Your Due (Do) Diligence List

Following up on properties in the process of purchasing them to make sure that you are actually getting what you thought you were is frequently confusing for investors. I believe that those who contribute to this forum will have many suggestions and tips to share here. I'll begin this column with some content from an article I found by Stan Mullen, CCIM, SIOR, from California. I've added a couple of additional points based on personal experience, and will share the link to Stan's complete article at the bottom. While some of these items may sound geared for personal residence purchases, many times they can affect the financials on the property and deserve evaluation by investors.
Title Insurance - One of the first items for the buyer to obtain in addition to the preliminary title report is a title commitment, binder, or policy of title insurance. Many buyers are unaware the preliminary title report does not guarantee that the insurance company will insure delivery of clear title to the buyer. Prelims will commonly have disclaimer language on their cover page similar to this “…this preliminary report is not a written representation as to the condition of title and may not list all liens, defects, and encumbrances affecting title to the land…”. At the back of the preliminary title report, a list of coverage exclusions will be listed, as well. So... focus on obtaining the policy of title insurance.

Property Taxes – As a buyer, you want to make sure that your property taxes are current and paid as of the date of sale, that any supplemental (sometimes referred to as “escaped”) tax assessments are paid and that property taxes are pro-rated as of the closing. Supplemental assessments typically show up when an addition has been made to an existing building or when a land site was acquired on which the tax bill is based and then a supplemental bill is issued once the building has been constructed. Keep in mind that often there is merit in appealing the assessed value of the building of either a) the value of the building has declined (not likely in the current real estate market) or b) if personal property such as business equipment, has been removed, but which remain an item of assessment on your tax bill. I believe the tax lien date is March 1st each year and your appeal data should be provided to the assessor within 90 days before or after that lien date.

Bonds – Some developments have Assessment Districts or Community Facility Districts that have been established as a way to pay for improvements that benefit the project. The costs of these improvements, at least in part, are typically added to your tax bill. Unlike CFD’s, the cost obligation for Assessment Districts (which are a lien against the property) is usually amortized over a finite period (say 20-25 years and can not be extended), have a fixed rate of interest established when a buyer acquires the land initially and can be pre-paid in part or in full at any time during the life of the lien, without penalty. As a buyer, it is important that you obtain from the seller or the municipal assessment engineer, a detailed breakdown of all costs and obligations of that lien. The lien amounts will increase your tax obligation and you should ask your tax advisor if any or all of this portion of your tax bill could be deducted from your federal or state return.

Common Areas – Many of the new developments throughout the U.S. are planned communities or business parks that have their own specific covenants that outline the manner in which you can design, build and operate your property. To maintain any of the common areas in the project, CC&R’s are recorded against title for each property. Before you purchase, make sure that you investigate the cost of your assessments, how the money is being used, what the regulations are, etc. Some areas, in the fine print, retain the right to limit the hours of business operation. As with taxes, buyers want to be sure that any monetary obligations of the seller are current and paid and that the seller is not in violations of their covenants.

In some cases buyers will elect to request an estoppel certificate from the association to memorialize that the seller has not violated any of the conditions of the CC&Rs.

Surveys – Buyers may wish to have an updated survey done for the site by a licensed civil engineer, but as a rule should not expect that seller to incur this cost. Typically this would come up in discussion if the buyer requested extended owner’s coverage in their title policy.

A few other items that buyers may want to keep an eye out for as they review the title report and all of the underlying exceptions are water rights, any type of monetary lien and the prospect of unrecorded leases. Certainly, if the property is improved, all structural elements should be investigated for soundness of construction and compliance with the law. Last, buyers should always check to insure that their intended use is permitted.

Check with City Planning and Zoning to see if they have any kind of compliance violations file on the property.

Because this synopsis cannot address the intricacies of your specific transaction, you should consult with your legal, tax and real estate advisors before making any commitment to property.

http://stanmullin.com/articles/buyers_diligence.htm

I'd like to invite other contributors to share your tips and suggestions for due diligence--I like to think of it as DO Diligence because that emphasizes that if you fail to do it, you could end up with major issues arising later on.