Everything you need to know about due diligence in real estate

Whether it's your first or fifth time around, buying a home is an exciting yet stressful experience. With average home prices skyrocketing in today's market, it may be tempting to snatch up the first decent home you tour to avoid missing out. However, it's not wise to be hasty just because the market is currently unfavorable for buyers. Buying a home is a big deal, so it's important to follow proper due diligence procedures.

Think of due diligence in real estate as doing your homework. Your homework includes scoping out the area, hiring inspectors, buying home insurance and more. Keep reading to learn what the due diligence process entails, or skip below to our checklist that provides a breakdown of each step of the process.

What is due diligence in real estate?

It’s important to know all the facts about the home you’re about to buy before you fully commit by signing the dotted line. This means learning about the home’s financial background, structural safety and even the neighborhood. This is all part of the due diligence process, which protects buyers when they’re buying a house.

What to expect during the due diligence period as a buyer

As a buyer, it's your responsibility to work through the due diligence process. No part of the due diligence process for buyers is a legal requirement. Parts of the checklist might be required by a third party, like a lender, but the majority are there for the buyer's protection. 

Throughout the process, you can expect quick movement upfront between the various inspections and other closing tasks. You will need to hire third parties for inspections and appraisals, which move quickly so the rest of the closing can proceed. Assuming you are working with a real estate agent, they will likely handle much of the scheduling and communication between parties, then update you as things are completed. 

Be sure to go into the due diligence process with the expectation that you might uncover potential issues with the house that could result in transaction delays or cancellations. Though disappointing, understand that this is normal. It’s better to find out these things before the purchase is completed. 

What to expect during the due diligence period as a seller

While due diligence mostly refers to buyers, sellers should also be aware of the process as it can affect them and the closing. If running through the process takes a while, it could push back the closing date. Or, if the inspection turns up unfavorable issues, the buyer can legally back out. Additionally, as a seller, you can expect to be asked to leave your home during scheduled due diligence tasks.

There are also a few things sellers are required to do for due diligence when putting a house on the market. Specifically, sellers must disclose any known property defects — but this won’t make a property unsellable. The purpose is to ensure buyers aren’t surprised by problems when the property is turned over. This protects both the buyer and seller.

Starting the due diligence process

Your realtor is your guide through the home-buying process, including due diligence. Laws and closing timelines regarding due diligence differ from state to state. It’s the realtor’s job to keep you informed on your state’s requirements as well as what to do should any issues arise. They should also give you a rundown of what is expected for you to complete during due diligence — from understanding the contract to the various inspections. Continue reading for a list of each step of the due diligence process.

1. Check out the area

Before submitting an offer, there are a few due diligence items to work through to ensure this is the neighborhood for you, including:

• Researching the address to check for any unusual history
• Checking into crime rates for the general area
• Driving by at different times of the day to see the neighborhood activity and noise levels
• Exploring the proximity to stores, doctors and more
• Understanding the homeowner association (HOA) fees and regulations
• Researching school districts if you have or plan to have children

2. Understand the property disclosures

As mentioned, sellers are required to disclose any known defects or facts that could negatively affect the home. Property disclosures are written within the listing papers to which a buyer's agent has access. A few examples of what you might find within property disclosure statements are pest infestations, appliance issues and water issues in a basement.

As a buyer, you want to make sure you understand these disclosures entirely. It’s no easy feat to hold the seller liable should you find any undisclosed, nonobvious issues after moving into the property. In some states, the seller may have no obligations for undisclosed issues. In other states, you may have to prove that the seller intentionally hid these issues.

In the property disclosure statements, a section may be added to include specifics of what is included in the sale, like appliances or play sets, and any work the seller plans to do prior to closing, like emptying a septic tank.

3. Hire an inspector

Perhaps one of the most important parts of buyer's protection during the closing, inspections are meant to help buyers avoid buying a lemon house. However, inspections are typically optional unless a lender requires it, and adding an inspection contingency may make you look like a less attractive buyer if others are waiving these contingencies. 

