One of the most important procedures that takes place prior to the closing in any real estate transaction is the due diligence process. The due diligence process typically takes place once the purchase agreement is signed by the parties, but the due diligence process may also begin prior to the execution of the purchase agreement depending on the transaction. While there are many different types of due diligence that can occur, this post will cover three specific areas: (i) title review; (ii) environmental review; and (iii) physical inspections.
As is vital in all real estate transactions, a thorough review of the title to property is necessary prior to closing on the purchase of any real estate. Often, a title review begins with the title examination, which is typically completed by the title company that will provide title insurance upon the closing of the transaction. During the review of title, the purchaser and their counsel must carefully review all documents that affect the title to the property, including, but not limited to, declarations, easements, deed restrictions, existence of any monetary or other liens, and other matters which may impact the purchaser’s intended use of the property. Many times, a declaration that is recorded against the property will outline use restrictions and other matters which could greatly affect how a purchaser can and will use the property after closing. Further, easements could be located in areas that make it difficult or risky to build certain structures. Due to the potential issues that could be hidden in the title to the property, a proper review of the title must be completed to determine all the risks involved and whether a purchaser should move forward to closing.
As potential environmental issues continue to manifest in our world, an inspection of the environmental condition of property becomes even more important. A “Phase 1” environmental test is the starting point for an environmental review and this will provide an initial assessment of whether there are any potential adverse environmental issues with the property. Should the Phase 1 detect any adverse environmental issues, a “Phase 2” environmental test may be necessary. A Phase 2 requires more in-depth environmental testing than a Phase 1, and often involves intrusive testing of the property, which can include subsurface drilling and the extraction of soil borings. Should any adverse environmental issues exist, the purchaser should determine the extent of the environmental conditions and work with the seller to mitigate any potential risk prior to closing. Once the property is transferred, it will be the purchaser who generally assumes the environmental risks and liabilities moving forward.
As when buying residential home, a physical inspection is important when purchasing commercial property. Most commercial sales are structured “as-is,” meaning the purchaser is taking the property with all defects, whether patent or latent, and the seller typically has no obligation to disclose any issues with the property. Therefore, it is imperative that the purchaser inspects the physical condition of the property in all aspects and negotiates any issues that may be remedied prior to closing. The purchaser should also, to the best of the purchaser’s ability, determine if the property is in compliance with all building codes and ordinances. Of most importance in completing the physical inspection of the property is determining the condition of the foundation, HVAC, roof, and other structural portions of the property as these often carry the most expense for maintenance or replacement. As stated, since the sale is normally an “as-is” sale, the purchaser will often have no recourse against the seller after closing the transaction and must make any objections prior to such time.
If you have any questions about the due diligence process, please do not hesitate to reach out to an attorney who can help you work through any potential issues.