Why This Matters
Due diligence isn't just a box-checking exercise—it's the process that separates profitable investments from costly mistakes. You're being tested on your ability to identify risks across multiple dimensions: legal encumbrances, physical deficiencies, environmental liabilities, and financial performance gaps. Each item on this checklist represents a potential deal-killer or negotiation lever, and understanding why each matters will help you structure comprehensive analyses on exams and in practice.
The best investors approach due diligence systematically, recognizing that issues in one area often signal problems in others. A property with deferred maintenance might also have outdated permits; a building with environmental concerns may face zoning restrictions that limit remediation options. Don't just memorize what to check—understand what each finding reveals about risk, value, and investment potential.
Legal and Title Verification
Before you can profit from a property, you need to confirm you can actually own it free and clear. Title defects, boundary disputes, and undisclosed encumbrances can derail transactions or create ongoing liability.
Property Title Search and Review
- Chain of title verification—confirms legal ownership history and identifies any breaks or gaps that could cloud your claim
- Liens and encumbrances include mortgages, mechanic's liens, judgment liens, and easements that survive transfer and affect property rights
- Marketable title means the property can be sold or financed without objection; title insurance protects against undiscovered defects
Survey and Boundary Verification
- Professional ALTA survey confirms exact boundaries, dimensions, and identifies any encroachments from or onto neighboring properties
- Easements and setbacks must be mapped to understand actual usable area and development constraints
- Boundary disputes can result in litigation, reduced lot size, or required demolition of improvements
Permits and Licenses Review
- Certificate of occupancy confirms the building's legal use matches its actual use—mismatches create immediate liability
- Permit history reveals whether past renovations were properly approved; unpermitted work may require costly corrections
- Active licenses for specific uses (restaurants, medical facilities) must transfer or be re-obtained at closing
Compare: Title search vs. survey—both verify ownership rights, but title search examines legal claims while surveys examine physical boundaries. An FRQ might ask you to identify which due diligence item catches an encroachment (survey) versus a mechanic's lien (title search).
Physical Condition Assessment
The building itself represents your largest capital investment. Deferred maintenance, code violations, and structural deficiencies directly impact both value and required capital reserves.
Physical Property Inspection
- Building systems evaluation covers roof, HVAC, plumbing, electrical, and structural elements—replacement costs can exceed six figures
- Deferred maintenance represents accumulated repair needs that reduce value dollar-for-dollar and signal management quality
- ADA compliance and safety standards violations create legal exposure and may require immediate remediation
Building Code Compliance Check
- Current code conformance differs from original construction standards; older buildings may be "grandfathered" but lose protection upon major renovation
- Violations and citations appear in municipal records and may include daily fines or use restrictions until resolved
- Non-conforming use status can be lost if the property sits vacant too long or undergoes substantial modification
Environmental Assessment
- Phase I ESA reviews historical uses, regulatory records, and site conditions to identify recognized environmental conditions (RECs)
- Hazardous materials including asbestos, lead paint, and underground storage tanks trigger disclosure requirements and remediation obligations
- Phase II testing involves soil and groundwater sampling when Phase I identifies potential contamination—costs range from $10,000 to $50,000+
Compare: Physical inspection vs. environmental assessment—both examine property condition, but inspections focus on building systems while environmental reviews target contamination and hazardous materials. Environmental issues often carry strict liability, meaning you're responsible regardless of when contamination occurred.
Numbers tell the story of what a property actually delivers. Historical performance, operating costs, and lease structures determine whether pro forma projections are realistic or wishful thinking.
Financial Analysis and Review of Income/Expenses
- Trailing 12-month financials (T-12) reveal actual NOI performance versus seller's pro forma projections
- Operating expense ratio benchmarked against comparable properties identifies management inefficiencies or understated costs
- Capital expenditure history shows whether the seller has invested adequately or deferred maintenance to inflate short-term returns
Lease Review (for Commercial Properties)
- Rent roll verification confirms tenant names, lease terms, rental rates, and expiration dates against actual lease documents
- Lease provisions including CAM reimbursements, renewal options, and termination rights directly impact income stability and value
- Tenant creditworthiness assessment—a long-term lease means nothing if the tenant can't pay; request financial statements for major tenants
Property Tax Assessment and History
- Current assessment basis may reset upon sale, potentially increasing taxes significantly in states without assessment caps
- Tax appeal history indicates whether current taxes reflect successful appeals that may not survive ownership transfer
- Special assessments for infrastructure improvements can create unexpected future obligations not reflected in current tax bills
Compare: T-12 financials vs. pro forma projections—T-12 shows what happened while pro forma shows what might happen. Sophisticated buyers discount pro forma assumptions and underwrite based on trailing actuals. If asked to evaluate investment risk, always note the gap between historical and projected performance.
