What is due diligence in a real estate transaction? It’s a question that always comes up when either a buyer or a seller is seeing a deal for the first time.
It sounds like a fancy business term but it’s actually a simple idea.
Due Diligence Real Estate Definition
Due diligence in Real Estate is broadly defined as the time when they buyer has expressed their intention to buy, but needs a few things to make sure they want to finalize the deal. The steps a buyer takes to close on a deal after an offer has been made is commonly referred to as the “due diligence” period in a real estate transaction. These items are:
1) Securing financing
2) Ordering a home inspection
3) Looking up HOA rules and fees
4) Asking for a list of outstanding warranties and contracts on household items
Active Due Diligence
Have you come across a property that says under “active due diligence?” This means that the house is under contract and in the first phases of the due diligence process. The home may come back on the market if the buyer drops out for whatever reason during the due diligence process.
Some real estate professionals consider pre-offer actions as part of the overall “due diligence” for the home buyer.
Here is a checklist of things that buyers will want to do to continue throughout the buying phase of a home.
Home Buying Due Diligence Checklist
- Talk with a mortgage company. This will educate you as to the price of a home that you can buy. The mortgage person will be able to give you an idea of your monthly costs that will normally include an estimate for property taxes and insurance.Make sure you know what the monthly payment that is given to you includes. If you put less than 20% down there will also be a mortgage insurance cost per month. This is insurance for the bank, not you.
- Find a real estate agent you will be working with. Make sure you have a good rapport and that the agent will have the time and knowledge need to assist you.A good agent will be aware of the steps you need to take in buying a home and will guide you through the process.
- Be clear with the agent what it is you are looking for in a home–price, size, neighborhood features etc.
- Secure financing from your lending institution
- Make sure the house doesn’t have any skeletons in the closet with a home inspection
Found the house! Now what?
-Your Real estate agent will have the tools to guide you through the offer process , this will vary from area to area ,but a licensed agent will be fully aware of the process. Generally ,you sign an offer or contract that will stipulate certain contingencies such as , you must be able to get a mortgage for the house, and the house must pass a home inspection to your satisfaction. If a contingency is not met you will be able to get your deposit money back–which is the check that you will be putting in with the contract. The deposit money can also be called earnest money. It is not necessarily the entire amount of money that you will ultimately be putting down on the house. It is valuable consideration to create a valid contractual agreement
Now it is time to actually apply for a mortgage, shop for one too maybe, check out the various closing costs of each bank or mortgage company. Once you have chosen one apply and follow the steps the mortgage company gives to you, such as supplying them with income verifications, employment verifications etc.
Make appointments with inspectors . You might find a one inspector who will take care of most of your inspection needs. Some of these might include–well water testing, septic system inspection,
Pest inspection, home inspection, Radon gas testing , wind mitigation inspection.Your bank may have certain inspection requirements.
Home Inspection Checklist
This is when things start to get serious for the buyer. If all of the basics check out, it’s time to take a deeper dive into the status of the house.
Inspectors check out every square inch of the house to determine the integrity of the structure. The dead giveaway for a house that is not structurally sound is when you find lines throughout the house that are not level.
For example: the sides of the house, are they level or staggered? Are the doorframe and window frames square or do they look bowed or tilted? Lines that aren’t straight indicated that a foundation was either not laid properly or is beginning to shift.
That is a bad sign for a house.
Other things inspectors will look for include:
-Proper drainage away from the house
-leaks from septic tanks (but you should have caught this in your walkthrough!)
-trees / branches hanging over the house which may cause problems in the future
-siding and paint on the outside of the house is loose, chipped or falling apart.
