Earnest Money, Due Diligence Fees, & Other Upfront Costs Explained

You found the deal, ran the numbers, and you're ready to go. But before you write that check, how much should you put down as earnest money and what actually happens to it if you need to walk away? Today on The Rookie Reply, we're digging into three questions straight from the BiggerPockets forums. Earnest money, due diligence protections, self-managing versus property manager, and how to confidently analyze a market that you've never set. This is The Real Estate Rookie Podcast. I'm Ashley Karas. And I'm Tony J. Robinson. And with that, let's get into today's first question. So this one comes from the BiggerPockets forums and it says, I'm under contract on my first investment property and my agent suggested I put down $5,000 in earnest money. I've also heard about a due diligence fee that's separate and non-refundable. I'm confused about the difference between the two. How much should I put down and what happens to my money if the inspection comes back bad and I want to walk? Can someone break this down for a first time? Homebuyer. Now, I've only leveraged earnest money. I actually haven't ever paid a due diligence fee. But I think I remember one of the recent agents we interviewed talking about this. But Ash, have you ever used a due diligence fee separate from earnest money? No. And the guest that we just had on, that was the first time I had really learned about that because we just have the earnest money that we put down and you have a window, a period of time to do your due diligence. And that's usually when you get your home inspector to come out and then you can get quotes on different repairs that need to be made or you can negotiate. But after that, time limit is done and then your earnest money is no longer refundable unless there is another contingency in your contract. Like say that typically if somebody does a loan, you'll see that the interest rate for the loan they're getting, if the interest rate goes above 7%, then they can get their earnest money back and get back out of the deal. So that could be like something contingent that it's on or maybe it's contingent on them selling their own house and they have 30 days from the start of the contract to get their house under contract or something like that. Then that could also be refundable. But what we learned about this due diligence fee is that you're basically paying the seller of the property days to look at the property and you don't get that money back. That is just, here you go, I'm going to pay you $50 per day. I need five days to do my due diligence and that's what you're getting paid. And then at the end of those five days, you decide if you're going to walk or if you're going to continue through with the offer on the property. Yeah. And that was episode 696 with Ellie Ridge and she's a realtor out in the Bay Area, which is one of the most competitive markets that are out there. And that's why I think there were some things that were specific to that area that we don't quite see in other parts of the country. But I think in most markets, you're probably just going to need to put down an earnest money deposit. But to your point, Ash, I think that they're, well, I guess to answer the question, right? He says, what happens to my money if the inspection comes back bad and I want to walk? Well, that is the entire purpose of the due diligence period in your purchase and sale agreement is that you get to say, I want... For me, I usually put 14 days. What does it look like for you in New York, Ash? Yeah, I'm usually doing less just because we can usually get a home inspector out there pretty quickly, but I'm usually doing like less than seven days, to be honest. Yeah. And it depends on the offer, right? If you're buying from like a wholesaler, you know, a lot of times you can't bake in a due diligence period. But if I'm buying on market, my usual approach, I'll ask for 14 days. And during that 14-day window, that gives me the ability to send an inspector out there, get my inspection report back, maybe send any qualified professionals to look at certain elements that the inspector recommended I get other folks to look at. And then once you get back all of those inspections and those projected costs, you can then go back to the seller and say, hey, based on my findings, there were some maybe material changes that I didn't know or I wasn't aware of when I made my initial offer. And because I now need to maybe replace the entire roof instead of patching it, or maybe all of the electrical needs to be, you know, redone because of X, Y, and Z. Well, now my offer goes from X to now Y. And hey, Mr. and Mrs. Seller, if you agree to these terms, we can continue on with this contract. If you disagree, well, then this is my ability to walk away because we're still within our due diligence period. So that is the entire purpose of the due diligence time period in your contract is to give you the opportunity to dig deeper, complete your due diligence, and then either say, yes, I'm ready to move forward, or no, I want to walk away. When I bought my first rental, I thought collecting rent would be the hardest part. I was wrong. I didn't expect to be playing an accountant, banker, and debt collector on top of being an investor. But that's what I was doing every weekend, flipping between a bunch of apps, bank statements, and receipts, trying to sort it all out by property and figure out who's late on rent. Then I found Baseline and it takes all of that off my plate. It's BiggerPockets' official platform that automatically sorts my transactions, matches receipts, and collects rent for every property. My tax prep is done and my weekends are mine again. Plus, I'm saving a ton of money on banking fees and apps I don't need anymore. Get a $100 bonus when you sign up today at Baseline.com.bp BiggerPockets Pro members also get a free upgrade to Baseline Smart that's packed with advanced automations and features to save you even more time. So we just learned about how to protect your earnest money. You close on your first deal. Now the question every new landlord faces, do you manage this yourself or do you hand it off to a property management company? So