Why Real Estate Investments Should Start From Property Due Diligence? Part 2

My first article on physical due diligence brought so much positive feedback so I decided to share even more valuable information on my second article. As I mentioned on my previous articles real estate investment due diligence process contains three different branches: physical, legal and business. All of them need to be scrutinized by independent professional bodies to prove or disprove the transparency of the investment. Legal due diligence is quite expensive and consumes certain amount of time to be properly executed, however spending money and time now helps to avoid problems that property may held. This applies no matter what kind of real estate you are buying, and especially with commercial real estate, because consumer protection laws that give home buyers some legal rights against sellers who violate those laws generally do not apply to investment property of any nature. You must be cautious and assume that the worst can happen even when dealing with noncommercial property.

I want to caution you about the legal responsibilities that you think the buyer or seller or their brokers might have in any real estate transaction. Laws that deal with fraud, misrepresentation, outright lying, theft, and that sort of thing will vary from country to country. But no matter what wrong is done to you, the ultimate problem may not be who is in the right but how much it will cost you to try to get a remedy. Legal actions of almost any kind can be long, expensive, and requires maintaining your composure. The tip I would like to give you is to avoid making the mistake of doing extensive and expensive due diligence without having a signed agreement that ties up the property. The reason should be obvious, but if you don’t see it, take note: There are many sellers who don’t want to give prospective buyers sufficient time to make these important investigations. Unless you feel you know so much about the property that you don’t need to do such inspections, then pass on properties where sellers balk at reasonable due diligence periods in purchase contracts. For more information on real estate investments, economics, asset management guidelines or due diligence please follow HeliosGroup.biz on Twitter, Facebook and LinkedIn platforms.

The areas that need to be assessed by your nominated solicitor are listed below. Never accept recommendation from the seller to use his legal team, always seek for independent solicitor with a proven track of record dealing with these issues in country of property purchase.

Survey and title:

A survey depicts not only the physical boundaries and dimensions of the improvements, but also certain other legal rights, including easements, encroachments, covenants, and rights of way. The aim of this process is a) determine that the title description shown on the survey is the same as that shown in the title report, b) Confirm exactly what real property is being acquired, c) establish all easements, Reciprocal Easement Agreements (REAs), Covenants, Conditions, and Restrictions (CC&Rs), and encroachments affecting the use of the property. Perhaps the most important concern is to see if there are any liens that should be discharged and released or any violations that need to be cleaned up. It is also important to determine if there are any zoning violations. Finally, any easements or encroachments that, if activated, would materially affect operation of the property. Since these actions will require negotiation and execution prior to close, discussions with the seller’s counsel should begin as soon as possible.

Entitlements:

Most properties are located in political jurisdictions that limit in some way the use of the property by the owner. Through the legal process, these jurisdictions establish the uses of a property to which an owner is “entitled.” Common entitlements may be: zoning, building codes, utility permits and similar. Discussions also should be held with the local planning, zoning, and building departments to understand any contemplated changes that might affect the future entitled status of the property. The main purpose of this review is to determine (1) whether the property complies with the applicable zoning ordinances and building codes, including setback, parking,10 height, and coverage limitations (floor/area ratio, or FAR), and (2) whether there have been any zoning or building code violations, particularly any life/safety violations. The review also analyzes the consequences of a “nonconforming structure” being destroyed or damaged by a casualty event.

Tenant Estoppel Certificates:

Tenant Estoppel Certificates are documents that verify certain lease information. Tenants are required in most leases to execute estoppels. (Estoppels forms may be negotiated in the Purchase Agreement.) In general, it is the seller’s responsibility to circulate and retrieve the estoppels. The estoppels process may take several weeks to complete, so it should be initiated early in the due diligence process.

Items usually covered in the estoppels include:

■ Location of space

■ Size of space (square feet)

■ Parking spaces

■ Outstanding improvement allowances due tenant

■ Subleasing arrangements

■ Any known tenant or landlord defaults under the lease

■ Security deposit

Once estoppels have been received by the buyer, they should be compared with the lease abstracts developed by the attorneys. Any changes or discrepancies should be noted.

Warranties:

The attorneys also should review warranties and guaranties to make certain they are transferable to the buyer. If the contracts require transfer fees, these should be arranged by the seller before close. The closing documents should identify service contracts that the buyer wishes to retain and warranties that he or she wishes transferred.

Service Contracts:

Purchase Agreements usually stipulate that the buyer has the right to assume or reject contracts for services such as trash removal, fire alarm monitoring, building security, landscaping, and janitorial services. Many of these contracts contain clauses that the buyer may find unacceptable, such as nonmarket rates, poor service response, or use of outdated equipment.

Other agreements:

Other agreements that should be included in the legal due diligence include partnership and joint venture agreements, agreements requiring third-party consent, and broker/finder agreements.

Remember to cover all aspects of legal due diligence. This is the most overlooked aspect of all. Don’t wait until you get past your due diligence period to make this kind of a comparison. It is easy for you to miss out on something if you let all the inspections go on separately without some coordination. Your lawyer is checking the contract, the title, and that sort of thing. But if you are not aware of the problems that he or she has uncovered, there may be another complication that should have been double-checked but wasn’t. Be sure that all the inspectors have actually seen the property. That is the only time they may notice that something is missing.