What is Due Diligence in Real Estate?

If you will be entering the world of real estate, you’ll encounter the phrase “Due Diligence” a lot. Whether you will be purchasing, owning, or investing, you’ll hear it. This phrase plays an important role in the real estate industry. In this article, we will tackle everything you need to know about it. What is due diligence and why it is important?

What is Due Diligence?

Due Diligence refers to the buyer’s evaluation and assessment of the property or business. Usually, due diligence takes place before making an offer, entering into a contract, and closing. This period of investigation is referred to as the due diligence period. Due diligence is where you “do your homework” before you purchase the property. It may involve doing calculations, reviewing the property/business documents, physically viewing the premise, and other tasks.

The due diligence period is critical and requires special attention. You wouldn’t want to miss even the little details of the property you are about to buy. Or else, you’ll find yourself spending a huge amount of money defects that can be detected earlier. That’s the reason why due diligence exits. It avoids any unpleasant surprises and unexpected costs. Besides, it also helps in making sure you are getting a good deal.

What can I do if I find problems during the due diligence period?

Before you start the buying process, you need to understand the due diligence law of your state. You can’t just refer to any due diligence law as they vary from state to state. And your real estate agent will help you with that. Your agent should provide you the detailed information on your options in case any problems happen. Moreover, what circumstances can allow you to walk away from the deal. These items need to be detailed in the contract. If there’s anything unclear to you, as questions. In the whole due diligence period, you need to put your trust in professionals.

Due Diligence Checklist

Here are the other things you need to check during the due diligence period:

Home Inspection

Ask for home inspectors to assess the overall condition of the house. Especially the important components of the property like the roof, plumbing, heating, and air conditioning. They usually make a list of items and defects they have found. You’ll know which problems are serious, quick-fix, or results of wear and tear. But this doesn’t obligate the seller to fix every item found in the inspection. You can negotiate if he can either fix the defects or lower the price of the home. It’s a case-to-case basis.

In case the sellers refused, you have the legal rights to cancel the deal. You can do the necessary actions bounded within your agreement. Also, some state allows the buyer to cancel the deal during the due diligence period and fully refund your deposit. That’s why you need to check and understand the law.

Title Search

Perhaps one of the important items you need to thoroughly investigate in performing due diligence in the owner’s title. It is a legal document that assures you the property is clear of any legal issue. Such as problems in ownership, liens, title claims, and other hidden title problems. For instance, there’s a financial lien on the home because of an unpaid liability. The title search will bring them up to you. In this way, you can resolve these issues with the seller beforehand.

In addition, mortgage lenders also require a title search because it protects both parties,

Homeowners Association

Typically, homeowner’s associations regulate covenants, rules, and restrictions to condo units, townhomes, and single-family homes. These enforced rules are efforts to protect the community. Some require limited upkeep, the number of vehicles you can have in front of your house, mandatory membership costs, and even maintenance fees. Take advantage of this opportunity to evaluate the covenants and restrictions. Once you’ve signed the contract and later find any of them inconvenient, there’s no turning back.

Home Insurance

You can also use this time to shop around for the perfect insurance for your home. There are several insurance types you can consider based on your purpose.

• Homeowner’s Insurance – If you’re going to reside in the new home, you can purchase this type to cover fire, theft, natural disasters, property losses, and liability.
• Dwelling Insurance – This type is for landlords that are renting out the home to tenants. It has liability coverage and protects the property.
• Vacant Property Insurance – If you’re looking to flip a property, this type best suits you. It covers theft, vandalism, or risk of fire in an empty house while you are working on the home.

Seller Disclosures

Just like due diligence, law involving disclosure also varies from state to state. However, federal law requires sellers in all states to disclose any information about lead-based paints in their homes. It is not mandatory for sellers to provide disclosures but, these will be useful to get a grasp of the past and present condition of the home. For example, any material facts that may affect the home value will be helpful.

Business Licensing

Based on the definition, due diligence doesn’t apply to homebuying only. There is operational due diligence where the prospective investor investigates the operation of the business. Like the current business standing, the market, competition, business model, and even its licenses and permits.

Let’s say you’re looking to invest in a real estate company. You would want to assess the business first to know what you are getting yourself into. You can ask for copies of the business organization and good standing, real estate leases, title policies deeds, mortgages, financial information, and permits. These documents will help you determine if the venture is a good financial investment.

Phase 1 Study

The Phase 1 Study is an evaluation done to protect a buyer, lender, or investor from any environmental risks and liabilities related to the deal. It is also referred to as Phase I Environmental Site Assessment (ESA). Before conducting ESA, you need to know first if the type of real estate you have needs Phase 1 study.

What is the coverage of the Phase 1 Study? If you will buy or sell land or a business, there are aspects of them that need to undergo investigation. Just like potential land contamination and hazardous substances on a site. Furthermore, the compliance status of the site in line with environmental permits, liabilities, and health and regulations. This helps in determining substances that may have adversely impacted the site and other environmental issues. Phase 1 study should only be performed in compliance with the American Society of Testing and Materials (ASTM) or the Environmental Protection Agency (EPA) standards.

Survey Check

Whether you are purchasing a property for occupation or investment purposes, you must perform a property survey. A survey is where a property surveyor will research into a property even before visiting the property. He will start in researching the history of the deed. He may also include a title search to make sure there are no discrepancies with who owns the property. After looking into the legal descriptions, the surveyor will actually go to the property. This is to sketch out the land, the elements that make up the property, and its boundaries. This is referred to as the fieldwork. After the survey is done, the surveyor will provide a map that details the property’s legal boundaries. It will also include a written description of the property, its location, and any improvements that the owner can make to the land.

DISCLAIMER:

Neither Alpesh Parmar nor Wealth Matters associated claim to be an expert in tax, legal or insurance strategies. WE STRONGLY URGE PROSPECTIVE INVESTORS TO CONSULT WITH THEIR OWN ADVISORS PRIOR TO DECIDING WHETHER TO INVEST. Please consult an expert or advisor.