Buying a house for investment is the biggest financial decision for many people. Besides involving huge amounts of money, real estate transactions come with a significant element of risk. This is why you need to do your own due diligence in real estate before buying an investment property.
So, What Is Residential Real Estate Due Diligence?
Real estate due diligence is simply doing your homework before purchasing a condo, single family home, apartment or multi family home to flip or rent out. The main aim of the real estate due diligence process is to find out as much as possible about the property for sale before you make an offer on a home. This includes uncovering information that the seller might not want you to know or details that the seller isn’t even aware of.
Here is a complete real estate due diligence checklist for real estate investors:
✔ Sort Out Your Investment Property Financing
✔ Conduct a Real Estate Market Analysis
✔ Conduct an Investment Property Analysis
✔ Check the Zoning Laws
✔ Perform a Title Examination
✔ Conduct a Home Inspection
✔ Get a Home Appraisal
✔ Check Condo Association or Homeowners’ Association (HOA) Rules
✔ Look Into Title Insurance
✔ Carry Out Due Diligence on the Seller
1. Sort Out Your Investment Property Financing
Unless you are planning to buy a rental property in cash, you will need to look into options for lender financing. Here are some of the financing options to consider:
- Conventional investment property financing from a bank
- Federal Housing Administration (FHA) loans
- Veteran Affairs (VA) loans
- Peer-to-peer loans
- Private money lenders
- Hard money lenders
Find out the requirements for each of these mortgage or home loan options and decide what works for you. At this point, you will also want to do a little digging into your own credit history and score to ensure you will be eligible for most financing options.
Related: How to Raise Capital for Real Estate: A Beginner’s Guide
2. Conduct a Real Estate Market Analysis
When it comes to investing in real estate, location is a very important consideration. Finding the right place to buy investment property requires a great deal of analysis and research. Real estate market analysis enables investors to identify a suitable location for buying property based on a few different metrics and statistics. What is the occupancy rate of rental properties in the area? What is the crime rate? Is it a buyer’s market or a seller’s market? To gather as much information as possible, consider working with an experienced real estate agent that is familiar with the area. For stats on average rental income and occupancy rates, you can visit Mashvisor’s blog or check out our real estate market reports.
Once you analyze the city, you still have a little more due diligence to do on the location. Specifically, you have to make sure the neighborhood is a profitable one that will attract tenants. Are there environmental hazards in the neighborhood? Are there amenities such as railway stations, hospitals, and schools nearby? What is the average income and occupancy rate for the neighborhood? This is called neighborhood analysis. For the exact steps, you can read: Neighborhood Analysis in Real Estate Investing.
Depending on the findings of this first element of the real estate due diligence checklist, you could choose to look for a rental property in that area or look elsewhere.
Related: How to Research Real Estate Markets: The Beginner’s Guide
3. Conduct an Investment Property Analysis
Now that you’ve checked off “Real Estate Market Analysis”, you can start analyzing the property for sale that you have your eye on. Investment property analysis involves checking potential rental investments to establish their viability based on their return on investment. Using tools such as Mashvisor, you can analyze metrics such as traditional and Airbnb rental income, monthly expenses, cash flow, cash on cash return, cap rate, and occupancy rate. This aspect of your real estate due diligence checklist will give you an idea of how much money you can make from a real estate investment.
Related: How to Do Investment Property Analysis
You should also perform a comparative market analysis (CMA) at this stage to get an idea of the home value. Use real estate comps from Mashvisor to figure out if the property for sale is listed above, below, or at fair market value.
4. Check the Zoning Laws
If you are planning to make any renovations on an income property or rent it out on short-term rental platforms like Airbnb, you need to get familiar with the zoning laws of the city where the property is located. However, don’t make the mistake of simply relying on what the seller says about zoning. Be sure to visit the planning department personally or simply make a phone call to inquire about the current zoning requirements. If you have any questions on this aspect of the real estate due diligence checklist, you can consult a lawyer for clarification.
5. Perform a Title Examination
Title examination is a very critical element when it comes to legal due diligence. One of the best ways of checking a property title is by conducting an online records search. This title search will reveal the legal owner of the home, as well as the property’s boundary lines, legal description, encumbrances, liens, usage rights, and property taxes. Any arising issues should be addressed with the seller before making a purchase offer.
6. Conduct a Home Inspection
A thorough home inspection will help buyers ascertain the condition of an investment property for sale before making a purchase. Here are some of the major things you should look out for:
- HVAC functionality and age
- Plumbing problems (leaking or corroded pipes)
- Faults with the electrical system
- Damage to the roof
- Signs of water damage
- Problems that threaten the property’s structural integrity
When such problems are detected during real estate due diligence, you can either ask the seller to make repairs first or negotiate a lower price that will allow you to fix it yourself.
Related: How Much Does a Home Inspection Cost in 2019?
7. Get a Home Appraisal
Whether you are purchasing income property using a mortgage or refinancing your existing mortgage, a home appraisal is a very important element of real estate due diligence. An appraisal is basically a third-party, unbiased approximation of the true property value. Although you have already performed a CMA yourself at this point, think of that value as a preliminary estimation. If you’re working with a lender, you will need to have one done professionally. A qualified appraiser will determine the home’s appraisal value based on current market trends, recent sales of similar homes, and the home’s features. Before hiring an appraiser, make sure they are certified or licensed, and familiar with the local neighborhood.
8. Check Condo Association or Homeowners’ Association (HOA) Rules
In case you are considering buying a condo or an apartment, your real estate due diligence checklist should include scrutinizing the covenants, conditions, and restrictions (CC&Rs) of the homeowners’ association. The CC&Rs address issues such as architecture, resident behavior, and common responsibilities. Some of these rules and regulations can be very restrictive. For instance, some HOA rules will not allow you to rent out your home on Airbnb or even at all. In case you find some of the regulations to be unreasonable, simply walk away and go elsewhere.
9. Look Into Title Insurance
Your real estate due diligence checklist should include checking to see if the property’s title is eligible for insurance. Having property insurance documents will guarantee protection from claims of validity and give you peace of mind. You will avoid potential issues after purchasing the investment property including:
- Old mortgages
- Unpaid back taxes
- Forgeries
- Pending legal action against the home
- Claims from heirs
10. Carry Out Due Diligence on the Seller
The real estate due diligence process should also involve doing due diligence on the seller. Why are they selling the property? This will help you figure out what steps to take when negotiating the price of the investment property.
Related: Septic Inspection: What Property Buyers Should Know
Closing Thoughts
Though the real estate due diligence period can be lengthy and stressful, it is worth it in the long run to protect your investment. If you know what to do before buying a rental property, you will proceed with confidence and snag a good real estate deal.