You hear the term constantly in real estate. But what does it actually mean and what should you expect a sponsor to be doing during that window?
Due diligence is the period between signing a purchase contract and closing. It is when a sponsor verifies everything they underwrote and executes as much of the business plan as possible before taking ownership.
Here is what a thorough process includes:
1. Physical inspection: is the property in the condition represented? What deferred maintenance exists? What will repairs cost?
2. Environmental review: Phase 1 and sometimes Phase 2 to identify contamination or liability.
3. Title and legal: who actually owns it, are there liens, easements, or encumbrances that affect the asset?
4. Financial audit: are the rent rolls accurate? Are leases in place as represented? Are expenses in line with what was underwritten?
5. Market validation: do the comparable sales support the assumptions? Is the vacancy data current?
6. Business plan execution: the best sponsors do not just verify. They advance the business plan during diligence. On our Gilroy acquisition, we tied up the property with no executed leases and signed a material portion of our leases before we closed (this is unusual though obviously preferred).
That last part is what separates operators from observers.
Before you invest in any deal, ask your sponsor: what did you learn during diligence, and what did you do with that information?
The answer will tell you a lot.
What is the most important question you ask during due diligence?
Wednesday Real Estate 101: What actually happens during due diligence
