Due diligence debunked: What it really means, and why you probably aren't doing it right

Home buyers are commonly encouraged to undertake due diligence before a property purchase. But what does this term really mean, and how should it fit into the buying process?

Due diligence is the investigation of every aspect of a property that could affect its value and suitability as a home or investment.

For many buyers, due diligence involves little more than a building and pest inspection and contract review. These steps are essential, but only form part of the process.

Where to begin

Due diligence should start before identifying a property to buy, and the key is understanding the objective of the purchase, according to Wakelin Property Group director Jarrod McCabe.

“If you’re looking at things from an investment perspective, your approach is going to be very different from an owner-occupier,” he says.

McCabe says owner-occupiers should consider how long they intend to live in a property and its suitability over that period. Investors, on the other hand, should be targeting properties that see demand from multiple buyer-types to maximise the chance of price and rental growth.

Buyer’s agent and NewFandangled Properties director Lesley Gregg says most buyers underestimate the financial implications of a property purchase.

“People work out the maximum they can borrow and go shopping for a house based on that,” she says. “Often what’s missing is the financial due diligence.”

Gregg says owner-occupiers often overlook stress-testing their financial situation and fail to consider whether holding a property might become less affordable if household income or interest rates change. She says investors often failed to forecast cash flow, and overlooked key costs like land tax.

Investigate features and potential

A common concern for buyers is when properties are marketed with rooms that may not be considered habitable, according to property lawyer and Real Estate Escapes author Tim O’Dwyer.

Bedrooms and rumpus rooms in basements or attics could fall into this category, as low ceilings or a lack of windows mean these spaces may be considered storage rooms under local council regulations.

This could cause problems further down the track.

“From time to time problems arise when there has been an insurance claim, and insurance companies will use that as a reason not to honour a claim,” O’Dwyer says.

Gregg says investors planning to develop a property need to understand its limitations and possibilities before buying.

“It would only take a few days to get a qualified person to look over your block and give you a report on what is actually possible,” she says.

Avoid deal breakers

Buyers should be on the lookout for red flags that may raise concerns with lenders, according to McCabe. “You do need to take account of what the bank might frown upon,” he says.

Lenders factor in a degree of risk when determining acceptable loan-to-value ratios, and lend a smaller portion of the purchase price if a property could take longer to sell than comparable homes.

McCabe says common culprits are company title apartments, as well as properties in suburbs that banks deem to be oversupplied.

“You may find they were prepared to lend you 80 per cent of the purchase price but if you go to them with a company title property, they might only give you 50 or 60 per cent.”

Negotiate more time

Homes sold at auction aren’t subject to a cooling-off period, but softer market conditions and lower clearance rates mean vendors selling privately may be more flexible on terms, according to Gregg.

“There might be a little bit more opportunity to negotiate in the current market,” she says. “It’s a great opportunity for people to buy at the right price.”

She says most people don’t dedicate enough time to the process and often make quick decisions they regret. She encourages buyers to always negotiate a seven-to-14-day due diligence period into the contract.

High stock levels can also give buyers more choice, meaning decisions don’t need to be rushed.

Gregg’s advice?

“Take advantage of the market and the opportunity to view as many properties as possible, and really find the gems.”

Due diligence checklist

Ask yourself these questions when deciding whether the property you’re about to purchase is right for you.

Location

• Infrastructure – Is the property near public transport connections, schools and shops? Is any more transport infrastructure planned for the future?
• Amenities – Are parks, cafes, restaurants and leisure activities located close by?
• Development – Is a lot of development planned for the area? Will this affect the value of the property?
• Neighbourhood – Is the property located in a pleasant and desirable area of the suburb? Are the neighbours friendly?

Property

• Zoning – Are there restrictions around what buildings can be built on the the block in the future?
• Rooms – Are all rooms marketed as bedrooms or living spaces actually considered habitable spaces under council regulations?
• Renovations  – Have all buildings and modifications been approved by the local council?
• Ownership – If it’s an apartment, is it strata or company title?
• Easements – Are there any shared driveways or access points to the property you need to know about?

Finances

• Mortgage – Have you ‘stress tested’ your finances to find out if you can afford repayments if interest rates were 2 per cent higher, or if you one had one income?
• Refurbishments – Have you factored in the cost of any renovations, maintenance and repairs that will be needed while you own the property?
• Pricing – Have you analysed comparable properties of similar size with similar features? Is the property priced competitively?
• Demand – Will you be able to sell the property quickly if you need to? Will you be able to rent it out, or will it sit vacant?