What is Real Estate Due Diligence?

Between your accepted offer and signing the contract is an important process – due diligence. But what on earth is due diligence? What happens? And why do you need it?

To answer these questions, I spoke to a top real estate attorney here in New York City, Michael J. Zadjelovich of Weidenbaum & Harari LLP.

What is due diligence?
Due diligence is the research that a buyer’s attorney performs on behalf of a buyer to help the buyer determine whether the property that they’ve had their offer accepted on is worth moving forward into contract. It’s conducted before the contract is signed and is one of the only ways to help to reveal any possible “red flags” that would deter the buyer from moving forward with a transaction.

Why is diligence important?
Diligence is important as it’s the only way to independently verify a lot of the information about the property that the seller has stated in the contract as well as the representations that the seller has made in regard to the condition of the property. It also helps the buyer to determine whether or not the purchase is a good future investment or not.

What happens during diligence for co-ops and condos?
When I’m representing a buyer, diligence begins the minute we receive the deal sheet. We request the two most recent years of financials for the building and schedule a time with management to read and take notes on the building’s board minutes. We also send a detailed questionnaire to management to complete which will help us to independently confirm a lot information about the unit and building (note: many management companies charge a fee to complete the questionnaire, anywhere from $150-$500). We also review the house rules, alteration and sublet policies of the building. If it’s a condo, then we verify the taxes and check the NYC Department of Buildings (“DOB”) to make sure there aren’t any open permits or applications for the unit. Once we have all these (and other) materials, we share them with our client and give our thoughts on how the building and unit rate verses other similar buildings and any “red flags” we spot.

What if someone decides to buy a house? How is the diligence process different?
For a house, the diligence process should start with the buyer immediately scheduling a home inspection after their offer is accepted. While that’s being scheduled, as the attorney, I would confirm the taxes and search the NYC DOB website to make sure there aren’t any open permits or applications and most importantly that it has a valid Certificate of Occupancy (“CO”). We also confirm with the buyer the use of the house and make sure everything aligns. For example, if it’s marketed as a 2-family home, the CO should reflect this and it should be taxed as a 2 family. If something doesn’t add up, it could lead to issues for the buyer, particularly with their lender if they’re financing.

What are some of the red flags buyers should be on the lookout for during diligence?
Due diligence can be a very subjective matter, since some conditions and issues that would bother one person may not be an issue to another. However, there are a few items that could be considered “red flags” that should be investigated further such as:

  • Litigation ongoing in the building
  • Noise or other complaints in regard to the unit or any neighbors or above/below floors
  • Rodents, bed bugs or any other similar pest issues
  • Maximum percentage of financing permitted by the building (if the buyer is financing)
  • Low reserves vs. Expenses (study of financials)
  • Increases of maintenance or common charges higher than 5% (almost all buildings in NYC raise them each year, anything from 2-5% is common, but above that could signal a building that is not well run)

Finally – what kinds of things signal that a buyer has the green light to move forward with a purchase?
With diligence being such a subjective matter, it’s hard to pinpoint a specific green light, however if a buyer is satisfied with the items below, that’s usually a good sign that the building is in good shape to move forward:

  • Financials are strong
  • No complaints about the unit or areas surrounding it
  • No ongoing litigation in the building
  • No CO / open permit or DOB issues
  • Low yearly increases of maintenance/common charges
  • Confirmation the building permits the amount of financing buyer is seeking
  • Pet policy is agreeable (if buyer has a pet)

Other thoughts you’d like to share?
For most people, a real estate purchase (particularly in New York City) is one of the biggest (if not THE biggest) investment they will make in their lives. So it definitely makes sense to do a very detailed investigation of it before locking yourself into a contract. Always be sure your attorney is conducting due diligence prior to signing a contract and always make sure you are comfortable before signing.

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If you have any questions on due diligence or any real estate related legal matters, Michael is always happy to help. He can be reached via email at [email protected] or via phone at (212) 832-7400 x 4118.