Upon receiving a home inspection report, buyers can choose to continue with closing as is, request repairs, negotiate the offer price or back out of the sale altogether. For some mortgage types, like a VA loan or a Federal Housing Administration (FHA) loan, an inspection and passing report is required to proceed with the mortgage application. Weigh the pros and cons before waiving any of the following inspections.

Home inspection

A basic home inspection analyzes the general condition and overall safety of a house. A licensed inspector will evaluate the entire property, including the exterior and interior structure, electrical systems, appliance and waterline function, grounds and more. 

Radon gas inspection

Buyers can opt for further inspections, such as a radon gas analysis. Radon is a radioactive gas released from radium decay in the soil. It's colorless and odorless but is the second leading cause of lung cancer. Although it's naturally occurring, preventative measures, such as increasing airflow and ensuring proper door seals, can mitigate the radon levels inside a home. 

Asbestos inspection

Another dangerous material often found in older homes is asbestos. Asbestos is not currently banned in the U.S.; however, it is not commonly found in building materials today. Asbestos raises cause for concern due to its link to lung cancer and mesothelioma. 

Asbestos was often used in building materials for strength and to provide heat insulation and fire resistance. It can be found throughout older homes — in flooring, shingles, insulation, paint and joint compounds, furnaces, gas fireplaces and more. Removing asbestos must be done by a professional as it is a microscopic particle that, once unsettled, can be easily inhaled through the contaminated air.

Lead-based paint inspection

In 1978, the federal government placed a ban on lead paint for consumer use after it became apparent that the paint was causing lead poisoning in children. You can expect homes built prior to the ban to contain some lead paint; however, it’s likely covered by years and layers of non-lead paint. Once covered, the cause for concern is significantly reduced. However, action should be taken in areas with deteriorating paint. Lead-based paint inspections assess the level of concern regarding potential lead poisoning in older homes.

4. Get an appraisal 

Home appraisals provide a professional opinion on a home's monetary value. Lenders require appraisals as proof that the requested loan amount matches the estimated worth of the property.

The appraiser is a neutral third party contracted by either the lender or the buyer. They create a report based on an inspection of the property, favorable aspects of the home, market trends and recent sales of comparable homes. Once complete, the lender reviews the report to determine how to proceed. If the appraisal value is much lower than the contractual sale price, the transaction may be canceled or delayed.

5. Survey the property

A property survey determines or confirms boundary lines and legal descriptions of a property. For properties with nearby neighbors, a property survey can help homeowners avoid encroachments — property disagreements — with neighbors. It also uncovers any easements — shared property — like a shared driveway with a neighbor or a telephone pole with a utility company. Additionally, a survey shows the elevation and hazard areas, both of which are important to insurance companies.

If a property survey has not been completed in some time on the home you intend to purchase, you may need to add it to your due diligence checklist. Depending on the state, you may be required to complete this regardless of the date of the last survey. 

6. Compare homeowners insurance

When financing a home purchase, mortgage lenders require proof of purchased homeowners insurance. Insurance providers consider many factors when pricing a homeowners insurance policy — the location, flood zones, cost to rebuild and so on — which is why much of the due diligence checklist should be completed before obtaining an insurance binder. If you are buying a home with cash, homeowners insurance isn't required but is still recommended.

Not all insurance companies are the same. You may find one that offers better perks and a significantly lower premium. However, most providers cover similar concerns, and issues that fall outside of this may require additional coverage. Issues not typically covered by traditional homeowners insurance policies include:

• Normal wear and tear
• Intentional damage
• Damage to vacant dwellings
• Damage from major weather conditions, such as flooding
• Government actions/war

To save money and ensure you receive the best protection, be sure to compare homeowners insurance providers or try bundling your home and auto insurance policies.

Careful due diligence can set you up for success as a homeowner. But after you close on a property, it’s up to you to upkeep the home to maintain its value.

Sources: HSH | Rocket Mortgage | Investopedia | Quicken Loans