our second question comes from the BiggerPockets forums and it says, I just closed on my first rental property, a single family home, about 25 minutes from where I live. I've been going back and forth on whether to self-manage or hire a property manager. The PM I spoke with charges 10% of monthly rent plus a leasing fee equal to one month's rent. My cashflow is already thin at about $200 per month. Self-managing would protect that margin, but I've never been a landlord before and I'm worried I'll make mistakes. What should a rookie actually consider here? I think this is a great question to be asking yourself because there's many things you should be asking yourself before you make the decision. And this, first of all, the fees of the property manager, I would say this is very, very typical. The 10% of monthly rent, you can see it vary from when I was managing 80 residential units and I handed those off to a property management company, they gave me a big discount because there was so many properties at a larger or so many units at a larger scale. So it can vary depending on how many units you are bringing. They can give a bulk discount, but also you can see this go up to 12%, 15% of the monthly rent. So you want to make sure you understand what is included. So what exactly are they doing for you? Are they doing the bookkeeping? Are they handling the maintenance requests? Are they doing, you know, are they taking all of your leasing questions? Like what is happening with all of that? What is included in that? Then the next thing is the leasing fee equal to one month's rent. Also, I've seen that very, very typical to be one month's rent. So what you need to consider here are any additional costs. So for example, when I use property management company, they also charge $25 per a month per a property. And that was for any after hours phone calls or maintenance. So instead of charging, you know, me overtime for their employee to go out to the property to do an emergency thing, they just consistently charge that $25. And I was still charged their standard rate of, I think it was $45 per an hour for any of their maintenance work that was done. So ask about any of those other fees that may be tacked on. While I was working with them, they added in something to their agreement, property management agreement that they would be performing six months preventative maintenance at each of the properties. Every six months they would do this and you would be charged X amount. I think it was like $75 or something. Well, it ended up being a lot more. They would go in and say all of these things that needs to be done and then upcharge you all of these things. And it was like, it started to get ridiculous at this point of things that actually didn't need to get done. So really understand their process and their model and that can help you make a decision. Then the next thing is looking at your time. Do you have time to self-manage? You're going to need to respond to messages. You're going to have to do lease renewals. You're going to have to show the apartment when you're renting it. So there are different things. I think the yes, the money and how much they'll charge, but also what are you actually getting for your money? And then do you have the time to do it? But 100% you can self-manage your property for sure. I think with all the tools that are available to landlords today, self-managing is probably easier than it's ever been. And I think with the right support, the right frameworks, right systems, BiggerPockets has books on managing properties. We've done tons of episodes on the Rookie Podcast. I mean, you get a really good lease. Maybe you find a really good attorney in case you do need some support around evictions or, hey, how should I handle this tenant question or relationship? And then you put all the tools and the automation in place and self-managing I think is a viable option for most people listening today. But I think to your point, Ashley, the question that we want to answer is, well, hey, what is your actual goal on this first deal? And maybe what are your long-term goals for yourself? If you really want to be a hands-off investor and you just want to focus on finding the deals and underwriting and analyzing, getting the financing and putting the deal together, but you have no interest in actually managing, well then, yeah, hand it off to your property manager and just try and make sure your next deal has a little bit more margin. But if you want to be part of that management process and that is a part of the game that you want to learn, then I think it's worthwhile to jump in today. But Ashley, I think you hit all the important questions someone should focus on as you're going through that. If you go to biggerpockets.com slash leases, there's also lease agreements available per state. So they're made by attorneys and they're specific to your state. You'll just have to change them specific to your property. So for example, if you have a shared driveway, putting that in, what are the parking rules, things like that, that are specific to your property, you'll have to make those changes in there. But it's a great, great resource is using those lease agreements. We're here for our last question. And this one says, I live in an expensive market where the numbers just don't work for me as a first-time investor. I've been looking at markets in the Midwest and the Southeast where prices are lower and rents look stronger on paper. The problem is, I've never been to these cities. I don't know anyone there and I'm not sure how to tell if a market is actually good or if I'm just looking at cherry-picked data. How do I properly analyze an out-of-state market before I commit? This is a question that I feel like we get often from Ricky investors, especially those who are in high cost-of-living areas or maybe the numbers don't work out all that well. So when we talk about selecting a different city, and I appreciate how they frame this, you know, they said, how can I make sure that it's a good market and that I'm not just looking at cherry-picked data? I think that we can build confidence for ourselves by going and sourcing our own data. And it sounds like you're talking