Property Due Diligence: A Beginner’s Guide
I cannot emphasise enough how important property due diligence is for ALL property investment strategies!
Without proper due diligence you risk taking on property deals that don’t generate you any profit, or even worse, cost you money!
Often, the reason for property ‘failure’ is either non-existent, poor, or at best ‘hopeful’ due diligence, something we’re here to help you avoid.
From area research to estimating utilities, buying costs to estimating refurbishments, even understanding the difference between market price and market value, we’ve got you covered!
What is Property Due Diligence?
Property due diligence is the research carried out on a property to assess its suitability for your requirements.
Research covers many different things, some of which apply to all property investing strategies and others which are more specific to the investment strategy itself.
Know your investment strategy
Different investment strategies will need to take different elements of property due diligence into consideration.
For example, a property you intend to purchase, “do-up” and sell for profit (often referred to as a “flip”) would need different due diligence to a property you intend to take on a rent to rent basis.
Understanding your property investment strategy will help you focus your attention on the right due diligence and help you avoid any issues in the future.
One thing you will need to carry out for all strategies is area research.
The research you do however will depend on what you intend on doing with the property after taking ownership / control of it (sometimes referred to as your “exit” strategy).
If you intend to let it out, is it in an area where your intended tenant type want to live?
If you intend to “flip” it, are the buyers who are prepared to pay your asking price likely to want to buy in the area you have purchased in?
Is there potential investment / regeneration in the area that could lead to long term capital growth?
The more you understand an area, the more likely you will be to avoid mistakes with your exit strategy.
Rock solid local area knowledge will not only help you avoid mistakes, but it’ll also give you confidence when dealing with agents, vendors, landlords and anyone else involved in the process.
Having that local knowledge also gives those you are dealing with confidence in you! Something that goes a long way in the property industry, trust me!
Understanding market valuation
One particularly important element of property due diligence you MUST understand is valuing (or I prefer to call it appraising) property prices, whether for sale or to rent.
There are so many factors that will affect price including the area, condition of the property, desirability and of course the competition (what’s already currently on the market).
Your job is to get to know your area inside out so that, when speaking with the Estate and Letting Agents, you’re already one step ahead of them when it comes to understanding “actual” market value vs. what they’re suggesting the price should be!
Agents’ Marketing Price vs. Actual Market Value
Understanding actual sales market values vs what estate agents market properties at is a very important element of property due diligence if your chosen strategy involves a purchase at any stage of the process (i.e. traditional purchase, assisted sales or lease options).
Estate agents are instructed by vendors to market and sell their property for as much as they think they can achieve. They are also paid a commission based on the sales price they achieve.
Naturally this means they often try their luck at prices much higher than what we call “Actual Market Value” – what the property is currently worth based on comparable sales evidence (i.e. what other similar properties have sold for in the area).
Knowing what the “Actual Market Value” of a property is allows you to start your negotiations at the number where you break even (excluding costs which we’ll come onto in a bit).
You’re not in this to break even!
So actual market value is your starting point for any purchase you’re considering!
Estimating Rental Income
Most property investment strategies involve generating income by renting the property to tenants (i.e. single tenants, multiple tenants, holiday makers etc).
If you have chosen to go down the single let route (i.e. renting your property to single person, couple or family) you will need to know the amount of rent you are going to be able to achieve.
You might be choosing to go down the multi-let route (i.e. renting your property to a group of sharers either as a group or on a room by room basis), in which case you will need to know what the room rate in the area is and what your ceiling rent (highest rent before you struggle to find tenants) is likely to be.
Or you might choose to go down the short term stay path where you operate the property as a holiday let for example. In this instance you need to know how much you can charge per night.
The method is the same as you would use for sales – look at what’s currently on the market, get an average across 3 or 4 and use that as your base number.
Whichever “exit” you have decided to follow, you will need to know how much income the property is likely to achieve so you know whether it’s worth investing in that property or not.
In my experience, underestimating refurbishment costs is one of the biggest mistakes investors make, and that applies to experienced and inexperienced investors alike!
RELATED: Estimating Refurbishment Costs for Investment Property
You may have seen the programme “Homes Under The Hammer”, where someone buys a property at auction, tells the cameras what they’re planning to do and usually share a refurbishment budget that most experienced investors laugh at.
