The concept of due diligence should be familiar to you in the context of commercial company transactions. This is a process in which the acquiring company examines the acquired company to ensure that the details of the transaction correspond to the reality. In the real estate world and especially in the real estate investment sector, due diligence is gain special importance. The complexity of the real estate transactions combined with numerous details of importance in the transaction make the due diligence examination – a pre-purchase examination – a significant and a crucial activity.
Just as you will not consider purchasing a car without a pre-purchase inspection, the same applies in real estate – do not move ahead before receiving and checking all the necessary details.
Types of due diligence
Different assets and different real estate deals require a respective type of due diligence process.
It is important to note that the process required before purchasing an asset directly, buying from a company or purchase via real estate fund may vary and have different emphases. The due diligence for a single home will differ from purchasing an apartment complex for rent or an asset designated for renovation or improvement.
Your target – reducing the risk
Due diligence is intended to minimize the level of risk that the buyer takes in a real estate transaction and to collect all the relevant data that may affect the profitability of the investment. In addition, due diligence reduces the likelihood of additional expenses after the acquisition and may affect on the yield.
In the real estate markets there are many professionals who specialize in performing due diligence I for real estate assets. The type of transaction you wish to perform dictates to a large extent the type of the procedure required before the actual closing of the transaction.
In what cases will due diligence be required?
Buying a property overseas – the due diligence examination will include checking the condition of the asset and the level of the required renovations and/or investments, the examination of the relevant documents so that the transfer of ownership will be properly carried out and of course the examination of the area in which the asset is located – its quality and the investment history and profitability expected from the purchased property.
Transactions requiring financing from financial institutions abroad – due diligence will relate not only to the asset but also to the financial conditions of all those involved in the transaction. The financing entities would expect to receive a full picture of the quality of the property itself, the risks related to the area in which the asset is located, in order to assess the risk and the safe return of the funding.
Transactions involving investment companies or real estate funds – in this case, in addition to the asset inspection, the due diligence will address the strength of the companies, their business history, other transactions they have performed and their experience in acquiring, maintaining and managing similar assets. Your risk will grow once you are involved with inexperienced companies who are performing the deal for the first time.
Complex transactions with respect to special assets or commercial properties – in such cases, due to the complexity of the transaction (usually multi-family assets in which an asset is purchased including several leased units or commercial mixed purpose assets), the due diligence must also include the examination of the tenants and the various relate parameters – contracts, risk level of lessees, investments in renovation and maintenance, and more.
What might include a due diligence process?
Among other things, a due diligence examination for a real estate transaction should include the following:
- Value of land and value of built-up assets
- Planning, legal and environmental limitations
- Costs related to pre-acquisition repairs, current maintenance and equipment investments
- Issues related to property insurance
- Checking the owners and, if necessary, the tenants and other related parties
- Examination of documents relevant to the transaction – documents of ownership, registrations, etc.
- Examination of the various municipal and legal restrictions – changes in designation, restrictions on construction and future planning and zoning
- Issues related to taxation
- Examination of economic feasibility and potential yield calculations – income, expenses and financing
- Structure audit – the state of the property, the area, environment, neighbors and more
- Business and economic examination of entities involved in the transaction – robustness, business analysis
This is only a partial list and there are also additional tests that may be added, depending on the type and complexity of the transaction. The complexity of due diligence requires cautious approach, consultation and expert participation, but in the end of the day it is a process and investment that greatly reduces the degree of risk and greatly improves the buyer’s ability to make an optimal and worthwhile transaction.