We have to pay very focused attention when we qualify property for purchase. It is a special attention called due diligence. Put another way, we say; “Caveat Emptor”, or “let the buyer beware”. What it means is that we, as investors, are responsible for discovering information in all the areas of the transaction we are about to make in buying the subject property.
Due diligence is the persistent act of checking and rechecking all the details of the deal before we go to the closing
table. It is a generic term that refers to constant, persistent effort in making sure that we are getting what we are paying for and nothing less. Due diligence can be applied to buying houses, apartments, notes or any other significant investment.
It is important because ultimately, the person responsible for the transaction is you. You are the buyer, you are the one writing the check, you are the one who will win or lose. In one sense, due diligence is the “degree of attention or care expected of a person in a given situation”. We expect sellers to be honest and forthright in the deal, and sometimes they are.
Sometimes sellers will try to hide certain details concerning the property that they feel will keep you from buying their property. Mistakes get made on paperwork, the wrong numbers get transcribed into legal documents and critical details get dropped through the cracks. There are lots of pieces that go into buying a piece of property, and it is up to you to make sure that you are getting what you are told you will be getting. It is especially important that you perform your due diligence before you close on the property because after you finish signing your name for an hour at the closing table, win, lose or draw, the property is yours. If something has gone south in the details, it’s your baby.
Do not under any circumstances take anyone else’s word for anything on the transaction until you have verified it for yourself. Delegating responsibility to a real estate agent or a partner or a title company or, God help you, the seller, is acceptable as long as you verify everything they tell you or show you. Don’t take anyone’s word for anything unless you have checked it yourself.
You normally hear me preaching the gospel of scope and budget and its place in purchasing property. As your inspector of choice it is my job to help you keep from making mistakes. Scope and budget are only two of the critical areas where you need to be paying attention to when you buy properties.
There’s more here that you need to be aware of. Let’s take a look at some of the parts that make up a real estate transaction and talk about how you apply due diligence to them.
Inspections – you either have to inspect the property yourself and go over it with a fine toothed comb, or you need an inspector to come in and tell you what is wrong and what needs to be fixed on the house.
Title work – be sure you know who is really in title. If the seller tells you one thing and the title company tells you another, keep digging until you know the full, legal truth. This discrepancy shows up sometimes in the case of a divorce where one person says they have the right to sell the property when in fact they do not.
Liens and Encumbrances – the title company will dig up and filed document that uses the subject property as collateral for a financial obligation such as a loan to install solar heating panels. The title company will find out for you if there are any IRS or taxing authority liens against the property that will have to be satisfied for the title of the property to be transferred to you.
Mortgage terms, Conditions and Balances – is the mortgage in arrears? How much? What does the seller’s mortgage company have to say? What is the real market value of the property and how was it determined? Here’s a hint; anyone who has been in this business for any length of time will tell you that the Appraisal District records (HCAD, MCAD, GCAD, etc.) are FULL of errors, and their version of property values may or may not have anything to do with current reality.
Property Owner’s Association Dues - All paid up and current? These are encumbrances that are subject to late fees, fines and exorbitant legal fees. Be sure to get an up to date accounting of these obligations from your title company.
Scope and Budget – double check your scope of work and your budget before you close to be absolutely sure that you have everything in there that the property will need. Any work that needs to be done to bring the property to a good and marketable condition has to be accounted for here. If it is not in the scope of work and budget, you will be paying for it out of your profits. Be sure all of it is taken into consideration before you close.
Learn how to read a closing statement (HUD 1). It is confusing at first, but it is your responsibility to be familiar with all the charges on the transaction and who is responsible for them. Be sure to double check EVERY WORD on this statement, including the address and legal description of the property. Errors are common, don’t close with errors in the paper-work, they are difficult to correct.
Ask to see a copy of how the title company will record the title transfer with the county clerk. Read slowly, savor every word. Once the deed is filed, it is a matter of record. Mistakes can be corrected, but it can take a lot of time
and headaches that can be avoided if you do your due diligence.
Renting - Do credit checks, do background checks, do former landlord checks and be hardnosed about lease agreements. Trust no one, double check everything connected to the renter and his ability to pay and respect your property. This is critical because it takes lots of money to turn these rentals over when someone fails to pay, trashes the place and leaves just ahead of the sheriff and the bonded movers.
Stay Focused - Pay attention to details. Ask questions. Expect performance and inspect the results of those performances. In the end it all comes back to you. Don’t be scared, be diligent, it is a learned behavior like speaking English or driving a car. Practice makes perfect. Practicing due diligence will make you a much better investor, with much better profits.
So go, do a good job, don’t expect anyone else to take responsibility for your success. Oh, they may help and they
may be supportive, but in the end it is you and you alone who is in charge of your success.
Check Your Homework - Check everybody else’s homework. Check it one more time before you go to close. When you begin to investing, go over the details until you feel silly spending so much time checking details. Yes, it will be slow at first, but soon you will get the hang of it and you will get faster and better at spotting items that need attention or explanation. You will be glad you did.
Remember: by the time you get to the closing table you will have paid out some money for inspections, appraisals etc., and sometimes the deal just doesn’t close. I hate to lose money just as much as you do, but sometimes it is better to lose the fees and not close the deal, than to close the deal and get buried by unexpected expenses. Better to let go of two or three slices than to lose the whole loaf. Do your homework. It is slow, diligent work, but it is some of the best effort you will ever put into your investments.
Reprinted by Permission. The author, of Forward Assist, has conducted "Mr. Fixit" workshops, and served on the Realty Investment Club of Houston Board of Directors as “The Enricher” Newsletter Editor for three years. He shares his treasure chest of secrets with anyone who asks. You can reach him at (713) 858-1330
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