What does due diligence mean in a real estate contract?
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 before a specific event or decision. In real estate, due diligence includes reviewing documents, financial calculations, and evaluating risks.
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 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.
Real Estate due diligence is the research that a buyer’s attorney performs on behalf of a buyer to help the buyer determine if they should sign a sales contract. It’s conducted after an offer is accepted but before the contract is signed. Diligence is one of the only ways to help to reveal any possible “red flags” that would deter the buyer from moving forward with a transaction.