Investors: Do your Due Diligence!

“Due diligence” in real estate refers to the process of learning enough about a property to determine that the superficial value of purchase price or rental rate matches the reality of the condition of that real estate. Whether you are renting an apartment, purchasing a primary residence, buying a single family house to flip, or purchasing a commercial property, you will have to do some level of due diligence to arrive at a purchase price. The due diligence process is a spectrum of activity and review that depends on the nature of the real estate transaction being contemplated. An apartment dweller may simply tour the property, test out a few appliances to be sure they work, review the lease documents, and then agree to the transaction once these inspections have been done. An apartment rental is less of an investment and typically less permanent, than purchasing a primary residence or a commercial investment property, for example. Hence, the due diligence is much simpler. If the rental is for longer than one year, the lease agreement must be notarized and an inspection is often recommended. When someone is buying a primary residence, due diligence is likely to include much more than a quick walk-through with their broker. The homebuyers will probably want to see some research on comparables, that is, what other similar homes have recently sold for in this neighborhood. They will probably want information on the neighborhood, demographic trends, schools in the area and crime statistics. They may want to know how far the property is located from employment, schools or night life; whether it is on public transit lines or has a high walk score; and whether there are parks, libraries or other amenities nearby. Unless they are a real estate professional familiar with construction, inspection or appraisal, they will probably hire a home inspector to check for any defects in construction or workmanship. The inspection should include a pest inspection, as rodents, birds or wood-boring beetles may cause havoc with houses in this area. I usually recommend that homebuyers include a side sewer inspection during the inspection phase, especially In Seattle, with its older stock of housing and mature foliage. Tree roots can cause major damage to old clay sewer pipes. In many parts of the country, a radon inspection is also recommended, although it is much less of an issue in the Pacific Northwest. If there is a body of water located nearby, it would be good to check in with a hydrologist, or at least find out where the flood plain is located and whether there will be any problem getting flood insurance. Insurance agents can be helpful in dealing with many otherwise un-insurable issues such as steep slopes and critical areas that may affect a homebuyer’s ability to purchase insurance (or build on the property). Septic systems and water wells are more of an issue in rural areas, and should be inspected as well.

Seller disclosures can provide much information about what has been done to and what is known about the house. If there has been recent remodeling, were all necessary permits obtained? Federal law requires disclosures regarding lead paint and other hazardous materials such as asbestos used in houses built prior to 1978.

Checking the chain of title on a property may reveal liens, covenants, restrictions or easements that may affect the buyer’s use of the property. A check of the zoning may reveal opportunities to further develop the property in the future, or perhaps even a subdivided tax lot that the seller did not know about.

Due diligence on a commercial property may be even more complex, with various environmental reviews, surveys, and a review of sellers’ “books and records” to include leases, rent rolls, and maintenance records.

When working with contractors or partners, due diligence may include a review of business licenses, professional reviews, testimonials and personal references. If you are lending money, you may want to do the same due diligence on the collateral used to secure your loan, and on the borrower personally.

Always check references. Always. Ask me how I know….