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Real estate due diligence is the process that encompasses all the actions that go into investigating and analyzing a site’s potential risks and opportunities before a transaction is finalized. By conducting a thorough diligence process, you can mitigate risk over the lifecycle of a project, get an accurate picture of the project’s financial health, and discover potential opportunities to lower costs and boost returns. Considering all factors - from inspecting a property’s structural integrity to ensuring you can meet zoning requirements - is necessary for a project’s success.
Since the process can be complex and contain multiple steps, relying on a due diligence checklist can help you ensure all the necessary precautions and assessments have been completed. Digitizing your due diligence checklist can offer further benefits, allowing you to keep track of key documents more easily and boost communication among stakeholders.
Here, you’ll learn about the essential items to include on your due diligence checklist, from property and title review through environmental evaluation of the site, as well as tips for leveraging technology to modernize your process.
Understanding Real Estate Due Diligence
Real estate due diligence is the process of fact-finding around a property's physical and financial condition and conducting market research. Owners, developers, and investors are all likely to complete the assessments involved in the process. In most cases, a seller will sign the Letter of Intent (LOI) and offer a due diligence period, during which time the buyer will invest time and funds into analyzing the feasibility of the project. The due diligence process is vital to understanding the potential risks and opportunities associated with a given property.
By conducting a comprehensive due diligence process, you can identify potential issues with the property’s financial, legal, physical, environmental, or operational components. Due diligence allows you to be proactive and decisive; you can either take the necessary steps to manage or avoid potential issues before they arise or decide the property is too risky an investment to move forward with.
Budgeting can also be improved through due diligence. Financial analysis can help you get an accurate property valuation and project future returns. By understanding a project’s finances in more detail, you can make sure you’re paying a fair price for the acquisition, and your budget for the project won’t have dramatic overruns.
The main aspects you will want to review in your real estate due diligence checklist will be the legal, financial, physical, and environmental components of a project. See what tasks might be necessary in each of these categories and start creating your own due diligence checklist with our guide in the next section.
Real Estate Due Diligence Checklist - A Comprehensive Guide
Development teams should be prepared to conduct a thorough real estate due diligence process once the Purchase and Sale Agreement has been approved and the seller sets the agreed-upon period. Consulting a real estate due diligence checklist can help you move through the stages more deliberately and make sure no key steps or assessments are forgotten. Below, you’ll find key steps to include on your real estate due diligence checklist as you go from title review to closing.
Property and Title Review
Property and title review should come up in the first stage of the process, as this will help you ensure the property’s legal ownership is clear, transferable, and free from any complications. In the property and title review process, make sure the following tasks have been completed:
- Conduct a comprehensive title search to uncover any potential hidden risks on the property, working with an attorney on the review process to uncover any potential legal entanglements.
- Review Title Insurance policy to understand what risks are being covered or relevant exclusions and exceptions
- Confirm the property conditions match the conditions on the title and survey before the sale
- Obtain information about the ownership chain, or the historical sequence of ownership transfers on the property, to make sure the title is clear and marketable
- Look for any potential liens, mortgages, or disputes on the property that could impact the property’s ownership or use.
- Ensure the owner of the property is the sole owner and not a part owner trying to sell the property out from under other stakeholders.
- Complete an ALTA survey to obtain critical information about the title insurance company and the parties involved in the transaction.
Physical inspection often occurs as part of post-offer due diligence, which will allow you to identify any structural issues, and by undertaking several steps, you can ensure a property is ready for development.
- Begin with a general inspection involving structural items such as foundation and roof,
- Conduct a geotechnical assessment to uncover important factors such as soil-bearing capacities, water-table elevations, and any other seismic concerns on the site
- Evaluate utilities such as electrical, plumbing, and HVAC systems, including maintenance history and potential efficiency or environmental upgrades
- Obtain will-serve letters to confirm if a particular utility (water, gas, etc.) is available on your project site
- Assess environmental risks or other safety hazards such as lead paint, asbestos, or other contaminants requiring remediation or mitigation
- Seek a flood zone verification to see if the property requires additional insurance coverage
- Check out current parking capacity and road access points to ensure facilities meet local zoning requirements and occupant’s needs
- Take photographs and videos of the property to accurately document conditions ahead of acquisition or development for legal purposes
Legal and Compliance Checklist
Be sure to review and assess the following documents as part of the legal and compliance section of your due diligence process.
- Obtain a letter of intent and client authorization letter
- Discover all binding legalities for property use, including restrictions, covenants, historical conservation easements, or other conditions
- Reach out to local planning boards or other regulatory authorities to establish a relationship in case rezoning or other compliance concerns arise
- Identify any land encroachments or land disputes that might disrupt the development process moving forward
- Seek out all impending or current litigation that could affect the property’s owner
- Ensure the property is not on a historical preservation list or subject to historical preservation efforts in the future
Financial analysis is a key step in your due diligence process, allowing you to assess risk and get an accurate valuation before making a budget. Below are a few considerations you should make before finalizing your purchase of a property:
- Compile pro forma financial projections for your project, estimating future revenues, expenses, and cash flow
- Calculate key return metrics such as net operating income (NOI), Internal Rate of Return (IRR), and cap rates
- Estimate capital expenditures required for the property, including roof replacements, HVAC upgrades, or other large, one-time investments that might come up
- Review all insurance policies currently in place, including all filed claims
- Conduct thorough market analysis, including comparable deals on similar projects in your area
- Consider demographic research and analysis of the surrounding area to determine trends (such as increased interest in residential mixed-use housing or decreased use of office space) to help ensure your project’s profitability
Environmental review will also help you ensure a property is compliant with regulations and avoid potential liabilities. The following steps can help you keep compliant with environmental review:
- Conduct a Phase 1 Environmental Site Assessment (ESA), which includes a site visit from an environmental consultant to observe current and past conditions of a property or adjacent properties and a review of historical records, aerial maps, and regulatory databases to identify environmental concerns
- Evaluate the property’s compliance with environmental zoning laws, including land use and waste disposal regulations
- Consider a Phase II Environmental Site Assessment (ESA) if necessary; Phase II ESA is typically more substantial and will typically require permission from the seller to drill for soil or groundwater
Digitizing the Real Estate Due Diligence Process
Digitizing your real estate due diligence process can further benefit your team, making the process more accurate and efficient. Historically, development teams have relied on outdated and error-prone spreadsheets to organize due diligence timelines and compile the financial, legal, and regulatory documents related to the process. Due diligence typically requires extensive collaboration with third-party stakeholders - such as representatives from environmental agencies or local planning boards - and key paperwork is at risk of getting lost in the shuffle.
Modern real estate development software can help you get faster access to your relevant due diligence documents, By centralizing due diligence documents, reports, and key project data, all stakeholders will have access to up-to-date information, avoiding duplication or other potential mistakes. In addition, the platform can increase visibility among stakeholders throughout the process, providing real-time updates and facilitating easy communication. Northspyre’s platform can increase the reliability and efficiency of your due diligence checklist by syncing with your email-based workflows to capture key data from relevant project documents.
Real estate due diligence is vital for avoiding unexpected challenges in the development process and ensuring your projects are a success. Due diligence can significantly mitigate risk, from confirming the property is structurally sound to preventing legal or regulatory obstacles from derailing your construction timeline. You may never be able to predict all scenarios that arise over the lifecycle of a complex development project, but putting together a comprehensive, digitized due diligence checklist can get your projects off to the best possible start.
Download our white paper, Commercial Real Estate Needs to Rethink Its Relationship With Excel, to learn more about how technology aligns with your modern development needs.
Tag(s): Real Estate Development
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