Buyers and sellers of real estate assets may not be completely aware of the tasks that are necessary to fully analyze and evaluate a property during the “due diligence period.” The due diligence period plays an important role in real estate, and involved parties should be familiar with the basic concepts, otherwise they will eventually face its legal and financial implications.
What does due diligence mean in real estate?
The legal definition of due diligence is the level of care, prudence and activity a person or company would have to take to acquire objective and reliable information prior to a specific event or decision.
In real estate, due diligence includes reviewing documents, financial calculations, and evaluating risks. It is essentially the “doing your homework” part of real estate. When RE agents bring up due diligence, they usually refer to either the buyer’s research prior to making an offer or the contingency period before to the final closing.
Real estate due diligence period
During real estate transactions, the due diligence period typically starts as soon as the Purchase and Sale Agreement (PSA) has been accepted by both buyer and seller, and contractual deposits have been made. During this contingency period, the buyer collects all the information about the property to help in making a final decision about whether they will proceed with the transaction or not.
The due diligence period time frame
The time frame for due diligence can vary depending on the terms of the PSA, which is agreed to by the parties involved in the transaction. A typical due diligence period runs between 30-90 days, however, some more complex transactions can have due diligence periods that greatly exceed that time frame. During that window there are often required time frames for specific contingency items dictated by state law or negotiated between the parties.
What is involved in due diligence?
If you are the buyer in purchasing a real estate asset, you would use the due diligence period to obtain and review detailed documented information related to the property. This includes a variety of tasks:
- Primary research on items such as zoning and building permits, title and title exceptions, demographics, traffic, noise, hazardous materials, earthquake faults, etc. Some real estate agents assist with this but the buyer can enlist real estate consultants as well.
- If a buyer is a real estate investor, and the goal is to acquire an income producing property, they or their real estate consultant will investigate economic factors such as market supply and demand, comparable rents, vacancies, operating expenses, real property taxes, and insurance.
- Most properties include existing buildings or structures. For performing due diligence on the state of the buildings, astute buyers will often hire a professional to carry out an inspection. This is often done by hiring an engineer or building consultant to conduct a commercial property inspection and create a property condition report.
- For undeveloped properties, the due diligence for raw land should involve more engineering expertise for development feasibility.
- Depending on the location (such as near current or historical industrial/processing facilities), performing environmental due diligence can be prudent as well, sometimes going as deep as investigating environmental subsurface conditions.
During the due diligence period, the seller would have to make all the legally required disclosures and has the responsibility to provide access to the property for inspections.
What about the earnest money deposit?
The earnest money deposit is a contractual deposit spelled out in the PSA. It’s paid by the buyer according to the terms of the PSA. The deposit is held by the seller, or an agreed upon third party, until the termination of the due diligence period.
At any time prior to the conclusion of the due diligence period, if the buyer decides not to proceed with the transaction, the deposit is typically returned to the buyer and the transaction terminates. If the buyer intends to proceed with the transaction, the deposit is usually released to the seller and is credited to the buyer as part of its purchase price.
If the buyer defaults or decides against proceeding with the transaction after the expiration of the due diligence period, the deposit is typically released to the seller and forfeited by the buyer.
Expert consulting on real estate due diligence
VERTEX is a global real estate consulting company dedicated to ensuring that our clients’ interests are fully protected against risks associated with their real estate matters. We conduct thorough examinations and analyses of your real estate assets and related real estate matters across the United States, Mexico, Canada, and other parts of the world. We report our findings in a timely manner, allowing you to make informed decisions related to your real estate acquisitions. Get in touch with VERTEX’s experienced engineering, construction and real estate professionals for reliable assistance with your due diligence. Protect your financial interests by partnering with the leading experts in the industry.