If you’re just getting into real estate investing, then you’ve probably heard the term “due diligence” getting thrown around.
What is it?
Why is it important?
And how do you do it?
In this article, we’re going to answer your burning questions about due diligence as it applies to real estate — we’ll even show you the exact process for performing due diligence on a property.
The video below is long; an hour and 23 minutes.
But if you’re serious about learning due diligence, then it’s 100% worth watching — Ryan Dossey is an experienced investor with hundreds of properties. He shows you how to do due diligence on a property from A-Z.
Otherwise, keep reading. We’ll review the key points from that video.
What is Due Diligence?
In real estate investing, due diligence refers to your responsibility as the buyer to inspect, analyze, and do your homework on the deal you’ve attained before going through with the purchase of a property.
This is a super important part of doing deals.
It’s the most common place where real estate investors — both new and experienced — make mistakes… and it’s the most expensive place to make mistakes.
Why?
Because real estate is a game of numbers — but you can only determine…
- Property Value Estimates
- Rehab Costs
- Holding Costs
… and other critical information if you do a good job with your due diligence.
During the due diligence phase, you’ll also look at things like neighborhood desirability, cash-flow estimates, chain of title, and liens to make sure that you’re buying what you think you’re buying.
The purpose of due diligence is to make sure that deal you think is a good deal… is actually a good deal.
Now let’s take a look at how you can do due diligence on a property — a lot of this information is taken straight from the interview posted above with Andrew Syrios. We’re even going to give you access to the templates and documents he uses to run due diligence on his deals.
Pre-Offer Due Diligence
The first phase of due diligence comes before you make an offer on a property.
This is the fast version of your due diligence where you’re depending more on estimates and educated guesses than on actual hard numbers. If the seller accepts your initial offer (with contingencies, of course, that allow for adjustments based on what you find later), then you’ll do a deep dive into the property.
But the pre-offer phase shouldn’t take a ton of time and should allow you to quickly make ballpark offers to sellers.
1. Location Analysis
First, we want to look at the neighborhood where the property is located.
Is there a lot of crime? Is the neighborhood desirable for renters?
A temptation that many new real estate investors fall into is buying a property because it’s just so darn cheap… but it’s in a bad, undesirable neighborhood with a lot of crime.
Unless you’re planning to specialize in that niche and know what you’re dealing with, we recommend steering clear of those neighborhoods entirely.
Andrew Syrios talks about how one property he bought in a bad neighborhood for very cheap ended up being a massive headache of damage, vacancies, delinquency, and other problems.
Regardless of whether you’re going to rent or flip the property, it’s easier to buy a mid-cost property in a decent area than it is to buy a cheap property in a rough area.
How do you determine if an area is good for investing?
The easiest way is to drive the neighborhood. Look at the quality of the homes, the yards, and the people walking around. Does it look safe and desirable? Or does it look run-down and sketchy?
Additionally, you can use Neighborhood Scout (you’ll need a subscription) to pull tons of useful information on neighborhoods. You can look at crime, cost, demographics, and more.
2. Value & Financial Estimate
The next step is to estimate the value of the property and what your returns will look like if you buy it.
You’ll want to run comps on the property to determine its ARV (after-repair value). We have a detailed guide to running comps over here — this will give you the ARV.
You don’t need to walk the property to get that information (save that for if the seller accepts your initial offer based on contingencies). Just ask the seller about the state of the property, take notes, and do online research to run comps.
3. Rehab Estimate
To determine if the property will be a profitable investment, you need to know how much it’s going to cost to repair.
But, again, you don’t need to walk the property just yet.
Instead, just ask the seller about everything they know of that needs to be fixed, maybe drive by it if it’s not too out of the way, and make some simple pen-and-paper calculations. Your rehab estimate will help you determine your initial max cash offer.
Here’s our complete guide to estimating rehab costs like a pro.
Post-Acceptance Due Diligence
During the previous stage, it’s very important to be upfront and tell the seller that your offer is not final — it’s contingent upon what you find during the post-acceptance due diligence phase.
In this phase, you’ll dive deeper into due diligence on the property to make sure you’re getting what you think you’re getting.
1. Physical Due Diligence
It’s time to visit the property in person (or, if you’re investing remotely, have someone check it out for you).
It’s time to visit the property in person (or, if you’re investing remotely, have someone check it out for you).
