The LANDFLIP Blog

Property buyers: Putting the “do” in due diligence

“Due diligence” is the process of careful investigation that buyers use to identify the values, issues and problems embedded in whatever they’re buying.

Since all property purchases are different and no Consumer Reports exists to simplify making choices, each buyer must dig out the story of a seller’s dirt.

This research is the responsibility of the buyer—not the buyer’s lawyer, not the agents involved, not the buyer’s lender or appraiser and not the buyer’s third cousin by marriage who was a real-estate agent 20 years ago.

The point of spending the time and money doing pre-offer research is to gather reliable information from which to propose a sensible price and terms.

I advise buyers to do most of their due diligence in advance of making an offer rather than propose a 90-day study contingency. Advance research gives the buyer a fact-based offering price, not an approximate stab in a hostile dark.

Deals have a better chance of getting done when the offering price is as hard as the buyer can make it. A study contingency amounts to a free look for the buyer, and sellers are often reluctant to tie up their properties this way.

Due diligence walks through these steps:

Start with what the seller discloses.  Different states require sellers to disclose different types of information. These usually cover “material (important) latent (concealed) defects,” which are items not obvious or readily knowable. I often find that sellers do not disclose significant defects, both the concealed kind and those that are observable but not readily understood.

Some states allow sellers to opt out of disclosure.  A seller who chooses not to comply with disclosure may have something to hide. A buyer won’t know this until he’s done with his due diligence.

A buyer can write a contingency into a contract offer that makes the sale depend on the seller disclosing all defects in the deed and property of which he is aware.

Where a seller does disclose a defect, the buyer needs to research all of its implications.

Boilerplate inspections. Many standard contracts provide for four inspections. The seller usually pays for three: 1) termite inspection, 2) certificate showing that the house drinking water is safe, and 3) septic inspection that indicates the system is in working order. The fourth is the house inspection that is generally done at the buyer’s expense, although some smart sellers are now providing a current house report as part of their marketing effort.

Buyers should not waive any of these without good reasons.

The termite inspection should include structures in addition to the house, such as detached garages, barns and workshops. Wood-eating bugs don’t confine their dining to the seller’s home.

The water-quality test should screen for heavy metals and chemicals in addition to E. coli bacteria.

The septic inquiry should go beyond determining whether the system is functional. A buyer needs to know whether the house’s grey water goes into the septic system; it may go into a dry well or straight into a creek. Some counties grandfather these non-conforming practices, but more and more are requiring owners, especially new owners, to upgrade to the current standard, which runs both grey and black water into the septic system.

Buyers should also determine whether the current septic permit fits current and future uses. I’ve seen a listing for a four-bedroom farmhouse that only had a two-bedroom septic permit. If the new owner adds square feet or another bedroom, additional septic capacity will be required beginning with the two bedrooms not covered under the existing permit. In the worst case, this can mean installing a completely new septic system at a cost ranging from about $3,000 to more than $20,000.

A routine house inspection generally does not cover asbestos, radon and mold.

Fee ownership.  Buyers need to understand exactly what the seller is selling. Buyers want to buy property in fee (also fee simple or fee absolute), which means all the rights the land contains—surface, minerals, water, timber, wind and so on. The buyer needs to know before making an offer whether all rights convey and whether the seller is reserving a right or anything else from the sale.

Eight Questions a Buyer Must Answer Before Submitting an Offer

1.  Boundaries lines.
Do the boundaries of the seller’s property on the ground follow the boundaries as described in the seller’s deed?  They should.  A surveyor can plot the deed’s boundary description on a topographical map, which will help you determine in a general sense whether the deed matches the ground reality. If the description does not match what you find on the ground, hire a surveyor to figure out what’s wrong.    

2.  Physical and legal access
Does the seller have legal and physical access to the property he’s selling?  If the seller’s property has frontage on a state-maintained public road, the seller should have direct access.  If the seller’s property does not have direct access to a state-maintained public road, the buyer must make sure that the seller is conveying a legal and physical right to cross the property of another(s) to get to that state-maintained road.

I’ve faced a situation where the legal access to a seller’s property was not the physical road that the seller used.  The legal right of way (ROW) should be identical with the physical access road, otherwise problems will arise.  The right of way in the form of an easement should be sufficiently wide to suit the buyer’s purposes.  A 12-foot-wide ROW is wide enough for pick-up trucks, but not wide enough for snow plowing and log skidding.

If the seller’s property is accessed by a road that connects the property to a public road, make sure the seller has a recorded document establishing the right to use this road.  Make sure this right-of-way easement imposes no restrictions—such as width, traffic weight, types of use—that would limit your intended use of the property.

