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What is Due Diligence ?

Discussion in 'Articles' started by Jacque, 15th Aug, 2005.

  1. Jacque

    Jacque Team InvestEd

    16th Jun, 2005


    What Is Due Diligence?

    A frequently used term, in relation to the purchase of real estate, is Due Diligence. It can be defined as the process of investigating, through appropriate research, the likely implications and risks of purchasing a property for investment. By conducting such research and analysing the information found, we are better able to make an informed decision and thus mitigate risk. Each investor’s circumstances and motives vary, one investor’s process of due diligence may be quite different from another’s.

    For the purposes of this article we are assuming that the investor is searching for a long term (seven years plus) residential property investment with the expectation of solid capital appreciation, as well as passive income in the future. This income could occur as a result of increased rents over time (which eventually exceed outgoing expenses) or through accessing the increased equity to convert into an income stream.

    Knowing your strategy before you begin your search is essential, in that you have a plan and know the why, where, what, when and how. This may sound simplistic but is absolutely crucial in the wealth creation process. Financially overextending because the possibility of higher interest rates wasn’t taken into account, or being unable to afford expensive maintenance costs on an aging house are not healthy situations to be in. In some extreme situations, the investor may be left with little option but to sell for a possible loss.
    Last edited by a moderator: 17th Oct, 2009
  2. Jacque

    Jacque Team InvestEd

    16th Jun, 2005
    Why Invest?; Where?

    Why Invest?

    Being in control of your investments is a critical element, and this can only occur if you have planned and prepared yourself accordingly. It is always recommended that you obtain independent financial advice as part of your wealth creation plan, but especially if you are unsure how to start. Becoming self-educated is just as important, if you are to understand the rationale behind what it is you’re trying to achieve, and if you are to implement a workable plan to get there.

    Once you have ascertained how property investment fits into your plan, it’s necessary to get personal finances in order. Knowing how much you can, or want, to borrow obviously determines where and what you end up buying. Being familiar with what you can afford is the next vital step, as unrealistic expectations of costs can prove fatal to an otherwise sound investment plan.

    Why invest in property?

    Taking into account the likely out-of-pocket expenses, it must be the capacity for capital growth that determines whether a property presents a sound investment. This capital growth is usually the reason most investors are prepared to negatively gear into real estate – for the long term benefits. Whilst there are those who will actively seek out high yielding property that provides an immediate income through positive cash flow, it seems that the majority of property investors in Australia are willing to take cash losses now for the equity that the property will hopefully be providing over the long term.

    Historically speaking, residential property in Australia has provided consistent overall returns as an asset class, and remains a popular investment vehicle for many of us.


    This is a point at which many first time property investors suddenly find themselves drowning in a sea of information. Every relative, work colleague and neighbour immediately becomes a property “expert” and is providing advice on where and what to buy. Looking up a few Real Estate websites and discovering new sources of information produces so much data, the investor can become easily overwhelmed.

    So, how do you determine where to invest?

    This can be tricky, as some investors will not feel comfortable moving within 5km of their own area, whilst others are prepared to investigate interstate and even internationally. In the end, it comes down to personal choice, as there’s no point investing in an area if you wind up not being able to sleep at night worrying about it all. Making a decision about which state/country/district/city ultimately rests with the investor and the level of affordability of the area. Talking with fellow investors who’ve bought into the area you’re researching can also reap enormous benefits, as their experiences may disclose something you may otherwise miss.

    Purchasing a Residential Property Return Report through a company such as Residex is often worthwhile, as it charts past capital growth figures and median sales prices, as well as rental and total returns for individual postcodes. The aim is to identify those suburbs/towns which have had consistently solid total returns over the last ten years, in a median price range you can afford. A rule of thumb is to select growth rates which cause the property to double in approximately 8-10 years.

    The median price is determined by taking all the sales prices over a period, and sorting them from smallest to largest, to identify the middle price. Most investors use the median price as a guide to what they should pay, though this can vary, depending on strategy. As another general rule of thumb, however, the median price presents a more affordable entry price to buyers, sellers and tenants, with more consistent returns. Of course, if you manage to find a great deal on an above-, or below-median property, then it’s worth pursing it!

    We are relying here, however, on a predictive model based on historical rates to give us a picture of what the future might hold. Whilst this can work well, it does differ from others’ techniques such as Steve Navra’s Rental Reality strategy. There are also other aspects to consider, such as rental demand, current economic and social conditions, market trends and economic factors that may affect the future value of a property. A touch of crystal ball gazing is required, as predicting the future holds no certainties!

