Due Diligence Process
Due Diligence is an investigative process conducted by the equity investor buyer incorporating the evaluation of property value, conditions and details of the commercial note assets, and of the real estate securing said note assets. The due diligence process varies dependent upon the particular selling financial institution, and the size and type of commercial loans being sold.
FORMAL DUE DILIGENCE: In most cases, Due Diligence is a formal process that is exclusively granted to one selected equity buyer after the financial institutional seller and equity buyer execute a Purchase and Sale Agreement (PSA). The PSA specifies a fixed acquisition price (Indicative Price) for the commercial assets, and also specifies other terms and conditions including the Due Diligence period and terms. Typically the equity buyer is to deliver a refundable deposit, from 1% to 10% of the acquisition price, and is granted a nominal period of 7 to 21 days to conduct a thorough investigation, at the buyers expense. During this process, the financial institutional seller will deliver all loan documents and property information, that the seller possesses, over to the equity buyer. The equity buyer may then conduct current market value appraisals of the real property, physically inspect the real property, thorough review of the note and trust deed documentation, review title reports, and conduct other pertinent investigations.
At the end of the formal Due Diligence process, the equity buyer has one of three options, as follows:
- One, the equity buyer does not discover any items of concern during the Due diligence, and simply proceeds with transaction by delivering the remainder of the acquisition funds and closes.
- Two, if the Due Diligence discovery is very unfavorable, the equity buyer can simply elect to cancel the PSA contract, get their deposit back, and only loose the funds and time that was spent on the Due Diligence investigation.
- Three, the equity buyer found some major items of concern, but still wants to pursue the acquisition. In this scenario, the equity buyer may attempt to replace some assets, eliminate some assets from the portfolio being purchase, or make a small renegotiation of the acquisition price, or attempt some other reasonable counter offer. The Seller may than accept the counter offer proposal, counter back to the equity buyer with another proposal, or decline to sell said asset altogether, at which time the deposit will be refunded to the equity buyer.
INFORMAL DUE DILIGENCE: In other transactions, the financial institutional seller will not enter into a PSA allowing the equity buyer to conduct an exclusive Due Diligence as described above. These less frequent scenarios occur when the selling institution is highly motivated to sell their distressed assets quickly in an auction like setting. In this scenario, the institutional seller will set a very attractive Strike Price (asking price) that typically represents a substantial discount percentage below current market value of the asset.
The equity buyer must conduct their Due Diligence prior to the seller agreeing in writing to the equity buyers offer to purchase (PSA). When the equity buyer is prepared to make an offer to purchase, the PSA will be dictated by the Seller. The terms of the PSA will typically specify a nonrefundable deposit of 5% to 10%, and a short 5 to 7 day closing time, with no Due Diligence contingencies. If the equity buyer does not close the transaction, for whatever reason, the deposit is automatically forfeited to the seller.
DUE DILIGENCE INFORMATION: Some financial institutions (ie: GSE’s) selling non-performing loan portfolios make no representations or warranties in connection with the purchase, and all of the risk of loss associated with the loans are passed to the purchaser upon closing. The rights and remedies available to the purchaser are solely contained in the underlying loan documents and the associated collateral. While other financial institutions (ie: Banks) will allow a period of time after the sale, in which the investor can return /swap out a small portion of defective loans/properties on a mutually agreed basis. In any case, a detailed review of the loan files, including the collateral said loan(s), are critical elements of the due diligence process.
SVP of Asset Management