Due Diligence by Brad Bone
Due diligence is a big subject. There is no end to how much due diligence can be done to ensure you are buying the correct property. For that reason, due diligence can be overwhelming.
There are many ways to think about due diligence and often it can come down to personality. For example, is buying sight unseen in another state a good idea? Those who would say “no” often feel that physically laying eyes on the property is vital to their due diligence. I know an investor who chooses to never see properties at all even if buying in his own town due to the belief that his bias could compromise the due diligence process he has established. One thing we can all agree on, however, is that due diligence is a vital and necessary part of real estate investing.
The key is to establish a due diligence process that works for your investing philosophy and for the acquisition strategy being used.
Below are several due diligence processes used by buyers:
Traditional home buyer
- In California, traditional home buyers normally use a 17-day inspection period and typically order a handful of inspections to confirm the condition of the house. Traditional buyers are much more interested in the condition of the property then they are of the value. The reason this due diligence process is used by thousands of buyers every day, is because it fits with a typical traditional home buyer’s priority which is knowing that they are buying a house they will be happy to live in.
Investor buying direct from sellers
- The nice thing about sourcing your own off-market deals is that the investor can establish a due diligence process that works for them. There are no agents, lenders, or wholesalers involved with their own set of expectations and demands. The deal is between the investor and the seller so the due diligence process can be negotiated right along with the buy price. I’ve bought houses with 60-day inspection periods when I was first starting out. I don’t need that much time anymore, but back then it was necessary because I needed a due diligence process that worked for me.
Investor buying from a wholesaler
- The due diligence piece when buying from a wholesaler can get tricky. Many wholesalers in hot markets do not allow an inspection period and require a hefty non-refundable deposit to get a property under contract. This can be daunting for new investors and especially for investors out of state. The idea is that investors are allowed to walk through the property and do any due diligence they require; however, it must be done before going under contract. The risk is that you could spend money on inspections and then find out the house is no longer available. With a good process and clear communication with the wholesaler, adequate due diligence can be done to make this acquisition strategy profitable.
Investor buying via the MLS with an agent
- The due diligence process when using an agent can vary widely but some of the best processes I’ve heard of is having an agent either package together rehab bids and comps before presenting the deal to the investor, or have the agent send a contractor to perform due diligence before the earnest money deposit is required. Using this strategy, an investor can have 90% of the due diligence complete before putting the deposit money down.
Investor buying through foreclosure auction
- Foreclosure auctions are one of the easiest places to buy houses…all you have to do is overpay. In reality, finding a deal can be difficult because competition is inherently built into the auction process and adequate due diligence can be almost impossible since often times investors can’t even see the inside of the house before the auction. However, it can be a great strategy in the right market cycle for people who are willing to stomach a little less certainty on the up front due diligence. The extent of the due diligence for many foreclosure auctions is a title search, pulling of comps, and a drive by of the property. If the investor can peek inside, all the better. This strategy works well for the big volume buyers who can afford to take on a loser here and there.
As the market shifts, so does the acquisition strategy. So, in order to survive, investors need to be flexible but at the same time committed to a due diligence process that works for their market, strategy, and risk tolerance.