(Published by the Idaho Business Review, June 2009)

           In the past, many members of the construction industry have also become real property owners.  Despite its perception in the current economy, real estate may still be a strong long-term investment.  In this market, with many foreclosing lenders and short sales, investors and other bargain hunters have numerous attractive opportunities to acquire distressed real estate.  Due diligence, however, is sometimes only hastily conducted before the purchase agreement is signed, with no opportunity for renegotiation of terms.  Buyers with cash are picking up properties quickly and sorting out the problems later, not realizing what they are really buying into.  

Although due diligence has always been important, comprehensive research and understanding is mandatory in down markets, especially where many investment opportunities are presented as bargains and sellers are in a rush to close deals because of underlying problems, whether financial problems, land use problems, environmental problems, or other distresses.  The goal of the due diligence process is to eliminate unknown risk.  Potential buyers need to ensure that their properties are suitable-legally and from a practical business perspective-for their intended use.  In-depth due diligence is necessary to determine what a property is really worth.   

Buyers must have an understanding of zoning and land use issues.  Upon identifying a property, the potential buyer should determine that a property's intended use is lawful under all applicable land-use laws, codes, and regulations, including zoning ordinances, subdivision requirements, and any local agency's future plans and policies regarding the property.  In addition, buyers should examine whether the property is located in a special financing zone or redevelopment area.  Although normally established to provide financing for revitalization and redevelopment projects, most implementing plans include land-use restrictions.  

The physical condition of the property is also significant.  A licensed engineer's inspection should confirm the property's repair and maintenance needs, both long term and near term, as well as estimates of these costs. There may be a substantial difference between a seller's assessment of these needs and costs are and an engineer's. 

Review of the title and survey of the potential property is vital.  The title commitment and survey may not be prepared for some weeks after the contract has been signed, so it is not unusual for the contract to have a contingency period relating to the review of these materials that is separate from the remaining due diligence period. Usually the purchaser will have some time after receipt of the title commitment, exception documents, and survey to object to matters shown in them; then the seller has a period of time to cure or have the title company insure over the matters.  A purchaser should take the time to determine if any matters adversely affect the value of the property.  There may be easements encumbering the property or easements benefiting the property; there may be a water or sewer pipe that runs across the adjoining owner's property for which an easement has not been obtained; there may be encroachments;  there may be liens; or there may be other covenants and restrictions.   

Another important area to complete due diligence is current contractual obligations.  If the identified property is in the middle of construction, the buyer should review all construction contracts relating to initial construction, determining the assignability of warranties, guarantees, indemnities, and any other rights.  The buyer should review private restrictions, such as reciprocal easement agreements and covenants, conditions, and restrictions.  These so-called CC&R's often include limitations and restrictions that can preclude a desired use or can include obligations for future maintenance costs which could result in substantial future expense to the buyer.  The buyer should also review any service contracts, including any property management agreements, maintenance agreements, and any other service agreements.  It is important to determine whether these agreements will transfer, or whether the buyer can procure new service-providers with (potentially) lower fees.

The current tenant or occupant status is also important.  The purchase of a single family residence, seemingly simple, may turn ugly if the current tenant refuses to vacate the premises.  Retail investments can be particularly risky if the entitlements associated with a specific development are conditioned upon the continued operation of key anchor tenants.  Accordingly, in addition to obtaining and reviewing a summary of the leases associated with the property, a potential buyer should also evaluate the financial status of individual tenants. 

Prospective buyers also must conduct comprehensive environmental due diligence to determine whether environmental liabilities exist, their potential scale, and how and when they may be triggered.  A buyer may want to hire an outside environmental consultant experienced in environmental analysis and engineering and potentially perform a Phase I inspection in order to reduce or completely eliminate certain potential liabilities. In addition, prospective buyers also should review applicable environmental regulations-particularly new regulations related to storm-water management and "green" building-as these regulations may limit future proposed uses or may result in substantial costs and potential liabilities for property owners. 

            To prevent buyer's remorse, be sure to include a specified due diligence period in the purchase agreement and the right to terminate the purchase agreement if the property is unsatisfactory for any reason.  Skipping over proper due diligence of a potential investment property in order to obtain a "good deal" is never a wise idea.  If a deal looks too good to be true, it probably is. 

  Anna Eberlin is an associate with the law firm Meuleman Mollerup LLP, practicing in the areas of real property acquisition, development, finance, and leasing.  Ms. Eberlin had five years of real estate management and investment experience prior to joining Meuleman Mollerup.  Ms. Eberlin can be reached at 208.342.6066 or by email at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it .  More information at www.lawidaho.com.