Whether you’re buying real estate for investment or to live in, you’re putting money into that property. A lot of money. You don’t want to inherit a seller’s problems when you buy.
Before signing on the dotted line and taking ownership of any real estate asset, you need to do your homework. This is a process called due diligence.
But what, exactly, is the due diligence period in real estate? How long should it last? And what should be on that due diligence checklist? While answers can vary to these questions depending on why you’re buying the real estate and what kind of property it is, there are general rules of thumb when it comes to successfully moving through the process.
Defining Due Diligence
Sometimes known as the “feasibility period,” “study period,” or “investigative period,” due diligence refers to an investigation or audit of an investment, which gives you all material facts pertaining to a transaction. Basically, the process helps reduce any surprises or post-sale shocks when it comes to your real estate purchase.
When it comes to investment property, the study period can be generally divided into pre-offer due diligence and post-offer due diligence.
First: Do Your Homework
Pre-offer due diligence is the information you obtain before approaching the seller with an offer to buy. The following information can help you structure a realistic bid:
- Area Analysis
- Population/job growth
- Median household income
- Percentage of renter-occupied households, vacancy rates, and median rents
- Neighborhood, school, and crime rankings
- Financial Information
- Gross rental income, application, or late fees
- Vacancy and tenant credit reports
- Deferred maintenance and ongoing repairs
- Property taxes and insurance
- Contributions to capital expenditures for future major repairs
- Financing/lending options
Second: Thoroughly Investigate
Post-offer due diligence typically kicks in when the contract is signed. This is when you get into the nitty-gritty of the property, thoroughly investigating the physical attributes. Items on your feasibility period checklist should focus on the items below:
- Physical Inspections
- Roof and foundation
- HVAC, plumbing, and electricity
- Driveways, sidewalks, and drainage
- Pest infestation and damage
- Environmental issues (i.e., lead-based paint and radon gas)
- Flood zone verification, well-water inspection, or environmental reports
- Financial Inspections
- Profit and loss for the past two years
- Income tax return (income and expenses reported to the IRS)
- Current rent roll, including terms, expiration dates, and deposit amounts
- Allowance for pets or other fees
- Receivables report
- Property tax information
- Capital expenditures and improvements
- Legal Issues
- Pending litigation or liens
- Violation notices
- Title and survey
- Review of liability insurance
- Zoning and land use
The above is not an exclusive list—there could be additional requirements, based on state and municipal laws.
How Long Should Due Diligence Be?
The feasibility period clock typically starts ticking within 24 hours of contract signing. How long that period lasts depends on a few factors.
The time allowed for due diligence on a residential home is generally built into a home sales contract. Depending on the geographic location, the period can last from 10 to 15 days, or longer.
When it comes to commercial real estate, or property used for investment purposes, the timeline is a little more complex. This is because commercial real estate doesn’t have the same consumer protections that primary residence homes do. As a result, you might need more time for your investigation. You could be looking at 30 to 60 days, depending on the property and what’s involved.
If you’re buying real estate for investment, be sure to negotiate enough time to completely understand the property. Based on your pre-offer due diligence, you should have an idea of what will be required.
The due diligence process is highly important when it comes to successful real estate ownership. It gives you insight about the property you’re buying, so don’t rush through the research.
