What is Due Diligence in Real Estate?
Mar 18, 2023
So you've found that perfect home, made an offer, and the sellers have accepted your offer. Once the contract goes binding, you've now entered the due diligence period.
In some states, due diligence is often referred to as the "inspection period." Although an inspection is very common, the homebuyer is not required to perform a home inspection during this period.
What is Due Diligence?
What exactly is the definition of due diligence, anyway? In the world of real estate, due diligence is a legal term for “doing your homework.” But what exactly happens during the process and how is your earnest money related to the process?
In general, "due diligence" pertains to the period of time that allows the homebuyer to investigate the physical structure (interior and exterior) and also the location/neighborhood. It's a opportunity for the homebuyer to discover any potential problems or issues with the home and importantly, negotiate an amendment with the seller if the contract allows for it.
This period is very beneficial to the home buyer because it gives them time to inspect the property and back out of the deal without penalty if they find something serious or just don't feel comfortable moving forward.
6-Step Checklist for Due Diligence
1. Get a Home Inspection
A home inspection is one of the most common and most important things to complete during the due diligence period. While the typical home buyer may not know all the things to look at when buying a home, a home inspector does.
A general home inspection will look at the overall condition of the home. The inspector will inspect the main structures and systems of the home, including the roof and windows, heating and cooling systems, plumbing, appliances, etc. They will then prepare a full report of the home including any issues found and the severity of each.
You should also consider getting other inspections that aren’t included in the general home inspection. Hiring a professional to inspect the home for wood-destroying organisms, lead-based paint, and radon gas are also advisable. These hazards are typically not checked by a general home inspector, but are worth the extra money as the problems they cause can be very expensive to fix.
2. Read the Disclosures
Included in most real estate contracts are the seller’s property disclosures. While you should read over the property disclosures before making an offer on a home, it is also a good idea to take a second look during due diligence for any issues you may have overlooked.
The disclosures are a form including detailed information about the home such as the age of the HVAC and roof, any known water intrusions, age of the home, items included in the sale and more.
If the seller has knowledge of any material defect, they are generally required by law to provide that information in the disclosures. The laws governing disclosures vary from state to state, but if you are provided with disclosures, it is a great opportunity to learn important information about the property. So make sure you read through the disclosures carefully as this is an important step in doing your due diligence.
3. Order the Home Appraisal
Although this step is technically performed by the mortgage lender, getting the ball rolling on this step will ensure that you don't miss the closing date. Generally your appraisal window will be longer than the due diligence period, so it's not necessary to have the appraisal complete - just ordered.
If you are getting a mortgage loan to purchase your home, then your lender will require an appraisal. This is their way of assuring that the home is actually worth the money they are giving you. Even if you are paying cash for your home, an appraisal is not required but is in your best interest to make sure you aren’t paying more than fair market value.
During the appraisal, a licensed appraiser will inspect the home and provide an unbiased opinion of its value. The appraiser will visually inspect the home and then create a report based on their inspection, including details of the home and recent home sales nearby. All of this information will be used to provide the estimate of the value of the home. If your contract contains an appraisal contingency and the appraisal comes back low, you will also have the chance to renegotiate the price for the home.
4. Secure Home Insurance
Due Diligence is also a good time to secure home insurance. Home insurance is essential to giving you peace of mind and will likely be required by your mortgage lender.
Homeowners insurance will protect you in the event of damages to your home or property. Make sure you can secure coverage and that it won’t be prohibitively expensive. Some areas, such as flood zones or hurricane prone areas might not even be able to get a policy. Get a few different bids from different carriers as part of your due diligence.
5. Engage a Closing Attorney or Title Company
While you may have focused all of your attention so far on the physical house and property, it is also very important to investigate the title of the home through a title search. In order to “take title” or establish legal ownership for the property, you have to make sure you can secure the title free and clear. This step is performed by a title company in about half the states in the US, or by a closing attorney in the other half of the US. For example, Florida utilizes title companies while Georgia utilizes closing attorneys.
Your mortgage lender will require a title search as it protects them as well.
Through the title search, you will discover if there are any financial liens on the property due to unpaid taxes or other liabilities. You will also learn if there are any claims on the title such as an investor or even family member of the previous owner that hasn’t signed off on the sale of the property.
Investigating the plat of the property will also show the actual situation of the physical boundaries of the property. Are there any encumbrances or unresolved boundary disputes you should know about? These are issues that are uncovered by the "title chain" or "abstract of title" search process.
6. Check Out the Neighborhood & HOA
While you can fix issues with the home and improve the property, you can’t change the location of the home or the surrounding area. So it’s a good idea to spend a little time finding out more about the area.
Is the home located in the city? Do a few drive-throughs to check traffic and find your way around. Can you easily find parking? How convenient is the closest grocery store or pharmacy? Are there any places you don’t want to live near like a prison, noisy airport or maybe a cemetery?
You should also look into the local schools, crime rates and government to make sure you are comfortable with all of them.
Is your potential home a condo or a house located within a homeowners association? Make sure you read up on all the covenants, restrictions, and conditions. You will have to be willing to follow the rules and regulations that are established. There may even be fines for infractions.
Some homeowners associations can be quite strict, even having the power to limit the color of your home or how many vehicles you can park out front or what time you have to bring in trash cans. You should evaluate all of the regulations and make sure you are willing to comply.
How Long is Due Diligence?
The period of due diligence begins at the time the contract goes binding. That happens once the buyer and the seller agree to the terms, they have both signed the contract and the contract has been delivered.
The length of the due diligence period can vary from contract to contract, but it is negotiated before the contract goes binding.
Depending on the needs of the buyer and what has been negotiated with the seller, the due diligence period can be as short as 7 days and as long as 45 days. The typical due diligence period will last between 7-10. This should give the buyer enough time to secure financing, get the inspections, and complete the other necessary tasks.
Once you have a clear picture of the condition of the home, you can negotiate with the seller to either make the repairs, lower the agreed upon price, or decide if you are willing to accept the home as-is.
If for whatever reason there isn’t enough time to address all the issues or come to a mutual agreement, the due diligence period can be extended to allow more time to come to a satisfactory resolution.
Now, let’s move on to some of the tasks you should complete as part of your due diligence.
What If I Find Problems During Due Diligence?
When searching for a home, you will be hard pressed to find a perfect property. Even brand-new homes can have flaws. Your due diligence period is the time when you should discover all those flaws. However, the seller is not obligated to fix all the issues that you have.
There may be cosmetic issues which are easily fixed or more serious problems that the seller is unwilling to address. Whatever the case, this is your opportunity to discover any problem, negotiate with the seller, or exercise your right to walk away.
As long as you terminate during the due diligence period, you won’t lose your earnest money. A local SimpleShowing agent can help you negotiate a fair due diligence period and guide you through the entire process.
Connect with one of our real estate agents who is familiar with your area, and they'll explain the entire due diligence process. Plus, when you buy any home with a SimpleShowing agent, you get an average of $5,000 towards closing costs on average through our Buyer Refund program.