loans, which could be problematic if you are relying on those loans as your investment capital. Before investing in a property, make sure you have a good under‐ standing of the laws and regulations regarding zoning changes and that the property you are interested in is marked appropriately.
8. Lease Review
Before investing in a property, use the due diligence period to review the lease and all the paperwork that comes with investing in a house. Approach a real estate attorney to review the contract to make sure that everything is legitimate and that you, as the investor, are protected throughout the process. Legal documents can also be quite complex and may require some professional insight to confirm that everything is above board. Doing your due diligence can feel like an administration-heavy part of real estate investing, and it is, but it is also a good way to make sure you are making the best possible investment. Here are a few things that can go wrong, and some common mistakes people make when ignoring the importance of due diligence:
If you fail to do your due diligence, you could risk buying the wrong house. If you aren’t aware of all the code violations, the title history of the property, or whether the property is eligible for insurance, then you might encounter a few nasty surprises once you have invested in a project. Especially if you are new to real estate investing, you don’t want to make the wrong decision and end up cutting your investing journey short. Finding the right house is like solving a Rubik’s cube. All the colors must be on the right sides for it to be complete. If even one square is in the wrong place, the whole deal could go sour. For example, if everything else about the house is perfect, but it has serious structural damage, this could cost you thousands of dollars. Confirm that everything lines up before making a serious decision like investing in a property.
About the Author:
Anthony (Tony) Rosado is a real estate investor and agent, specializing in buying and selling homes in foreclosure, short sales, bankruptcy, probate, and bad tenants. Koi and his team help homeowners resolve their problems by giving them solutions in today’s real estate market, including negotiating short sales or a loan modification for clients that want to stay in their home or selling quickly avoiding foreclosure.