If you are buying undeveloped property that borders a public road, make sure that there is enough sight distance on either side of your proposed entrance to allow you to get a new-entrance permit from the state or county road office.

3.  Do any neighbors have a claim against the seller’s property?
If you find a fence line that is not where the seller’s deed states it should be, either a neighbor may have fenced in some of the seller’s land or the seller may have fenced in some of the neighbor’s land. Consent for this may or may not have been obtained.  If the encroaching party can meet the state’s definition of adverse possession, that party will gain ownership of the fenced in land.  A party can also gain use of the property of another by meeting the state’s standards. Sometimes, a neighbor (or the seller) will have a claim of one sort or another, though no evidence shows on the ground.  You need to ask both the seller and the neighbors if unrecorded claims of any sort burden the property.

4.  Is the seller conveying all rights and interests in the property, i.e., is the property being conveyed in fee simple?
The ideal situation for a buyer is to find a seller who is able and willing to convey all rights and all interests in his property to the buyer. This means 100 percent of the property’s ownership and 100 percent of all rights in the property.  The buyer must have his lawyer check the title for any other party owning a portion of what the seller is selling.  This situation often arises when the seller’s property has been part of an estate with many heirs.  The seller may be selling something less than 100 percent ownership.

If the property has had some right—minerals, timber, water, wind—severed and sold, the seller cannot convey that right to you.

Easements that allow some party to use the seller’s property are relatively common; they may or may not be significant.  Utility companies will own an easement allowing them to install and maintain power lines.  A neighbor may have an easement to cross the seller’s property.  A conservation easement involves some right that has been donated or sold, and which the buyer cannot reacquire.  These can be very important rights, such as the right to develop the property for housing, the right to cut timber, the right to extract minerals, the right to sell water commercially and so on.

13 Documents You Should Have Before Buying Country Property

1.  Copy of the seller’s deed with the boundary description.
This description may be found in an earlier deed, which is referenced in the seller’s.  The deed may include the price the seller paid for the property, or tax notations, such as deed stamps, that would allow you to calculate the price.

2.  Topographic map with boundary lines drawn on it, taken from seller’s deed description.
Use this map to locate boundaries on the ground and find your way around unfamiliar terrain.  If a recorded survey is available, make a copy for your files.

3.  Recorded documents, in addition to seller’s deed.
These would include easements the seller holds, easements that others hold that impact the seller’s property (such as right of way held by a neighbor that crosses seller’s land), sale or lease of minerals, utility easements, mortgage note, liens, estates, reservations of interests, releases, survey and so on.  Water contracts and leases should be recorded.  If the seller’s property is burdened with a conservation easement, make sure that you read and understand its restrictions, with which you will have to comply. All recorded documents should be found in the county courthouse where deeds are recorded.  Permits and licenses are not recorded documents. But both are publicly available.  If the seller’s property uses a septic system and a well, obtain the relevant documents/permits from the local sanitarian or health department.

4.  Releases.
When the seller, or his predecessors in title, encumbered the property or leased it, those documents should be recorded.  When these arrangements expire, a release should be recorded, as, for example, when the mortgage is paid off, a holder of the mineral lease allows it to expire or a holder of a life estate in the property voluntarily gives it up.  A release is the official notice that the arrangement is no longer in effect.  Ask the seller to obtain a release if one is not recorded.

5.  Tax information on seller’s property.
Each county has a system for establishing the fair market value of every property within its borders for tax purposes.  This information will be in the county courthouse, or other relevant jurisdiction.  Photocopy this page from the county’s land book or print a copy from the computer records.  Included will be the acreage figure on which tax is calculated (an acreage figure that may or may not be accurate); tax-assessed value for land, improvements (residential and farm buildings) and minerals; current level of tax on property; deed book and page number of seller’s deed; land-use status (tax break for farmers and timber owners, depending on county/state); and land classification for tax purposes.  Use the tax-appraised value of the seller’s property in your negotiations.

6.  Appraisal.
I recommend that buyers in most cases pay for a professional appraisal of any property they are determined to buy.  A drive-by appraisal is cheap and may be all that you need for negotiating.  A drive-by appraisal is not a full-scale effort.  If you are borrowing from a lender, have one of the lender’s approved appraisers do one for you before you make your offer.  The lender can use this appraisal for making the loan.

You can also get a local real-estate broker to prepare a Competitive Market Analysis (CMA), which is a brief summary of recent selling prices of properties that are broadly comparable to the seller’s.

