Due Diligence – What it is and Why it Matters!
When it comes to purchasing real estate, due diligence represents the time period in which a buyer checks the property condition and validity of title before finalizing the transaction.
If the buyer’s investigation uncovers defects with the property, they may either propose a solution to the seller by addendum to the real estate contract or cancel the purchase.
Contractual Due Diligence
There are certain elements within the sales contract or purchase agreement which are critical to the ‘satisfaction’ of due diligence. Let’s take a closer look at each of them.
Contingencies – Any contingencies which the buyer wants performed prior to finalizing the purchase must be stated on the sales contract. Some examples of these conditions may include: inspections, partner’s approval, financing, research of code violations or permits – and, of course, a clear and marketable title. At the end of the contingencies timeline, the buyer must either release the them and proceed with the sale or cancel the purchase.
Time is of the Essence – Due diligence supported by contingencies comes with a definitive timeline in the sales contract. If the buyer cannot complete his/her due diligence by the deadline, he/she will have to renegotiate with the seller. The seller has the choice whether or not to agree to the extension; which in turn may compel the buyer to follow through with the purchase regardless, or cancel the contract.
Title Discovery – Whenever you purchase real estate (especially as an investor) a marketable title is the most crucial element. Without it, an investor cannot sell or transfer the property. There are several types of title discovery searches which look into a chain of title; as well as liens or judgments against the property. The following are 2 main types of searches performed; keep in mind these may go by different names according to the title company and location:
- Full Title Search – the most complete of the two, this search checks into everything affecting the property’s history. It is the only one that will be used prior to issuance of title insurance, and is of course the most expensive to perform.
- Letter Report – a summary of what’s on the title; which reveals any possible liens and judgments.
Please note: Securing title insurance is an important step. Though title insurance for cash transactions is optional, it is mandatory when the buyer must obtain a mortgage to purchase the property. In my professional opinion, an investor should always acquire title insurance. According to Wikipedia, “Title insurance is a form of indemnity insurance predominantly found in the United States which insures against financial loss from defects in title to real property, and from the invalidity or unenforceability of mortgage loans.”
Due Diligence Questions & Answers
Q: Should an investor perform due diligence on every property before purchasing?
A: Yes, and no. When an investor is looking at several possible deals at the same time – and not sure if they will go through with a specific contract, holding back could be wise. For example, it would be prohibitively expensive to perform even a Letter Report (average cost is $150) on every single property. These actions are also time consuming: even a title report will take 3 business days to be issued.
With that said, there are times when some basic due diligence is an important decision factor; for instance, when an investor is considering a property coming online at a foreclosure auction. The investor will want to know what potential issues there might be on title (liens, judgments) and whether the title would be marketable.
Q: Is it necessary for a title company to perform the due diligence for any sales contract?
A: The investor can actually perform a lot of their own basic due diligence without hiring a title company or spending any money. Checking with the appropriate government offices (most of them can also be accessed online) for some basic discovery is the simplest way to gain confidence in proceeding with your purchases.
Q: Which government agencies do you recommend searching to complete due diligence?
A: I don’t check with all the government offices for each property. If my discovery at the Recorder of Deeds Office comes out clean (with no red flags) I will stop there; unless I see a spotty history of liens and releases on title. This is also a useful means of locating properties undergoing issues that have kept them off the MLS. Here is a list of searches available in the public domain, and what you can expect to find:
- Recorder of Deeds Office – Will have record of liens such as: Mortgages, Federal & State Income Tax Liens, Sewer, Water, Judgments, HOA (Homeowner’s Association); and other property document history.
- Collector of Revenue – Lists any Back Property Taxes and Tax Liens
- Building Inspections Office – Data on any building violations and inspections.
- HOA – If the property is within a subdivision or a condo development, there are probably Homeowners’ Association Dues.
- Clerk’s Office – Mechanics Liens (filed by contractors for unpaid work on the property).
- Comptroller – City liens, for unpaid taxes and fees.
Due diligence is a must when it comes to purchasing real estate. Though a preliminary search can be performed at no cost before making your decision to proceed – it is my opinion that a full title search and insurance are necessary prior to final purchase.
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