A recent innovation in the residential real estate business, “due diligence” is an important process that both buyers and sellers need to understand. Its purpose is to help both parties to a sale feel confident they know anything and everything they need to about the property before closing the deal.
It’s a well-established concept in the commercial real estate market that’s moved into Wilmington’s residential real estate segment in just the last couple of years. Due diligence is sometimes confused with earnest money, and it’s important to understand the difference.
The time between the initial agreement between buyer and seller, and when the buyer’s earnest money becomes non-refundable, is called the due diligence period. During that time, the buyers do all the investigating they need to do about the house’s condition: Conduct a home inspection, get a termite inspection, have the property surveyed, test the water supply. If any repairs will be needed, getting bids from contractors is an important part of the process. Because this is also the time that the final loan approval process takes place, the due diligence period is usually 30 to 45 days.
During that time, the seller agrees to take the house off the market, in exchange for a small fee. That’s usually just a hundred, up to a few hundred dollars, and rarely, if ever, more than $1,000. Sometimes, because we’re still in a buyer’s market, a buyer may pay no fee at all! That’s likely to change, though, as demand for real estate is on the rise. Expect the due-diligence fee to rise, along with prices, in a seller’s market.
Keep in mind that the fee, and the length of the due-diligence period, is negotiable. The fee guarantees the buyer that the seller won’t be taking any competing offers while the inspections and other tasks are being done. That doesn’t mean the seller can’t talk to other prospective buyers, or even negotiate a back-up offer during that time. The seller is at the buyer’s mercy during that period, so if for any reason the original agreement falls through, it can save time if a back-up buyer is interested.
In that event, the fee wouldn’t be refundable to the original buyer.
But when all goes well, no major problems crop up, and the sale is closed, the due-diligence fee will be applied to the purchase price.
This is where it’s important to understand the difference between due diligence and earnest money. Earnest money is a much more substantial sum, usually in the thousands of dollars. Unlike the due-diligence fee, which puts the transaction on hold while important information is gathered, earnest money is more about a sincere intention to buy. If the deal is canceled during the due-diligence period, the earnest money will be returned to the buyer.
But a cancellation after due diligence is completed means the buyer’s earnest money is definitely at risk.
That gets me to the main things both buyer and seller should be certain of when negotiating the due diligence period.
The buyer should make sure it allows enough time to make an informed decision. If for any reason the necessary inspections can’t get done in time, it’s a very good idea to negotiate an extension. It’s always better to learn about a problem with the house before closing than after.
If you’re the seller, make sure you have enough time after due diligence ends before closing. The idea is to give yourself time to arrange the move to your new home.
Have a question about buying, selling or any other real estate matter? Let me know and I’ll address it in a future article.