‘Trust but verify’ in due diligence
When you go under contract to buy a piece of commercial real estate, you will always want the seller to give you a period of time to do due diligence. In other words, you will need to insist upon a contractual period of time to make sure the property is all it’s cracked up to be. You will want time (30-60-90 days) to investigate and verify all aspects of the property that contribute to its value.
The type and amount of due diligence that is done by a buyer is a function of the type of property being purchased (office, retail, industrial, multi-family, land) and the relative size of the purchase. If, during the contractual due diligence period, you find out information that taints the purchase in some material way, you can either go back and renegotiate the deal or walk away and get back your earnest money.
In most contracts to purchase commercial real estate, the buyer asks the seller to produce certain “deliverables.” These are documents, studies, reports, plans or tests that the seller might have in his possession that will confirm or verify what the buyer has been led to believe about the property. For example, if the property is being sold as a 15,000-square-foot building on 2 acres, a survey would demonstrate that information to be accurate (or not). Of course the buyer or his lender might insist that the seller provide a current survey just to make sure nothing changed since the original one. Another example would be where the seller represented the property to have a B-2 zoning classification and the buyer took a trip to City Hall to confirm that critical piece of information. That’s what’s called doing your due diligence.
According to the Ontario Real Estate Association Blog (2/27/13 – “What is Due Diligence?”): “In commercial real estate, due diligence means taking all reasonable steps to confirm financial, legal, structural, zoning and environmental concerns. It is a lot more expansive than due diligence for residential real estate.” If a buyer is not careful and does not exercise his right to perform due diligence while he can, he can get stuck with a piece of property that isn’t worth what he paid for it.
Unfortunately, in a real estate transaction, you cannot assume the seller’s representations about his property are true and accurate. Some sellers are outright devious and conspire to hide certain pertinent information about the property. Does the roof or basement leak or have they ever leaked? Or do you have an underground gasoline or oil storage tank? These are examples of questions that some sellers on rare occasion don’t come clean. I have found most sellers to be honorable but I would be hard pressed to tell a buyer to “take the seller’s word for it.” Trust but verify is the operative approach when performing due diligence.
There are professional firms that specialize in performing due diligence for their real estate clients. If the process is more than you can handle between yourself and your attorney, you might want to looks into hiring such a firm. According to Bruce E. Gudin, Esq. (5/29/02 – “Performing Your Due Diligence”): “The benefits of having an independent evaluation ensures that an enlightened and clear assessment of a project’s potential and pitfalls will be exposed.”
What’s the buyer’s broker’s role in the process of due diligence? Buyers routinely ask their brokers, “what do you think?” about any number of aspects of the transaction. Our professional opinions are sought as a means of gathering information on which to base a buy or no-buy decision. As brokers, we have to be exceedingly careful not to speculate. Buyers always ask me, “How’s the roof?” You can bet I’ve never been ON the roof and I usually can’t see it from the ground, so all I say is whether I’ve seen any water leaks during the showing process and whether the owner told me when the roof was last replaced or worked on. I always say to the buyer that he should have a roofer check it out. Buyers are notorious for coming back to the broker if something goes wrong after the closing which is why we have to carry Errors and Omissions insurance.
“The function of due diligence is to independently verify all representations made by a prospective seller as well as to uncover pertinent facts which have not been disclosed but which are important to the buyer.” (Grudin).
If you’d like a due diligence checklist for a transaction you’re involved with, give us a call.
• Joe Billitteri is a broker associate for Premier Commercial Realty. Email firstname.lastname@example.org. Phone 847-854-2300