Market and Location Analysis
Properties don't exist in isolation—their value depends on external factors you can't control. Market dynamics, neighborhood trends, and regulatory environments shape both current returns and exit potential.
Market Analysis and Comparable Sales
- Comparable sales approach uses recent transactions of similar properties to establish market value—adjustments account for differences in size, condition, and location
- Cap rate analysis compares your acquisition cap rate to market averages; buying above market cap rates suggests either a bargain or unidentified risk
- Supply and demand dynamics including new construction pipeline, vacancy trends, and absorption rates predict future performance
Neighborhood and Area Analysis
- Demographic trends including population growth, income levels, and employment base drive tenant demand and rent growth potential
- Infrastructure and amenities such as transit access, schools, and retail directly impact residential desirability and commercial foot traffic
- Gentrification or decline indicators help predict whether current conditions represent a floor or ceiling for property values
Zoning and Land Use Verification
- Current zoning classification determines permitted uses—mismatches between zoning and actual use create legal non-conforming status
- Development restrictions including FAR limits, height restrictions, and parking requirements constrain expansion or redevelopment potential
- Rezoning feasibility assessment considers political climate, comprehensive plan alignment, and neighbor opposition likelihood
Compare: Comparable sales vs. income approach—comps work best for owner-occupied or single-tenant properties while income capitalization suits multi-tenant investments. Know which valuation method applies to different property types and when they might diverge.
Risk Management and Compliance
The final layer of due diligence protects against ongoing operational risks and regulatory exposure. Insurance gaps, contract obligations, and compliance failures create liability that survives closing.
Insurance Coverage Review
- Coverage adequacy must reflect replacement cost, not market value—underinsurance leaves you exposed in a total loss scenario
- Policy exclusions for flood, earthquake, or terrorism may require separate coverage depending on location and lender requirements
- Claims history reveals recurring problems and may affect future insurability or premium costs
Utility and Service Contracts Examination
- Contract assignability determines whether favorable rates and terms transfer to new ownership or terminate at closing
- Service reliability assessment includes reviewing outage history and backup systems for critical utilities
- Cost escalation provisions in long-term contracts may create unexpected expense increases over your hold period
Legal and Regulatory Compliance Assessment
- Pending litigation against the property or seller may create successor liability or cloud title
- Regulatory compliance across ADA, fair housing, environmental, and local ordinances—violations create ongoing exposure
- Rent control and tenant protection laws in applicable jurisdictions significantly impact income potential and eviction rights
Compare: Insurance review vs. legal compliance—both manage risk, but insurance transfers financial risk to a third party while compliance prevents risk from arising. A property can be fully insured yet still face regulatory penalties that insurance won't cover.
Quick Reference Table
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| Ownership verification | Title search, survey, permits review |
| Physical condition | Property inspection, building code compliance, environmental assessment |
| Income analysis | Financial review, lease review, rent roll verification |
| Cost analysis | Property taxes, operating expenses, capital expenditure history |
| Market positioning | Comparable sales, cap rate analysis, supply/demand dynamics |
| Location factors | Neighborhood analysis, demographics, infrastructure assessment |
| Development potential | Zoning verification, FAR limits, rezoning feasibility |
| Risk management | Insurance review, contract examination, legal compliance |
Self-Check Questions
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A Phase I ESA reveals the property was previously a dry cleaning facility. Which due diligence item would you pursue next, and what specific risks are you investigating?
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Compare the information revealed by a title search versus a professional survey. Which would identify an encroachment, and which would identify a mechanic's lien?
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You're analyzing a multi-tenant office building. The seller's pro forma shows 15% higher NOI than the trailing 12-month financials. What three factors might explain this gap, and how would you evaluate whether the projections are realistic?
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A property is currently used as a restaurant but zoned for general commercial. What due diligence items would you prioritize, and what risks does this situation create for a buyer?
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Compare how insurance coverage review and legal compliance assessment each protect against investment risk. If an FRQ asked you to identify due diligence items that manage ongoing operational risk versus one-time transaction risk, how would you categorize these?