Ten Sources of Useful, Free Advice and Information About Buying Country Property

1.  County Clerk.
This individual may have a different title, but the job is essentially the same from state to state.  The County Clerk works in the office where deeds, surveys, leases and other documents are recorded.  Deeds are recorded in deed books; other documents may be recorded either in the deed books or in books devoted to one type of document, such as a survey book or a minerals book.  This office is the place where you can track back the deeds into the seller’s property.  The Clerk will show you how to use the County’s system and help you when you get stuck.

2.  County Extension Agent.
Each state has an extension service that is affiliated with a state university.  Most rural counties have an extension agent who is broadly familiar with local agriculture and has access to extension faculty at the university.  Some extension agents are specialists in a particular commodity or subject matter, such as agricultural taxation, beef cattle, corn, orchard crops, vineyards, etc.  Extension publications are useful—and range from introductory to advanced.

3.  County Forester.
A county forester may work in one or more counties.  He is a state employee whose job is to work with forest-owning landowners on ways to improve and manage their timber resource.  He can help you estimate the value of your timber and put you in touch with private-sector consultants.  He will also have information about forest-health issues, government cost-share programs, state seedling sales and forest-taxation questions.  The county forester can put you in contact with the state’s timber-management program, which may offer a significant tax break for your participation.  The state forestry department will usually produce publications, including a quarterly report on stumpage prices for each tree species, by in-state regions.

4.  State geologist.
Every state has a geology program that over the years has identified mineral resources.  Geological maps are available that cover your target property.  These maps will indicate in general terms whether your property contains oil, gas, coal, hard-rock minerals and so on. Specialists are likely to be familiar with the area of your target property and its resources.  The geology office will either have or, can direct you to, information on water resources, underground faults, karst formations, caves and earthquake hazards and so on.  Most states will also have a department of mines and/or department of minerals, which issues permits and oversees mining and drilling.  This department (s) will have records of past mineral production on your target property.

5.  U.S. Department of Agriculture.
(Farm Service Agency and Natural Resources Conservation Service)
Somewhere in or near your target county, you will find a USDA Farm Service Agency (FSA) office. This is the gateway to USDA programs, ranging from crop subsidies to conservation programs and financing. The FSA office is likely to have an aerial photograph of your target property that you can copy.  It should also have free copies of the county’s Soil Survey, whose maps will tell you the soils on your target property and whose tables will tell you the suitability of each soil type for construction, septic systems, timber productivity, wildlife and agriculture. Get a copy of your target county’s Soil Survey.  The NRCS handles USDA conservation programs.  NRCS can advise you on how to build, maintain and restore your soils; you may want to participate in the cost-share programs that encourage certain practices.  In the West, you may also need to touch base with the local office of the U.S. Department of Interior’s Bureau of Land Management.

Fourteen Numbers You Need to Know Before Buying Country Property

1.  Acres.
How many acres will the seller convey to you, physically on the ground and legally in his deed?  These numbers should be the same, but are often different.

A surveyor can plot the seller’s deed description on a topographical map that you can use in the field. The plotting will determine exactly how many acres the seller can convey to you by deed and whether the deed description closes.  If the drawn boundary does not close, there’s an error in the description. It’s not uncommon to find either more or less acreage on the ground than in the deed.

2.  Tax-assessed value.
What is the tax-assessed value of the seller’s property?  This dollar amount is supposed to reflect a reasonably current fair market value of the seller’s real estate.  It is the number on which the seller’s property taxes are calculated.  The number is found in the county courthouse where taxes are assessed.  Tax-assessed values are updated every few years, but they may not reflect actual current market values, especially in rapidly appreciating markets.

3.  Fair market value (FMV).
What is the current fair market value (FMV) of the seller’s property as an entirety.  You can determine this by hiring an appraiser to do an appraisal for you before you submit an offer.  Make sure that your appraiser is approved by the lender that you plan to use, otherwise you might end up paying for two appraisals. A local real-estate broker can perform a competitive market analysis (CMA) of recent sales for you.  A CMA is similar to an appraisal done by a licensed appraiser, but not as rigorous.  Use the property’s FMV in negotiating price with the seller.

An appraisal does not research property for defects in title, acreage and its assets.  The appraisal provides you with an appraiser’s opinion about the market value of the property in gross terms.  It generally does not determine the real market value of timber and minerals.

4.  Seller’s equity in the property.
How much of his own money does the seller have in the property he’s selling?

This includes down payment and closing costs when he purchased it, principal that he’s repaid and capital improvements that he’s made.  It does not include interest that’s he’s paid on his mortgage, property taxes, insurance, appreciation, depreciation and routine maintenance expenditures.  This number gives you a point from which to start projecting what the seller will make from a sale at various prices and various terms.  It’s a good number for buyers to know when it shows a seller making a lot.

