06-30-14 - dueDue Diligence: Houses

Due diligence is the nitty, gritty part of real estate investment that is often overlooked, but only at the investor’s peril. Proper due diligence is absolutely vital to avoid making huge mistakes.  Unfortunately, I learned this the hard way. Once I bought a property with no plumbing in the basement, another time the electrical had been so completely scrambled by some overly ambitious DIY seller 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?

You will generally have 30 days to close and 10 to 15 days to inspect, at which time if you back out, you should be able to get your earnest money. This is negotiable and varies, so make sure you are aware of what your time table is up front.

The Balancing Act

There is always too much of a good thing. If you are in a volume business and buy 5 to 10 houses a month, missing something during due diligence from time to time is the cost of doing business. You should still do due diligence of course, but if thorough due diligence bogs down acquisition, it becomes counterproductive.

On the other hand, if you buy one a month or so, there is no messing around. That one has to be good, so very thorough due diligence becomes nonnegotiable.

What to Look For

For thorough due diligence, you will need to get the water, electricity and gas turned on if they are off. You want to make sure the HVAC system and electrical work and that there are no plumbing leaks. Key things to look for:

–          Fuse boxes (you will probably want to replace them)

–          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 concerning and you should get an expert out there to inspect it. There should be piers in the basement if the foundation is moving at all.

–          Plumbing leaks or galvanized plumbing which often rusts

–          Old HVAC (it is probably near the end of its useful life, even if it is still working)

–          Dry rot or signs of pest damage

–          Roof leaks or substantial roof damage (this often requires getting on the roof to verify)

Especially for newer investors, it is a very good idea to get an inspector and review the inspection report thoroughly. You should have them do a pest and dry rot inspection too. This will also help if you find problems and want to renegotiate the price. Never be afraid to walk away if the deal doesn’t work.

Also, 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.

Pricing it Out

Most investors and almost all new investors think things cost less to repair than they actually do. Especially if you’re new, get some bids or quotes on the major work and add some to your budget for unforeseen and knick knacks (around 25%). Make sure this is in line with your expectations when buying the house. It’s better to find out you were wrong at the beginning and back out then to buy a bad property.

Finally, always close at a title company or with an attorney. If you don’t, you may find yourself with a property that has massive tax lien attached to it or something like that.

Any problem you find before you close, you can use to renegotiate or back out. If you find it after you close, good luck getting the seller to pay for it. So do your due diligence!


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