Whether you are a seasoned investor operating in a field you have deep knowledge of or you are venturing into new territory, you will have a lot of questions ahead of making a real estate investment. Every real estate deal is unique and has its own set of potential pitfalls.
Identifying these pitfalls is a process generally referred to as “due diligence.” That can mean different things in different contexts, but there are a few generalities should be aware of.
What a Due Diligence Checklist Looks Like
Due diligence is a discovery process intended to identify potential liabilities and problems before a property is paid for. Often, due diligence is a formal stage of the sale, when the potential buyer has paid earnest money and has 30-45 days during which they can back out of the sale and receive their money back without providing a reason.
The first step in due diligence is to ensure that enough time is provided for in your sales agreement for you to inspect the property. Otherwise, another buyer could purchase the property before you have concluded your investigation.
In the case of a 1031 exchange, due diligence should be carried out as part of the process of choosing a replacement property.
There is no canonical due diligence checklist. There are scores and scores of possible checks to make, ranging from a cosmetic inspection (is the fence in good condition?) to an examination of the property’s financial performance. Some of these are easily carried out by an individual investor (kick a fence post), while others are commonly entrusted to specialized services (title search, for example). Other issues may require a higher degree of specialization even to identify (how’s the wiring?).
Essential Steps in Due Diligence
There are certain actions and areas of interest that are common to any due diligence process:
- Select counsel to review the purchase and sale agreement and decide whether or not to accept it.
- Select a title company to do a full investigation of the title.
- A financial audit of the property should be conducted. Taxes and operating costs should be examined, confirmed, and compared to similar local properties. The local landlords’ association can provide valuable assistance at this step. Outstanding debt should be assessed. The seller’s bank statements, rent accounting, and tax returns may be needed during this step.
- Service contracts and insurance coverage should be reviewed. Some of these agreements may have to be renewed or renegotiated.
- Shared expenses with the seller and proration of ongoing expenses have to be agreed on.
- Litigation involving the property should be identified and reviewed.
- Personal and physical property should be thoroughly inventoried and inspected. Deferred maintenance and the need for upgrading and modernization now or in the future should be identified and assessed. The availability of parking should be considered as well.
- Environmental issues, such as groundwater levels or nearby sources of pollution, and earthquake risk should be addressed.
- Zoning, licensing, and permitting should be confirmed to be in order.
The due diligence period also provides an opportunity for you to confirm your actions. Does the property meet your expectations and needs? Is it in line with your original buying intentions? Do you have sufficient financing and will it be available on time?
This is only a general outline of due diligence issues. Individual properties can present any number of specific challenges. It is essential for due diligence to be carried out by experienced professionals.
CWS Capital Partners specializes in multifamily housing communities. Our experts can help guide you through the most complex acquisition process.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
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