How To Conduct Real Estate Due Diligence

Underwriting and due diligence is the most important part of the real estate investment process. Putting capital into the wrong investment can result not only in money lost but serious liability issues as well.

Underwriters put a tremendous amount of time, effort and knowledge into conducting property due diligence . . . before presenting an opportunity to  investors.

Here’s a quick overview of how to conduct real estate due diligence and underwriting.

Understanding Real Estate Underwriting

Underwriting is the process used to evaluate and determine the potential of various investment real estate opportunities. Underwriting that isn’t conducted properly creates below-market performance, expensive liability issues, and loss of capital for investors.

Good underwriters combine a boots-on-the-ground, big-picture approach for underwriting with sophisticated software modeling. They analyze a countless number of various data points, and both qualitative and quantitative factors to evaluate the risk-return potential of each prospective investment.

Detailed Due Diligence Steps

Once a potential investment has been identified, a lead underwriter is assigned to the property. The underwriter ensures that the property meets a stringent risk-return profile by performing an extensive and detailed analysis.

There are literally hundreds of data points used in a detailed due diligence process including:

Financials

  • Review last 3 years of tax bills
  • Capital expenditure (CapEx) review for last 3 years and current budget
  • Current month’s tenant improvements (TIs)
  • Schedule of tenant security deposits
  • Outstanding TIs and leasing commissions due
  • Utility records
  • Current invoices from service contract providers and utilities
  • Insurance quote review
  • Loss report from current insurance company for last 3 years

Building

  • Building and site plans including subcontractor warranties
  • Existing Phase I report
  • Insurance quote from 3 vendors
  • Property owner association (POA) document review, where applicable
  • Easement agreement review
  • Building service contracts, including leasing broker and property management companies
  • Maintenance and CapEx log review
  • Warranties
  • Property management agreement
  • Tenant contact list
  • Certificate of insurance
  • Copies of zoning and government permits, and written confirmation of code adherence
  • ALTA survey on file
  • Certificate of occupancy, improvements, and renovations for last 3 years
  • Current property condition reports
  • Copies of zoning reports
  • Warranties for all mechanical and structural systems such as HVACs, roof, and riser system
  • Notice of past, current, and pending litigation, citations or violations

Reports

  • Property condition assessment ordered
  • Phase I update ordered, if needed
  • UCC and judgment lien searches
  • Research any restrictive covenants, easements, and agreements

Comparables

  • Contact area brokers experienced in asset type being acquired
  • Obtain lease comparables – with both historical and current asking rents – for surrounding properties
  • Generate demographic information

Loan

  • Loan commitment letter from lender
  • Estoppels signed by tenants
  • Subordination and non-disturbance agreement (SNDA)
  • Property appraisal
  • Deed of trust/mortgage
  • Security agreement
  • Assignment of rents
  • Fixture filing
  • UCC-1
  • Contract assignments
  • Escrow closing instructions
  • Broker opinion of value
  • Partnership/LLC borrowing authorization
  • Corporate manager borrowing resolution
  • Signature authorization form
  • Primary and secondary lender commitments, if applicable
  • Lender loan documents
  • Budget and proforma review and approval

Title

  • Order title search from escrow
  • Order updated survey, if needed

Miscellaneous

  • Schedule site tour
  • Deposit earnest money
  • Register legal entity to hold property
  • Create operating agreement
  • Set up bank account for holding entity

Post Closing

  • Schedule and confirm property visit by asset management company and management committee member
  • Confirm all client-specific asset acquisition requirements are met
  • Notify in writing asset manager, property manager, and accounting firm of new ownership, when applicable

If at any point during this rigorous due diligence and underwriting process the underwriter decides that the property does not meet its requirements, they should not hesitate to walk away from the prospective deal.