Later in the programme they re-visit the property and somehow, even with unexpected costs, they often manage to keep the refurbishment within budget.
What the inexperienced viewers don’t consider are the man hours spent at the property decorating, stripping floors, tidying gardens and all the other factors that would cost most investors money as they are unlikely to do the work themselves.
Unrealistic estimates mean that, when something unexpected comes up (which it invariably does), the cost of sorting it out comes out of the profit. The bigger the cost, the more profit is eaten up to the point where I’ve seen deals cost the investor money rather than making them any!
Strategy Specific Refurbishment Costs
I keep referring to strategy specific property due diligence and refurbishment estimating is no different!
I won’t go into too much detail about colour palettes and furnishings as this isn’t an interior design article, but I will talk about a couple of more specific refurbishment estimates you need to be careful with.
Flipping properties (Buying, refurbishing and selling for profit) will usually require a much higher quality of finish than a property you intend to rent out.
If you try and scrimp and save on fixtures and fittings you will be found out and you won’t achieve the profit you wanted.
For higher end properties it might also be worth considering “staging” (furnishing and dressing the property to give prospective buyers an idea of what it might look like to live there). Remember you’ll need to factor this cost into your estimates before purchasing.
Alternatively, you might intend on converting a property into an HMO (House of Multiple Occupation).
If the property meets certain criteria you will need to include specific elements to your refurbishment including things like hard wired smoke alarms and fire doors. They’re all to do with tenant safety and can cost more than standard fixtures and fittings so remember to factor that in.
Furnished or Unfurnished
Final refurbishment consideration before we move on is whether to furnish your property for your tenants or leave it unfurnished.
As before, your intended tenant type will determine whether you do or you don’t but remember to factor the cost into your estimates if you do choose to furnish.
ALWAYS REMEMBER YOUR CONTINGENCY
For those of you who don’t know what a contingency is, it’s a percentage you add on top of your refurbishment estimate for any missed or unexpected costs you might encounter when doing the work to the property.
On larger projects we usually factor an additional 20% “just in case” although on smaller projects it might only be 10%.
Either way, having a “buffer” will give you that peace of mind and if you’re lucky not to encounter any extra costs, you’ve just added that to your profit!
Set Up Costs
When I talk about set up costs in terms of property due diligence, I mean the costs incurred before the property becomes yours, whether owner or controlled (i.e. rent to rent or lease options etc).
The reason these are important to include in your due diligence is because it’s usually cash you need up front before completing on the deal.
Set up costs will of course, depend on the strategy but usually include:
- Stamp Duty (traditional purchase strategies only)
- Mortgage advisor fees
When working out the “true profit” your deal is going to generate, you need to factor in all expenditure no matter how small.
Whilst some stop at the up front costs when doing their property due diligence, I always advise you go a level deeper and understand the running costs.
Running costs will depend on your chosen “exit strategy” of course but will include:
- Mortgage payments
- Utilities (if you choose to include bills for your tenants)
- Property Management fees (if you choose to use a Letting Agent)
You also need to remember there will be additional expenses that vary in frequency and cost like maintenance, voids, tenant arrears etc.
For these I like to allow for 1 month’s void per year and a 10% maintenance allowance per month, both of which are provisioned into a separate bank account for the “rainy day” you hope never comes.
Practice makes perfect
Confidence comes with practise and fortunately for you there’s plenty of opportunity to practise the skill of property due diligence.
Find a property online using one of the property portals (Rightmove, Zoopla, On the Market) and then follow your due diligence process, understanding what you need to know for your chosen property investment strategy and then do the numbers.
Repeat this process a few times with deals you might consider going to look at.
Once you’re confident with your numbers, arrange to view the property, estimate the refurbishment more accurately than you can do from the photographs and come back to compare your notes and check there isn’t anything more to add.
Now it’s time to make your offer… good luck!
About the Author: Mark Dunsmore used to be an estate agent before he learned to apply the same skills to sourcing properties for investors. Having built up a nationwide sourcing business, he’s now teaching other investors how to find their own deals – either to build their portfolio, or make a profit by selling them on to others.
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