Nobody would buy a car without seeing if it has a history of being in an accident, or hire an accountant without talking to someone who had had taxes prepared by him or her. Doing research on a person or organization before any papers are signed is known as “due diligence,” and it’s an important business step.
So then why would anyone buy a piece of property if they hadn’t already done due diligence on the land?
“Basically, as a buyer you’re going to want to know that after you buy the property you will be able to operate or develop the property for your intended use without any interruptions,” says John Morse, an attorney and member of the Real Estate Group at Barnes & Thornburg.
Smart Business spoke to Morse about the importance of due diligence when acquiring property.
What does due diligence consist of when acquiring land?
Let’s use an income-producing property as an example. The most important aspect is going to be with the leases. You’re going to want to get a sense of what the payment histories have been with respect to the tenants. You’re going to want to review the leases to insure that the tenants pay for everything you expect them to pay for. They will have a base rent obligation, but are they responsible for maintenance costs and real estate taxes as well? Are there obligations under the lease for the landlord to complete any build-out, or do the tenants have the right to an early termination?
If you purchase a vacant piece of property that you want to develop, you’re going to want to be sure that you reach out to the proper government bodies to make sure the zoning matches up with how you intend to use the property. You also need to make sure there will be utilities available for the property.
And there is always a concern over environmental issues. You must understand what the seller and prior users used the property for, so you can determine if there will be any environmental contamination.
Who is responsible for due diligence?
The buyer is typically responsible. Through negotiations and the buyer agreement, buyers should make sure that sellers deliver everything they have in their possession. That at least gives buyers a starting point. Especially with income producing properties, sellers are going to have copies of all of the leases. Everything buyers will want to look at will be in the seller’s possession.
If there are things the seller doesn’t have, or if the buyer wants to do his own investigation, then he just needs to hire a surveyor and an environmental engineer to make sure he is comfortable with the property he is buying.
Who carries out the due diligence?
Typically, there will be someone on the buyer’s side who will be the designated deal person who will review the due diligence. But in most cases this is where the real estate attorney comes in, because this is something we do every day and we are able to reach out to the right people to make the right determinations.
Do all companies need to do due diligence, or just the larger ones?
Everyone needs to do it because you don’t want to end up buying something where you take on liabilities that you didn’t contemplate in the first place. And if you’re a smaller company, you want to make sure you don’t spend money on something that you won’t be able to utilize the way you want.
If due diligence isn’t done and problems arise after the sale, who’s at fault?
Typically under a sales agreement, the seller affords the buyer an opportunity to do due diligence. Sellers are always hesitant to give extended representation and warranties with respect to the property, so if the buyer chooses not to do due diligence or misses something, normally the buyer will not have any recourse against the seller after the fact.
How long does due diligence take, and how long do the results last?
That’s always negotiable. It is important that the buyer leave enough time for the environmental assessment. I would never recommend a due diligence period of less than 45 days. If there are zoning issues, then you will need even more time, even up to three months.
It is important to remember that as a buyer you need to protect yourself from any potential liabilities. If the seller has a due diligence report that is three years old and you use that instead of commissioning an environmental engineer to do a new one, if there is contamination, you can’t defend yourself with the old report.
JOHN MORSE is an attorney and member of the Real Estate Group at Barnes & Thornburg. Reach him at (312) 214-5668 or [email protected].