    However, by sticking to the fundamentals of property investing, the chances of selecting the “right” area are increased:

    • solid capital growth
    • position and desirable location
    • good proximity to services and amenities
    • consistent rental demand
    • minimum 30% land value content
    • potential to add value
    It can be dangerous to rely on capital growth figures alone, as they don’t give the complete picture. It’s just as important to get a feel for the market into which you’re buying and apply the fundamentals measures to each property that you’re considering purchasing. It’s a combination of these factors that drive growth in the first place.
  3. Jacque

    Jacque Team InvestEd

    16th Jun, 2005
    What?; When?


    When considering type of property, factor in the following:

    1. How much ongoing maintenance is this property likely to have?

    Older or high maintenance properties can really affect cash flow and running costs, so be aware of these. For example: timber exteriors which require regular painting; in-ground pools; aging appliances; common property in older unit blocks such as carpets; driveways; fencing; elevators; electrical upgrades.

    2. Are there any restrictions on making changes/improvements to the property?

    Restrictive covenants or council regulations may prohibit extensions or modifications to the property, should you wish to improve or develop later down the track. This can work both ways – some suburbs with restrictions on higher density development and the types of dwellings that can be built can lead to increased values through scarcity and a more consistent feel to a suburb. But at the same time, some significant capital gains can be made through development of a property into higher-use or higher density classes – which is unlikely to be possible in such restrictive areas.

    3. Can I afford any strata/community/onsite management fees?

    Another often overlooked cost can be body corporate fees that can eat into your bottom line, as they can increase frequently, depending on the number of costs that the owners are responsible for. Particularly in newer high-rise blocks, with gyms, pools and elevators, the ongoing maintenance expenses in these areas can become a real financial burden.

    4. How much local rental demand does it have?

    Being aware of this before you buy is vital to ensure that demand is relatively strong and consistent for your property. Chatting to local property managers will assist in gaining an understanding of the local market. Additionally, ensure that the property is close to major transport routes, local shops and in a position desirable to the majority of tenants.

    5. What is the land value content?

    A general rule of thumb is to allow for at least 30% of your purchase price to be made up of land value. Eg: If you paid $600 000 for a property, then at least $180 000 of this should constitute land value. As it is land that appreciates, whilst buildings generally depreciate in value, this is an excellent point to keep in mind when buying.

    6. How popular is it to future home owners?

    Future saleability may not initially feature on your list of considerations, especially if you’re aiming to invest for the long term; however an area with high home ownership is generally more desirable to home owners. This is because home owners tend to improve their properties more, therefore increasing desirability. Emotional owners influence demand and so the prices tend to increase accordingly.

    7. What potential does this property have in terms of future improvement or development?

    Chat to local council about upcoming plans or infrastructure changes that may affect your purchase. Most are now online with Local Environment and development plans available for easy perusal. Zoning maps also allow you to readily view what land usage restrictions apply to your land.

    8. How much control over the property am I comfortable with?

    With a unit, you retain little control compared to a freestanding freehold house. This is because your vote counts as only one amongst all the apartment owners, and so things may not always go your way. Depending on the current body corporate committee, you may experience decisions being made that you disagree with. A strata search (usually carried out by your conveyancer/solicitor) can be useful here in uncovering any problems, past or present, that strata are experiencing. It’s also helpful in finding out the current financial records of the body corporate to uncover any glaring inconsistencies or outstanding liabilities.


    Whether or not you purchase a freestanding house, a unit, a retirement home villa, townhouse, duplex, terrace home or serviced apartment, the numbers must add up so that you can estimate whether the price is considered fair value against the risks associated with the purchase of that particular property. Your price range based on the amount of money you have available to spend will also narrow down the types of property available.

    The aim is to remain dispassionate about your purchase, and concentrate on the numbers and collated information.


    The market will rarely seem perfect for the investor to make a decision on when to purchase. At the end of the day, however, the saying “It’s not timing, but ‘time in’ the market that counts”, can ring true. If the investor could pick the top and bottom of the market before the event, then all would be rosy. We could stop investing and become speculators instead. Unfortunately, it can be very difficult to accurately determine when those market peaks and troughs occur – especially with sales statistics typically lagging by at least 3 months. By the time you get the statistics on the market – the peak or trough may have already happened! However, if the deal stacks up and the property appears to still be a sound investment, given your due diligence, then timing becomes less relevant.

