Due diligence is an integral component of real estate investment. This involves performing extensive research, analysis, and evaluation on any prospective property before purchasing it. Due diligence plays an essential role here: it should be part of every buyer's and investor's preparation before proceeding with property purchases. But do you know what is due diligence in real estate?
Due diligence involves conducting thorough investigations on properties to assess their accuracy, value, and associated risks. Due diligence involves scrutinizing every factor, from legal documents to physical features, to make informed decisions about proceeding with transactions. This article discusses its significance further along with the steps involved in performing due diligence on various properties.
How Does Due Diligence Work in Real Estate Transactions?
As part of your home-buying journey, you must conduct thorough investigations on both the property and the seller to make sure you receive what was agreed to. Doing your due diligence will prevent costly surprises down the line, such as hidden defects or liens on a home that you thought you knew well enough to purchase.
Due Diligence Period
A due diligence period occurs from accepting an offer until a property closes. It provides buyers with time and opportunity to inspect the property and conduct other investigations to ensure they're getting what they've paid for.
Pre-Offer Due Diligence
It involves gathering information about the property to see if it's the right fit for you and if the price is fair. Think of it like doing your homework before taking a test - you want to be prepared and have all the necessary information to make a good decision. An effective pre-offer due diligence process includes the following:
- Research the neighborhood thoroughly by exploring the crime rate, school quality, and amenities available within its boundaries.
- Comparable properties will also help determine whether it's priced fairly. A home inspection may uncover any hidden problems with the property or potential problems that might need attention immediately.
- Order a title search. A title search will identify any liens or encumbrances on your property that might negatively impact its title and ownership status.
Post-Offer Due Diligence
It allows buyers and investors to conduct further investigation after accepting a property offer to ensure they receive what was promised before closing on it. It gives one last chance for verification that what has been purchased matches what you expected, which it will offer them before finalizing any agreement on closing costs and moving ahead with closing procedures.
One way you can conduct post-offer due diligence is:
- Review the property again after the pre-offer inspection to address any concerns not adequately addressed in its initial examination. Get additional appraisals if you are concerned about its value.
- Negotiate repairs. Should the home inspection reveal any major flaws, you could deal with the agent to have those problems corrected before closing.
What to Look for During Due Diligence
Below are a few key items to keep an eye out for during due diligence:
Property Inspection
A property inspection visually examines the property to identify any potential problems. The inspector will look for structural damage, mold, pests, and other issues affecting the property's value.
Appraisal
An appraisal provides an estimation of the value of a real property based on factors like location, condition, and size when estimating its estimated market value. The appraiser may keep in mind these factors, like location, condition, and size, when determining its worth.
Title Search
It involves examining your property title history to ensure there are no legal claims, known as liens, against it and no restrictions placed upon its usage by any encumbrances (limitations on use of property).
Survey
A property survey provides you with an outline map showing its boundaries, helping to confirm that the size was as indicated when purchasing it or that any encroachments compromise it.
Disclosure Review
Sellers are required to disclose any known issues with the property. It might include the roof's age, the septic system's condition, and any environmental hazards present in it.
Zoning and Land Use
Before purchasing property, ensure it has been zoned accordingly for its intended use. For instance, if you plan to shop there, ensure the area has been zoned for commercial use only.
Homeowners Associations (HOA) Rules
If the property you intend to purchase is part of a homeowners association (HOA), understand their rules and regulations before beginning work. These may restrict elements like paint color choices, fence size limitations, and pet types allowed within their boundaries.
Review Insurance
Your property must have sufficient insurance to safeguard it adequately, the kind will depend upon both its nature and financial circumstances.
Real Estate Due Diligence Checklist
Purchasing a home is a major decision, and it is crucial to conduct thorough research before making such a significant commitment. Here is a vital checklist for real estate due diligence to ensure you get the most out of your investment.
Pre-Offer Due Diligence Checklist
- Research your neighborhood thoroughly to learn about its crime rate, schools, and amenities. Compare comparable properties to assess whether they are reasonably priced, and get an inspection to identify any possible property issues.
- Order a title search. A title search can identify any possible liens or encumbrances on a property, and pest inspections can identify potential pest problems.
- Consider getting an environmental inspection. An environmental inspection can reveal any ecological threats on a property and review seller disclosures for known defects that exist on it.
- Speak with neighbors. Get their view on what this property and neighborhood mean for them, visit at various times of day, and trust your instinct if anything seems off. Be confident in making any decision that might go against what your gut instinct says is right!
