Commercial real estate investors are racing to fill their acquisitions pipelines before the market turns. However, as teams fly around the country bidding on properties, they can lose sight of a sobering fact about real estate deal-making: The faster the pace, the harder it can be to ferret out problems with prospective acquisitions. In the worst-case scenario, the buyer finds out about a huge issue only after the ink on the closing documents is dry.
How is it that a robust market can put downward pressure on the quality of due diligence?
In a sluggish environment, the seller of a value-add shopping center or multifamily property might struggle to find bidders. So when an interested party does come along, that seller is likely to give the buyer ample time to conduct a thorough due diligence process.
When competition for assets heats up, though, a seller might have multiple suitors willing to pay competitive prices. All else being equal, if one bidder requires 45 days for due diligence while another is content with a short 15- or 20-day process, the seller will take the latter bid. This is part of the reason investors sometimes push ahead with “expedited” due diligence. Competitive pressures also can affect the availability of resources for the process: When acquisitions teams are busy hunting for and bidding on multiple targets, they have less time to pore over the stacks of paperwork associated with each property.
This level of risk might have been tolerable in earlier eras. But today’s real estate market is characterized by a heavy emphasis on value-add plays as well as rampant disruption in retailing and other sectors. Amid thin margins and a high degree of uncertainty about the long-term prospects of some tenants and assets, getting due diligence right is imperative. The process should involve more than “checking the box” on whether documents are in place; rather, due diligence should have an investigative quality, with experts asking hard questions about the property’s financials, vendor contracts, co-tenancy clauses, Common Area Maintenance (CAM) reconciliations and more.
When acquisitions move forward based on a relatively surface-level assessment, bad things can happen. By contrast, a solid due diligence process can give investors confidence in their decisions. Consider a few examples drawn from the recent experience of my firm’s due diligence team.
Last year, the seller of…