As part of the pre-contract due diligence, a real estate investor who is interested in a particular property, such as a three-family house, confirms the leases and rents at the property, the amount of real property taxes, and how much the operating expenses will be. If the property appears to meet the criteria of the real estate investment plan, the investor and the seller will sign a contract. This is when post-contract due diligence kicks in. The due diligence period between the signing of the contract and the closing of title is the last chance to find out as much as possible about the inner workings of the property and to decide whether the property will be a money-maker or a financial black hole.
Post-Contract Due Diligence Steps
After the contract is signed, several steps must be taken at about the same time. The investor takes some of these steps and the investor’s attorney and lender take the others.
- Property inspection: The investor should hire a licensed professional property inspector to look at the property from roof to basement.
- Appraisal: If a conventional lender such as a bank or mortgage company is financing the purchase, it will arrange for an appraiser to determine whether the market value of the property is equal to at least the purchase price.
- Survey: a conventional lender also will require a survey if the seller cannot or does not provide a recent one; the investor’s attorney can order the survey, which the title company also will want to see. Even if the financing is from a non-conventional source (such as savings, a hard-money lender, or the seller acting as lender), the investor should consider obtaining a survey to find out the boundaries of the property.
- Review of seller’s books and records: The leases should reveal whether the owner or the tenant is responsible for the heat, utilities, water, and sewer bills. The lease also should state whether a tenant receives a Section 8 housing subsidy. The rents on the leases should match those listed on the rent rolls. The investor also must find out the amounts of the security deposits being held by the seller and where they are being held. Other records that the investor may examine include the rent-collection report, expense reports, and documentation of all work performed at the property during the seller’s ownership.
- Title Search: The investor’s attorney orders the title work on the property. The title insurance company will search for all the recorded deeds, mortgages, liens, easements, and other interests in the property. The title company and the investor’s attorney will insist that all open items, such as open mortgages or liens against the property, be closed before the purchase can go through. When the title company is satisfied that the seller can pass clear title to the investor, it will issue a policy of title insurance that protects the investor from claims that the title that passed was not marketable and free of encumbrances.
Due Diligence and Real Estate Negotiations
Throughout the due diligence period, investors should keep asking questions until they receive satisfactory answers in writing from the seller. If the review of the books and records or the inspection of the property reveals shortcomings or substantial problems, the investor, through an attorney, should ask the seller for credits against the purchase price or other concessions.
The seller may refuse to do anything at first but, in a challenging real estate market, that stance may change if the seller sees that the investor is willing to cancel the contract and walk away from the deal.