Unlocking Success: A Comprehensive Guide to Real Estate Due Diligence

It is often said that an ounce of prevention is worth a pound of cure. In the world of real estate, an ounce of prevention is likely worth more than that—a solid ton of cure would be my guess. To avoid being taken for a ride, one must carry out a meticulous investigation, known as due diligence. This process will guide you through a maze of potential pitfalls towards successful investments. So, how does one carry out this investigation? What steps are involved?

Understanding Due Diligence

Due diligence entails a comprehensive evaluation of the property, revealing its assets and liabilities. In essence, due diligence is the linchpin that equips real estate investors with the essential information to make confident investment decisions. Imagine it as a shield against surprises. Investors employ due diligence to unearth potential issues concealed within a deal before they commit to it. This rigorous process delves deep into the information provided by the seller, ensuring transparency and accuracy. If discrepancies emerge or unforeseen issues arise, the investor has the leverage to renegotiate or gracefully step away. Conversely, if due diligence corroborates all the provided information, the path to a confident transaction becomes clear.

Navigating the Due Diligence Process

How Does Due Diligence Work? Real estate due diligence is marked by two distinct phases: pre-offer and post-offer due diligence.

1. Pre-Offer Due Diligence

This initial phase is akin to a reconnaissance mission. Before making an offer on a property, investors undertake essential due diligence steps. These include:

• Scrutinizing the local submarket to ensure alignment with investment objectives.
• Conducting online research and investigating the property’s history and the seller’s background for red flags.
• Reviewing property condition reports and seller disclosures for any glaring issues.
• Analyzing government-issued documents such as permits, certificates of occupancy, and code violations.
• Studying environmental and energy reports.
• Verifying zoning and permitting compliance.

This preliminary due diligence phase serves as a strategic filter, allowing investors to discern promising prospects from potential dead ends. It safeguards against wasted time and resources on unsuitable properties.

2. Post-Offer Due Diligence (Site Underwriting Due Diligence)

Upon submitting and having their offer accepted, investors transition into the post-offer due diligence phase, often termed “site underwriting due diligence.” This stage involves a deeper exploration of the property and its financial intricacies. Key tasks include:

• Engaging professional building inspectors to conduct a thorough examination, from structural integrity to systems compliance.
• Commissioning an environmental assessment to identify potential hazards.
• Ensuring the property’s resilience against future flood damage and securing flood insurance if needed.
• Assessing mold history and remediation efforts.
• Validating proper permitting, zoning, and obtaining required easements, permits, and licenses.
• Collaborating with appraisers for property valuation.
• Compiling a list of comparable properties and conducting competitive analyses.
• Requesting comprehensive documentation from the seller, such as leases, contracts, and financial statements.

This exhaustive exploration empowers investors with in-depth insights, guiding them towards confident investment decisions.

The Due Diligence Checklist

Real estate due diligence requires a methodical approach. Here’s a preliminary checklist to guide your journey before submitting an offer on a property:

• Study the property’s local submarket, ensuring it aligns with your investment goals.
• Conduct online research on the property’s history and the seller’s background.
• Review property condition reports and seller disclosures diligently.
• Examine environmental and energy reports.
• Analyze government-issued documents, including permits, certificates of occupancy, and code violations.
• Investigate recent capital expenditures and deferred maintenance.
• Obtain a rent roll to understand current rental rates and lease terms.
• Evaluate property tax and utility bills over the past few years.
• Scrutinize the property’s profit and loss statement.
• Assess existing property debt and compare terms with the market.
• Conduct a thorough site visit, possibly with trusted advisors.
• Develop a list of planned maintenance and capital improvements.
• Engage lenders for preliminary underwriting to gauge potential financing terms.
• Crunch the numbers to ensure the property aligns with your investment objectives, accounting for known maintenance and capital expenses and unforeseen costs.

This preliminary due diligence phase acts as a filter, allowing you to step away from unsuitable properties while gathering valuable information to make informed offers.

The Post-Offer Due Diligence Checklist

Once your offer is accepted, the journey continues with a more detailed exploration of the property:

• Engage professional building inspectors for a comprehensive examination.
• Commission an environmental assessment to detect potential hazards.
• Ensure the property’s resilience against future flood damage.
• Address mold history and remediation.
• Validate permitting and zoning compliance.
• Collaborate with appraisers for property valuation.
• Compile a list of comparable properties and conduct competitive analyses.
• Request comprehensive documentation from the seller, including leases, contracts, and financial statements.
• These steps enable you to delve deep into the property’s nuances, equipping you with the insights needed to make informed investment decisions.

The Importance of Due Diligence

The due diligence process is your compass in the realm of real estate investments. It provides the knowledge and confidence to make prudent decisions, ensuring that you tread the path to success with assurance. While due diligence may seem like a burdensome endeavor, it is an indispensable one, protecting your investments and unlocking the potential for financial growth. If everything goes well, it may seem to have been a waste of time, but if you remain in real estate long enough, eventually you will come across a property that is a “lemon.” When this happens, you will be happy you went that extra mile.

Franklin Carroll

Franklin Carroll is Kukun's VP of Modelling and Analytics; After finishing his studies at the University of Chicago, he worked at Fannie Mae where he helped build Collateral Underwriter, roll out the Value Verify initiative, and specialized in collateral related and credit related policy.

Published September 18, 2023