Evaluating Inspection Reports on Investment Properties
Make wise investment decisions with a professional property inspection.
Before you purchase an investment property, it is customary that you have it professionally inspected (just as buyers do before finalizing the purchase of a house they plan to live in). A property inspection is typically written into the initial purchase agreement as a purchase contingency, and the buyer usually has ten days or so from the agreement date to have the inspection completed. But once the home inspector is done, what are you supposed to do with the multi-page report you get? Here are some general guidelines to consider.
The Inspector’s Take
It is in the home inspector’s best interest to cover everything that is possibly wrong with the investment property in their report. Inspectors do this to reflect a high level of professionalism, as well as for liability reasons. Inspectors want to make sure they are covered, so they will document every blemish, nick, and crack (if they’re worth their salt). Inspection reports are typically about 20 pages long, with two pages of general disclaimers, eight to ten pages of general guidelines, and ten pages specifically evaluating the property from top to bottom (from roof to foundation). For larger or more complex properties, such as a duplex, the total report may run 30 pages or more.
To protect themselves against lawsuits a buyer may bring for failure to identify a defect in the property, inspectors typically include disclaimer language in their report, such as:
- “This inspection is not intended to…be a guarantee or warranty.”
- “This inspection is not a building code compliance inspection or engineering study.”
- “This report does not cover issues that are not visible.”
To learn more about lawsuits against inspectors and real estate professionals, see the Nolo article Home Defects: Sue the Seller?
Red Flags in Property Inspections
In most cases, especially if this is your first investment property, you definitely want to be present during the actual inspection to have the inspector explain potential issues to you directly. It’s much easier to determine your appetite for risk if you can get a visual of the problem. But once you have the inspection report, these are some of the highest risk items you want to consider before buying and renting out a property to prospective tenants:
Electrical. If the wiring is not up to code you have a potential fire risk on your hands, and you can never underestimate a tenant’s usage of the service panel. Solid investment opportunities often come in the form of older houses that are selling at a discount because no one has yet invested in modernizing the property. Electrical risks are common in older properties and addressing them will reduce the biggest risk to your property – fire.
Structural. Structural issues can lead to a number of headaches down the road and can be the most significant cost item to address. Lot grade issues as well as termite and rot damage to supporting beams and sills can lead to house “sagging”, resulting in uneven floors, shifting door frames, and other problems. While structural concerns may not be an immediate risk for property damage, they could be an issue when you go to resell the property down the road. Buyers tend to shy away from properties with significant structural issues so it’s important to analyze the financial impact it will have to correct them.
Roofing and exterior siding. Any gaps or damage in these areas can lead to interior water leaks resulting in rot and potentially mold. While replacing an entire roof is an expensive undertaking, if the exposed areas are limited to just a few locations, it could be a relatively painless expense if the rest of the exterior is in good shape.
Furnace. If it’s pretty deteriorated, you could be faced with a large capital expense right away. Again, fire and health risks are the two main items you need to concern yourself when renting out an investment property. The inspection report can tell you whether the furnace is a bigger problem than the sellers are making it out to be.
Once you have an inspection report you can get estimates from local contractors on what it would take to repair some of the principal problems noted. A good real estate broker will help you through this process and will often help negotiate a reduction in the sales price with the seller to compensate you for the repair costs.
How to Determine What Repairs Are Necessary
The inspection report should cover an exhaustive list of every defect, but not all of these are issues that need to be fixed in order to provide a safe and comfortable property to rent out. Cosmetic items in particular, like mismatched exterior paint or bathroom tiles, do not necessarily need to be addressed. Of course, they help make the property more inviting and rentable, which may be key if you are looking to rent out property in a competitive market. But keep in mind that some improvements or cosmetic repairs will not have an impact on your liability for tenant injuries or damages, which will typically be your main concerns.
The Value of Inspecting Investment Properties
Buyers often feel frustrated with the lack of information they get from an inspection report because many of the problems they subsequently face come from those “not visible” areas the inspector absolves himself from looking at, such as broken pipes or faulty wiring. Some buyers look at inspection reports as an additional cost burden that doesn’t protect them, so they may want to skip it knowing there will be unexpected costs that the inspection report can’t predict. But the reality is that if you are investing and renting out real estate, insurance companies will want to know you had an inspection done, even if it’s after the purchase. If a structure fails, resulting in an injury or property damage, and you didn’t do your due diligence of getting the property inspected, your insurance company may make you responsible for covering the damages. The inspection is worth it not only from that standpoint, but it can also help you gauge a priority list for improving the property’s value for when you sell it in the future. And, of course, you may use an inspection report in negotiating a reduced sales priced from the seller.
Keep in mind that in some situations, you may want to arrange additional, more specialized inspections, such as for hazards from floods or earthquakes, or if the general inspection identified problems that require a special analysis (such as mold).
More Advice on Home Inspections
The Home Disclosures, Inspections and Appraisals section of Nolo's site includes useful articles on getting a home inspection, removing inspection contingencies, and reviewing seller real estate disclosures (the rules on required disclosures vary by state--some such as California, require considerable disclosures).