Before finalizing a new acquisition, development, disposition or lending deal, the due diligence process allows investors to thoroughly vet the deal, ensure that it aligns with their investment strategy, and identify any potential red flags. A thorough due diligence process acts as the final buffer between the initial screening, often driven by data analytics and the investment itself. Because every deal is unique, due diligence checklists can be thorough, often to the point that they become overwhelming. As you evaluate new deals, these are the main real estate due diligence checklist items you should bear in mind.
Breaking Down the Real Estate Due Diligence Process
Investors rely on real estate investment due diligence checklists to ensure that they’ve identified all potential risks a new deal holds. Throughout this process, the goal is to identify and understand any risk that could threaten the deal’s projected ROI.
All firms follow a unique real estate due diligence process that’s shaped by their own pipeline management process, as well as special considerations based on the deal type and other specific factors. For simplicity’s sake, this list will break down due diligence into two phases: the preliminary checklist, and the more formal underwriting process that comes later on.
Investment management teams work scrupulously to ensure that no stone is left unturned throughout the due diligence process. The preliminary stage is the first round of thorough inspections into regulations, tax implications and other factors that could preclude profitability. By illuminating potential issues early on, investors can discard unworthy deals before devoting valuable time. While all investments include due diligence, these processes are catered toward traditional building acquisitions and land purchases.
Throughout your preliminary real estate due diligence process, review or address the following items:
- Current title policy, along with other related documents
- Development and construction plans, including as-built, architectural, engineering, and any other relevant plans
- Property condition report
- All government-issued documentation relevant to the building, including permits, certificates of occupancy, warranties, government notices, special assessments, code violations and unexpired guaranties
- Property tax bills within the last three years, which includes special assessments and incentives
- Energy and utility bills from the prior two years
- All relevant environmental and energy reports
- Capital expenditures
- Documentation of any personal property currently on the land
- Add costs for identified issues to determine potential costs
Following these steps, investors generally understand enough about the property to determine whether the risks present outweigh the potential ROI. If properties pass this phase of the process, they may move on for a more detailed evaluation.
Site Underwriting Due Diligence Checklist
Further along in the deal lifecycle, investors perform the site underwriting process. This second leg of the real estate due diligence process is the final opportunity for investors to vet the property and learn everything they need to know.
Because the site underwriting process typically involves a deep dive into the property’s legal and financial standings, it can involve multiple parties and take a month or more to complete.
While underwriting the property, review or address the following items:
- Insurance policies currently in place, as well as any filed claims
- ALTA (American Land Title Association) survey, as well as other topographical surveys
- All impending and in-process litigation that could impact the future property owner
- Letter of intent and client authorization letter
- Site inspection to investigate the property’s location within the market, accessibility, and to gain first-hand insight into other variables
- Review the purchase contract
- Review the property’s legal description
- Review the zoning compliance certificate
- Current liens
- Encroachments from neighboring properties
- Recent or past appraisals of the property
- Review pro forma information
- Review any binding legalities governing how the property can be used, including covenants, conditions, restrictions, reservations and easements
- Request a profile of the existing tenant or tenants, which includes their credit ratings
- Review current tenant leases and abstracts, including amendments
- Review SNDAs (subordination non-disturbance and attornment agreement) currently in effect, unless the property is a multifamily unit
- Review up-to-date rent roll including expenses ancillary tenant expenses, such as security deposits, real estate taxes, security deposits and CAM billings
- Review service contracts to determine if cancellation incurs penalty expenses
- Review tenant sales report, aged receivables report and a list of security deposits
- Interviews with current tenants
- Interviews with the local municipality
- CAM (common area maintenance) recommendations for how tenants should contribute to building fees
- Confirm parking aligns with government regulations, as well as practical and contractual needs
- Demographic research and analysis of the surrounding area
- Perform a competitive analysis
- Compare selling price against deal comps from similar opportunities
- Compare lease financials against similar deals
- Perform a year-over-year cash flow analysis
After exhausting this list, investors generally know everything they need to in order to make a final determination on the deal’s potential before moving forward to raising capital. While meticulous attention to detail may cause the underwriting process to drag on, it often pays off. Detailed property reports often play a significant role in bolstering confidence from other investors and while raising capital for a deal.
Digitally Systematizing the Real Estate Due Diligence Checklist
At a high level, the goal of due diligence is always to ensure that no minor details slip through the cracks, which might otherwise cause investors to incur unexpected expenses further down the line. Not all due diligence processes are the same, though. Depending on the property type, location, and countless other factors according to your firm’s preferred level of scrutiny, additional steps are usually necessary.
Real estate due diligence checklists were once based entirely in Excel spreadsheets. This frequently presented bottlenecks for teams without a clear process for passing data along throughout the asset lifecycle. Especially for deals under tight time constraints, it also made collaborating in real time a challenge. Analysts had no choice but to request due diligence information from external third parties, like legal counsel, then manually record it in a spreadsheet.
Deal management software like Dealpath has simplified the way teams track real estate due diligence checklists. To streamline the process, firms can create standardized real estate due diligence checklists within investment software to apply to every deal, with configurable templates based on the property type and other factors. This process is not only easily repeatable, but also enables firms to assign tasks and hold analysts accountable, while maintaining a high-level overview. Additionally, deal-based caveats can add unique, conditional steps based on certain factors. For example, land purchase due diligence checklists may vary between Massachusetts and Wyoming, and standardized checklists would reflect those differences.
Creating Visibility and Accountability
Standardizing due diligence checklists benefits firms in a number of other ways. After data is passed from the acquisition team to another team, deal management platforms ensure that all changes are tracked, and that up-to-date data is readily available to the entire organization. In many instances, third parties can also access the software to directly input information they’re accountable to obtain. If an analyst leaves for vacation in the middle of the due diligence phase, executives and teammates can simply check the task list to easily find remaining tasks. When new analysts come on board, this standardized checklist clearly articulates required tasks.
By standardizing due diligence checklists in a deal management platform, your team can work faster, more collaboratively and efficiently, and deliver results at scale.
Take Your Real Estate Due Diligence Checklist to the Cloud
Due diligence is inevitably a collaborative process, but many teams without modernized technology struggle to piece together data and checklists across various systems. Nonetheless, like all other steps throughout the investment process, maintaining clear visibility into how deals are progressing is crucial.
Download this e-book to learn how modern deal teams grow competitive portfolios by managing due diligence in a cloud-based tool. After reading the e-book, you’ll understand why deal teams standardize processes and collaborate in lockstep.