REISkill - When Buying - Due Diligence Investigation

Learning Due Diligence 

Due Diligence - Caveat Emptor
 

In a nutshell, due diligence is exhaustive research. In more real estate specific terms, due diligence is about doing your homework. There is nothing worse than jumping in with both feet only to find that you have bought a lemon. In fact, it goes deeper than that.

 

A good property deal is only (and I stress only) a good deal if it can generate positive cash flow. This means that it needs to generate money from the get go. For this to happen you need to be able to sell it for more than you bought it for including expenses or you need to be able to rent it for a profit.

 

When purchasing property, the due diligence process is your protection. Caveat emptor, let the buyer beware. In many ways due diligence is your peace of mind.

 

The more you know about a potential investment, the more confidence you can have taking the next step. Beyond peace of mind, due diligence is needed to ensure that your investment will be financially viable. Use your team to dig deep into your potential investment. Through each phase of the due diligence

process, make full use of your team to uncover as much information about the property as possible.

 

In real estate, the due diligence process consists of a three-part examination of a property.

 

Structural

This entails a physical breakdown of the property. This is where you need to call upon your housing inspector. During this phase of due diligence, you need to determine all of the shortcomings of the property.

 

This means anything that is wrong with it.

• Does the roof leak?
• Are there lead pipes?
• What other repairs need to be done?

 

This information is crucial. In order to resell or rent the property, you have make the needed repairs. Your housing inspector will be able to assess the costs of all of the required repairs. If the cost of the repairs pushes your budget too high, then the house is no longer a deal – at any price. For example, if you find that the cost of repair forces you to charge high rents, then chances are you will not be able to keep your vacancy level low. In other words, your renters will not be able to carry the property with the added expense of the repairs. Similarly, if the repairs raise the necessary asking price of the property above market, then you will have a hard time selling it.

 

Monetary

This phase looks at the fiscal aspects of your investment. To begin with, you need to crunch the numbers to make sure that the property is viable. Once you have established the property’s viability, you need to do a little forensic accounting.

• You need to determine any outstanding debt on the property that may be transferred over to you when you take possession.
  
• The most common are tax liens. A tax lien is essentially a penalty for unpaid property taxes. These can amount to several thousands of dollars and, in the worst case scenario, the government can actually sell the home to recoup its lost tax dollars.

 

Your two most valuable team members for this phase are your lawyer and accountant. Working with them, you should be able to uncover all the monetary information you need to make an informed decision about the property.

 

The Law

There may be some legal restrictions on the property. In a really far-fetched example, the people who are selling the home may not actually be entitled to do so.

 

Your lawyer should ensure that the property can, in fact, be sold and that the people selling have a right to do so. Have your lawyer draft up a disclosure contract.

 

Under a disclosure contract,

• the selling party is obligated to disclose anything that is problematic with the property that they are aware of.
  
• This includes structural, financial and intrinsic factors.

 

Further, when it comes time to write your offer, ensure that you include everything that you are expecting to get with the property, everything from appliances, landscaping items, fixtures and any decorations.

 

As well, you should

• include any intrinsic selling aspects that make the property an attractive purchase.
  
• For example, the house may back onto a set of train tracks that you are not initially aware of, but you can include the quiet neighborhood as an intrinsic feature that you want protected in your contract.

 

In closing, the more information you have the more protected you are. The reverse is also true.

Leaping before you look can expose you to a lot of risk.

• Due diligence is the closest thing you are going to get to a guarantee on your investment.
  
• The more homework you do, the clearer the investment picture becomes.
  
• When you have a clear picture that you are confident with, the investment becomes a no-brainer.