Real estate due diligence: Types, timeframe, and checklist

The global value of the commercial real estate market reached  $37 trillion in 2023, up from about $35 trillion in 2022. The sector is obviously evolving. But what does it take to succeed in the industry? 

The thoroughness of due diligence definitely makes a difference. 

In this article, we discuss the due diligence definition in real estate and provide a commercial real estate due diligence checklist to follow. If you’re looking to successfully purchase an income-producing property or to sell it, read on.

The commercial real estate acquisition process explained

Before delving into the essence of due diligence in real estate, let’s first take a brief look at what the commercial real estate acquisition process generally looks like. The key stages are as follows:

1. Identification and origination of commercial property. At this stage, a real estate investor or an assigned real estate agent defines investment criteria that help identify potential commercial properties to buy. The search is done through market scouting and leveraging broker networks or real estate platforms. It also includes initial evaluations and contacting property owners or their real estate agents to express interest and get preliminary information.
2. Underwriting and market research. During this stage, an acquirer scrutinizes the financial health of the potential real estate investment and checks its position in the local market. It includes examining market conditions, trends, and comparable property values and ensuring that the property fits within the investor’s financial and strategic objectives.
3. Due diligence. Comprehensive due diligence is a crucial part of the real estate transaction. During this process, a real estate investor conducts a thorough property investigation to verify all information and uncover any potential issues. This includes physical inspections, reviewing financial documents, tenant leases, legal compliance checks, and environmental assessments. The aim is to confirm the property’s value and ensure there are no hidden liabilities.
4. Closing. This is the finalization of the transaction, where the buyer and seller complete all legal and financial arrangements. This involves signing the purchase agreement, transferring funds, and recording the deed. At this stage, the deal sides execute all the negotiated terms and conditions, officially transferring ownership to the buyer.
5. Asset management. After the official deal completion, effective management of the real estate asset takes place. This stage is about proactive oversight and strategic planning for the property’s future performance to ensure it maximizes investment returns. 

What is due diligence in real estate?

Real estate due diligence is the most essential stage of real estate transactions. 

This is about verifying the information provided by the commercial real estate seller and ensuring that it meets the investment criteria and strategic objectives of the prospective buyer. As a sign of starting due diligence, a buyer typically pays a seller a due diligence fee. This is a non-refundable due diligence money designed to compensate the seller for taking the property off the market. 

Additionally, a buyer often makes an earnest money deposit either to the seller or an assigned third party. The deposit is held until the termination of due diligence. There are three main scenarios of what happens with this deposit:

• If the due diligence is successful and the buyer proceeds with the purchase, the deposit is then released to the seller and credited to the buyer as part of a purchase price.
• If by the end of due diligence, the buyer decides not to purchase the property, the deposit is then released to the seller and is forfeited by the buyer.
• If the buyer decides not to proceed with the deal at any time before the end of due diligence, the deposit is then released to the buyer and the deal is terminated.

As a result of thorough due diligence, a due diligence report is drafted. This document presents all the due diligence findings and, sometimes, recommendations regarding the most appropriate purchase price or potential risks. 

Note: Though in this article we focus on commercial real estate acquisitions, due diligence can also be a part of a residential property acquisition. In the home buying process, due diligence is less complex, expensive, and risky and broadly involves home inspection and key document checks. However, the main due diligence tasks remain the same: to ensure that the property is worth the investment and that there are no hidden risks or problems.

Main types of commercial real estate due diligence

Broadly speaking, real estate due diligence can be divided into six main types: financial, legal, market, physical, environmental, and operational. We discuss each of these DD types below. 

Financial due diligence

Financial due diligence starts with the underwriting stage of the commercial real estate acquisition process. 

This is about assessing a property’s financial performance and stability. It includes reviewing income statements, balance sheets, rent rolls, and historical financial data to evaluate revenue, expenses, and profitability. The goal is to confirm that the property’s financials are accurate and sustainable. It also implies verifying tenant payment histories and assessing future income potential.

Legal due diligence

Legal due diligence focuses on the legal aspects related to the property. 

This involves reviewing title search results, zoning laws, lease agreements, any existing liens, and different contracts such as a purchase contract. The purpose is to ensure that there are no legal issues or restrictions that could impact the ownership or use of the property. Additionally, this process includes confirming property compliance with local, state, and federal regulations.