about a traditional long-term rental. So we'll just go with that as your strategy here. But the things we want to look at, obviously price, and can you afford to buy there is probably the first thing, right? Because even if all the other numbers work out, but you can't actually afford to go into that market, then it's not worthwhile. So just the actual cost of real estate as it relates to your ability to buy. But once you check that box and you say, okay, I actually can't afford to invest here, things like population growth, are people coming in or are people leaving, right? Which way is this population headed? Things like jobs and industry and diversity of business, which is actually slightly different for if you're doing a short-term rental but for long-term, those things are important, right? Because if one company employs 80% of the people in that town and that company goes under, well, what happens to that local market, right? But if you've got several business headquarters and you've got a university and you've got large medical centers and there's some diversity of industry there, then that's a good time for you as well. The other piece you can look at are things like crime stats and is this a place where you might get robbed while you're sitting in a red light or is this the kind of place where you can sleep at night with your doors unlocked? So just understanding the data around crime, schools and how well those schools do and trying to identify which parts of the city and which neighborhoods have the better performing schools because people typically want to live in those parts of town to send their kids into those better schools because you get a better tenant pool and things of that nature. So there are certain data points that we can go grab to help us understand without taking into account anyone else's data, what is the actual health of this market and what does that look like? So I would just start building my own database of data points and I've shared this before, but if you guys go into the Real Estate Rookie Facebook group, we don't talk about that often, but it's still sort of pretty active Facebook group and you search for my name, Tony Robinson, one of the very first posts I did in there and this is before I was a host on the podcast. I just did a huge data dump of the research I was doing because I was searching for my first market and I had tons of data points in there. I can't even remember at this point, but I pulled every, they're called MSAs, but statistical areas and I put all these data points for all these different parts of the country. So if you want to see what my research looked like, just go search in the archives for that Real Estate Rookie Facebook. One thing that I think you can do is really narrow it down to two or three markets and then Tony did this with one of his markets is connect with an agent from Agent Finder in those markets and ask them what they know about this market. And I remember Tony, when you talked to this agent, you got this long email back that was just this wealth of information about that market. And then you can kind of take those three emails from the agents and compare them and use that as though, okay, here's somebody, here's who's on the ground. What are the pros and cons? And then even take it a step further and ask them like, what are some of the negatives of investing in this city and put them on the spot for that? Because nobody can say, oh, this is perfect. There's no, you know, nothing wrong. This is the best investment. That's going to be a red flag right there, not to work with that person and ask them like, honestly, what are the negatives of this? Like if someone was going to ask me about that for Buffalo, I would say that within like the last year and a half, I think it's been, there's been new, there's been political changes where they're really, really cracking down on landlords. The evictions are getting way worse, way longer, way harder with the new judge they have in the city. So I think that would definitely be a negative. The second thing is, is that the property taxes are really high too. So, you know, there's going to be negative things with every city. And I think that's, you want to know all the glory, but you also want to know what are going to be the pain points before actually stepping into that market too. Okay. Well, thank you guys so much for joining us for this episode of Ricky Reply. I'm Ashley, he's Tony. If you guys aren't already a member of BiggerPockets, you can sign up for free, but we also have a pro option and it is getting better and better by the day. So I used to have this all memorized of these pro perks that you could get, but we just added so many of them that I don't even have them memorized anymore. So I'm just going to share with you guys real quick some of the things. So we actually now have a pro partner where you can get $2,000 per year towards your DSCR loan closing costs. Okay. We love DSCR loans. Okay. Plus 0.25% off your upfront funding fees. Another $1,250 if you do a fix and flip loan off your upfront fees. Okay. Insurance. Everyone needs their landlord insurance and proper insurance. So we've now partnered with Steadily and you can get a 5% discount up to $256 per year off of your insurance premium. And then we go into, you know, rent ready, you get that for free as a added perk of, you know, that's included into your membership. A base lane, you're getting automated banking and the bookkeeping for free with base lane, Home Depot, you get their elite tier pricing, which I'm going to actually be using very, very soon on my next rehab. So there's a ton more things I could go into, but it definitely is worthwhile. You can start a free trial for seven days and check out these pro perks and see if it's worthwhile for you. But just head over to biggerpockets.com. And I think we actually might have a 20% off code that you guys can use. Try Tony or try Ashley. See if any of those work. They were valid at one point. I'm not sure if they are anymore, but I'll work on getting those codes working again if they're not. But you can put in Ashley or put in Tony to get that 20% discount. Thank you guys for listening and we'll see you on the next episode.