Due Diligence Clauses for Real Estate
You might have heard people talk about due diligence when they’re trying to sound smart about like assisting a deal. “Hey, I need to do my due diligence.” But let’s dive into what does that actually mean in a property context. So, if you want to get a property under contract and you want to do some analysis and you need some time to check out the specifics, what you want to do if you can, is try and get a sale and purchase agreement for the property, get it under contract and have it conditional on due diligence.
Now, what this kind of clause is, it’s a coverall. So, when we’re talking about sale and purchase agreements and we’re talking about conditions, sometimes we do a condition for builder’s inspection, sometimes a condition for finance, sometimes a condition for, you know…there’s a bunch of them. Now, what the due diligence clause is it covers everything.
And what it means is if for any reason you decide you want to back out of the deal, you can and you don’t really have to tell the agent or the seller why you’re backing out. And you don’t have to disclose necessarily to the bank the reasons. Let’s say you’re doing a builder’s report, after you’ve done the builder’s report, you’re not really sure whether the bank’s going to say yes or not.
If you say on your sale and purchase agreement, “Hey, my condition is I need a builder’s report,”the bank’s probably going to ask for that and they want to see it. If the building fails anything on that builder’s report or there’s any red flags the bank’s going to pick up on that. Now, if you’re doing a due diligence and then you’re doing your own builder’s report, now in theory, you should submit that, but you might not need to.
And so what a due diligence clause allows you to do is lock up the property for a week or a month or longer, and it allows you to do all of these things, you know, inspections, talk to the bank or mortgage advisor about finance, talk to the lawyer about, you know, whether this is a good deal or not, whether it’s a safe property to buy.
What checks should you make during due diligence
Gives you an opportunity to start canvassing the market for a resale potential without being scared that anyone else is going to come in and try and steal the deal off of you, you’ve got it locked in for that period of time. It allows you to start talking to potential tenants. You know, you buy a commercial building, there’s going to be a lot of room for the, you know…it might be empty building. You know, you got to see, hey, should I buy this and should I fill it with tenants?
It allows you to do calculations. Yield calculations, maintenance, like gives you time to assist the deal without worrying too much about the specifics. So, if you lock a property up and you say, “Hey, conditional on Meth testing,”and then you do a builder’s report and the builder’s report comes back with big problems, but you didn’t condition for that on the sale and purchase agreement, it gives you much less negotiation power.
You don’t have as much opportunity to back out of the deal. Due diligence covers everything and anything. And generally speaking, real estate agents aren’t really keen on due diligence clauses. So, the appropriate place for a clause like this is usually when not many other people are trying to buy the property. And unless you’ve got really a good strong reputation already with the agent or in the market, putting this clause in place is sometimes difficult unless you are the only bidder.
So if you want a copy of the clause, you can flick me an email, firstname.lastname@example.org, there’s a few different versions depending on the property type you’re looking at. But, you know, when you’re looking at spinning a lot of money on property, if you get the opportunity, sometimes due diligence is a good way to lock it up and you might not necessarily be looking to actually buy this property unless you uncover some real gold underneath the cover.
And sometimes you really need to lock in the building on a contract to give you confidence that it’s worth spending money on these types of things. Because there’s no point in our eyes, in doing expensive building inspections, spending money on a lawyer, spending heaps of time doing all of this stuff, unless you’re going to be able to get the building under contract for a price that you’re happy with.
And what has been common in the past is people will do due diligence clauses, they’ll do all of this work, you know, might be two or three weeks worth of work, property has effectively been off market for that time, other buyers have been able to put their contracts in place. And you can come back with a list of things that need to be fixed and prices attached.
And sometimes it gives you negotiation power to bring down that offer that you’ve put forward. It’s not saying we always recommend being really hard bargainers, but if you’re that type of investor then, you know, by all means, try it out.