Real Estate Deal Analysis & Advice

Real Estate Due Diligence: 2 Critical Steps You Can’t Afford to Screw Up

Expertise: Mortgages & Creative Financing, Business Management, Landlording & Rental Properties, Commercial Real Estate, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Personal Development
197 Articles Written
viewing in a magnifying glass the design of a house layout / inspection of construction objects

One bad deal can set you way, way back. A friend of mine once put it like this: “One bad deal prevents you from doing the next 10.”

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OK, that’s a bit hyperbolic. But if you haven’t noticed, many of BiggerPockets’ most prolific authors have made sure to emphasize their worst deals. I’ve done it, as have Engelo Rumora, Brandon Turner, Mark Ferguson, and many others. The reason is that such deals can break new investors or turn them off from continuing in real estate.

So despite it not being a particularly fun topic to discuss, many of us believe it is essential to do so.

And the No. 1 lesson to learn when it comes to all of our worst deals? In order to avoid such bad deals, you must do due diligence thoroughly and correctly.

Establishing a Process

A while back, I wrote a thorough guide on due diligence and noted the importance of using a checklist. My checklist looks like this:

  1. Pre-Offer Due Diligence
    1. Area Analysis
    2. Value and Financial Estimate
    3. Rehab Estimate
  2. Post-Acceptance Due Diligence
    1. Physical Due Diligence
    2. Financial Due Diligence
    3. Legal Due Diligence
    4. Inspections
  3. Retrading (if necessary)
  4. Final Decision and Walking Away (if necessary)

The due diligence that is important to discuss here is part two. Part one is what you do before you make an offer and parts three and four are what to do with the information you’ve collected from your due diligence.

For houses, by far the most important thing is the physical due diligence and inspections. But, of course, the financial component is critical, too.

If the property is currently rented, you will want to get a copy of the rent ledger and the operating statement (profit and loss statement) for the last year. You will also want to get a copy of the lease. Review it to make sure the rent and deposit line up with what the seller said, the utilities are in the tenant's name (unless otherwise stated), all the standard clauses exist (like for late fees), and there's nothing weird in the lease (such as the tenant being responsible for the maintenance or something like that).

I would also recommend getting some sort of proof of deposit. I’ve witnessed several times when sellers have faked rent rolls or just rented the building out to random people regardless of whether they could pay or not to make the rent roll look better. Tax returns, bank statements, or deposit slips all work for this.

But again, with houses, the most important thing is the physical due diligence.

due-diligence-inspection

Related: The Ultimate Guide to Due Diligence

Physical Due Diligence

Even if you have already walked the property, I would recommend walking it again. Do it very thoroughly and create a detailed scope of work. And try to get the utilities on if they are currently off. Sometimes, this won’t be possible; for example, if the wiring has been stolen. If that’s the case, make sure to add an extra contingency to your rehab budget.

If you are not experienced with putting together a rehab budget, first and foremost, pick up J. Scott’s The Book on Estimating Rehab Costs. But in addition to that, feel free to ask a contractor or an experienced investor to go by the property and give you a broad estimate. Offering lunch always helps with this.

You can also learn rehab costs by looking over line-item bids from contractors on other rehabs and reviewing your previous projects.

Finally, if the property has a tenant, take careful note of how they treat the place. If they are messy or smoke inside, it’s likely you will have a fairly significant turnover on your hands when they do eventually move out.

Related: Your 48-Point DIY Home Inspection Checklist

Inspections

For any new investor, I always recommend getting a professional, third-party inspection. First of all, if you want to retrade (ask for a discount), having a third-party inspection report is a great thing to point to. But further, it's always good to have another set of eyes on the property to make sure you didn't miss anything—particularly a set of eyes trained to spot such defects in the property.

Seasoned investors should also usually get third-party reports. That being said, if you do a lot of volume, have a good amount of experience, and put in a solid rehab contingency, you can afford to go without such inspections if you choose.

Finally, if you see any signs of dry rot or termites, you should get a pest and dry rot report. In some areas, you may want to get a radon inspection as well or have particular items looked at by a specialist (roof, HVAC, etc.) depending on the condition of those items.

Conclusion

Whether bad deals cost you the “next 10” or just the next one, it really doesn’t matter. You want to avoid them. And the way to avoid bad deals is to verify what you think you know going in with thorough due diligence. So don’t skimp on it!

What does your due diligence checklist look like? Has it helped you avoid bad deals?

Share your experiences in the comments below.

