Due Diligence

Due Diligence During the Escrow Period

The due diligence period is critical for ensuring that the property meets your client’s expectations and complies with the terms of the purchase agreement. For residential income properties, this process also includes reviewing tenant leases and securing tenant estoppel certificates for any current tenants who will remain after closing. This ensures that both the buyer and seller have a clear understanding of existing rental agreements and tenant obligations.

In this lesson, you’ll learn how to:

1. Schedule and manage property inspections.
2. Review title reports, seller disclosures, leases, and tenant documentation.
3. Address concerns and discuss options with your client.
4. Submit contingency removals or requests for repairs/credits.

Step 1: Scheduling and Completing Inspections

Types of Inspections to Schedule

Physical inspections allow the buyer to assess the property’s condition and identify any issues.

Essential Inspections:

• General Property Inspection: Covers structural elements, electrical systems, plumbing, HVAC, and more.
• Pest Inspection: Identifies signs of termites or wood-destroying organisms.

Specialized Inspections:

• Roof Inspection: Evaluates the age and condition of the roof.
• Plumbing Inspection: Checks for leaks, sewer line issues, and pipe integrity.
• Electrical Inspection: Ensures wiring and systems meet safety codes.
• Foundation Inspection: Evaluates structural integrity.
• Environmental Assessment: Detects mold, radon, asbestos, or other hazards.

Pro Tip: Use trusted inspectors and schedule all inspections early in the contingency period to allow time for follow-up actions.

Step 2: Reviewing Title Reports and Seller Disclosures

Title Report

The title report reveals the legal status of the property and any potential encumbrances.

• Key Items to Review:
  • Liens or unpaid taxes.
  • Easements or rights of way.
  • HOA restrictions or covenants.

Pro Tip: Work with the title company to address any issues that could affect the client’s ownership or use of the property.

Seller Disclosures

Sellers are required to disclose known issues about the property.

• What to Look For:
  • Known defects or repairs.
  • Past property damage (e.g., flooding, fire).
  • Rental history or tenant issues for income properties.

Pro Tip: Cross-reference seller disclosures with inspection reports to identify inconsistencies.

Step 3: Reviewing Tenant Documentation

For income properties, due diligence includes verifying tenant-related details to ensure rental income and obligations are accurately represented.

Key Documents to Review

1. Tenant Leases:

   • Verify rental terms, monthly rent, security deposits, and lease expiration dates.
   • Ensure leases are signed and legally binding.

2. Rent Roll:

   • Review a summary of all rental income, including unit types, occupancy status, and payment history.

3. Tenant Estoppel Certificates:

   • A tenant estoppel certificate is a document signed by tenants that confirms lease details, including:
     • Rent amount and payment frequency.
     • Lease start and end dates.
     • Security deposit held.
     • Awareness of any landlord-tenant disputes.

Why Estoppel Certificates Matter:

• They protect the buyer by ensuring that lease terms match the seller’s claims.
• They clarify tenant obligations and verify there are no undisclosed agreements.

Pro Tip: Request estoppel certificates early to allow time for tenant responses and any necessary clarifications.

Step 4: Addressing Concerns and Discussing Options

Once inspections, title reports, disclosures, and tenant documents have been reviewed:

1. Summarize Findings for the Client

• Highlight critical issues, such as major repairs, deferred maintenance, or inconsistencies in rental documentation.
• Explain the potential costs and risks of each issue.

2. Discuss Options

Your client may choose to:

1. Proceed as-is: If no significant issues are found.
2. Request Repairs or Credits:
   • Submit a request for specific repairs or monetary credits to cover costs.
   • Credits can be applied toward closing costs, the down payment, or post-closing repairs.
3. Terminate the Agreement: If significant issues make the property unsuitable.

Step 5: Submitting Contingency Removal or Repair Requests

Option 1: Contingency Removal

If your client is satisfied with the property’s condition and documentation:

• Submit a Contingency Removal Form to the seller, indicating that all contingencies (e.g., inspections, financing) are waived.

Option 2: Request for Repairs or Credits

If issues are identified, your client can negotiate with the seller:

• Request for Repairs:
  • Provide a detailed list of items to be fixed before closing.
  • Include inspection reports as supporting documentation.
• Request for Credits:
  • Propose a monetary credit to offset the cost of repairs or upgrades.

Pro Tip: Be prepared to negotiate, as the seller may counteroffer or refuse certain requests.

Case Study: Due Diligence in Action

Scenario: A client is purchasing a 10-unit income property and discovers during inspections that the plumbing system requires upgrades and one tenant’s lease terms are unclear.

Approach:

1. Obtained contractor estimates for plumbing repairs.
2. Reviewed tenant leases and found discrepancies in one unit’s rent amount.
3. Submitted a request for a $15,000 credit to cover plumbing repairs and demanded a corrected estoppel certificate for the questionable lease.
4. Negotiated with the seller, who agreed to a $10,000 credit and provided updated lease documentation.

Result: The client proceeded with the purchase, confident in their understanding of the property’s condition and rental income.

Best Practices for Due Diligence

1. Act Early: Schedule inspections and review tenant documentation as soon as escrow begins.
2. Document Everything: Keep records of inspection reports, contractor estimates, and tenant certifications.
3. Communicate Clearly: Keep your client informed at every step, summarizing findings and options objectively.
4. Use the WE ARE REALTY Platform: Track due diligence tasks, document submissions, and deadlines efficiently.

Conclusion

The due diligence period is your client’s opportunity to thoroughly evaluate the property and its financials. By managing inspections, reviewing title and lease documents, and addressing concerns proactively, you ensure the transaction moves forward smoothly. Whether submitting a contingency removal or negotiating repairs and credits, your expertise ensures your client’s interests are protected.

Next Steps:

1. Download the Due Diligence Checklist to stay organized.
2. Practice summarizing inspection findings and tenant lease reviews for a hypothetical client.
3. Familiarize yourself with common negotiation tactics for repair requests and credits.

In the next lesson, we’ll discuss closing preparations, including reviewing final walkthroughs and ensuring all contingencies are resolved before the transaction is finalized.