A wise client once told me that “nothing happens without funding,” and this client has gone from a net worth of ZERO to over $300M in fewer than twenty years by following his own mantra. I am going to show you how funding, both debt and equity, play into the process of due diligence (DD) on a property, along with a laundry list of nine major categories of due diligence and 69 items under these major categories , all of equal importance in underwriting a property for acquisition as a part of a due diligence process that I and other sponsors like me employ.
In order to tackle the due diligence process in an efficient and timely manner (Due diligence periods are usually 45-60 days, so time is of the essence.), we are guided by a “due diligence checklist.” Some of the major categories on this checklist are Contract, Property Data, Marketing, Title and Survey, Operations, Financial Data, Tenant Review, Financing, and Closing.
Typically in DD, the long lead time item is the debt financing, which is ultimately capped by the appraised value of the property for purposes of determining the loan-to-value (LTV), the ratio of the amount of the debt to the value of the property. Remember “nothing happens without funding,” right?
For instance, if a property has a value of $1,000,000 and I want to borrow 75% ($1,000,000 x .75 = a loan of $750,000), then the appraised value of the property can be no less than $750,000 for me to borrow that amount. Make sense? So at this early stage of DD, my mortgage broker is soliciting soft quotes on financing to see that I am in the ballpark on my numbers. I am assuming at this point that the DD on the property will be to my satisfaction, which I still have yet to prove up, but without financing I can’t close on the deal. The next long lead time items in DD are the third-party reports, such as Survey, Title Commitment (TC), Property Condition Report (PCR), Phase I Environmental Assessment Report Phase I), and Appraisal. Usually the survey is ordered early in the DD period because it is needed in conjunction with TC to determine if there are any objections to title. The review of the Survey and TC are most often done by an attorney specializing in property transactions and well versed in title law. The other third party reports are ordered later, but in time to have at least executive summaries in hand before the end of DD. The last item ordered is the Appraisal, which is done after the terms sheet with the lender is signed. The lender takes bids and orders the Appraisal in accordance with federal requirements. There are many more major and minor steps in the DD process, but these are the critical path items which, if addressed early on in the process, will ensure that I can meet my DD deadline and make an informed decision to proceed with the acquisition or not. More about the rest of the steps in the process later!