    Naturally, the investor should be aware of current market trends and sentiment, but avoid the “herd mentality” of investing simply because it’s the flavour of the month (or not). Becoming educated and getting out there and investigating the market yourself, makes for a much better strategy than listening to the whims of the general investing population.
  4. Jacque

    Jacque Team InvestEd

    16th Jun, 2005


    Once you’ve established your strategy, financial limit and location, the fun part is about to begin! The physical search for an investment property can be either exhilarating or mind-numbingly boring, depending on your personality type. Some investors, at this point, may elect to employ the services of an independent Buyers’ Agent to do the legwork for them, due to a lack of time or inclination, or even a lack of confidence. Others, however, enjoy the process and set about on a mission of thorough investigation of a particular suburb or area. This involves knowing the following:

    1. Demographics of the area

    Population makeup; income groups; home ownership versus rental population; type of dwellings; and so on. The website is a practical start, as the Suburb Snapshots provide information gleaned from the Australian Bureau of Statistics, which gives you an overall picture of the particular suburb. This is useful when considering the impact of social conditions on property values (see below).

    2. Median prices and rents

    Again, this information is available on some real estate sites, and can also be purchased from specialist real estate statistic companies. Some magazines, also contains tables in the back which outline median rents and prices, state by state. Be aware that, while statistics will assist, it’s important to get talking to agents, property managers and fellow investors in the area for up to date information. Numbers alone will certainly not provide you with everything you need to know.

    3. Familiarity

    Local area
    Nothing beats driving and even walking a suburb to become more knowledgeable. Locate all the services and amenities yourself – knowing where local transport routes, schools, shops, parks, hospitals, medical clinics and community centres are, gives you an insight into what particular tenants want and need as well. Note them down on photocopied street directory maps for future reference.

    Pick up a copy of the local newspaper and become aware of community events and issues. Some investors, who aren’t at all familiar with a particular region (especially in regional or interstate areas) like to subscribe to the local paper a few months ahead, as most have real estate sections as well.

    Individual property
    With specific properties, chat to neighbours and shopkeepers to pick up local knowledge and develop more of a “feel” for the area. Remember to view property at different times of the day (especially if it’s in an area which may by affected by traffic routes) and become as familiar as possible, to build up a “Warts and All” picture. Remember, this is an investment! You are the only person to blame if you discover too late that the neighbours are well known illegal drug suppliers who turn off tenants, or the in-ground pool has a serious leakage that requires a $6000 repair bill! Ask as many questions as you think necessary to discover all the nuances of a property, and if the person you’re asking doesn’t know, keep asking until you find someone who does.

    For future reference, keep checklists and maintain records on those properties you’ve inspected, and who you inspected them with.
    Check with your solicitor or conveyancer that the contract is sound, the survey shows no anomalies or concerns, all the searches are okay and all inclusions are correctly shown.

    Engage reputable building and pest inspectors and ensure you understand any issues raised from these reports. Don’t let a building inspection report that identifies problems necessarily turn you off an investment – no property is perfect – but use the report to make sure you don’t have any surprises after purchase! With a comprehensive report on the state of the property, you can make an objective decision as to whether the price being asked is reasonable, or whether maintenance costs are likely to make the investment unsustainable.

    If applicable, employ a quantity surveyor for a depreciation schedule. In most investment properties, this is considered a must-have and will assist in increasing the taxation benefits available to you. Though this does not need to by done upon immediate purchase, it’s probably wise to begin asking around for a recommended specialist and get it done sooner rather than later. Naturally, check with your accountant first that a depreciation schedule suits your personal situation.

    4. Local council planning

    Contact the council to see if anything is happening that may affect your property or the community. Pending future development plans can impact in various ways, and it helps to be aware of and prepared for any ramifications of these. For eg, buying into an old unit block may possibly cause future rents to fall if you discover two high rise blocks are planned right next to yours.

    Also investigate specific concerns such as flooding zones if you are aware of them beforehand. Obviously, your solicitor/conveyancer will assist in this department if required, but it doesn’t hurt to know beforehand if a particular area has geographical limitations that may affect your future plans.

    Most councils now have websites with LEP (Local Environment Plan) zoning maps, which clearly show the different land use zonings and restrictions on various areas within a suburb.

    5. Rental knowledge

    Knowing the rental market is vital, as you are dependent on the regular income from rent to assist in paying off your loan payments and ongoing expenses. Be realistic about what rent your property is likely to achieve, and get more than one property manager’s appraisal before you commit to the sale. Sales agents are not usually entirely familiar or accurate with rents, and usually refer you to the property manager (PM). It’s preferable to talk to them personally and ask for current examples of comparable properties as well.

    Also don’t rely on just one appraisal, but get a couple of other local PM opinions as well. Most will be happy to assist, as you will be viewed as a potential client.