Post-Offer Due Diligence Checklist
- Inspection. Reinspect the property if any concerns were left unaddressed during your pre-offer inspection, or obtain more appraisals if any valuation concerns arise.
- Negotiate repairs. If the home inspection reveals any problems, try to discuss them with the seller to get them fixed before closing.
- Purchase a home warranty to protect you against unexpected repairs post-closing on the property.
- Examine all closing documents closely. Ensure you fully comprehend all the terms of the contract before signing it. Additionally, obtain home insurance, as this can protect against financial losses caused by damage to your property.
How Long Is a Due Diligence Period?
During the due diligence period, after an offer has been accepted and before the property closes, buyers can thoroughly inspect and conduct investigations on the property or other investment assets they are purchasing. This allows them to ensure they receive what they anticipate from the transaction.
Due diligence periods can differ depending on several factors, including transaction complexity, type, and risk tolerance of the property; typically, for residential properties, the due diligence period usually lasts 7–14 days, while that for commercial real estate can extend up to 60+ days.
Due diligence can involve many activities. The buyer can arrange for a home inspector to look over the property. Order a title search and review seller disclosure documents; negotiate for repairs from the seller as necessary; seek credits instead of repairs; etc.
Buyers have an option if they are dissatisfied with the due diligence results. This option is known as a "due diligence contingency and allows them to withdraw if any property issues arise during due diligence.
Due diligence should always play an integral part in any real estate transaction. By conducting extensive investigations before purchasing an individual or investment property, due diligence allows buyers to avoid costly surprises down the line.
Here are a few items that could be discovered through due diligence:
- Structural damage
- Mold
- Pests
- Environmental hazards
- Liens or encumbrances on the property
- Problems with the title
- Defects in the property that the seller did not disclose
Tips for Successful Due Diligence
Here are a few key strategies for conducting successful due diligence when purchasing real estate:
Work with a qualified team
When purchasing property, you must work with an experienced team. Your ideal team should include a real estate agent, a home inspector, an attorney, and a lender.
Real estate agents and home inspectors are essential in finding and purchasing property competitively, with potential issues identified through home inspection reports. A lawyer should review purchase contracts to ensure they protect your best interests, while lenders provide financing solutions to facilitate your purchase.
Review documents carefully
Once you find a property of interest, it is vital that all documents, including purchase contracts, property disclosure statements, and title reports, be thoroughly studied before making an offer.
A purchase contract is the cornerstone of every real estate transaction, outlining the price, closing date, and financing terms. A property disclosure statement provided to buyers lists any known issues with their homes. In contrast, title reports provide insight into who owns what property and any liens or encumbrances encumbering it.
Follow Up on Findings
Once the home inspector identifies any potential problems with your property, any relevant findings must be followed up. This may involve scheduling additional inspections or getting estimates for repairs.
As part of your pursuit to buy or lease real estate, it's also vitally important to clarify any questions regarding a property promptly and appropriately by speaking directly with your real estate agent, home inspector, attorney, etc. If something needs to be clarified, feel free to consult them directly, including asking your realtor, home inspector, and attorney!
Negotiate repairs or credits
If the home inspector identifies major flaws with the property, you could discuss with the agent having these fixed or receiving credit towards your purchase price.
Repair or credit amounts depend on the severity and willingness of both parties involved to negotiate.
Consider the Big Picture
When conducting due diligence, you must consider all relevant aspects, such as the location, condition, and market value of the property.
Excelsior Realty: Your Trusted Real Estate Partner
Excelsior Realty stands out as an experienced real estate agency in Minnesota with years of experience under our belts and intimate knowledge of local market conditions. When working with us, expect nothing short of exceptional results, whether that means negotiating sales contracts, providing insights on current market values, or creating marketing strategies tailored specifically for your home. At Excelsior Realty, our aim is always to build lasting client relationships based on trust.
As intimidating as purchasing or selling a home may seem, we promise we have your back every step of the way, ensuring you remain informed while making informed decisions.
The Bottom Line
As part of any successful real estate transaction, due diligence should always play an integral role. By conducting proper due diligence, including seeking professional assistance as needed, and performing extensive investigations before entering any agreement or making purchases or agreements on property purchases or lease agreements, mistakes and costly decisions that won't serve your long-term needs can be avoided and more informed decisions can be made that are beneficial in the long run. Take your time with deals before doing your research, and always remain diligent when conducting transactions!
