Due diligence as defined by the Oxford Dictionaries,
1. reasonable steps taken by a person in order to satisfy a legal requirement, especially in buying or selling something.
a comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential.
In residential real estate a seller is often, most states that I am aware, required to fill out a form disclosing any known material defects with the property. Such as the roof has a leak over the back corner bedroom. Or that there is asbestos under the beautiful laminate wood flooring in the kitchen. Some states may refer to this as a residential condition form or residential disclosure form here in Ohio. These forms are required for single family homes and up to quads, four unit residential units. This is an area that often leads to lawsuits after the transaction has closed. Why does that happen? More than likely the sellers knew something materially defective that would have resulted in a reduction in the selling price. Many sellers will not disclose something in that situation and leave it up to the buyer to figure it out. That is of course illegal in the state of Ohio and most other states. This usually results in the listing broker and agent being pulled into the lawsuit as the buyers, buyers agents, and lawyers will assume that the selling agent or broker were aware of the issue. In the state of Ohio, if your a seller and you disclose a material deficiency to your agent that agent has a duty to disclose that condition to the potential buyer. In fact I as an agent broker would insist on the seller adding an addendum to the disclosure form or submitting a new form with the updated information. If the seller refused I as the agent would verbally inform the potential buyers and add it to the listing. Sellers may fire me as their agent over this action, but its better to be fired than to be sued and labeled my your peers as someone who is not honest. Even knowing this you as a buyer should still have a whole house inspection completed. As the current sellers may honestly not be aware of an issue.
But what about investment rental property? More importantly a property that is 5 or more units if its residential, commercial, industrial or some combination. Or if the property falls under certain exclusions such as new construction, government owned (HUD homes), inherited property where the heir has never lived in the property and most important bank owned properties. These are some of Ohio’s exclusions to disclosure in residential property and it extends to our investment rental property situation of 5 or more residential units.
What to do in a situation where you want to invest in real estate, especially residential rental property that is more than five units. First you should be aware of Caveat Emptor, let the buyer beware. First thing is to hire a local real estate agent familiar with the area. The agent should be able to help you understand the area faster than it would take you to do the research, become familiar with rent levels, area desirability maybe even know something about the particular subject property. After all, if your in this business long enough working a certain area you are bound to run into someone familiar with the property, been into the property etc. Second step if you manage to reach a preliminary deal, your agent should negotiate that agreement with clauses giving you the right to inspect and conduct due diligence. Those rights to conduct due diligence should come with a time frame and the right to rescind that offer. You want the time period to conduct your due diligence on every facet of the subject property since sellers in this situation are not legally bound to volunteer up information, this is a straight up business deal essentially.
Due diligence should include putting attention to every detail. This would include hiring a an inspection company to look at the building, you may need to hire a building engineer or structural engineer if certain concerns are raised during the inspection. I often insist that buyers make certain we get the right to inspect every unit in the building. Many sellers will argue that its to much of a hassle to their current tenants and that just a certain percentage should tell us what we need to know. That is an instant red flag to me that the seller is trying to hide something or has made statements that possibly are not completely honest. In those situations I would still insist that my buyer has the right to inspect every unit. If seller is not willing to accept those conditions my advice to the buyer is to walk away from the deal. However, if accepted then it is advised by me that the inspection company give us detail workups on every unit, common area, and utility areas including building systems. Depending on the area and what was historically located around the property or on the property you may need to do a soil sample. Every unit should be checked including the ground around the property for lead and other contaminants. If I am also going to take over management of the property I will walk with the inspectors every inch of the inspection and I often encourage the buyer to do the same. Its important that the buyer and myself if taking management of the building to understand every detail of its condition. There is added bonus to doing this as it gives an opportunity to speak with every tenant along the way. Part of the due diligence is going to include verifying the name on the lease matches the individual in the unit. You can check at that time how long they have rented there, what is their current rental amount, amount of security deposit they paid, let them look at the lease documents to be sure those are the correct documents and that the seller hasn’t fudged the numbers. You can get feedback from the tenants about the area the building has its been run during there time renting, are they planning to renew their lease. You can use this information to confirm the current financial records and operational performance of the building. Of course you will want to view at least one years worth of utilities, taxes, insurance if the seller is willing to provide that but its easy to estimate that number. This all goes together to give you an overall picture of how the building has performed as least recently, one year is my suggestion. If will let you know if the rental property has structural issues, what condition the individual units are in, age and issues with the buildings mechanical systems such as heating, water supply, cooling. It will give you the opportunity to review each lease for verbiage, compare them to the rent roll, match tenants to leases, develop your own financial picture of the property which is more useful than what is provided by the current seller which is often doctored to look better than it is actually performing. And you will know just about everything there is to know at this point. Sometimes its all a match, the financials match up and are positive, the building is in great condition or is in the condition as expected and the deal is ready to be closed. Sometimes you may find a seller who has tweaked the financials or did not disclose the fact the building needed more repair than advertised, this gives room to renegotiate now that you know or to walk away from the deal. Rarely, you may find a building that is beyond as stated, very rare as most listing agents would not leave money on the table if possible, but sometimes a seller has their reasons for under pricing a building to move it quickly, don’t over analyze the situation lend on your due diligence to give you the information. Construct your deal based on your knowledge at that point understanding you have done everything possible. Due diligence is an absolute necessity when evaluating rental property but especially when its five or more units. A true mistake if you do not conduct a thoroughly inclusive check. Good deals are made at the closing table but if you don’t know the rental property for which you are making the deal chances are you will make a bad deal. Do your due diligence, hire an agent familiar with the area to represent you. In the Cincinnati Ohio are call Resident Properties or visit them at www.residentproperties.com