The due diligence process is one of the most important steps in the House Flipping process.
The due diligence process seems to be common place to overlook, even though in our eyes it is one of the most important steps to a profitable flip.
So what exactly does due diligence mean? In dictionary terms it is "reasonable steps taken by a person in order to satisfy a requirement, especially when buying or selling something".
Does this directly apply to the our meaning of due diligence... not exactly, but there are some similarities.
During our due diligence process we are taking reasonable steps to satisfy a requirement but our definition requires more detail. At a high level we are taking reasonable steps to mitigate our risk and losses in order to ensure a profit by making sure all scope is accounted for pertaining to the subject property, while also allowing for contingencies for unexpected work.
The due diligence process starts early and does not end until construction begins. The more systems you can develop around this process, the less scope you will miss and the more profitable your jobs will become. With that being said we always allow for contingencies in our estimates to make up for any of the missed scope during our initial due diligence. During any renovation project that you take on, there will be unforeseen changes that pop up. Just understand this and develop a system to account of these changes depending on the condition of the house.
In this post we want to touch on a couple key topics that we believe will make your flips more profitable.
1) When the due diligence process begins
2) Systems you can consider creating around the due diligence process
3) Contingencies to include in your contracts to protect yourself for unforeseen scope
The majority of the construction planning will be done during a specific window of your due diligence period. This window begins the first time you visit the property until construction begins, with specific deadlines and checks in between.
How The Due Diligence Process Works When Flipping And Checkpoints
The majority of the due diligence will be done on during a specific window. This window begins the first time you visit the property and ends once construction begins. During this window there will be specific checkpoints and deadlines that need to be met in order to utilize certain contract contingencies that we put in place.
First Appointment Set
After you have qualified the lead and ran some preliminary numbers, you will now set up your initial appointment with the seller. During this appointment, your due diligence process will begin. As we all know, we will not close all of the appointments that we go on. We still need to take the necessary steps as if we are closing every property. During this initial appointment, we will have a couple key items that should be completed pertaining to due diligence, they are:
Preliminary Scope of Work
Photos / Video
Relationship Building
Location Analysis
Since this is your first appointment, your preliminary scope of work will be a high level interpretation of the condition of the main areas of focus on a specific renovation project. The photos that you take of this property are very important because they will be used as a reference as you move through the due diligence process. I want to harp on the photos for a second, just due to its importance. When you go to a property, you need to have a focus on taking good photos of the property. You need to have the mindset (while at the property) that you will need to use these properties at a later date when finalizing numbers and putting together offers. You will use these photos as a reference point to produce your scope of work. These photos will ensure that you capture all of the necessary repairs for this subject property.
Pre-Contract Acceptance
After you go on the first appointment, build a relationship and do some of your preliminary work, we are now required to get into a little more detail to see what price we can offer the seller. From our preliminary scope of work and photos, we continue our due diligence process. At this step of the due diligence process, we are typically working through an estimate, using some rules of thumbs and "throwing" numbers at specific tasks to see where our high level construction estimate stands for this project. As stated earlier, this is one of the times that you will need to reference your photos to get more detailed with your scope of work.
TIP : WE TAKE OUR PRELIMINARY SCOPE OF WORK AND INSERT THIS INTO OUR ESTIMATE WORKSHEET (EXCEL DOCUMENT) AND WORK THROUGH OUR PHOTOS TO CAPTURE A MORE COMPLETE SCOPE AND CREATE AN ESTIMATE FOR EACH LINE ITEM. WE THEN BUILD IN CONTINGENCIES FOR SPECIFIC DIVISIONS (HVAC,PLUMBING,MECHANICAL,FOUNDATION) AS WELL AS AN OVERALL PROJECT CONTINGENCY (ANYWHERE FROM 5-10% OF THE TOTAL CONSTRUCTION COSTS).
If you are just starting out, we recommend that you work through this initial estimate with a general contractor or try and complete the scope of work and send it out to a general contractor to price (then add 10% on top of their number as contingency - if just starting out)
Contract Acceptance
Once you have completed your preliminary due diligence and you have come up with an offer that you feel fits your specific profit requirements, the next stage of your due diligence process begins.
