Image Alt Text: Real estate agents wearing hard hats inspect a property's exterior, assessing potential investments.
A comprehensive due diligence checklist will help prevent major errors prior to signing on the dotted line.
The checklist is your tool to validate all aspects (financial, legal, physical) of a transaction. Performing a review with discipline will include auditing the financials, physically inspecting the property, conducting a legal title search, and evaluating the local rental market.
Due diligence experts suggest that it would be advisable for you to engage a professional property manager as soon as possible during the acquisition process. Their purpose is to evaluate issues so you can purchase an income-generating asset rather than simply a property.
Due diligence is a comprehensive review process used by buyers when purchasing real estate to verify all claims made regarding rent income, expenses, physical condition of the property, and other information presented by the seller.
Real estate experts describe due diligence as the buyer's ability to access a seller's records, contracts, systems, etc., during a specific timeframe, which is usually 7-14 days, from the day an offer has been accepted on a property.
Due diligence is often cited as the most common reason for regret experienced by novice investors. Completing a comprehensive due diligence review provides the buyer with confidence and eliminates uncertainty associated with making educated guesses.
Image Alt Text: Two contractors inspecting a modern house interior wearing hard hats.
A thorough due diligence evaluation has four primary components to protect you against various types of risks.
Verify all numbers provided by the Seller. Obtain actual rent rolls, utility bills, repair invoices, and tax records for the past 12-24 months. Compare these to what the seller claims is the Net Operating Income. Often, there are differences in the numbers. Verify that the property does indeed generate cash flow.
Have a professional inspector inspect all of the roof, HVAC, plumbing, electrical systems, foundation, and pest activity.
Consider additional testing (such as Mold Testing) for older buildings to test for asbestos and lead-based paint. If at all possible, walk through the property yourself. Consult with Bay Property Management Group Baltimore, to verify that a property meets all regional lead-paint and safety compliance standards.
Anything major found on this inspection becomes your repair cost. Negotiate credits or price reductions based on issues discovered.
Conduct a title search for outstanding liens, easements, back taxes, or ownership disputes. The buyer needs a clear title to transfer ownership of the property. Additionally, check for compliance with any lease agreements, service contracts, and/or Homeowners Association (HOA) Rules. The attorney or title company can assist with this process to ensure there are no unexpected legal issues.
Determine current rental market rent levels, vacancy rates, and trend directions. Research similar rental properties located within a one-half-mile radius of the subject property.
Avoid over-estimating potential rent amounts; use rental data from property management companies or other services such as Rentometer. The rental market analysis provides the information needed to determine what a tenant would be willing to pay for the space, enabling accurate revenue projections.
Even seasoned investors have made due diligence blunders. The following are common issues that can cost you money, time, and ultimately frustration when you close on your rental property.
For rent rolls & expense reports, don’t just believe what you get from the seller. Get originals of all the above items. Bank statements & utility bills; verify each item with a cross-check. Sellers can exclude vacant units in their rent roll or even inflate rents.
Only by verifying the docs yourself can you be assured of the true cash flow. If this due diligence shows missing numbers or prorated rent, ensure to explain to tenants what prorated rent means to correctly account for the credits the seller owes you.
Don’t just rely on photos of the property or your friend's opinion; go visit it in person or have someone you trust visit it instead. While walking through the units, take some time to inspect the rooms thoroughly (under sinks, etc.), try out the appliances, and note any small signs of damage, such as water spots or uneven flooring.
You may even have to hire a plumber to understand the plumbing health of the property before proceeding with your plans. Regardless, these types of issues may not appear on an inspection report but could end up costing you a lot of money down the road.
You will most likely make an incorrect assumption about whether the property complies with all local laws and regulations. It is very important to check for any pending violation notices, any rental license requirements, lead paint rules, and local eviction moratoriums.
There are many ordinances that, if violated, can result in significant fines or require you to spend thousands of dollars on upgrades before you can lawfully rent the unit.
Don’t allow the pressure of an early closing to rush through your due diligence process. Ask for a due diligence time frame of no less than 10-14 days. Take advantage of each day to investigate, verify, and analyze. A rushed due diligence is a recipe for skipping important details that can ultimately lead to costly surprises once you have purchased the property.
Your last line of defense is due diligence. This helps ensure that the financials are accurate, the property is in good condition, all legal documents have been provided, and the property has the potential to thrive in the area where it will be located.
Additionally, you can assess if there are any environmental issues with the property. Most importantly, do not rush the process or take anything a seller says as fact. Once you complete all items on your checklist, you will purchase confidence, rather than buyer's remorse.
Therefore, completing your due diligence ensures that what may initially appear to be an unknown purchase opportunity becomes a great, long-term real estate investment.
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