Due diligence is an investigation of a business or person prior to signing a contract. Verifying to make sure that everything you’ve been told is correct and above board.
With property, assuming registered title, the documentation should be in order so it is reasonably straightforward for an experienced eye or adviser, to check facts and uncover any omissions. If the title is unregistered then it’s a matter of reading through all the deeds and ensuring any matters arising can be answered satisfactorily.
Interestingly, an aspect of due diligence that can be overlooked but which I consider important is whether the property has been sold before and if so then to whom and at what price.
Other than the Land Registry, there is no single source of prices paid so ascertaining is a matter of monitoring the market. For [property offered at auction there is a company whose subscription-service lists all lots and prices and in many cases the auction particulars themselves, but apart from the cost of the service being prohibitive unless you have an on-going need for the information there is the inefficiency of wading through lengthy listings. The service doesn’t list buyer identity but that’s to be expected since the parties to the transaction rarely need to be a matter of public record. The only other property industry source is also subscription-based and is again rather costly, albeit it includes the parties’ names where known, unless you also have a need for considerably more information than simply the prices. Otherwise, the only sources are those of us that have our own databases and monitor market activity.
A few years ago, an overseas investor bought at auction a shop property in a market town without seeing the property beforehand. The buyer asked me to advise on the lease matters arising and when I enquired as in which of the half a dozen or so auctions over a period of some 11 years the property had been bought, the buyer was amazed there had been so many. According to my records, the tenancy details and tenant had remained unchanged throughout and the prices fetched ranged from around £350,000 to £600,000. At each auction, the property fetched some more until the last auction when the seller was a receiver. By then the lease had almost expired so the risk increased. On yield alone, the proposition must have looked attractive, but unbeknown to the buyer the prime trading position in the town had shifted so when the lease came up for renewal the tenant wasn’t interested in renewing unless at a substantially reduced rent and other terms and conditions of the lease more favourable to the tenant. In keeping with retailer desire to capitalise on Christmas trading, negotiations were dragged out beyond the contractual term expiry until the requisite three months notice to quit could expire after the Christmas and New Year period. It took some time to resolve the dilapidations claim, during which the premises were widely marketed. A couple of unexciting offers were received but the consequence of accepting would have negated the dilapidation claim. Five years on, the property has been let but at a rent more than three times less than previously passing.
Many investors tell me there is no point in knowing the identity of the seller because the proposition is what it is and should be assessed on its merits. I do not agree. I consider it important to know the identity of the seller because whether it is the first time for decades that the property is on the market or it has been offered at auction on numerous occasions over a relatively short period of time, it begs the question, at least it does to my mind, that the seller knows something that isn’t obvious to buyers and which isn’t necessarily evident from the documentation. In the above example, the fact that the seller was in receivership suggests to me that a receiver would not have been appointed had the property been worth anything like the amount that seller had paid. In the two years or so before the trading position became adversely affected by the opening a new shopping centre in the locality, there were three auctions of this property, on each occasion a higher price achieved. Buying a commercial property that is let already isn’t the same as buying a vacant property. With a vacant property, the buyer can let it from scratch. With a let property, the buyer’s scope for capital appreciation hinges upon the premium that the investment market sentiment places on the value of the tenant’s covenant at the passing rent combined with the desirability of the property to the existing tenant. In this case, the rent, subject to upward-only review at 5 yearly intervals, had remained unchanged since 1996 which rather suggested, since about that time the new shopping centre had opened, that by 2001 and 2006 the property was substantially overrented.
For a different property, another investor instructed me to deal with a rent review. According to my records, the property had been auctioned a couple of times but the client had bought the proposition in the open market by private treaty and wasn’t aware it had been sold previously at auction. Here, it was useful to discover that the lease had been restructured which wasn’t mentioned in the new lease and I was able to provide details before and after the restructuring.
It is not only investors for whom due diligence involving the activities of previous ownerships can be useful, tenants too can benefit from a historic knowledge of the premises. In one case, a multiple retailer for whom I was doing a rent review in the town mentioned that its acquisition division was seriously considering relocating the branch to a larger unit nearby which was being marketed discreetly in anticipation of the tenant there not renewing. Knowing that the client disliked uneven floor levels, I enquired whether the acquisition surveyor knew about the step in floor level that spanned the full width of the shop in Zone B. Since there was nothing on the plans that were provided for the letting, after checking it it transpired that the landlord’s agents hadn’t mentioned anything because the plan of the shop had been prepared by the landlord. I knew about the step from having acted for a previous tenant.
A London-based private investor bought a shop property in the West Midlands let to a multiple retailer on a long lease with rent reviews every 14 years, the next review imminent. In the auction catalogue, the larger than usual size of the premises was highlighted. My having acted for another landlord of another property elsewhere let to the same retailer on the same sort of lease, I knew that the retailer had carried out extensive alterations to its property there so I thought that might account for the size of its West Midlands branch as well. Enquiries of the auctioneer came to naught, and there was nothing in the legal pack, my client had to take a view on whether there were any tenant’s improvements. He bought the property having to pay more than he’d wanted because of competition from less-informed bidders and sure enough at the rent review the tenant claimed the benefit of the improvements, rental value to be disregarded under the 21 year rule.
Where the seller is a company, the name of the company may be meaningless to the outside world so finding out the name of the director(s) is important. Property is about people and the names of the shrewd players (many of whom are secretive) can help in deciding whether a proposition is as good as it looks on paper. Established property investors and dealers often operate through different companies so it’s important to uncover the name(s) of the decision-makers. I’m not suggesting for one moment that one should never buying anything that’s offered for sale by one of the established players, simply that the rental and/or capital growth potential might be limited or exhausted because most if not all of the angles have been exploited already.