    6. Expenses and ongoing costs

    This is an area in which some investors fail to realistically take into account, yet costs can sometimes blow out and you need to be ready for them! For the individual property, consider the following:
    • Start-up costs: stamp duties; mortgage fees; conveyancing costs
    • Mortgage repayments and adjustments to possible rise in interest rates
    • Rates (council and water)
    • Strata fees and levies (mainly applicable in units and townhouses/villas)
    • Insurance; both building replacement cost and removal of debris; contents and Landlords insurance.
    • General repairs and ongoing maintenance (will vary depending on property age and type)
    • Property management fees and charges
    • Land tax
    • Pest inspection updates
    Also allow for a period of vacancy per annum (rule of thumb is 4-6 weeks) as this can occur, depending on tenant turnover and type of property.

    Factor in interest rates – if the rate was 2% higher, make sure you could still comfortably afford the repayments.

    7. Comparable sales and relevant factors

    Whilst “crunching the numbers” is part of the job of ensuring you are purchasing an affordable investment, the other element involves researching the current market in order to ascertain the worth of a particular property. The best way you can know this is to do what real estate agents do when they have to appraise a property for sale: use comparable sales, current trends, factors and market conditions, in order to arrive at a price.

    Obviously, you don’t need to become an economist to understand how various factors affect values, but it helps to be aware of the following:

    Macro factors
    These external forces play a significant role in affecting market value of property and can be broken into three categories:
    • Social: Includes demographics, population shifts, crime rate, geographical distribution of social groups, changes in family size, attitudinal values towards lifestyle, education and housing styles. Basically, any factor that influences people’s social instincts and desires.
    • Economic: Includes natural resources such as location, quality of life, external factors such as interest rates, taxation rules, consumer confidence and grants (eg First Home Owners Grant).
    • Political: Includes factors largely influenced by government such as town planning, land zoning, housing industry policy, limitations on particular properties (heritage listings etc) and building of infrastructure.
    Micro factors
    These factors are more locally based and can affect values, with changes related to:
    • Local population- age, sex, number in family
    • Employment and wage levels
    • Incomes
    • Current rent levels and vacancy rates
    • Land use and rent controls (eg protected tenancies, govt housing)
    • Availability and cost of land, labour and building
    • Sales prices
    Understanding how these factors impact upon sales prices and rentals assists in understanding the current nature of the market. For example, the rental market activity is directly linked to the vacancy factor within a specific region of a suburb or town.

    Obviously, some vendors or agents will be “marking up the price” in case they get lucky with an emotional or green buyer, or if the vendor is particular about achieving a certain price. Others will undervalue due to various reasons (examples include a highly motivated vendor who needs to sell quickly, or an agent outside of the local area who doesn’t do the required homework), so it is really up to the purchaser to ascertain whether or not a property is worth what their maximum offer is going to be. Remember, too, that the asking price is just that. The maximum price you are willing to pay, based on your due diligence, may be either over, under or right on the asking price. There are so many variables, and just because you buy for a certain amount under the asking price doesn’t necessarily mean you obtained a better deal than another buyer who paid full asking price.

    Obtain comparable sales data that is similar to the type of property you’re looking to buy. As well as sales prices, some of the sites offer individual property reports and title searches, and for a low cost, they are definitely worth the money to be able to access some of the same records that real estate agents have access to.

    8. Level of demand for local area

    Though this factor makes up part of the already mentioned micro factors, it deserves special attention. Ask yourself the following:
    • Is there a steady supply of new people moving in or upgrading/downgrading?
    • Is there new housing or increased building activity nearby?
    • How fast do properties sell?
    • How quickly do they rent?
    • Which types of properties are more popular to buyers/renters? Why?
    High demand for certain types of property also usually ensures that there will be more buyers/tenants for them. This in turn can lead to increased prices/rents, as demand outstrips supply.

    You can find this out from a number of sources, including those already mentioned. Also chat to real estate agents and managers, particularly the ones who’ve been in the area for a long period of time, about current trends and conditions. Don’t, however, rely on them as your only source of information, as they do have their own agenda – to sell you their properties!
  5. Jacque

    Jacque Team InvestEd

    16th Jun, 2005


    When you’ve found something that you’re ready to make an offer on, preferably submit it in writing and ensure your final maximum offer is a true reflection of the risks that you’ve weighed up. If the deal doesn’t work out, or if your best offer is rejected, walk away and keep looking. Remember that, generally speaking, there are always more bargains out there, and persistence will eventually pay off. Knowing the “How?” elements of due diligence and applying the knowledge learnt will greatly assist in the selection of a property that should ultimately hopefully become a solid and well performing growth asset over the long term.

    Remain dispassionate, focus on the numbers and remember your purpose. Don’t forget with property investing – there are no hard and fast rules, only guidelines. The most effective due diligence comes from your knowledge, experience and care. As the proverb reminds us, “Care and diligence bring luck”. So, start preparing to get lucky!

    See also