Due Diligence explained
Due diligence, according to Investopedia, is an investigation, audit, or review performed to confirm facts or details of a matter under consideration. In the real estate world, due diligence requires a buyer or an investor to embark on a fact finding journey by critically examining the legal, physical, environmental, financial and economic conditions of the property, and confirming every information supplied by the seller or his agent before agreeing to transact with the seller. Due diligence is primarily done to establish ownership of the property and to ensure that the property is free from all encumbrances.
Effect of one not carrying out real estate due diligence
In Nigeria and most developing countries of the world, it is difficult to establish ownership as there are obstacles to legality of landed properties ownership. This is connected to the fact that the property market is imperfect, and the system of gathering real estate data is inadequate to give adequate information about the property market. Many people, while investing in real estate have in some cases acquired landed properties from those (scammers) who have no legal interest in the subject properties; some acquired properties that fall under compulsory acquisition by the government while some bought unprofitable properties. All these happened because they failed to carry out due diligence on the subject property. It is therefore important to do some background checks before investing in real estate.
Things to look out for when carrying out real estate due diligence
On your fact finding journey, it is important that you have a checklist of what you need to look at before buying properties. While the list is exhaustive, the following are crucial and form the basis for carrying out property due diligence.
- Physical Features of the property
This involves you to inspect the property physically, checking the state of the land or building. In case it is land, you need to know the topography, dimension of the land, flood zone verification, drainage systems and other land components. In case it is a building, you need to physically inspect the structural elements such as the foundation, wall, and roof. Also, you need to check the utilities and mechanical systems such as plumbing and HVAC. Doing this will help you to know what the property looks like; what level of repairs is required (if it is an old building) and to eventually determine whether you can commit your funds on the property.
- Legal Conditions
The legal condition of any property states the interest an owner has in a property, and to the extent to which an owner can exercise proprietary rights. When investing in landed properties, you must ascertain that the property genuinely belongs to the vendor i.e. the seller. Therefore, you will need to conduct a title search, this is done by collecting the title documents available on the land and confirming the authenticity at the appropriate places such as the land registry in your state.
Also, you need to chart the land to ensure that the subject property is not subject to compulsory acquisition i.e. lands that are earmarked by the government for public uses. The implication of acquiring such properties is that the government may acquire it from you in the nearest future thereby, losing your investment.
To ascertain authenticity of an interest in property, you may need to consult any of these professionals; a legal practitioner, land surveyor, and an estate surveyor and valuer
- Economic condition of the property
The economic condition of a property is usually concerned with the economic value of a property, this is what the property can be exchanged for in the open market (usually the actual price of a property) between a willing seller and a willing buyer in an arm’s length transaction where both parties act knowledgeable and without compulsion. Therefore, while buying any property, you need to determine the economic worth so that you don’t pay higher or lesser than the actual value of the property. To do this, you need to engage the service of an estate surveyor and valuer, a professional who determines the value of an asset.
- Financial condition
In case you are buying an investment property, you need to ascertain that the property is profitable. To do this, you need to collect the financial statements that shows the income and expenditure on the property for example collecting financial statements showing the rent collected from tenants, and the amount expended on outgoings, or collecting the financial records of a filling station, hotels and other investment properties to determine the rate of turn over.
- Environmental conditions
The environmental conditions of the surrounding areas of the subject property must be thoroughly examined, you don’t want to invest in an area where your investment is adversely affected by environmental pollution, bad water, erosion and other environmental hazards.
Process of real estate due diligence
- Making enquiry
When you have identified a property you like to purchase, you need to make an inquiry from the property owner or their agent to confirm that the property is available for sale. In some cases, ‘for sale’ banners are placed on properties while in some cases vendors would like to sell their property discreetly, either ways, it is important to make enquiry about the market availability, status, price, title documents and other necessary information you need to know about the subject property.
- Physical inspection of property
Once you confirm the market availability of the property, it is necessary that you inspect the property to be sure that it is what you want and are willing to commit funds on.
- Valuation of property
After you have inspected the property and you are satisfied with its condition, it is important that you engage the service of an Estate Surveyor and Valuer to help you determine the fair market value of the property, this is to ensure that you are not overpaying for a property but rather help you in negotiating price with the vendor, thereby increasing your chance of buying the property cheaper than it is advertised.
- Letter of intent
At this stage, you write a letter of intent to the vendor to express your intention of buying the property, you may include an amount you are willing to pay for the subject property based on your idea of the fair market value. Also, in your letter of intent, you need to request for the title documents available so as to aid your title search.
- Receiving offer letter
Offer letter is written to you by the vendor or his agent, stating his willingness to sell, the sales price, condition of the property and title document.
- Conducting title search
This is the core and a critical aspect of real estate due diligence. At this stage, you confirm every information supplied to you by the vendor; the documents to request for includes certificate of occupancy (C of O), deed of conveyance/ governor’s consent, original purchase receipt, deed of assignment, survey plan and other title that may be available on the subject property. These documents will then be confirmed at the land registry, ministry of town and physical planning. This is to ensure that the land is not subject to compulsory acquisition by the government and to establish that the land truly belongs to the vendor claiming ownership title to land.
- Contractual agreement
Once you have ascertained that the title to land is genuine, you may now pay for the property and enter into a sales agreement with the seller, as well as ensuring that title to land is transferred to you.
Although the process of carrying out real estate due diligence might be complex and critical, it is indeed a crucial stage in any real estate acquisition, therefore, you must ensure that no stone is left unturned while purchasing a property in order to have peace of mind and safeguard your investment.
Moses Ibukunoluwa Adepoju.