What Is Real Estate Due Diligence?
Once you make an offer on a home and it’s accepted, there’s a process lasting a few weeks before you close the transaction. During this window of time, buyers are often told to “do their due diligence” on the home they soon hope to own.
But just what is the definition of due diligence, anyway? In the world of investment transactions, due diligence is a legal term for “do your homework.”
Before buying a property, you should fully investigate it for potential problems that could cost major money to fix after you’ve moved in, and verify that you still want to buy the property.
“Due diligence in residential real estate means [making sure] you’re getting the asset you’re paying for,” says Larry Anweiler, an Arizona real estate broker who teaches real estate at Kaplan University. Think of this as your last opportunity to kick the tires, turn on and off all the lights, and generally make sure you’re not getting a lemon.
What if I find problems during the due diligence process?
All real properties have flaws. Even (or sometimes especially) a brand-new house has things wrong with it, depending on how picky a person wants to be.
Home inspectors often make long lists of items they have found, for example, many of which are cosmetic, easily fixed, or simply a result of wear and tear on the property. The seller is not obligated to fix every item the buyer or an inspector finds.
If you discover during due diligence that the home has defects that should be fixed, you have time to negotiate with the seller, who may agree to fix the defects or lower the home price.
If the seller refuses, you have the legal right to walk away from the deal—and as long as you’ve placed some contingencies in your purchase agreement and you rescind your offer within the time periods specified in your contingency addendums, you won’t have to forfeit your financial deposit.
Your state may also have laws that give you time to back out of the deal during the process of due diligence, without losing your earnest money deposit. Be sure you understand the due diligence laws of your state before you start the process of buying a home.
Due diligence is definitely a process worth taking seriously when you buy such an important asset.
Here’s a checklist of what you’ll want to scrutinize before closing the deal.
A home inspection
Most home buyers hire a home inspector to scrutinize the house top to bottom as part of the due diligence process, looking for problems that could cost the buyer major money to fix. The inspector is looking for a crumbling foundation, faulty HVAC systems, termites, leaking roof, and other potential big-ticket problems.
You should also hire a separate professional to test for biotoxins, including mold, radon, and asbestos. These hazards are typically not checked by a home inspector and are expensive to fix if you don’t take due care now.
You should also check for larger neighborhood issues that could have an impact, like whether your home lies in a flood zone or near some environmental hazard. These can all be reasons to reopen negotiations with the seller and, if you’re not satisfied, prompt you to walk.
A title search
Due diligence is more than an investigation of the house. Before you can “take title” to the asset—a fancy way of saying you establish legal ownership of the property that’s entered into public record—you’ll want to do a title search to make sure you can indeed do that, free and clear.
Mortgage lenders will require a title search as part of due diligence, because it protects them as well as you.
For instance, what if the previous owner’s long-lost brother shows up claiming he is a financial investor in the property and has a right to equity in it, or a creditor has placed a financial lien on the home due to an unpaid liability, or there are unresolved boundary disputes with a neighbor?
Such problems can be costly to address, and due diligence in getting a title search will bring them to light so you can broach these issues with the seller before you make an acquisition you regret.
Condo or HOA rules
If you’re considering a potential investment in a condo or property within a homeowners association, you’ll want to make a thorough investigation of its declaration of covenants, conditions, and restrictions, or CC&Rs. Basically this is the list of rules and regulations, as well as fines for infractions.
Some can be quite strict, reserving veto power over the color you paint your home or the number or type of vehicles you can have in front of your house (RVs are sometimes banned). Given these are rules of conduct you’ll be living under for the foreseeable future, it’s wise to evaluate them as part of your due diligence and make sure you’re on board—and if not, you can back out with your deposit in hand.
If you are buying a condo, either as an investor or as a home buyer, your financial diligence should also include researching issues with the condo association.
The condo association should have healthy financial statements, including a balance sheet with a good reserve fund. If the condo association may be making special assessments soon, you’ll want to discover that during due diligence—not after you move in.