What happens in due diligence for an investment property?

What happens in due diligence for an investment property?

Due diligence is a 10-day period where an investor interrogates a property they would like to buy to see if it stacks up as a worthy investment and if they can get the money to purchase. The process requires juggling a lot of players and runs on a tight deadline.

In this article you’ll learn exactly what you need to do to run due diligence the right way.

What is due diligence?

Due diligence (DD) comes into play at the point when an investor wants to further investigate a property. Most investors will put the property under contract first, before starting DD.

That’s because going through due diligence costs money. All up, due diligence can cost between $2500-$3500, so it is important you conduct it only when you know it is a property you can buy and at an acceptable price to you.

If you wait too long to get the property under contract, there is a very real risk another investor will pip you at the post and get the property instead.

The end goal of due diligence is to see if the property stacks up legally and structurally as an investment and if it is the right fit for you as the investor.

Typically, DD is a strict 10-day deadline, starting the day after the initial contract is signed by both parties and ends when the investor gives his solicitor the nod to either go unconditional or cancel the contract.

Opes managing partner Andrew Nicol says it’s an environment where self-proclaimed “seasoned cynics” thrive.

Nicol’s advice is to approach any “seemingly great” property investment with a where’s-the-catch attitude and go from there.

There are going to be a lot of things the investor must interrogate, and decide how much discomfort some things are going to be worth in the long run.

In terms of getting everything done within the tight timeline, Nicol’s advice is to do the stuff that costs as little as possible first to establish the property is right for you, before you start dishing out the big bucks.

It is possible to ask for an extension if you run out of time. However, with the market being so hot at the time of writing, extensions are hard to come by. There is no guarantee a developer will grant an extension.

Sometimes, to appease your developer and get the extension, you might confirm on some of the clauses if only waiting for approval on one thing - like finance for example. This shows the developer you’re not messing around and are serious about purchasing.

Who should I talk to during due diligence?

During the 10-day process of due diligence you should talk to these people:

1. Contracts Manager / Property Partner / Real Estate Agent

The very first step in DD is to get the property under contract. In fact, the 10-day time period only starts the day after the buyer and developer sign the sales and purchase agreement.

You can get a contract from several channels. But if you’re working with a property investment company like Opes Partners, they’ll find you properties suited to your investment style. In that case, a contracts manager will organise and send the contract to you.

Alternatively, if you are working with a developer directly, they will have their own sales team who will send you the contract.

Getting a property under contract basically says: "As long as this property stacks up, I have the right to purchase it, and at a price that I have already negotiated subject to all of these other things”.

Cost: No Cost / Free

2. Lawyer

Once you’ve signed the contract its best practice to send it to your solicitor for their approval. They’ll make sure the contract is fair and not favouring one party over another.

After reviewing and negotiating the contract, your lawyer will move on to review the LIM (Land Information Memorandum) and Title. But only once the contract is acceptable.

When you are ready to confirm the contract and go unconditional, let your solicitor know. They’ll inform the vendor’s solicitor.

If you run out of time and need a few more days in DD, your solicitor can also organise this for you. Just remember the seller of the property does not have to grant any contract extension, and can sell to another purchaser.

While you’re getting the contract sorted, it’s also time to sort your finance and approach a mortgage broker.

Cost: $2,500 - $3,500

3. Mortgage Broker

A mortgage broker will help you fill out and process your lending application to get the money to buy the property. Initial conversations will involve going through your personal spending, day-by-day, as well as looking at what you own and what you owe.

At the time of writing, it can take banks up to 8 days to give you an answer, eating a big chunk into your 10-day deadline. So the best advice is to speak to your mortgage broker quickly and get it off to the bank fast.

Cost: Usually No Cost / Free

4. Developer

If you’re purchasing off the plans, you’ll likely sign the contract and start DD even before you do a site visit. That’s because the property isn’t built yet so there may not be much to see on site.

So, it’s about midway through DD when you’ll often conduct a site visit and meet the developer of your property.

Unfortunately, visiting the site of a new-build is usually going to involve driving to a vacant plot of dirt. But its dirt your property will one day be built on, so even though your property is not yet a visible part of the neighbourhood, other things are.

A short drive around the neighbourhood will give you a sense of the area and all of this information will give you peace of mind as the buyer that the property will be tenantable and it’s in an investable area.

Cost: Usually No Cost / Free

5. Property Manager

On the same day you conduct your site visit, you’ll often also meet your future property manager. A property manager is someone you’ll begin a relationship with during DD, but it is likely the relationship will last years beyond that.

A property manager will give you a realistic rental assessment of your potential purchase informed by research into the rental market, based on what is renting right now and who the tenant is likely to be. The property manager will also give you an idea of how quickly a tenant can be found.

Cost: Usually No Cost / Free

6. Accountant

During due diligence, an accountant will guide you through your property purchase from a purely commercial perspective. Most importantly, the accountant will help you decide how you should own your property once it’s bought.

You do this by discussing different ownership structures with your accountant.

Usually, most investors will choose to either hold property in their own name, set up a trust or use a “look through” company (LTC).

Cost: Initial conversation usually no cost / free. Setting up trust / look through company (if needed), $800 - $2,000 + GST

7. Insurance Broker

If you choose to, this is also the time you might engage with an insurance broker for extra advice about your property and what the insurance premiums are likely to be.

Insurance in New Zealand is risk-based, varies from city to city and will be affected by proximity to oceans, fault lines or anything deemed to be of an increased risk to your property.

Sometimes a distance of just a few kilometres can mean thousands of dollars of difference in premiums, so some investors believe this is advice well sought.

Cost: Usually No Cost / Free

What happens at the end of due diligence?

At the end of the 10 days, after contacting and engaging with all of the above professionals, you’ll probably have a good idea about whether the property is right for you or not. If you’re satisfied that it’s a good investment, notify your solicitor to confirm the contract.

Once this happens, the contract becomes unconditional and therefore legally binding. There’s no backing out now.

What does it take to be successful in due diligence?

To be successful in due diligence you need to be organised. From our experience, first investors tend to stress during DD when they don’t know what they’re supposed to be doing.

This article, along with the others within this series, should give you a sense of what you should be ticking off your list throughout this process, so you can focus on answering the question: “Does it make sense to add this property to my portfolio?”

Looking for more information about due diligence?

If you're looking to learn more about due diligence, check out these articles about: how to work with a solicitor during due diligence, how to work with an accountant during due diligence, how to get finance during due diligence, how to work with an insurance broker during due diligence, what to do on a site visit, and everything you need to know about signing a sales and purchase agreement in NZ.