Due diligence is one of the most important things to master when it comes to real estate investment, yet it’s often one of the things that’s most neglected. It’s boring and no one likes backing out of a deal or even renegotiating, which is what due diligence will often lead to. But it’s better to back out of a mediocre or bad deal than to deal with a headache or money pit later down the line.
That being said, even seasoned investors who make a priority of due diligence can miss things. I certainly have. Here are five of the easiest things to overlook in my experience.
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5 Items Investors Overlook When Performing Due Diligence
1. Sewer Lines
Let me tell you, there’s no better way to endear yourself to a tenant’s heart than for raw sewage to back up into their house a month or two after they’ve moved in. Unfortunately, I know this from experience.
If you’re buying a house that’s more than 40 years old, scoping the sewer line is a must. You can usually get a plumber to do it for around $150. I would always make sure to accompany them, though, because many will lean on the side of “better safe than sorry.” If a sewer line has a few roots or a small belly in it, you can probably baby it along. Just snake it out and flush some root killer down the toilet. But if there are significant bellies, breaks or endless roots, it needs to be replaced. This will usually cost $3,000 to $6,000. Usually you can have the plumber videotape it and give you a CD of the scoping. This can be great for renegotiating with sellers.
2. Poor Drainage
Kansas City has had some torrential rains this spring, and unfortunately much of that rain has found its way into many of our basements. When it’s dry outside, drainage is an easy thing to overlook. But you will find out soon enough about drainage issues, and so will your tenants!
Make sure the dirt going up to the house has a good grade (a slope away from the house). If there are any hills coming down toward your house, you may want to put in a swell or french drain to divert the water away from your house. And you also need to check the driveway and any concrete walkways or patios that touch the property. These are the most expensive to fix, as you will have to either float them (add concrete on top) or mudjack them (push them up from below) to address the drainage. And it’s not just important to check for this because of water in basements, left unaddressed; these water issues can cause serious damage to your foundation, too.
One quick note: If you are having water problems, the first thing to check are the gutters. They may just be clogged, which can lead to water pouring over the top of them and running into the foundation. Also make sure the downspouts point away from the house and have splash blocks as well.
3. Ungrounded Outlets
Older houses often have ungrounded electrical outlets. For rentals, this may be tolerable, although it’s certainly not preferable. But for flipping, it can present a big problem on the resale. And rewiring a house ain’t cheap. The first way to check is to look to see if the outlets have two or three prongs. If they have only two, that means they are not grounded. But it doesn’t mean they are grounded if they have three. Many devices don’t plug into two prong outlets, so people replace them with three prong, even though the outlet isn’t grounded.
One sign of this is if there’s a mix of two and three prong outlets throughout the house. That probably means the house is ungrounded and the previous owner replaced a few. However, the most surefire way to test is with a ground circut tester. You should probably get the heavier duty kind, as I have heard the cheaper ones can be fooled.
4. Bad Electrical Panels
Electrical panels, generally speaking, hold up pretty well over time. But if the house you’re looking at has a fuse box, you will probably want to replace it, especially if you are flipping the house. And watch out for Federal Pacific panels and Pushmatic panels. These panels can work. They have not been recalled like many people think, but they don’t trip very well. In a rental, they may work well enough (consult your electrician). But if you’re flipping the house, it will likely come up on the next buyer’s inspections, and you will probably have to replace it.
5. Old Appliances and HVAC
Even if these items work, you need to account for the fact they likely don’t have much life left on them. If you are flipping the house, you will probably want to at least replace the appliances — because old appliances make the house appear dated. With rentals, you need to realize that these appliances will go out sooner than if they were new and therefore should be considered at least a partial cost upfront.
My thoughts on HVAC is that more times than not, you should run it into the ground before replacing it. But you still have to be aware of the obvious fact that older HVAC is of less value. And then you need to account for that somehow when making your offer. My experience is that even if an old furnace or A/C compressor works, it won’t last long.
BONUS: Look Underneath Those Bad Carpets
This is on the positive side. You would be shocked how many times I’ve seen terrible or completely worn out carpet laying over perfectly good hardwood floors. So if you can, pull up the carpet in a corner and pull it back to see what treasures may lie underneath. You very well may be able to save a few thousand on flooring that other potential buyers aren’t aware of. We have multiple times.
Overall, finding these problems ahead of time offers two key advantages: 1) You can get out of a bad deal before it becomes your bad deal and 2) You can use these items to renegotiate with the seller. Both give you a huge advantage over the competition.
So make sure to check for them before signing on the dotted line.
What other items would you add to my list?
Let me know with a comment!