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Due Diligence Checklist – 25 Points in 5 Broad Areas
It’s stunning how home buyers and real estate investors spend so much time hunting for the “perfect” property to buy. But spend as little as 15 minutes on due diligence.
How can someone be so sure that a house and all the back-end that comes with it is as ideal as they perceive?
It defies all logic to put lesser effort on diligence checks as on the act of property hunting.
This is the time when you conduct your inspections and make detailed assessments of costs associated with predictable improvements, repairs and operations. Then evaluate how close reality is to the picture you painted in your head.
And it could very well be your last chance to unearth flaws that might make a good looking deal look downright ugly.
As the main reason why many purchasers don’t spend enough time on due diligence is due to a lack of time or just plain old laziness, here is a quick checklist to have most of your angles covered.
There are 5 main areas to go through thoroughly:
- Operating documentation
- Service agreements
- Interior inspection
- Exterior inspection
- Compliance with government standards
When hidden flaws are uncovered, you have to work out for yourself and estimate what type of resources and how much money it is going to cost you. Using that information, you have to evaluate whether a deal is up to your expectations.
Maybe a renegotiation would be appropriate?
1) Operating documentation
This includes all paperwork to verify and validate the potential income.
Signed rental agreements to ensure the validity of inherited tenants. Note that a contract has to exist for every unit rented out if you are buying a multi-family property. There will be no master agreement unless you have rented out a while building to one client.
Operating bank accounts showing rental collections that matches the specified rental rates. It goes without saying that questions should be raised when the numbers don’t match. Very often, there are legitimate reasons that can be easily explained.
Security deposits that matches those reported by the escrow agent.
Run standard tenant checks to have a basic understanding of the tenants. You’d want to know if you will be working with low or high risk tenants.
Standard operating account statements within the recent period like Profit & Loss, Balance Sheet, Cash Flow statements. Hopefully everything is neatly and properly tracked by credible accounting software.
2) Service agreements
Ideally, you’d want to hit the ground running and minimize any operating problems at all during the transition phase from one owner or landlord to another.
Landscaping contracts for maintenance and improvements in the long and short term.
Air-conditioning and heating service agreements. You are going to have very angry tenants if you don’t have a handle on this and things break down.
Laundry service contracts. Who does their own laundry these days?
Housekeeping service agreements. More and more tenants these days simply refuse to do housekeeping. Landlords are now hiring cleaners and making it a term on tenancy agreements.
Security provider agreements including for personnel and alarm systems.
Vehicle parking contracts. Surely there must a space for the car?
3) Interior inspection
Inspecting a home’s interior for defects is one of the most cumbersome tasks of a buyer. And it could be the most costly too if you are not meticulous enough in your job.
Standard inspection of furniture, fixtures, walls, flooring, appliances, etc.
Pest infestation. These can be a huge headache.
4) Exterior inspection
A property’s exterior often gets less attention than the interior. But when problems arise in this area, major works and bills can be coming your way.
Check the roof for leaks and wear and tear. Roofs often have a long lifespan. The problem is that when they “die”, you have very little options but to fully replace it.
Condition of temperature control systems and check maintenance records. This is something that is unavoidable and requires regular maintenance. You don’t want your tenants to live without a heater in the middle of winter. The best scenario is that the last one is very recent.
Electrical wiring that does not pose a safety hazard. Most domestic fires are caused directly or indirectly by faulty electrical wiring. Do you need a better reason to look into this?
Check plumbing and pipes for corrosion, leaks, and hazardous material.
Exterior paint. Needless to say, these are most susceptible to wear and tear.
Driveway, parking lots, and garage. You can’t expect these areas to be in mint condition. But problems here can usually be obvious when observed.
Landscaping problems. Look for problems with sprinklers, untrimmed grass, large trees, pest problems, etc.
5) Compliance with government standards
Violation of fire safety codes.
Remodeling and renovation permits.
Environmental health hazard requirements like asbestos, lead, mold, etc.
Zoning violations, encroachments, easements, etc.
Why all these due diligence?
The point of all these checks is to paint a more realistic picture of the expenses that you will incur once you takeover ownership of the property.
You don’t want to be taken for a ride and more importantly, you don’t want a buyer to feel the thrill of finding a sucker.
You might think why you should go through all these time-consuming and tiring activities when you are going to buy the property and pay for these costs nevertheless.
The answer is that you don’t necessarily have to.
Because you can either negotiate for a lower transaction price, or get the seller to fix the issues before closing. Most probably the latter.
This means that they money you have already mentally spent for the fixes, will be paid for by the seller. It is money in your pockets.
And if you are buying a newly built apartment like a condominium or townhouse, the developer will be obligated to fix them as long as you are still within the defects liability period. There’s no point paying for these repairs when someone else is legally required to pay them for you.