5 Reasons You Should Never Underestimate The Power Of Due Diligence
By JD Esajian on October 27, 2017
Due diligence is one of the most time consuming and monotonous things you will do as an investor. The more properties you look at the less enthusiastic about this you will become. However, all it takes is one oversight to have a dramatic impact on your bottom line. Every property you consider making an offer on must be treated the same way. You may see a dozen properties a month, but it is always the one you are lazy with that end up coming back to haunt you. Your business is too important to let an easily caught item fall through the cracks. Due diligence isn’t just something you do when you feel like it but a necessary part of investing in real estate. Here are five tips on improving your due diligence and what to look for on every property.
- Develop a system/checklist. Instead of guessing on what to look for you should have a concrete list you can use as a guide. By doing this not only will you reduce the risk of oversight, but you will also be much more efficient. You can walk right into a property a get started instead of bouncing around from room to room. Your due diligence should start well before you pull up to the house. Your checklist should include reading the listing sheet to see if there is anything specific about the property you should know about. Issues with title or zoning can be time consuming and may not be worth the hassle. Once inside the property you need to treat your diligence like you are inspecting the property. Your list should have potential trouble spots listed per each room, level or floor of the house. With a good system you can eventually hire people that can do this for you without skipping a beat.
- List trouble areas. The basic premise behind any due diligence is to know and understand exactly what you are getting into with the property. Knowing the scope of any work that is needed is critical when determining exactly what number to offer. In your initial diligence checklist there are a handful of potential trouble areas you should focus on. Start by walking the exterior and looking at the foundation of the property. A crack in the foundation isn’t necessarily a major issue but is something that must be addressed. Until you get more familiar with the work needed you should document everything either with a picture or a video. The more information you have the easier it will be for your contractor to give you a cost to cure. Staying with the exterior the next item to address is the roof. Between the roof and the foundation, you can easily be looking at repairs in the five-figure range. When you get inside you should shift your focus to the mechanicals, electrical and plumbing. Cosmetic items are the last items listed for a reason. They are the easiest to fix and usually the least expensive. Major items should be prioritized based on their cost to repair.
- Cost of repairs. Your contractor will most likely not tag along to every property you visit. It is important that you take good notes and supply them with as much documentation as possible. Knowing the repairs is just the first step in the process. The next is putting an actual number to them. This step is where most novice investors get into trouble. They aren’t sure on the costs, so they attach a number they think is appropriate. Many times, this number is lower than reality and only when the work is started do they realize their error. You need to work with a contractor that knows their stuff and can give you iron clad numbers, barring anything unexpected. If your cost of repairs is off your bottom line is directly impacted.
- Comparable sales. How well do you know the market? If this is a market you have experience in you may not have to do as much research. However, if this is a new market you need to break down as much information as you can find. Start by looking at recent comparable sales. You want properties that are as close to the subject property as possible. Once you go farther than a mile away the comparable becomes less effective. You also want the most current sales you can find. Markets change all the time. A sale that happened four months ago may not reflect what is currently happening. Your offer may not be a true reflection of the market based on the cost of repairs and the motivation of the seller, but the comps should be used as a guide.
- Property specific information. Does the property need tens of thousands of dollars in repairs? Does the seller need to settle quickly because of a current divorce agreement? Is there an issue with zoning or on title that has lingered for months? The final due diligence areas are seller motivation and property specific items. The motivation of the seller has a direct impact on the price. A property that has been on the market one day should be treated differently than a property that has sat on the market for six months. It is also important to look at specific property information that may restrict other buyers from having interest. Is the property unfinanceable and only can close with cash? Whatever reduces the buyer pool gives you an advantage. The more issues with the property or the market the more you will be able to dictate the price.
Due diligence separates good investors from great ones. Knowing what to look for and how to look for it will help you make better offers that lead to an increased bottom line.