It’s easy to talk about due diligence and check off the boxes in theory, but it’s another to practice it thoroughly.
When working with a commercial developer, a prospective buyer, a real estate broker, or whomever, it’s important to know due diligence is being done, and being done right. It's an integral part to starting the commercial real estate development process. Performing it properly can MAKE a development project – committing too many mistakes can BREAK a development project.
That’s why we want to take a look at some of the most common mistakes that occur in the due diligence process. Here are 7 of the most common due diligence mistakes.
1) Improper Site Valuation
Being too aggressive when it comes to underwriting the deal and failure to obtain enough (and accurate) comps can lead to improperly valuing the property. Estimating the value of real estate is necessary for a variety of endeavors, including financing, sales listing, investment analysis, property insurance, and taxation. So, improper site valuation can have a significant trickle-down effect on the entire commercial real estate project.
2) Misinterpreting Lender Requirements
Lenders consider several different variables you might not factor in, including intended use and environmental issues. Before moving forward it’s important to understand exactly what your lender requires and why. Failing to do so can mean lost time, money, and energy during due diligence.
3) Overlooking What Site Requirements Are Needed
When developing commercial property, knowing any and ALL requirements that are needed to bring the property up to municipal standards goes a long way in determining the viability of a project. In many cases, some requirements slip through the cracks and create numbing headaches down the road. The later in the project that these requirements are addressed means the more you’re going to have to pay and the longer your timetable will end up being.
4) Assuming Third Party Reports Are OK
Lenders can sometimes require that they give the approval to use third-party vendors for various site inspections. Making the assumption that you can use any third-party vendor or consultant is a common mistake that can add significant cost to a project. Mistakenly having to pay two different vendors for the same report costs much more than time; it is very expensive.
As a rule of thumb, if you’re not sure if your lender needs to approve of someone, ask anyway.
5) Assuming Seller Has Disclosed All Issues
Unfortunately, not all sellers are forthcoming about past and/or potential issues on their site. Not digging deep enough into the site’s history is a big no-no. Even if a seller has inspections and reports on-hand, it’s vital to review the reports and inspect the property yourself so you can get the assurance that everything is in compliance. Assume nothing.
6) Expecting the Closing Statement to Be Error Free
While reviewing any type of legal documentation should be done with the utmost diligence, ensuring the closing statement is error-free is crucial. The buyer needs to carefully review and scrutinize all entries listed on the closing statement and note any items that might have been omitted.
Making assumptions that all the previously discussed items are correct can be costly.
7) Failure to Thoroughly Review Title Issues
A thorough review of title issues is a must, this goes for both exceptions AND requirements. There may be a document recorded on the title (an exception) that limits or prevents certain developer’s actions, such as use restrictions or access issues.
There may also be something the title company needs (a requirement) that is difficult to obtain, such as evidence of probate or removal of liens. Mistakes in title review can cause delays in projects.
Learning from your mistakes is one of the most valuable lessons we can learn. But sometimes it’s also valuable to know how to avoid those mistakes in the first place. Take the time to thoroughly handle the due diligence process. Don’t make assumptions.