I believe it even became a buzzword of sorts last year because some people I know reminded others to always do their due diligence, pretty much like what I said here. But what is due diligence and why is it very important in real estate investing?
Definition of due diligence in real estate investing
In a nutshell, I would define due diligence in real estate investing as a process where you are taking the necessary and reasonable steps before the acquisition of a property and this may include, but is not limited to, conducting research and analysis that would cover the physical, legal, and financial aspects of a property.
Much of these can be done through property inspections, a visit to the local Registry of Deeds, City/Municipality Assessors office, Home Owners Association, etc. The rest calls for some number crunching.
Don’t forget to start with banks or lending institutions who should disclose any information they may have, including if the property has any liens, encumbrances, pending court cases, problems with technical descriptions on the title, illegal occupants, physical defects that are too costly to fix, arrears and/or real estate taxes that the buyer will have to shoulder, etc..
The information above that you can get from the sellers themselves (the banks or lending institutions) will definitely help you get started when you conduct your due diligence, but you have to keep in mind that you will have to verify the information you may get. If some of the information you need is not readily available, you may have to fill-in the blanks yourself.
Here’s a warning though, due diligence can be tedious, time consuming, and may require a lot of legwork. Which is why you should only do a “reasonable” amount of due diligence on properties that you have already pre-screened and have made it into your shortlist. You can’t do your due diligence on every property you see, that would be a recipe for wasted time, money, and effort.
Defining what is a “reasonable” amount of due diligence would greatly depend on the circumstances behind the deal or the property you are looking at.
Note: Make no mistake, no matter how tedious conducting due diligence may seem, it is definitely something a real estate investor cannot do without, especially with foreclosed properties, because they are for sale on an “as is where is” basis. The good thing about due diligence is it becomes easier with practice, and you can even outsource it if needed.
Do your due diligence fast if…
For example, if you are hard pressed on giving an offer for a property because you believe there are a lot of other interested buyers, then you need to do your due diligence fast so you can submit your offer before your competitors. In this case, a reasonable amount of due diligence might be limited to the bare essentials or non-negotiable’s.
You can take your time if…
On the other hand, If a deal has no urgency, a more thorough due diligence can be done. For example, if you believe that a foreclosed property has been in the market for so long with no takers, but you still believe the numbers look promising, then you have the luxury of taking your time to do a more thorough due diligence.
Obviously, a big deal that is worth tens or even hundreds of millions of pesos would naturally call for extraordinary due diligence, which can take a longer time to complete.
Let me tell you a story…
I remember the very first time I won on my bid for a foreclosed property during an auction.
I was the lone bidder and when the auctioneer banged his gavel which signaled my win, I really felt happy and relieved because I had finally won!
Imagine how I felt later on when I thought to myself “Maybe there is a problem with the foreclosed property others have seen which I have not, which is why no one else made a bid… except me! Oh no!”
Was it a case of finding an opportunity others missed, or was I the one who missed seeing a problem that discouraged other real estate investors from buying the same property?
If I had done my due diligence properly, I would not have had the feeling above in the first place, right?! Actually, I believe one cannot be 100% sure that he made the right decision in buying a property. But at the very least, doing proper due diligence allows one to make a well informed decision, and you would less likely have any regrets or “buyer’s remorse”.
An ounce of prevention…
As the late Benjamin Franklin said, “An ounce of prevention is worth a pound of cure.”, and that is exactly what due diligence is for. It should prevent you from buying a property that has problems or will give you problems down the road.
It is far better and easier to just walk away from a problematic property BEFORE you purchase it, than trying to “cure” its problems (which can be very costly) or dispose it later (it might even be harder to sell) AFTER you have already purchased it and parted with your money.
To answer the question, “What is the importance of due diligence in real estate investing?”, let me summarize it below:
When it comes to real estate investing, your best defense is conducting proper due diligence! – Jay Castillo
Happy real estate investing!
To our success and financial freedom!
Real Estate Investor
PRC Real Estate Broker License No. 3194
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Text by Jay Castillo and Cherry Castillo. Copyright © 2008 – 2012 All rights reserved.
Photo credit: somegeekintn, on Flickr
Full disclosure: Nothing to disclose.
P.S. I wrote this post to make a brief overview on “why” due diligence is important. To get an idea of “how” due diligence can be done, checkout my post on the 31 Questions you need to ask when inquiring about a foreclosed property which you can turn into a due diligence checklist for real estate.