For many people, due diligence is not a common phrase but it is something that every purchaser should consider if you are buying a commercial investment, residential property or business.
In short, due diligence is the process of researching, analysing and understanding the key legal and commercial risks of a property or business before buying it. Sensible purchasers will make an offer on the property or business subject to (or “conditional on”) due diligence. In the current “hot” market where demand for property is high and auction is the preferred sale method, this is not always possible.
Unfortunately, we are increasingly seeing purchasers making unconditional offers on properties and businesses without doing due diligence first. This can result in unwanted surprises later down the line.
Commercial Property Investors
In particular, where a purchaser is looking at a commercial property investment, the key drivers tend to be return, liquidity and security. However, there are other important issues that need to be considered, which may include:
- Building, weather-tightness and earthquake strengthening reports. The integrity and quality of any building you are buying is obviously important as this can impact on value, ability to get tenants, costs of maintenance etc. For example, regardless of the regulations around NBS earthquake strengthening, some corporate and government tenants will not lease a property with a rating less than 67%.
- Lease documents. The length of the current leases, the level of rent, the rights of the landlord to increase rent and when, the costs payable by the tenant etc are all important parts of any commercial investment. Some leases contain special terms (early release of tenant, tenant’s right of purchase, obligations for landlord to do specific work etc). As an example, we recently dealt with the due diligence of the proposed purchase of a large retail property, which our client planned to redevelop. One of the lease documents contained an obligation for the landlord to pay the tenant a large sum of money in the event of any redevelopment of the property. This became a key factor in our clients negotiating the purchase price for the property, which may have otherwise been missed.
- Title interests. Some land titles can be subject to restrictions contained in land covenants, encumbrances, body corporate rules or other documents noted on the title for the property. It is essential that you fully understand what you are buying in to and whether this will affect your intended use of the property.
- Finance/Valuation reports. Some banks will require you to have a registered valuation for the property before they agree to finance a purchase. If you are borrowing funds to complete a purchase, it is essential that you flesh out the bank’s requirements in advance.
- Land information from Council. A council issued Land Information Memoranda (known as a LIM report) may disclose issues about the property that impact you as a landlord and owner, such a soil contamination, designations and resource consents in the vicinity of the property.
- Other contracts related to the property. Depending on the type of property you are looking at, there may be service and maintenance contracts, body corporate rules and other documents that need to be reviewed. These need to be assessed on a case by case basis. If you have a due diligence condition in a contract, it is important that this clause contains an obligation for the owner to provide all relevant documents.
Due diligence is the process where you as a buyer, understand fully what you are buying. In some cases, we have clients who ask us to do due diligence after they have already agreed to purchase a property, so that they understand what they have bought (although if there is something sticky, they do not have the ability to cancel the purchase).
Another reason due diligence is important is because any issues relating to a property can affect your ability to:
- get a mortgage against the property; and
- obtain insurance for the property.
We have seen situations where a purchaser signs an unconditional contract to purchase a property, later to discover there are issues with the building that meant the bank would only lend on the land value of the property. Understandably, it is best to know in advance if finance or insurance is going to be an issue.
Many purchasers do not want to pay a lawyer for a due diligence investigation before they are confident the property has been secured for purchase. If you are purchasing a property or business, you need to weigh up the benefits of paying to have due diligence completed in advance.