DUE DILIGENCE

Most successful property investors make their decisions based on a set of criteria rather than an emotion or gut feel. Each investor uses their own criteria and makes different assumptions. If everyone had the same criteria and assumptions, there would be no deals being done! This difference in perceived value is why investors are willing to buy and sell. If you develop a better set of criteria and use better assumptions, you will have a better likelihood of winning the property game.

Generally, you should complete your big picture area due diligence before searching for properties, and from there you could complete basic financial analysis and put in an offer with a due diligence clause. This way you have the vendor locked into an agreement and the power is in your court, a sample due diligence clause is

“Sample Due Diligence Clause

This agreement is entirely conditional upon the purchaser approving, in the purchaser’s sole discretion, all matters that the purchaser considers may touch, concern or affect the property or the commercial viability of the transaction within X full working days after the date of this agreement. If notice of satisfaction of this condition is not received in writing by the vendor or the vendor’s solicitor or the vendor’s agent by 5pm on the Xth full working day after the agreement, then this contract will remain conditional and be subject to cancellation by either party on one working day’s notice in writing.

The purchaser shall not be required to give reason for any lack of satisfaction.

The vendor shall give the purchaser reasonable access to the property to carry out any aspect of such due diligence.

This clause is inserted for the sole benefit of the purchaser.

This clause is straight from Property 101,  A fantastic book by Matthew Gilligan. We recommend purchasing and reading it if you are serious about property investing.

Whether you are completing due diligence with a conditional offer in place, or in preparation for submitting an offer you need to complete a thorough process to avoid nasty surprises and protect yourself.

1. Before looking at a specific property you should have conducted an analysis of the wider area.

Read Where to Get Started for an in-depth look at choosing an area that matches your budget, goals and investment style and a breakdown of different regions within New Zealand. But very briefly what we are looking for is:

  • is there population growth to put upward pressure on prices?
  • what is coming on to the market, will there be a shortage or oversupply of housing?
  • Is it good at a regional/city level? Is it good at a neighbourhood/suburb level?
  • Do you like to buy close to transport, hospitals, good schools? What fits for you?

Okay great, if you are happy with the big picture fundamentals of the area and suburb, let’s focus on an individual property.

2. Financial analysis what price do I need to get the property to make my numbers work.

To calculate the numbers we first want to understand if it is possible to add value, and what that work would cost. From there we can calculate net yield and compare it to our criteria and other properties on the market. Remember you are always referring back to your criteria to see if it is suitable for you, and to other properties to find if there are more profitable options.

  • What is the property actually worth, what is its market value?
  • How much can it be rented for, what are the operating expenses?
  • After adding value, is there instant equity?
  • After adding value, what would the net yield be?

There are three typical ways of finding the market value:

  1. Comparable sales – look at comparable sales in the area. Remembering to discount/add depending on features and how they compare to the property your analysing. Finally also consider the CV of all the properties. You can also ask real estate agents, and add their opinion into the mix.
  2. Online valuation, for example, qv.co.nz often banks will use QV’s electronic valuation for an internal assessment of your property unless a registered valuation has been done.
  3. Registered valuation, this is a professional valuation completed by a registered valuer. They will value the property based on the physical condition, comparable sales and other factors they feel are relevant.

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The 3 minute mortgage snapshot will automatically calculate your available equity, refinance cash-back options, and servicing ability. 

3. Physical due diligence.

Again let’s begin with the big picture then get more specific.

  • What is the immediate area like? Is there anything to scare away or attract tenants or buyers? Look out for gang headquarters, noise from motorways or pubs, views that will be built out, power pylons, sewage ponds etc.
  • How much work is required to make the buildings suitable for renting? What would it cost?
  • Is the house weather tight? What is it clad of? Do I need to check that the lender will approve this property? (Get in touch, we can advise you. Remember all our services are paid for by the banks, so are free to you)
  • Get a building inspection completed, a professional building inspector will perform a visual inspection of plumbing, electrical, drainage, walls, floors, ceilings, roof cladding, foundations. They can also check for moisture. They will provide you with a verbal or written report, usually attaching a disclaimer to their reports to protect them from being sued, which means they are a comfort measure to reduce risk rather than providing financial certainty.

4. Legal. The devil could be hiding in the details.

Get the property file from the council, check the Certificate of Title and the LIM. It is difficult to be 100% confident all legal issues are okay, so we recommend you talk to your lawyer. But here are some opportunities or red flags to watch out for:

  • Does the house have a Code of Compliance, are all extensions permitted?
  • Are there second mortgages or finance company lending on the property – which would suggest financial pressure.
  • Is it freehold (fee simple) or a different type of estate?
  • Is the land safe? Is the land flood prone, or are there any subsidence issues? What easements, covenants or other rights of way are registered on the title?
  • Rates in arrears – again this suggests financial pressure.
  • District plan, understand what subdivision or building activities are permitted.

5. Human issues and opportunities.

Every business deal is actually an agreement between people, therefore as important as the numbers are, it is critical to understand the human motivations. It is worth taking the time to hear and listen between the lines to what the agent and vendor are saying. Try to understand what they are trying to achieve, are they wanting to sell for top dollar, are they looking for someone who won’t tear the property down, are they wanting to get a quick settlement, or are they wanting to stay in the property for 9 months? If you can understand what is important to them, give that to them in the negotiation and push hard for everything else.

  • Why are they selling? Are they under pressure to sell? Will I get a good discount because of this?
  • Is there anything the seller is hiding? Are there any relationships between the seller and other people involved in the deal?
  • Are there existing tenants? Do you want to keep them?

The decision making process.

As a result of this process you should understand:

  1. Is the wider area a good area to buy in?
  2. Is the specific neighbourhood a good area to buy in?
  3. Is the property in good condition, and will it have reasonable ongoing maintenance costs?
  4. Is there an opportunity for instant equity, and at what purchase price? Will I get enough of a discount from the market value to cover any issues stopping me buying at the full advertised price?
  5. What will your net yield be, and at what purchase price?
  6. Will finance be easy for me to secure in the time frame provided?

From here you are in a well-informed position to understand if this is a suitable property to purchase, and what price you can afford to pay.