Bring a checklist with you that covers each room. Here’s the checklist that Andrew Syrios uses. Some of the main stuff you’ll want to pay attention to includes…
- The state of the roof
- The condition of the windows and doors
- Signs of water damage or mold
- The state of the HVAC system
And more.
Take a lot of pictures and notes when you’re walking the property so you can reference them later.
2. Financial Due Diligence
Now that you’ve seen the property, it’s time to recalculate your rehab estimate and your expected returns based on what you found.
If you don’t know the cost of a certain repair, do a bit of research online, ask other investors, or (better yet), get a few bids from local contractors.
This is where a lot of new real estate investors make mistakes. They run their numbers before they see the property and then get emotional about the deal when they realize it’s not as good as they thought.
Don’t let that happen to you.
Update your pro forma based on what you found during the physical due diligence phase. If the numbers don’t work, walk away from the deal.
3. Legal Due Diligence
Repair costs and ARV aren’t the only things you need to figure out to ensure a deal is good — you also need to make sure there are no liens against the property and there’s a clean chain of title.
If there are any liens, you could be on the hook for them. And if there’s an issue with the title, you might not even be able to close on the property.
Here’s what you need to do during this phase:
- Order a property profile from your local tax assessor. This will show you any liens against the property.
- Get a title search from a local title company. This will tell you if there’s anything weird with the ownership of the property.
- If you’re still unsure about anything, you can also hire a local real estate attorney to give you a title opinion.
4. Inspections
It’s not 100% required and not every real estate investor does it, but getting inspections is good practice whenever you’re even a little bit unsure of your own analysis (and it’s virtually mandatory for beginners).
For a few hundred dollars, you can get a home inspector to come out and spend a few hours looking at the property. They’ll check for things like…
- Electrical and plumbing problems
- Pest infestations
- Water damage
- And more
If the inspector finds anything serious, you can use it as leverage to renegotiate the price with the seller.
Note: Keep in mind that inspectors are paid to find problems. It’s common, then, for them to point out things that aren’t really that big of a deal. It’s important to use your own judgment (or that of another experienced real estate investor) when determining what to fix and what NOT to fix.
5. Create a Scope of Work
At this point, you’ve done a deep dive into physical, legal, and financial due diligence on the property.
Assuming you’re going to move forward with the deal after everything you’ve found, it’s good practice to create a detailed scope of work for the rehab project.
What does that look like?
Here’s a sample scope of work from Andrew Syrios — he does this for every property he purchases and you should, too. Not only will these scope of work be a critical resource when you’re working with contractors, but it’ll give you more leverage if you have to renegotiate with the seller.
You can show them everything you have to do to the property, the cost of all of that, and how it deducts from your original cash offer estimate.
When sellers can see why the offer changed, they’re a lot more likely to understand and accept.
If you’re not sure how much each repair is going to cost, find a contractor to work with who you trust or get individual bids. You can then compare bids from multiple contractors to ensure you’re getting a fair price.
Renegotiating (If Necessary)
If you found any serious problems during due diligence that you weren’t expecting, it’s time to renegotiate with the seller.
You might not want to get out of the deal entirely, but you MUST be willing to walk away if the seller isn’t willing to come in at your new max offer.
Why?
Because you’re building an investment business. You can’t get attached to any specific property or deal — if you do, then you give the seller a ton of negotiating power.
And remember, there are other deals out there. You can’t let one bad deal get in the way of your long-term success.
The best way to renegotiate with the seller is to be very honest and upfront about what you found, how much it’s going to cost you to make repairs, and even what you think you’ll be able to sell it for.
Final Decision & Walking Away (If Necessary)
After you’ve renegotiated (if necessary), it’s time to make your final decision.
If everything lines up and you’re still confident in the deal, then move forward with it. If not, then walk away and keep looking for other opportunities.
Remember: There are plenty of fish in the sea. You’ll find another deal if this one didn’t work out.
Due Diligence Checklist & Other Important Documents
Thanks to Andrew Syrios, we’re able to give you a ton of goodies for free (you don’t even have to enter your email address.
In this Google Drive, you’ll find his sample…
- Scope and Systems Check
- Scope of Work
- Pro Forma
- Financial Analysis Form
Those will give you a huge leg-up from where you’re at now. You can use those when you’re walking through properties, creating your scope of work, or determining the cash-flow expectations for a specific property.
And don’t forget to grab our free gift below!