Understanding Due Diligence When Buying a Property

Whether you’re buying a home, purchasing an investment property, or representing a buyer in a real estate transaction, due diligence is a crucial factor in the success of your acquisition. 

Careful due diligence mitigates risk and empowers you to buy with confidence. 

What is Due Diligence?

Due diligence is a comprehensive evaluation of a property to determine any potential liabilities before completing a purchase. Thoroughly researching a prospective property helps you understand exactly what you’re buying and reduces the risk of unpleasant surprises once you take possession. 

The due diligence process involves several steps, some of which take place before a purchase offer is made, and some taking place once the offer is accepted. 

Pre-Offer Due Diligence Checklist

Before making an offer on a property, you can begin the due diligence process to ensure you’re looking at the right properties in the right locations.

Research the property market 

As you explore neighborhoods for your investment, research factors that affect property values, including population growth, job market shifts, new construction projects, educational opportunities, and the current real estate cycle. If you plan to rent the property to tenants, pay close attention to local rent amounts and vacancy rates.

Understand local property taxes

High property taxes can cut into your profits, particularly if you plan to hold the property for a long period. Find out how property taxes are calculated, how often they can change, and if there is a limit to tax increases.

Zoning

Zoning dictates how a property can be used. In many communities, large areas, such as industrial or residential, are designated for a single purpose. Confirm that you are looking for properties in areas zoned for your planned usage. 

Due Diligence Period Checklist

Once your offer is accepted, the official “due diligence period” (often called the “contract period” or “escrow period”) begins. This timeframe is negotiable, but it usually falls between 30 and 60 days for most properties. 

Seller Disclosures

Sellers are required to share certain information about the property with buyers. The exact requirements vary by state, but common disclosures include things like hazards, water damage, and items that are missing from the property. Review the seller disclosures carefully to learn what the current owner knows about the property. 

Building Inspection

A building inspection (called a home inspection in residential real estate) is a visual evaluation of the property’s physical condition completed by a professional inspector. The inspection report outlines all potential defects the inspector observed on the property. Some defects may need to be addressed, but many are documented simply so you can be aware of them.   

Specialty Inspections as Needed

In addition to the general building inspection, you might opt for additional inspections to confirm that the property is in good condition. Examples of specialty inspections include:

• Radon gas

• Mold

• Asbestos

• Termites and other pests

• Chimney

• Pool

Appraisal

An appraisal is a professional opinion of the property’s value by a licensed appraiser. This helps you avoid overpaying for a property. The lender will likely require an appraisal if you’ll be using financing for the purchase.

Title Search

Title searches confirm that the current owner has the right to sell the property. Properties sometimes have a “cloud on title”, also known as a title defect, that requires clearing before the transaction can be completed. For example, divorced property owners can create a cloud on title if the terms of the divorce grant the property to one party, but the other party is still listed on the deed. In this case, extra paperwork may be needed to correct the ownership via a new deed so the occupant can rightfully sell. 

Survey

A survey confirms the property’s geographic boundaries. If you cannot get a copy of an existing survey, you can order a new one. The survey can help you determine if structures (like fences) from neighboring properties are encroaching on your property or vice versa.

Liens and Easements

Liens are financial claims against a property. For example, if the current owner has unpaid property taxes or delinquent mortgage payments, there may be a lien to repay before your purchase can be finalized.

Easements are rights of use to third parties. Utility easements, for example, grant workers access to maintain and repair equipment and cables as needed to provide utility services.

Homeowner’s Association (HOA) Rules

If you’re buying a home in an HOA, you should review the Covenants, Conditions, and Restrictions (CCRs) to understand your responsibilities as the owner and confirm that you are comfortable with any limitations the HOA places on the look or use of the property. You should also review the HOA’s finances to find out how much you’ll pay in dues and if there are any upcoming special assessments you’ll need to fund.  

Insurance Requirements

Find out which insurance policies will benefit your property and which are mandatory. Homeowner’s insurance (or landlord insurance) is a common requirement. Additionally, specialty insurance policies, like flood insurance, may be required if the property is located in an at-risk region. In certain areas, insurance policies have skyrocketed in cost. This is an important consideration when looking at affordability.

Income and Expenses

If you’re purchasing an investment property, ask to see the income and expenses statements for the last three years, as well as any active leases and service contracts. This will give you an understanding of the recent financial performance.

What to Do if Your Due Diligence Uncovers an Issue

If a potential problem arises during your due diligence process, you have three options:

1. Accept the circumstances and proceed with the purchase. This might not always be an option. If a cloud on title cannot be cleared, for example, the seller may not be able to complete the deal. 

2. Renegotiate the purchase contract. If you find that the property is not worth as much as you originally thought, you can ask for a price reduction. If you find that you’ll need to invest money in urgent repairs, you might ask the seller for a financial concession to give you the money to pay for repairs.   

3. Terminate the purchase contract. If you find a deal-breaker, you can cancel the contract. Your earnest money deposit may or may not be refundable, depending on the terms of your offer. 

How to Gain a Due Diligence Advantage

The more information you can gather during your due diligence process, the more prepared you are to make sound real estate decisions. Uncovering potential liabilities early allows you to mitigate the associated risks and avoid costly property investment mistakes.  

With PropertyReach, you can get details on properties across the country. This enables you to find motivated sellers, dig into a property’s history, and even generate a value estimate for the property based on recent comparable sales.

Learn more about PropertyReach and discover how it’s helping real estate investors and industry professionals gain a competitive advantage in the market.