Due diligence is an extremely tedious, unpleasant and boring thing to do. It is also absolutely essential for any real estate investor. Proper due diligence is absolutely vital to avoid making costly mistakes. I, like many investors before me, have unfortunately learned this lesson the hard way. Once I bought a property with major foundation problems, another time with no plumbing in the basement, and another time the wiring had been so completely scrambled by some overly ambitious do-it-yourselfer that flipping the bathroom light switch turned on the porch light. It only takes a few of these mistakes before due diligence becomes a priority, so why wait?
When it comes to houses and small multi-family apartments (like duplexes and fourplexes), you will generally have 30 days to close and around 10 to 15 days to inspect. During the initial inspection phase, if you back out, you should be able to get your earnest money back. All of this is negotiable, but it is very important to be aware of what your time table is up front.
How Much is Too Much?
In all things known to humanity, there can be too much of a good thing. The point of diminishing returns, so to speak. If you buy a lot of properties, say five to 10 houses a month, missing something during due diligence every once in a while is simply the cost of doing business. You should still do due diligence of course, but if thorough due diligence slows down acquisition, it can become counterproductive.
On the other hand, if you buy one a month or maybe just one a year, there is no messing around. That one has to be good, so thorough due diligence becomes mandatory.
Key Things to Look For
Thorough due diligence requires turning on the electricity, gas and water if they are off. You want to make sure the HVAC system and electrical work and that there are no plumbing leaks. Other key things to look for include:
- Dry rot or signs of pest damage
- Fuse boxes (you will probably want to replace them with an electrical panel)
- Old furnaces or A/C Compressors (it is probably near the end of its useful life, even if it is still working)
- Large cracks in the foundation wall or movement. If it is more than three inches (you can check this by running your finger along the siding outside and seeing how far it is from the foundation wall) that is very concerning and should be inspected by an expert. There should be piers in the basement if the foundation is moving at all.
- Proper drainage
- Plumbing leaks, missing plumbing or galvanized plumbing (which often rusts)
- Roof leaks or substantial roof damage (this usually requires getting on the roof to verify)
- Knob and tube wiring (this almost certainly needs to be replaced)
- Condition of the appliances
While this list is not exhaustive, it covers many of the key points.
For new investors, it is especially important to get a home inspection by a qualified inspector and review the inspection report thoroughly. And it’s not a bad idea for a seasoned investor to do the same. You should have them do a pest and dry rot inspection as well. These reports will help you identify problems and can be useful in renegotiating the price as well. And never be afraid to walk away if the deal doesn’t work.
Furthermore, I highly recommend scoping the sewer line on any property that is more than 30 years old. I have bought several properties with broken sewer lines, and they generally cost $3000 to $5000 to replace. You should be able to find a plumber to scope them for around $100 to $200.
Figuring Out the Cost
Most investors and almost all new investors think things cost less to repair than they actually do. Get some bids on the major work and add a contingency to your budget for unforeseen items and knick knack items like blinds and outlet covers (around 20%). Make sure this is in line with your expectations when you got the house under contract. It is always better to find out you were wrong at the beginning and back out then to buy a bad deal.
Finally, always close at a title company or with an attorney. If you don’t, you may find yourself with a property that has a massive tax lien attached to it or something equally menacing.
Any problem you find before you close can be a tool to renegotiate the purchase price or back out. If you find it after you close, good luck getting the seller to pay for it. So do your due diligence up front and do it right!