Market due diligence

Market due diligence is about assessing market conditions and trends that could affect the property’s value and performance.  

This includes analyzing similar properties, local economic indicators, zoning laws, and demographic data. The aim is to assess the property’s competitive position and potential for appreciation or depreciation. Market research also implies studying future development plans in the area that could impact demand and supply.

Physical due diligence

Physical due diligence is about the actual physical property’s inspection to ensure it’s safe for accommodation and won’t cause any problems in the future. 

It includes evaluating the structural integrity of buildings, the state of mechanical systems (such as HVAC, plumbing, and electrical), and the overall maintenance status. The goal is to identify any immediate repair needs or long-term maintenance issues. It’s also common to hire professional inspectors or engineers from the outside to conduct detailed inspections.

Environmental due diligence

Environmental due diligence is about assessing the environmental situation around the property and that the land underneath the property is free from harmful pollution. 

Environmental due diligence typically includes Phase I and Phase II Environmental Site Assessments (ESAs). It implies checking for the presence of hazardous materials, soil contamination, and compliance with environmental regulations.  

Operational due diligence

Operational due diligence focuses on the assessment of the property’s current and potential operational performance and efficiency of the property manager. 

This includes evaluating property management practices, tenant satisfaction, occupancy rates, and lease terms. The key goal is to ensure efficient and profitable property operations after the purchase. 

Commercial real estate due diligence checklist example 

Now, let’s take a look at what a real estate due diligence checklist or due diligence questionnaire can look like. 

Disclaimer: This is just an example of a commercial property due diligence checklist. It can be extended or modified depending on the case. Use it for inspiration when drafting the one for your successful real estate transaction.

Note: If you’re to perform other types of due diligence and looking for due diligence checklist examples, check out our dedicated articles on customer due diligence, IT due diligence, and general M&A due diligence. 

How long does CRE due diligence take?

A due diligence period in real estate typically takes 30–90 days to complete. However, it can take up to six months, depending on the deal size and agreements between the seller and buyer. 

Among the main factors that impact the duration of the commercial real estate due diligence process are the following:

• Property type and size
  The bigger the property, the more time is required to review it. For instance, the due diligence of properties such as multi-tenant buildings and industrial facilities is likely to take longer.
• Physical inspections
  Generally, the inspection of the property condition requires the engagement of different third parties such as environmental consultants or structural engineers, which can add time to the process. Additionally, a poor property condition requires more thorough inspections, potentially lengthening the due diligence period.
• Legal and title review
  Resolving complex title issues, verifying zoning compliance, and understanding local regulations can be time-consuming, especially in areas with complex or unclear regulations.
• Environmental review
  Initial environmental site assessments can uncover potential contamination, which will require deeper evaluation. This, in turn, can significantly prolong the process.
• Negotiation and coordination
  Coordination and negotiation between buyers, sellers, attorneys, inspectors, and other parties involved can significantly impact the timeframe of the due diligence, especially if there are delays in communication or decision-making.

Streamline CRE due diligence process with iDeals

iDeals virtual data room is widely used for the management of real estate transactions. It helps streamline commercial real estate due diligence by offering the following benefits:

• Security of data
  By using iDeals virtual data room for real estate due diligence, you can rest assured that all the sensitive data about the property, such as rent rolls, tax metrics, or financial performance records, are kept confidential and secure. This is possible thanks to features such as two-factor authentication, eight levels of granular access controls, in-built redaction, and many more.
• Round-the-clock access
  You can significantly speed up the due diligence process since all parties can review the required data anytime and from anywhere since iDeals offers cloud-based data storage.
• Streamlined interaction
  All the deal parties can efficiently interact during the due diligence process thanks to advanced Q&A workflows.
• Multi-project management
  In case a seller has a couple of prospective buyers, they can create separate due diligence projects for each of them. This will enable several review processes to happen simultaneously.
• Digitalized due diligence checklists
  iDeals offers a free data room checklist with default real estate settings that helps to start the process of real estate due diligence straight away.

Key takeaways

• Real estate due diligence refers to the process of verifying the information provided by the seller and ensuring that it meets the investment criteria and strategic objectives of the prospective buyer.
• There are six main types of commercial real estate due diligence: financial, legal, market, operational, environmental, and physical.
• For an effective due diligence process, it’s recommended to use a real estate due diligence checklist. This document encompasses all the documents to review and actions to perform to ensure successful due diligence.

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