If you’ve been around real estate investors of any kind, you’ve most likely heard the phrase “due diligence.” Before a savvy investor pays cash for a property or real estate note, they will perform their due diligence. This is really just a fancy term for research, which varies depending on the investment type. This article covers the due diligence items specific to mortgage notes.

When an investor makes an initial offer to purchase a note, mortgage, deed of trust, or real estate contract, that offer is always subject to underwriting and due diligence. Underwriting refers to the financial analysis performed to determine an offer price based on the underlying risk factors. Due diligence refers to the specific research steps that make up this analysis process.

During the due diligence process, investors must put aside any preconceptions and look honestly at the deal. Every detail of the paper (note), property (collateral) and payer (borrower) must be reviewed and verified. Flaws must be uncovered so they can be factored into the underwriting algorithms. Note sellers should always be forthcoming about any known gotchas in a mortgage note transaction. This honesty streamlines the due diligence process and builds good will with the investor.

Standard Real Estate Note Due Diligence

Here are the most common items an investor will require as part of due diligence before closing:

• Review copies of legal documents (Settlement Statement, Promissory Note, Mortgage or Deed of Trust, etc.)
• Current credit report on Payer/Buyer/Borrower
• Real estate property tax history
• Proof of current hazard and fire insurance policy on the collateral property
• Payment history & verification of current loan balance
• Lender’s Title Insurance Policy or Commitment
• Payoff statements for any property debts still owed by note seller
• Current property value & photos (Drive-by Appraisal, BPO, etc.)
• Payer interview or estoppel (to confirm balance due on note)
• Additional items unique to the transaction

The seller usually starts the process by providing copies of the existing legal documents to the investor. Sellers can stand out from the crowd by anticipating and providing to the investor many of the remaining items on this list. The investor will decide what additional items they require and either order them (e.g., BPO, title search) or make additional requests of the seller as needed.

Many note investors will cover the cost of due diligence, but practices can vary so be sure to verify rather than assume. The option or purchase and sale agreement will cover these important details. It’s important for a note seller to understand in advance whether the investor’s offer is net (after costs) or gross (before costs).

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