The Importance of Due Diligence In Real Estate Acquisition

What is Real Estate Due Diligence?

Real Estate due diligence (REDD) is an investigation aimed at uncovering any existing risks or defects in a real estate asset.

This is arguably the most important step a purchaser or investor would take before closing a deal.

 A property may look like a good buy material, however reasons might exist why it should not be bought at all or why it should be bought below its offered price.

Steps to Effective Real Estate Due Diligence

The type and level of due diligence to be done depends on the asset class, the vendor, the nature of title involved and the purpose of the investment.

For instance, some commercial properties such as filling stations or hotels may require more extensive investigation when compared to residential properties.

Notwithstanding, it is always important to follow these three basic steps when doing REDD.

Physical Inspection (PI)

The investor must engage a professional to carry out a thorough investigation of exteriors and interiors if he is planning to buy a developed property. 

PI is meant to uncover any structural defects existing on the property. The obvious defects can be a leaking roof, cracks on the walls, termite infestation, etc. Some non-obvious defects such as easement rights, environmental hazards, porous security issues and high crime rates within the area are also very crucial in REDD. For example a residential property in an area where child kidnapping is rampant may not be a good choice for a family looking to acquire a home.

Land Charting (LC)

PI would uncover any defect in the physical structure of the property, but LC is meant to confirm the status of the land.

Consequently, a survey expert must visit the property, obtain its coordinates and apply for charting information. 

Upon charting the land, the purchaser would be issued a land certificate that says that the land is free, acquired or committed.

A committed or acquired land is definitely not a good investment choice.

Title Investigation (TI)

Title investigation involves verifying the ownership rights of the vendor. It also involves understanding if there are any other third party claims to the property either by way of a mortgage transaction or other encumbrances.

TI might either involve a series of checks or a simple straight forward check depending on the vendor, the type of property and the nature of title. The purpose is to ensure that upon closure, the purchaser can obtain title to the property free from any third party obligations.

During TI, the purchaser’s solicitor checks to see if the property is not a subject of any pending or inconclusive litigation. He must also investigate if the property was used as a collateral for any loans, mortgage transaction or charges that are still pending.

If the property was inherited, the purchaser must be able to verify that the vendors are the authorized executors, administrators or legal recipients through a conveyance instrument such as deed of assent or deed of gift. 

How is Due Diligence Conducted?

REDD is a thorough property assessment which can be executed through physical inspection, interaction with third parties and other steps that can help to verify all previous assumptions about the property. It also involves verifying the ownership status of the property in order to avoid fraud.

At the conclusion of the investigation, the solicitor would make a report of his findings and advise the purchaser on whether to proceed or to withdraw from the transaction.

Why is due diligence important in real estate investment?

Due diligence is very important because it helps to uncover potential risks in an investment. You cannot determine if there are any defects in a property unless a thorough investigation is carried out.

It is obvious that most vendors would not be willing to disclosing the defects in his asset in order to sell at an advantageous price. It is also possible that the vendor is aware of the risks associated with the asset and may be looking to dispose it to an unsuspecting investor.

It is highly risky to purchase a property without first investigating the physical and legal status of the property. A purchaser might be exposed to the risk of fraud, pending litigation on the property, or the inability to obtain the title of the property.

Also, effective due diligence would help the purchaser make a better investment decision. For instance, the due diligence might help to uncover structural damages that may be costly to repair, or unpaid taxes, utility bills and other debts that the vendor had refused to pay.