TIP : DEPENDING ON THE LEVEL OF COMPETITION IN YOUR SPECIFIC AREA OR ON THIS SPECIFIC LEAD, WE SUGGEST THAT YOU USE YOUR HOME INSPECTION CONTINGENCY. THIS WILL GIVE YOU 5 DAYS TO EITHER GET A PROFESSIONAL HOME INSPECTION OR DO YOUR OWN HOME INSPECTION TO GET ANOTHER LOOK AT YOUR SCOPE TO SEE IF YOU MAY HAVE MISSED ANY HIGH PRICED ITEMS.
From our tip, we will have 5 days to finalize the first phase of our due diligence process. We want to complete our estimate, budget and scope of work during these 5 days, so if we discover a costly unforeseen we have the ability to back out of the contract. By including this contingency, it allows us to make more offers while mitigating our risk or offering some protection when the contract is accepted. Be sure to get the utilities turned on, if possible for this final home inspection on the property.
During this 5 day window, we will be able to set up another appointment at the property and spend as much time as we need to finalize scope and numbers to ensure our preliminary due diligence was on point. We recommend that you utilize any resources that you may have in the construction business to assist you with this task.
Here are some additional quick steps to consider when the contract is accepted:
Get lockbox code or make copy of key if bought off market (with owners permission)
Purchase new lockbox
Place keys in lockbox and install at property (with owners permission)
Send contract over to title company to begin process
If certified funds are required for earnest money:
Submit earnest money to agent
Post Home Inspection Window
After the contract contingency period has expired and you are essentially locked into purchase the contract, your due diligence process continues but for the most part at this point it should be completed. During this period of time, you will spend:
Creating your schedule
Creating your material list
Getting estimates from contractors/subcontractors
Getting exact measurements and counts on specific tasks/material
As well as lining up your funds and communicating with your attorney for closing.
Due Diligence Systems To Help Streamline The Process
If you have been following our blog for any extent of time, you know that we pride ourselves on creating specific systems around processes in order to make our lives and our employees lives easier. That is business in a nutshell anyways, right? Well... not exactly, ok back on topic.
As stated previously, the due diligence process is very important and allows you a period of time to really narrow in and focus on the exact scope for a project and the price surrounding that specific scope. This period of time allows you to capture all of the costs associated with the renovations and truly lock in a profit before the project starts.
I want to go over a couple systems at a high level that we use during our due diligence process to help capture a complete scope and lock in profits before a project actually starts.
1) Pre-Acquisition Task List - In other words, this is our preliminary scope of work. It is a very simple document that we bring with us on our first sales appointment in order to capture scope at a high level for specific divisions within in a project.
2) Ipad/Photos/Dropbox/Podio - This is our photo taking and photo sharing system. All of our acquisition associates/managers are equipped with Ipads to take photos on their appointments. Once these photos are taken on site, they are then uploaded to our "Seller Lead Property Photos" folder on dropbox. These photos are then attached to podio under the specific lead for further reference.
3) Quick Rehab Estimate Tool - An excel tab sheet that we created for quick estimates on properties depending on square footage and level of renovations.
4) Estimate Tool - An excel document created to incorporate our scope of work and easily calculate budgets associated with specific tasks.
5) Scope of Work - An excel document created to document and organize all tasks for a specific project.
These are just a few of the systems that we have put in place in order to help streamline our business and this specific process. Without systems (even with systems) it can be very easy to get overwhelmed and it can be very difficult to delegate certain tasks to people who may be able to do them better than you.
In Conclusion
Systems and processes are what make a real estate investing business run smoothly. You need systems and processes for each aspect of your business. Whether for marketing, acquisitions, property management, closing or anything in between. The more efficient your systems are the better off your business will be.
What we talked about today is just one process that you need to create a system around in order to make your business run more efficient. Figure out what areas of your business a system is needed and try to create a checklist or a basic way that you can relay tasks to someone easily. The more systems you create for specific processes the easier it will be to scale, hire and grow your business.
HS Property Funds, LLC
Fund to Help, Problems to Solve
(315)516-8023
www.hspropertyfunds.com