What is 'due diligence'? Investment terms explained

During your property buying experiences it’s very likely you’ll come across two terms more commonly than others.

The first: Caveat emptor. The second: Due diligence.

They have a lot in common. The first, which means ‘buyer beware’  you can read about in this quick explanation here. It essentially puts the onus on you to do your research and be wary about your property purchase.

This is where due diligence, or the act of doing your research and checks prior to purchase, comes in.

Doing your due diligence means that you must exercise care before buying, including researching important facts and numbers, and undertaking your own thorough analysis before buying. Initially due diligence was a business term that has spilled over into real estate as investing in property grew in popularity.

But what does that entail?

Unfortunately, the term is intentionally vague. Just as the word diligence means “careful and persistent work or effort”, it’s unsurprising that this varies from person-to-person. Being told “make sure you do your due diligence” is useless if you haven’t got an established system and process for verifying what you are told. Consider this to be like building a ‘checklist’. For instance, the Queensland government has a due diligence checklist that those looking to buy businesses can follow, which can give you an idea of how systematic you can make this.

There may be documents to ask for from council, and your own due diligence may even go down to minor details such as checking appliances.

Investors usually come up with their own research or ‘due diligence’ system that explores the potential downsides and uncovers the facts about their purchase, and you can definitely borrow from other peoples’ experiences.

Observer Mark Armstrong has a three-part due diligence system:

1. The first concerns structural integrity, and ensuring that you get the necessary checks (such as a building inspection, a pest inspection or a strata inspection) to ensure that the building is sound.
   
   
2. The second relates to the vendor’s statement, where you can double check exactly what it is your buying.
   
   
3. The third is ensuring you have the sufficient funds to meet your contract on the agreed date.

However, arguably, due diligence also extends to getting a property at the right price – meaning that research and paid-for valuations may be a part of this – and ensuring the suburb itself is a good area to purchase in, either as a home or for an investment property.

There may be documents to ask for from council, and your own due diligence may even go down to minor details such as checking appliances. Each investor is interested in different aspects of the home. While some will be concerned that all of the kitchen is in perfect working condition, renovators may be less inclined to spend time on this aspect of their research. Instead, they may want to know if the property is nearby the necessary tradespeople and suppliers (this is particularly an issue for regional areas) and the location of the load-bearing walls. Some home buyers may be concerned with proximity to schools, others more interested in the commute to work and some wanting to research who the neighbours are. Everyone’s version of due diligence will be a little different.

Consumer Affairs Victoria has a checklist for home buyer due diligence here. You can easily learn from their steps and add them to your own list. This includes crucial steps like considering if the property may be subject to fire or flood, looking to see whether you’re in a growth area with upcoming infrastructure, and even consider lifestyle aspects.

For instance, for rural property buyers, they prompt them to ask these questions as part of their due diligence:

• Is the surrounding land use compatible with your lifestyle expectations? Farming can create noise or odour that may be at odds with your expectations of a rural lifestyle.
  
  
• Are you considering removing native vegetation? There are regulations which affect your ability to remove native vegetation on private property.
  
  
• Do you understand your obligations to manage weeds and pest animals?
  
  
• Can you build new dwellings?
  
  
• Does the property adjoin crown land, have a water frontage, contain a disused government road, or are there any crown licences associated with the land?

Source: Consumer Affairs Victoria

This is just a selection of what you should be considering asking before entering into a substantial property purchase.

Ideally the process should be done before you enter into a contract for sale, warn Emil Ford Lawyers. However, even if you haven’t undertaken this process, there are a few things that you can do listed here.

Here are eight risks that can turn your property into a financial nightmare if not found during the due diligence process and carefully managed.

What does your due diligence checklist look like?