-Curling or mold on the shingles
-Making sure there are no more than two layers of roofing
-Evidence of excess roofing cement or tar
-Rusty or loose gutters
-Chimney with cracks, properly flashed, the condition of the mortar / cement cap
-Testing for the entire electrical system and plumbing to make sure everything is in working order
-Making sure every door, window and appliance that comes with the home is in good working order
-Looking for signs of water damage and decay under sinks and in other areas with potential plumbing damage
-Heating and cooling systems work properly with good air flow and circulation throughout the house
This is the stage of the due diligence period in real estate where most deals fall through. The home inspection turns up a potential issue and the buyer gets cold feet—or the buyer gets cold feet and goes digging for a potential problem as an out.
As a seller, if you know something might come up during an inspection, try to get ahead of it and address the issue before you let a deal get to that point. Don’t try to sweep a problem under the rug—it almost always comes back to bite you.
Bank Orders Appraisal of the House
At this stage your lender will also contract an appraiser to come put a market value on the house to make sure it’s worth the amount of money you want to borrow to pay for it. This is another popular drop-off point in the lifecycle of a contract.
You think a house is great. The seller is ready to sell. There isn’t anything wrong physically with the property and you start thinking this could be the one!
You go to get an appraisal, and the number comes back lower than what you and the seller expected. HUGE bummer.
Unfortunately, the appraisal system can be a bit funky and sometimes flukey. If a few people in your neighborhood let their house go for cheap, all of a sudden your house, if’s comparable in size and features, will be worth less money.
In many ways the appraisal system is what kept our housing market in the tank for so long. Just when prices would start to recover, people sold low and stifled the recovery.
The appraisal process definitely deserves it’s own post, but for now just know that it’s coming from the bank.
Thing to do After the Inspection
Now that the inspection checked out and the bank as done an appraisal, now you are waiting for the underwriting of your loan and for the title company to check the properties title. You will be notified prior to the closing of the amount of funds you need to close , and you will be instructed as to the method of payment.
Normally the method of payment is a cashier’s check or a wire transfer. Once the closing date has been established, you can work on getting the utilities in your name,sometimes requires a deposit,getting you homeowners insurance and getting your mail forwarded.
Going the Extra Mile
At this stage of the game, you are set to go for the closing. If you want to go that extra mile, add these additional items to your due diligence check list for extra credit.
Review HOA Information
A home owner’s association is governing body of a community that sets the rules for the community. If residents do not abide by the rules set by the HOA, they can even put a lien against your house!
That’s serious stuff, so you are going to want to read up on the rules during the due diligence period.
HOA’s commonly charge a fee as well, which you must pay to be apart of the community. Make sure to add this expensive in when deciding if the house fits in your budget.
Checking Title History of the House
All titles documents are public record, which means you can confirm whatever the homeowner is telling you from a neutral source.
During the title review you can confirm whether the seller actually does have the title to the house (it’s been a common scam for people to try to sell property they don’t actually own).
You can also confirm that there is no pending litigation that might put the title of the house in jeopardy. Also be sure to check that there are no liens on the house (maybe they pushed the HOA folks passed their limits!)
Outstanding Contracts and Warranties on Key Household Items
This is another common deal-wrecker outside of the inspection during due diligence. Throughout home ownership, things come up that need to be replaced or updated. Some big ticket items like water heaters and solar panels will be inherited by the buyer.
Solar Panels in particular are often sold to the homeowner under a contract when they are installed on the house.
This sometimes proves to be a huge pain in the neck to buyers if the seller signed into a bad or complicated deal.
Make sure before you buy you ask to see the details of any contract you might inherit as the buyer and make sure you are OK with the terms.
Confirming the Zoning of the Property
Typically you can trust what the seller tells you but why not confirm just to be on the safe side. We are talking about being diligent after all! Here are the steps you can take to look up the zoning for the property (warning: in some counties it can be a bit tricky, stick with it!)
Head to the county property appraiser website for the county that the property is located in.
On the website, look for the words “parcel database” or “real property search”. It should bring you to an overly complicated, not at all intuitive or clear to understand at all search page (it’s local government after all).
Enter in the address of the property and see what it says for zoning. Keep in mind, some property can be zoned for both commercial and residential use, which is exactly what you want for a home-based business.