Buying and owning real estate always involves an element of risk. Many people have lost a lot of time and money pursuing deals which turned out to be disappointing. This is why it is important for every real estate investor to do their due diligence in real estate before buying an investment property.
So, What Is Due Diligence in Real Estate?
Due diligence real estate is doing your homework before deciding to buy a piece of property. Whether you are planning to purchase a multi family home, condo, single family home or apartment, you need to do your due diligence in real estate in order to minimize risk. Real estate due diligence could involve reviewing documents, procuring insurance or performing calculations.
Though you could hire a real estate agent or company to carry out investment property analysis on your behalf, it is always advisable to do your own due diligence in real estate.
Real Estate Due Diligence Checklist: 9 Things You Need to Do
Many real estate investors and home buyers find the real estate due diligence process to be stressful and intimidating. They don’t know where to begin, what data to look for, and how to analyze information to decide if an investment property is right for them or not.
If you are unsure about how to go about buyers due diligence, here is a checklist of the 9 things you need to do:
1. Inspect the Investment Property Thoroughly
A home inspection is a crucial element of the real estate due diligence process. Hire a professional home inspector to check the home thoroughly for evidence of damage or defects that will cost you money to repair. The inspector should check for problems such as a faulty HVAC system, crumbling foundation, leaking roof, termites, and other major issues.
It is also recommended that you hire a different professional inspector to conduct due diligence in real estate for biotoxins such as asbestos, radon, and mold. Such problems can be very costly if they are not dealt with immediately.
2. Conduct a Title Search
Due diligence in real estate is not just about investigating the property for sale. You need to do a title search to ensure that the property title is clean. Make sure the title has no hidden encumbrances or liens that could pop up later and cause problems. If you come across such problems, address them with the seller early enough and get them resolved before real estate acquisition.
Once you have conducted the title search, get an owner’s title insurance to shield yourself from problems that were not discovered during the title search. This could be issues such as forgery, undisclosed heirs, mistakes in records or omissions in deeds.
3. Conduct a Neighborhood Analysis
The surrounding neighborhood can have adverse effects on the value of real estate. So you must perform a local real estate market analysis. Is the investment property located near some environmental hazard? Are there abandoned properties in the area? What is the traditional rental and Airbnb occupancy rate of rental units in the neighborhood? What is the rate of return for similar income properties? Are there amenities such as schools, hospitals and bus stations nearby? Depending on the findings of your due diligence in real estate, you can renegotiate the deal with the seller or simply walk away.
4. Conduct an Investment Property Analysis
Investment property analysis will help you figure out the performance of real estate before making a purchase. You can determine the viability and profitability of an investment property using the following metrics:
- Cap rate – This is a value that shows the return on investment based on the current value of the property
- Cash on cash return – Unlike cap rate, CoC return establishes the property’s profitability based on how much cash is invested in the property
- Price to rent ratio – This metric shows the ratio of the property price to its rental income
Easily perform a rental property analysis using Mashvisor’s real estate investment tools.
5. Scrutinize Homeowners’ Association (HOA) Rules
If you are thinking of investing in a condo or apartment within an HOA, you need to thoroughly scrutinize its restrictions, conditions, declarations of covenants, and CC&Rs. Get familiar with all the rules and regulations, as well as the penalties for infractions. Some rules can be very restrictive, determining whether you can rent out the property on Airbnb (or at all), if your tenants can have pets or not, or even the color you paint your house. If you find some of the rules to be unreasonable, you can always back out and go elsewhere.
6. Check Recent Sales Activity
If you are planning to buy and sell property, check the recent sales trends in the neighborhood. How long are properties staying on the market? Are they languishing or moving fast? How many of the recent sales were distressed assets? What are the rent vs. buy trends in the area? How much are properties selling for? Have prices been going up or down? You can find such data for comparative market analysis on Mashvisor.
To learn more about how Mashvisor can help you find profitable investment properties, schedule a demo.
7. Investigate Zoning Requirements
If you are planning to rent out an investment property, talk to a real estate attorney to find out if there are any laws or ordinances that could restrict you. Some neighborhoods are not zoned for rental property, while others limit the number of rentals. Other areas even limit the number of people that can reside in a single unit. This could be a problem for someone that wants to invest in student housing. You should also check out zoning requirements if you wish to run a non-owner occupied Airbnb rental property.
8. Check Eligibility for Insurance
As part of your due diligence in real estate, check if the investment property meets the minimum requirements for insurance. For example, if the home is located in a hurricane- or flood-prone area, you might not be able to acquire a policy. Even if you do, it will probably be very expensive.
Here are some of the insurance policies you might need to protect your real estate investment property:
- Homeowners insurance – If you are planning to live in the property and rent out one unit or a room, you will need homeowners insurance. This covers major losses such as theft, fire, private property losses, natural disasters, and liability.
- Dwelling insurance – In case you are buying to rent out, dwelling insurance will protect your assets and cover liability.
- Vacant property insurance – If you intend to purchase a home and then flip it, you will need this insurance to protect your vacant property from the risk of fire, vandalism or theft
9. Compare Investment Property Financing Options
If you are planning to take out a mortgage, don’t just settle for the first or second lender you come across. Instead, compare different lenders to find the best deal available for real estate transactions. What are their interest rates? What is their pre-approval process? Would they be willing to finance the type of income property you want to buy? Due diligence in real estate should also involve reading reviews to find out what previous customers are saying about the lender.
Doing your due diligence in real estate will save you a lot of unnecessary headaches and expenses. The checklist above will help you make smart purchasing decisions and avoid costly mistakes. Above all, trust your gut feeling at all times. If something doesn’t feel right during the due diligence period, it probably isn’t.
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