What is Due Diligence?
Due Diligence includes all reasonable steps taken by a person in order to satisfy a legal requirement, especially in buying or selling something. Basically, it’s learning anything and everything about a property before you buy it in order to know whether it is a deal. For a single-family fix and flip, you must look at the listing price of the property, the estimated cost of repairs and the After-Repair Value (ARV) as part of the due diligence process.
Use Accurate Comps
When determining the ARV of the subject property, look at the sales price of houses of comparable size, layout and around the same year built all within the same neighborhood. Some of the comps may just be cleaned up homes, while others are completely updated. If there are multiple properties currently for sale, this could mean that people are not buying in that area. Look at the listing days on market (DOM). If houses are taking longer to sell, this will increase your holding costs, which can put you at more risk as the market can shift dramatically. Use conservative comps that are more accurate based on the level of upgrade intended.
Be sure to include holding costs in your due diligence.
Include all the additional holding costs, such as the hard money costs, insurance, closing costs, commissions, etc. Failing to do so can lead to a vastly overestimated profit and end up with a loss.
You would rather spend more money in the remodel than the holding costs.
If the property is under improved, it will sit on the market collecting holding costs, whereas adding more money to the rehab would have moved the property quicker. Kitchen remodels can escalate in price quickly due to the level of appliances included in the property.
Two ways to analyze the rehab on a property.
The lipstick on a pig model is basically cleaning up the property with no significant updates. This includes minimal cosmetic updates such as painting the walls. A full remodel means renovating everything in the house including updating the kitchen and bathrooms with upgraded appliances.
Create a due diligence spreadsheet for yourself and the lender.
Add in all costs considered. Add the estimated time the property will be held. Include the time to rehab and time to sell as those costs can add up. Insurance, utilities, loan payments. Make notes on all the included comps so the lender will know the level of upgrade for each comp used.
Run the due diligence for 3 different scenarios.
Consider all outcomes: the anticipated outcome, the worst case and the best case scenario. Including all scenarios make the lenders more comfortable that you, the borrower, are aware and prepared for each case. In the spreadsheet, you can copy/paste the data to each of the scenario tabs and adjust is accordingly. Holding costs are extremely important. You must know your daily holding costs, not including rehab costs, this will help you determine the important time metrics for each contractor.
Include Contractor Draw sheet, Rehab Checklist.
This allows you to update the lenders in a timely fashion. The estimator must be updated to accommodate the current prices of materials, etc.
You must have alternate exit strategies ready for each investment.
If the market shifts, how can you get out of the property? Determine multiple exit strategies such as using the property as an Airbnb or Assisted Living Facility, etc.
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