Updated: Oct 16, 2019
If you are planning to purchase a property, then it is important to have a thorough understanding of what is due diligence.
The process of due diligence is carried out after the property buyer as well as seller agree to an agreement, but before a contract/deal is signed. Read on to find out the need and importance of property due diligence in real estate.
Due Diligence Explained
Due diligence is usually defined as an extensive research that is carried out before signing of an agreement, especially one where the sale or purchase of a real estate property is involved. Due diligence is all about taking a precaution, analysing and reviewing documents, performing several calculations, buying insurance, conducting inspections as well as doing an extensive homework before entering into a real estate contract. This period of due diligence is referred to as the preliminary due diligence process and it lays down a specific period before executing the real estate agreement so that the buyer is able to investigate a property and ensure that they are fully satisfied/happy with it even before they actually enter into the contract.
Some of the common considerations in property due diligence include pest, septic and home inspections, financial documents exchange, repair negotiations, loan qualifications etc. Once the contract has been executed, due diligence process continues with bank appraisals, property surveys, loan commitment, title search etc. In case the buyer is not satisfied after due diligence, he/she can refrain from buying the property.
The Need for Due Diligence in Real Estate
Due diligence is crucial in residential and commercial real estate related transactions as it allows the buyers to analyse the value of the property properly and also design an offer strategically. A number of documents that help you to find out more about the net profitability of a property can be accessed by a buyer only after the offer is made. Similarly, at the time of valuing a commercial property, income production becomes extremely important.
The main ratio that needs to be determined here is the NOI or the Net Operating Income, which is equivalent to income minus OS or Operating Expenses (does not include interest and taxes), as well as should be the main factor in assessing the amount that you are ready to pay/give for the real estate property. Following is the checklist for due diligence that you need to stick to conduct your investigation:
Due Diligence for Commercial Property
Due diligence for commercial property is important for ensuring that the property buyer is aware of what actually they are planning to buy. Commercial property due diligence entails physical inspection of the property, assessing the environmental conditions, title review, zoning needs, leases, contracts as well as survey.
Reviewing such documents includes:
· Special assessments
· Environmental assessments
· Any notice related to pending government or/and legal action.
· Copies of the property bills
· Service contracts
· Copies of the property bills (if any)
· The construction plans that are in the possession of the seller
· Warranties for construction (if any)
· Seller inspections
· Actual, existing use of property
· The deed
· Information about existing tenants
· Zoning documents that indicate permitted uses of property
· Land as well as improvement surveys
· Existing title insurance
· Other insurance
Apart from reviewing the above mentioned documents, the property buyers must also conduct an extensive independent investigation. In fact, the buyer can also ask the seller to conduct or/and pay for 3rd party assessments that you would want to get inspected, and also negotiate them to be included in the contract.
Residential Property Due Diligence
It is also important to conduct the due diligence of residential real estate property before making the offer. During the due diligence process of a real estate property, the buyer conduct:
· Inspection of the property
· Appraisals of the property
· Assessment of the environment
· Inspection of insurance documents
· Title and deed review
· Surveying documents
While residential and commercial due diligence entails a great deal of work, it must be carried out to understand if you are actually interested in the property or not and whether the property is what you really wanted. Inspecting the property thoroughly, researching about its ownership as well as regulatory history in addition to examining the contract that has been proposed is the ideal way of assessing the risks and value of the property.