When purchasing a real estate investment, it’s difficult to overstate the importance of doing your due diligence. The degree of due diligence depends on the complexity of the property under consideration. For example, purchasing raw land may require less rigorous due diligence than purchasing a commercial building.
Due diligence begins well before you purchase the property. In the real estate purchase and sale agreement, allow yourself sufficient time to do a thorough analysis of the property. Life’s too short to get stuck with a problem property for 20 years. Don’t be lured by the promise of big potential profits on paper and overlook important details. Follow the old adage, “If it looks too good to be true, it probably is.”
Due diligence can be divided into three categories: (1) Physical Due Diligence; (2) Legal Due Diligence; (3) Financial Due Diligence. Physical due diligence involves hiring an expert or experts to physically inspect the property. It entails such things as inspecting the structural integrity of the building to having someone inspect the mechanical, electrical and interior systems of the building. It should also review such locational issues as ingress and egress.
Legal due diligence may require the assistance of an attorney or title company. Legal due diligence would include things like: inspecting the title report, reviewing the survey, confirming that the property meets the zoning requirements and building codes and has obtained the necessary licenses and permits It could also involve reviewing service and vendor contracts, taking an inventory of the personal property. And, especially if it involves new construction, a Phase I and possibly a Phase II environmental study.
Financial due diligence requires a review of all the historical income and expenses associated with the property. This would include things like, reviewing the rent roll to determine if the income is as represented, reviewing operating expenses, especially payroll, utility bills, property taxes, property insurance and any maintenance costs. Also, confirm that your rental and income projections are accurate and the value of the asset has been determined. This often requires hiring qualified people to perform a feasibility study and do an appraisal.
Finally, if you are selling a property, check out the buyer’s credentials and references. If you are purchasing a property, assume nothing you have been told is accurate. Do your own due diligence hire a team of qualified people to help you through the process. It will be money well spent.