5.  Seller’s remaining mortgage debt.
Remaining debt is the amount of money that the seller has to pay from the proceeds of the property’s sale to free the property from a lender’s lien.  Subtracting the seller’s debt from a purchase price gives you a ballpark idea of what he might pocket before taxes.  The seller may need to pay off other debts that are tied to the property, not just a mortgage. He may also have debt with the owner from whom he bought the property.

6.  Basis.
This is a tax number.  It represents what a seller has “in” the property at the time he sells it to you from a tax perspective.  Original basis is the seller’s cost of purchase. Over the years, basis is adjusted up or down, according to what the taxpayer has done with the property.  Depreciation subtracts from basis; capital investments add to basis.  The lower the seller’s basis, the more profit he’s likely to make on his sale.  Profit is figured by subtracting the seller’s adjusted basis from his net sales income.

7.  After-tax net income from sale.
This number depends on many seller-related variables—whether the property qualifies as a principal residence; whether the seller has held it for more than one year as a property that qualifies as a capital-gains sale; his tax bracket; his income from other activities; the selling price; and other factors.  This number is an estimate of what the seller will have left after all his expenses and taxes from the sale are paid.  There are ways for buyers to help sellers increase their after-tax net income, which can help a buyer in negotiations.

Ten Quick Tips for Buying Land in the Country for Investment and Profit

1. Don’t make a deal on your first visit.  Don’t buy impulsively.  Don’t make an offer before scoping the property.  If you disregard this advice, include a 60-day study contingency with results acceptable to buyer in your contract; this allows you to void the contract if you find something during escrow that’s a deal-killer.                

2. Visit on a cold, rainy miserable day.  Look for water problems on the roof and at the foundation.  Is the creek high or in flood?

3.  Visit at night and on weekdays.  Is night-time lighting offensive?  Traffic?  Noise?  Odors?

4. Submit your offer in the lowest low of the off-season.  Early January is a great time to buy rural property outside of the South, especially when the seller’s Hummer bogs down as he’s driving you around.

5. Never confide in a real-estate broker or agent who is working for the seller. Never reveal your finances or your best price.  Never tell such a broker or agent that you love the seller’s property or that you need to have it. NEVER.

6.  Rework the standard broker’s purchase contract with your lawyer.  Delete what you don’t like and add language that you want.  Do this before you present your offer. Read the contract you submit.  Make sure that you understand the meaning and implications of phrases like, “___ acres, more or less,” “Warranties to survive contract” and “Time is of the essence.”

7. Have your local lawyer with you when you present your offer to the seller or his agent. Have your lawyer help draft any last-minute changes that are needed to get the deal done. If you’re not confident in your negotiating ability, have your local lawyer dicker with the seller over price and terms.

8.  Ask both the seller and his agent to disclose in writing all material defects, both latent and manifest, in the property and its title that would negatively impact your possession, use and enjoyment.  Buying “as is” does not exempt a seller from state-established disclosure requirements; it means that the seller refuses to fix/repair anything the buyer doesn’t like.

9.  Let the property you’re buying help you pay for it.  Sell something from what you buy at a higher price than what you paid.
                  
10. Location, Location, Location.

Location is important, but it’s a factor that a buyer can use to work down the seller’s price.  In buying country property, location has three meanings.

First, it’s the proximity of the seller’s property to local goods and services.  A farm ten miles from town may not be priced lower than a property five miles from town, because farms, locally, are valued for other factors not their proximity to town.  A remote property—far from a publicly maintained road—should be priced lower than one with road frontage, all other things being equal.  A buyer who does not need or want proximity to town or public road should not be expected to pay as much as he would for more convenient property.  Use the absence of location and access to your advantage.  Hunters looking for hunting tracts should look for land that’s comparatively cheap owing to its remoteness.  If the seller’s property is close to town, complain about its closeness. 

Second, location involves the proximity of the seller’s property to the buyer’s principal residence.  The buyer, not the seller, puts a value on this location factor.  Use distance from your home in your negotiations with the seller.  Even if they’re pretty close to each other, complain about the stress of increasing traffic—a fact of everyone’s life.

Third, the seller’s property is valued higher or lower according to what’s around it. A public trash station opposite the seller’s entrance decreases value.  Complain in a resigned voice about something around the seller’s property.  A pretty open field across the road may become the next mega-development—it’s possible.

Curtis Seltzer, land consultant, is author of How To Be a DIRT-SMART Buyer of Country Property at www.curtis-seltzer.com.