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What is Due Diligence?

 


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Due diligence is the credo of every successful investor. It means to conduct thorough research on any product or service before you buy it. The key word is thorough. This is especially important when buying assets and incurring liabilities. Your final analysis will be whether the risk is worth the reward, or whether the reward is worth the risk.

It sounds simple enough, doesn't it? Yet I am amazed at how poorly this skill is applied on the most significant purchases in a persons’ life. I am referring to the purchase of a house.

This applies whether the house is a primary residence or an investment property. For starters: How old is the house? If it's brand new, is it covered under a builder's or home owner's warranty? If so, what is the coverage? Did you read this document before you bought and know what you were getting in to or afterwards when it was too late? If the house is 10, 20, 30 or 40 years old, then be aware of the various building codes at the time the house was built. There are a host of things to watch out for from electrical upgrades, plumbing and re-piping, structural issues from the foundation shifting to the roof leaking, mold and bacteria due to moisture and condensation. Is it a heritage house? Many communities have laws protecting these homes from being torn down and even more onerous guidelines for renovations.

And my favorite question for older properties: What, if any, environmental impacts or remediation has taken place with the property since it was built? This question is referring to underground oil tanks or mines. In the early days, there was no gas or electricity to heat a house. And just because a mine in the area was closed down one hundred years ago doesn't relieve you from liability when someone falls through a sinkhole in the back yard which was built over a deteriorating mine shaft. Or, perhaps a nearby gas station has leaked hazardous materials and the leaching has encroached onto your lot, from twenty feet below ground. These are important to know because it is the current owner's responsibility to clean up any environmental hazards found on your property. This is law. This is not covered by insurance. This is just the tip of the iceberg when it comes to due diligence. The key is to ask lots of questions and make sure you get answers. Surely your investment valued in the hundreds of thousands of dollars is worth a few questions. For real estate investors, these are routine questions designed to limit our risk exposure and protect our investment.

There are two levels of due diligence with investment properties. Let's call it hardware and software. The hardware is the tangible property. There is the physical due diligence of the house to make sure you are buying an asset that will last for many years and produce a healthy investment income. The software is the financial statements or the numbers proving the asset is a good investment. These numbers include rent from tenants, laundry income, vacancy losses, property tax, utilities, insurance, repairs and maintenance and so on. These numbers can be fudged or exaggerated. This is why every line item on an Income and Expense Statement must have third party verification.

Is the rent income shown on the financial statement current and accurate? You'd be shocked at how often the numbers do not match. Lease agreements and amounts are double-checked with every tenant in every suite. Every expense item is to be confirmed by city hall, the utility company or invoices must be supplied as proof of payment. All discrepancies are documented and this information can be used to negotiate a more favorable price. In the end, it's all about coming to a mutually beneficial agreement between a Seller and a Buyer. No matter how nice or charming a person is, we are dealing with a significant investment. Especially for real estate investors, we are in the business of buying and selling businesses. Due diligence is your safety net.

July Ono is a real estate investor, educator, mentor, author and millionaire. She is the Founder of On~The~Beach~Education® Corporation a premier real estate education program designed to empower people to live wealthier sooner by creating passive income through real estate investing. On~The~Beach~Education® Corporation offers a range of seminars, workshops, networking and mentorship opportunities to coach entrepreneurs to create their own financial independence. On~The~Beach~Education® Corporation has successfully helped its students invest in millions of dollars in real estate throughout North America since 2006. http://www.onthebeacheducation.com - http://www.julyono.com

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