I can speak to acquisitions due diligence with greater detail, so I’ll focus on that in my response.
What is Due DIligence?
So first off, due diligence is the process where you try to figure out as much as you can about a property You want to leave no stone unturned. Because once you buy a property, any avoidable issues that arise will be your responsibility.
DD is Split into Phases, the First is Desktop Underwriting
Due diligence is split into the same phases as a deal usually follows. During the first phase, you really just confirm what you can from your desktop computer, which is why phase one diligence is often called desktop underwriting. So in step one, you receive a teaser. If you like what you see, you sign an NDA. Once you sign the NDA, you get access to the dataroom. The part right after you sign the NDA is where our course Breaking Down REPE kicks off. This phase is called the desktop underwriting. So if you’ve worked through our course, you actually know exactly how a desktop underwriting works.
You Trust Seller Data during Desktop Underwriting
This is where you do the bulk of your modeling work, the only caveat is you generally take the seller and their broker at their word that their data is comprehensive and they aren’t hiding anything material. At the end of the day when you sign a final purchase-and-sale agreement, the seller signs that the data they gave you in the dataroom is true and accurate and they’ll compensate you if you underwrote off any false information. All this to say, during phase one diligence you usually just underwrite with the files they give you and any sort of data you can pull from comps databases, tax assessors’ offices, research reports, etc.
Moving Forward into Exclusivity
If the deal makes sense from a desktop underwriting, you’ll submit a non-binding bid. If your bid wins against the competition, then you’ll sign a letter of interest (LOI) that is like a non-binding agreement that clearly states the pricing you are both working towards. At this point you enter exclusivity and you are the only buyer. Once you’re exclusive, it makes sense to spend real money on diligence reports from third parties.
Hiring Third-Party Consultants
Once you’re in exclusivity, you begin checking the facts independently. This is when you hire third-party consultants to do environmental reports, engineering quality checks, and such. Though you may have walked the property during the competitive first round for a casual look, you’ll likely go back to more thoroughly inspect it now that you’re expecting to buy it.
So far in my response, I’ve skimmed over the nitty gritty details of what you actually check-off during due diligence. A quick google search will show you several lists, all of which look pretty solid. For instance, I thought this was a good list of common DD items. Just keep in mind that you usually don’t pay for the third-party reports until you’re pretty sure you want to buy this property and you’re in exclusivity.
Reps and Warranties
Final note – if you find something wrong with the property during final diligence, that doesn’t necessarily kill the deal. You’ll just revise pricing or add a clause to your reps and warranties. For instance we once found a rooftop pool was leaking through into the building and would cost $20M to fix. So we just included in our final purchase-and-sale agreement (PSA)’s reps and warranties section that the seller would cover all costs to fix the problem.