Due Diligence for Real Estate Sales Transactions

As with any other commercial transaction, “due diligence” is an essential aspect of the sale and purchase of real property.  Each side (the “purchaser” and the “seller”), assisted by counsel, should prepare a due diligence checklist for its own use.  The due diligence checklist serves several important purposes.  The checklist forces counsel (and, to a much more limited extent, the client) to review in advance all aspects of the transaction, including the payment terms, the manner of payment, and the potential environmental or title problems peculiar to the parcel to be purchased.

The due diligence checklist may be as detailed, or as brief, as counsel concludes is necessary.  For the sale of commercial real property, the due diligence checklist should include, at a minimum, terms requiring investigation of a number of different matters, including any potential title defects with the property, and how those defects might be cured; whether a survey has been conducted (or is even necessary) to identify all improvements to the property; an inventory of the personal property where the seller intends to convey personal property along with real property; and a search of the UCC filing records of the Secretary of State of the state in which the property is located.  Depending on the law of the state in which the seller resides, the purchaser may also have to check the records of both the Secretary of State’s office of that state, and the county recorder’s office.

The due diligence investigation is usually conducted before the parties negotiate and sign an agreement for purchase and sale of the property; however, in some cases that agreement will include a detailed list of the information regarding the property that the seller is required to deliver to the purchaser as part of the purchaser’s due diligence with respect to the property.  Items that might be delivered include the following:

  • Copies of any written operating contracts that will survive closing, including all modifications, supplements or amendments, and a list of all unwritten operating contracts;
  • Copies of any leases of the property, lease guaranties, estoppels, and subordination, nondisturbance and attornment agreements, and all amendments and correspondence with respect thereto, and a current "Rent Roll" containing (i) a complete list and description of the leases, (ii) rental rate and deposits paid by each tenant, and (iii) the term of each lease.
  • Copies of the real estate and personal property tax statements covering the property for the three (3) previous tax years and, if received by Seller, the valuation notice issued with respect to the current tax period;
  • Copies of all existing liability, property, rental value and other insurance policies pertaining to the property;
  • Copies of all permits;
  • Copies of any surveys, site plans, and as-built plans and specifications for the property;
  • Copies of all unexpired warranties and guaranties covering the personal property and the roof, heating and air conditioning system and any other component of the improvements;
  • Copies of all utility bills received during the most recent 12 months of seller’s ownership of the property.
  • Copies of environmental reports, soils studies, other engineering inspections and other studies and reports pertaining to the land or improvements or any portion thereof, and information regarding the existence of hazardous substances or underground storage tanks on the property or use or storage of hazardous substances on the property and all reports and audits with respect to compliance of the property with the Americans with Disabilities Act ("ADA") and any plan in existence for compliance with ADA and similar state or local laws with respect to disabled persons;
  • An itemized list of the personal property;
  • Copies of any and all written claims, demands or notices from any third party which concern or otherwise affect the property received by seller during its ownership of the property; and
  • A list of major repairs (excluding tenant improvements) and major casualties occurring during seller’s ownership of the property.

In addition, since the due diligence is being conducted after the agreement is signed the parties should provide for an “inspection period” that would run for a specified period of time after the effective date of the agreement and during which the purchaser would have reasonable access to the property and the opportunity, at its own cost, to conduct reasonable investigations, inspections, audits, analyses, surveys etc with respect to the property.  The purchaser should covenant not to disrupt seller’s business or other activities with respect to the property during any inspection procedures. In addition, the purchaser should be required to indemnify the seller against any damages or losses that the seller might incur as a result of negligence of willful misconduct of the purchaser or purchaser’s agents during the course of any review or inspection of the condition of the property.  Completion of the closing of the transaction hinges upon the purchaser’s satisfaction with the condition of the property as determined during the due diligence investigation and the contract will generally require that the purchaser provide the seller with formal written notice of acceptance of the condition of the property on or before the end of the specified inspection period.

The content in this post has been adapted from material that will appear in Business Counsel Update (March 2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

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