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Every transaction on a real estate market brings about certain risks – related to profitability of the project, legal or technical status of the investment, its quality, and alike. Due diligence is a process that helps to estimate real estate’s potential and an increase or decrease in its value over time. In practice, “due diligence” means a comprehensive analysis of the project of interest that assesses it from the financial, commercial, legal, tax, and technological perspective.

In the context of investment real estate, due diligence is conducted prior to the purchase decision, and it takes into consideration the following aspects: quality of workmanship (in the case of real estate offered on the secondary market), legal status, land analysis, and technical status. These factors are surveyed to draft a comprehensive assessment of the future (un)profitability of the investment. Thus, the analysis provides valuable information to both seller and buyers. It allows to assess chances and risks related to the investment. Due diligence report is typically commissioned by the investor and prepared by experts in the given field – brokers, real estate market consultants, valuers, lawyers, and chartered auditors, who use their know-how to adequately review the transactions’ potential. It needs to be kept in mind that experienced professionals who are familiar with the characteristics of a relevant industry need to be engaged in the due diligence process, especially if it is as complex as the real estate market.

Obtaining information on legal status and spatial function of the property

One of the key elements in the due diligence process is determining the property’s legal status and spatial characteristics. Detailed analysis of land and mortgage register allows to confirm the ownership structure of the property and determine if the offering party is actually authorised to sell it. The register includes also information on encumbrances and third party claims, if any. From the investor’s point of view, particularly important is also an excerpt from the land registry. Such information is used to establish any discrepancies between the land and mortgage register entry and the land registry. The comprehensive analysis should include information on planning determinants, available infrastructure, and zoning plans, if any. This should be based on the information included in the spatial development conditions and directions study of the commune that determine the local zoning policy and management principles. The study typically includes a description of the current situation and conditions for further development of the neighbourhood, which is particularly important in the long run. The zoning plans help us learn what are the possible permitted purposes of the given real estate. Attention needs to be paid to the environmental issues, too. Environmental provisions are strict and may significantly affect the planned investment.

Analysis of the investment offer versus competitive offers

Due diligence includes also an analysis of the offer compared to the competitive offers, which helps the investor gain a comprehensive view of the market environment and assess if the proposed price is not too high. Due diligence reviews the number of comparable projects realised by key market players, and their strengths and weaknesses. The following local conditions are also evaluated: if there are any close competitive projects in the relevant segment; if the investment object has infrastructure that guarantees its potential growth; and – in the case of development investments – the construction costs, availability and quality of labour, and option to commission a renowned contractor. Similarly important is also analysis of the location when it comes to its closest neighbourhood, convenient access, exposure of the plot or structure to the different points of the compass.

Strengthening negotiation position 

 For a person who buys a pre-investment “survey” of a property, gaining full knowledge of the object of the transaction becomes a strong argument that can be used in the negotiations process and influence the final valuation of the property. Due diligence can be used as a material to optimally prepare for the talks, properly direct their course and determine potential blind spots. After a thorough analysis of the project, the buyer can easier influence the key parameters of the transaction, as s/he has gained arguments based on relevant documents and expert opinion. Thus, the buyers are aware of any inconsistencies or deficiencies. Their bargaining position is therefore stronger, which affect the final price of the project in question.

Identifying potential risks  

At the same time, the analysis uncovers a number of potential risks for the investment that eventually affect the profitability for the investor. It makes the buyer realise any additional costs that can be associated with adaptation of the structure of plot for the planned investment. The process may help detect issues related to legal provisions, infrastructure, etc. Non-regulated legal status may significantly impede the realisation of the project, or even turn entire investment into a failure. On the other hand, analysis of planning conditions helps to mitigate the risk of the incompatibility of the investment with the local zoning plan, as well as learn about any planned inconvenient investments in the vicinity. It provides also valuable information of the building alignment and conditions for dividing and aligning of real estates. Due diligence helps also to avoid a situation where our project is subject to the conservation office’s protection, which may hinder, or even prevent us from pursuing the investment, as in such a case each division of the property (such as renovation or rebuiling) required a prior permit of the conservation office. Potential risks may be discovered on every stage of the investment. It is worth to mention here for instance a need to confirm that the property has access to utilities – otherwise, the buyer will be required to cover the cost of connecting to relevant installations. Technical infrastructure is typically expensive to build, therefore it is advisable to eliminate such costs by analysing that part of the project. Similarly, verifying if the property has a proper access to a public road will prevent problems when obtaining construction permit. Analysis of documents related to the property will help also to mitigate risks such as ongoing court, administrative, or enforcement proceedings.

Increasing the possibility of the transaction’s success

A comprehensive due diligence report analyses the property from every angle which is significant form the investor’s point of view. Multi-level survey makes it easier for us to assess the actual profitability of the investment and helps reduce the risks of depreciation of the property’s value over time. 

Author: Agata Karolina Lasota