Due diligence is a term used for a number of concepts involving either the performance of an investigation of a business or person, or the performance of an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations. A common example of due diligence in various industries is, the process through which a potential acquirer evaluates a target company or its assets for acquisition. – From Wikipedia
It is important to not only know what due diligence is, but how everyday investors make it work in their favor when buying a home. Proper homework can not only eliminate some of the risk when buying, but it can also lead to a better return on your real estate investment. An article is not enough to outline the various forms of due diligence one could perform on a real estate transaction. However, here are five simple but important steps to take when buying a rental or investment property:
- Neighborhood – Once you have identified a property, go find a map of the area and draw a 5 mile radius circle around the home. Look closely at the circle for parks, schools, freeways, and amenities. Also drive the streets of the neighborhoods looking for indications on whether this area is on the way up or down in terms of condition and crime. Your rental is an asset that you want to appreciate, so having a good idea of the surrounding area can help make a good decision.
- Crime – Most metropolitan police departments either have web sites or information they can give on a particular area. High crime areas are not only difficult to rent to your ideal tenant, but are nearly impossible to sell at a premium.
- Internet – Utilizing the websites like Zillow, Google Maps, and state and local websites can give you insight into the property from a number of perspectives. Zillow can show estimated values, recent properties sold and an area map. Google maps can give you a satellite view which allows for a close look of the neighborhood. Identifying freeway access, parks, golf courses and schools are all future marketing elements used to sell your investment.
- Appraisal & Inspection – The value and condition of your potential property is critical to future appreciation. Investors should structure their purchase contracts to allow proper valuation and inspection of the property. Once the reports are done carefully, walk through each report with someone that understands them better than you. Even seasoned investors should have someone they trust to thoroughly walk through each report. Remember different regions and neighborhoods require local expertise.
- Market Analysis of Rental Market – Even if cash flow is not your reason for investing, investors should analyze whether they are going to be able to cash flow the property. I have seen a number of fix and flip projects fail because of market changes and the investors could not carry the negative cash flow long term. Remember, positive cash flow can survive all market cycles. Most lenders require both Single Family Comparable Rent Schedule (Fannie Mae Form 1007) and Operating Income Statement (Fannie Mae Form 216) when funding a property with conventional financing. Your Realtor should be able to complete an analysis of the rental market using the regional MLS. Also look at Craigslist and local newspaper classifieds.
There is no way to sugarcoat due diligence; it is hard work. But it is also a way to increase your knowledge and become an expert on the property you are about to purchase.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.