Real estate due diligence is a crucial process that increases the probability of a successful investment. It helps give buyers confidence in the property they are acquiring by resolving potential issues before they close a purchase. It’s a comprehensive property evaluation to help satisfy all legal requirements and reduce risk.
Here’s a closer look at what due diligence means and how it works. We’ll also provide a checklist to help real estate purchasers complete comprehensive due diligence of a property.
Real estate investors must thoroughly evaluate a property before closing a deal. There are several steps they should take before even submitting an offer. Here’s a preliminary checklist of due diligence items to complete before submitting an offer on a property:
- Study the property’s local submarket. Make sure it’s in a good location by doing online research and talking to people who know the area, such as a local real estate agent.
- Do an online search of the property address and current seller. See if there’s any history of crime, fraud, or other red flags with the property or seller.
- Review the property condition report. Pay close attention to the seller’s disclosures to see if there are any glaring issues with the property.
- Review any provided environmental and energy reports.
- Analyze all government-issued documents related to the building, such as permits, certificates of occupancy, code violations, and notices.
- Review any recent capital expenditures and make a note of any deferred maintenance.
- Obtain a rent roll to see the current rental rates and remaining terms on existing leases. See if lease rates line up with the market, or if there’s upside potential to bringing them up to current market rates.
- Evaluate property tax and utility bills from the property over the past few years.
- Review the property’s profit and loss statement.
- Evaluate the existing debt on the property and compare the rate and terms to those currently available in the market.
- Complete a site visit of the property. Walk through any common space and see if you can enter some of the units. Consider taking trusted advisors on the property tour, such as a local commercial real estate agent and general contractor. Look for any potential deferred maintenance or structural issues. See if you can speak to current tenants, employees, and the property manager.
- Develop a list of maintenance and other capital improvements planned for the property after closing.
- Contact lenders and begin a preliminary underwriting process to see what terms they might offer on the property.
- Crunch the numbers to be sure the property can achieve your investment objective. Be sure to consider any known maintenance and capital expenses while accounting for some unexpected costs.
The preliminary due diligence process aims to identify issues with a property before a real estate investor commits too much time or money to a deal. They can walk away at any step in the pre-offer process if they grow uncomfortable with the property. Otherwise, the information gathered during the preliminary process can help them make a more informed offer.