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Due diligence? You hear the term, but what does it really mean? Here's a simple definition: "Investigation and verification of the details of a particular investment." In real estate investment, you can start this process before you make an offer, but you also normally have clauses in the offer that allow you to have inspections done, and reviews of the books and certain documents.

Due Diligence - What To Look For

You'll need to look at the files, to verify income. You will be looking for rental agreements that are signed by the tenants, as well as rental histories that show if there are any problem tenants or late payments. Review rental deposit documents as well, to see amounts and where the deposits are kept.

Other documents you need to see are service contracts and agreements. Note whether they transfer, or if you are free to seek better deals. These may include property management agreements, pool cleaning service, landscaping, snow plowing, and cooling system maintenance agreements.

Due diligence always includes a look into the books and records, of course. Generally, you'll want to see the last 24 months income and expense statements. watch for anything unusual, like expenses that are too low or income that seems too high. In reviewing the rent roll, you'll want to find out if the rents are over or under the market rates for the area. If there are employees, you need to see the payroll records, and look for any surprises, like accrued vacation time you'll have to pay.

You due diligence should include an interior inspection. You want to learn about the place, the tenants, and any problems that you will have to fix in the next several years. Watch for pests, water or fire damage, obvious "problem tenants." Note if there are any empty apartments that are listed as occupied. Bring in professional inspectors as needed for pest inspections, safety inspections, and such. A fire Marshall may do a free inspection for you to verify that the building meets current codes.

For the exterior inspection, you will want to first walk around and take notes. Watch for anything that looks unusual or in need of repair. Then you can get professional inspections, if necessary. You want to verify that the electrical and plumbing systems are up to date and meet current codes. You also want to get an estimate on how many years of use the roofing has left. You'll look at driveways, landscaping, and exterior paint condition.

Check on compliance with government regulations as well. Are there any permit problems? Call the local authorities to see if there are any zoning or encroachment problems. Have there been any fire code violations, and were they corrected?

Get help in doing your due diligence. An accountant will be better than you at deciphering the books and noticing any problems. A lawyer can review your offer and any documents - as well as tell you what other things you should be doing.

Take notes. List problems, and the costs to correct them, to use during subsequent negotiations. Most of what investors run into when buying income properties is not unforeseeable. They can be avoided or resolved if you just do your due diligence - and use a checklist.