Andrew Syrios has been investing in real estate for over a decade and is a partner with Stewardship Investments, LLC along with his brother Phillip ...
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    Terry Lowe
    Replied about 2 months ago
    Due diligence is so important! One area I have failed on, time after time is the landscaping. Specifically on trees. They may be big and beautiful when you buy the property, but they require maintenance, which is expensive. If they have to be removed, for a variety of reasons, it’s even more expensive! I’m a tree hugger, so this has been a monumental issue for me! I’m learning.... slowly.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied about 2 months ago
    The big thing with trees is to account for how much it will be to trim the limbs so they're not near the roof and also check if they're dead, because those ones have to be removed. There can also be issues with roots (usually sewer lines but sometimes foundation walls), but you can find those things by evaluating the foundation and scoping the sewer line.
    Christopher Smith Investor from brentwood, california
    Replied about 2 months ago
    I feel your pain on the acquired tree front. I acquired a rental with 6 giant palms ringing the back yard. They were truly impressive to see, And to cut 100 lb seed pods, And to prune branches that grow 5 feet every year, And to dispose of a mountain of waste big enough for a dump truck, Not to mention they were the favorite hang out and superhighway for roof rats jumping between them and on to the house. Needless to say they are all gone now.
    Ashley Mitchell from North Carolina
    Replied about 2 months ago
    WOW!!!!! so basically avoid properties with trees around them all together right ?
    Joseph M. Rental Property Investor from Sacramento Area, CA
    Replied about 2 months ago
    Hi Andrew, After being an investor for almost 20 years, I have built up a lot of experience. The first thing for me is I don't know what I don't know. I have assembled an awesome team. One of those team members is a Professional Home Inspector. In fact, I have two of them that I can tap with just a phone call. They are worth their weight in gold and they are used on every one of my deals that are in contract. I cannot emphasize enough, especially to the newbies, a QUALITY and DETAILED home inspection is mandatory. The fee you pay is minimal and it can save you from buying a money pit. Case in point, I just cancelled a deal two weeks ago due to what my inspector found. The house was under contract for $80K, needed $15K worth of work and an ARV would be around $125-130K. Rents would be $1,200-$1,250/mo. and I would buy and hold with a cash out ReFi in a year or two. Nice large yard, original hardwood floors, upgraded electric....House was built in 1947. All looked good and as expected UNTIL my inspector was about to scope the pipes. They were the original pipes from 1947 and according to my inspector, if he would have inserted the scope and if it hit the walls of the pipe, the pipe would cave in. He looked from multiple points and the house would need a complete re-plumb all the way to the city connection. Estimated cost would be over $20K, assuming nothing else was found. End result, I cancelled the contract and happily paid him the $395 of the inspection. In closing, factor in an Inspector on every deal. It WILL save your back-side!
    Asim Ardaman
    Replied about 2 months ago
    I totally agree on using an inspector. Simply put it is a $400 insurance policy. It has saved me big $.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied about 1 month ago
    Any new investor should definitely use an inspector, and most seasoned ones should use one as well IMO.
    Seth Holland Rental Property Investor from Mount Juliet, TN
    Replied about 2 months ago
    Great video and article. I would definitely like a copy of your sheets. Also, what is that poster behind you about logical fallacies?
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 15 days ago
    Sorry fort he late reply Seth, Steven is right about the posters. Just send me a DM if you would like copies of the templates.
    Steven Arthur Homeowner from Las Vegas, NV
    Replied about 2 months ago
    I was interested in the poster also Seth and Googled what I could see in the video. There are several versions of the Thou Shalt series. The website is yourlogicalfallacyis.com and their store is at thethinkingshop.org That particular poster is $20.00 +s&h.
    Yuji Miyamoto from Torrance, CA
    Replied about 2 months ago
    Awesome video! I am still newbie stuck in a due diligence period. So I'd appreciate it if you could spare a copy of your sheets! Thanks for your big contrition to BP as always!
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied about 1 month ago
    Sure thing Yuji, just accept my colleague request and I will send the forms over (we have to be colleagues to share docs).
    Patrick Pierre New to Real Estate from Garden Grove, CA
    Replied about 2 months ago
    Thanks for making the video and writing the article. Would it be possible to get a copy of your 1 page and 5 page template you mentioned in the video?
    Account Closed
    Replied about 2 months ago
    Thankyou for this amazing piece of information. Really helpful !!
    Marcus Pugh Investor from Concord CA
    Replied about 2 months ago
    Great video, may i have a copy of your templates, would love to review these. thanks again!
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 28 days ago
    Sure thing. I just sent a colleague request (we have to be colleagues to share docs), just accept and I'll send it over.
    Rene' Ayala from San Jose, CA
    Replied about 2 months ago
    Great Video. Where can I locate templates?
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 28 days ago
    Sure thing. I just sent a colleague request (we have to be colleagues to share docs), just accept and I'll send it over.
    Megan Brooks Rental Property Investor from Fort Lee, NJ
    Replied about 2 months ago
    I would also add to checking the zoning on the house at the building department, especially for multi families and making sure they are legal.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 28 days ago
    Definitely a good thing to add to the list for sure, especially if it's not a cookie cutter subdivision or something like that.
    Courtney Duong
    Replied about 2 months ago
    I would like to get copy of your templates too. Please tell me how. Thanks.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied about 2 months ago
    I just sent you a colleague request (we have to be colleagues to share docs). Just accept and let me know and I will send them right over.
    Eldridge Stroman
    Replied about 2 months ago
    Good day Gentlemen, Very informative. Could you please send me a copy of your guide, 5 page! Thank you!
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied about 2 months ago
    I just sent you a colleague request. As soon as you accept it, I will send them right over.
    Lewa Owolabi
    Replied about 1 month ago
    Great article! I am interested in the templates too!
    Tonya Burke Investor from West Palm Beach, FL
    Replied about 2 months ago
    Excellent article! I, too, am interested in the templates. Thanks.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 29 days ago
    Hey Tonya, sorry I missed this, I just sent you a colleague request (we have to be colleagues to share docs), so please accept and shoot me a message back and I'll send you the docs.
    E Stephens New to Real Estate from Houston, TX
    Replied about 1 month ago
    I am interested in the 2 templates.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 29 days ago
    Sorry I missed this, I just sent you a colleague request (we have to be colleagues to share docs), so please accept and shoot me a message back and I'll send you the docs.