“Thorough due diligence reduces risk,” Real Estate Attorney Nancy Park writes in PublicCEO
An unsuccessful property purchase can damage government agencies.
They can tarnish the agency’s reputation, undermine public confidence, and jeopardize taxpayer dollars. However, there is also a positive point. Negative results are almost completely avoidable. When it comes to acquiring real estate, the importance of careful scrutiny and fact-finding cannot be overstated.
Take San Diego’s acquisition of 101 Ash St., a downtown high-rise that was evacuated in mid-January following multiple asbestos-related violations. The city, which took over the building in early 2017, signed a 20-year lease for a total of $ 127 million.
When the deal was approved a few months earlier, the San Diego City Council was told that the building needed about $ 10,000 in work to clean, seal and pressure the outside, although the deal included a $ 5 million premium with a commitment that the city authorities paid. improvement of the tenant.
The scope of renovation work grew rapidly.
The City continued to spend over $ 30 million on renovations and asbestos pollution control before relocating employees to the building in December 2019. A few weeks later, city officials were asked to leave the building and be transferred to other locations. In the months that followed, the acquisition led to the resignation of city officials, prompted legal complaints from contractors who argued that the city had denied any risk of exposure to asbestos, and initiated investigations.
One such investigation, written by a law firm that has already advised the city on asbestos-related litigation, asked to investigate the mishandling of a purchase on Ash Street. It is a matter of concern that the City did not conduct an independent assessment to determine the amount of asbestos-containing materials in the building, nor did it assess the various building systems prior to purchasing it and starting the year-long renovation.
Instead, the city relied on environmental assessments and reports provided by the vendor.
It’s a tricky situation, but the moral of the cautionary tale is simple: Do your homework.
Whether you are buying an aging structure or open space, there are steps that agencies can take throughout the property acquisition process to reduce risks and avoid future surprises.
First Steps: Creating the Conditions for a Successful Due Diligence Investigation
Before proceeding with the acquisition, you probably answered a number of questions related to the scoping of the project, for example: Who are the parties involved? How will the purchase be paid? Will he use bonds? What’s the schedule? Are there any consequences of the California Environmental Quality Act? Is an environmental impact report required? What is real estate zoned for? Does your agency have zoning and / or approval powers? What rights are acquired? Is this the wrong purchase? Rent or easement?
Your purchase agreement will include a script for the transaction. He will install the required lots and provide a description of the property. It will set out prices and conditions, leases and contracts, and statements and guarantees. And he will set the time for due diligence and closure.
You will need as long as possible to go through all the documents to find and review any red flags.
The next steps in the process involve considering everything you can about the property. With any purchase, it all comes down to detail.
Introductory report: review phase of the entire acquisition
Getting a record of ownership after an escrow is opened is critical for your agency to know the best it can. This report will identify property taxes and provide information on liens (such as federal taxes and liens on mechanics) and other encumbrances that are currently being imposed on ownership of property. In this report, you will learn about easements and assaults. Covenants, conditions, and restrictions will also be set forth.
Review all items made in public records and other items known to the property owner (called “exceptions” in the preliminary title report) to better understand them and their impact on the property. This is where easements, agreements with others that affect the use of property and judgments due to others, and viewable rights or restrictions on the use of property appear. Any items that are registered in public records or that might be found upon inspection of the property are imputed as items that the buyer knows or should have known when purchasing the property. As such, failing to scrutinize these elements could bite you later if you are unable to view the relevant registered documents. as well as visit the property to find things that do not match your understanding of the rights transferred in the transaction. Curiosity will do you well here (unlike a cat!). Further physical examination issues are discussed below.
After you understand the recording items, are there any issues that might interfere with your current or planned use? Are there any problems that can be fixed? This is your agency’s ability to analyze problems and determine if they can be resolved or resigned to after closing.
Due Diligence: The Acquisition Stage Requiring Immediate Action
Due Diligence is a complex and responsible stage of any real estate acquisition. This is the stage in which you explore both the contractual and physical aspects of the property. This will most likely require hiring an environmental consultant to conduct a Phase I or Phase II survey of the site and, if required by the cost and size of the project, a surveyor, as well as verification of contracts, records and rights. You can also negotiate a valuation or valuation contract with a broker to ensure that the contract price is in line with the market price.
At this stage, your agency can review contractual terms and third party approvals, examine the economic performance of the property, and request the seller’s books / records, especially if you are purchasing an income property where you want to see projected income and future expenses. It is helpful to see older buildings and property reports, but building conditions and standards change, so a 5- or 10-year old report may not include items that are currently not subject to regulatory claims. Relying on the other party’s reports is sensible and foolish, and in fact, for hazardous materials, a report older than 6 months is too old to rely on under the Comprehensive Environmental Measures, Compensation and Liability Act, better known as CERCLA. , due diligence.
Physical improvement inspections or third party condition reports will determine the operational viability of a property by examining its fire and safety systems, structural functionality, accessibility, roofing, heating and cooling systems or, on agricultural land, soil, wells and pumps. Inspections should also be carried out to detect asbestos, lead, toxic mold and other hazardous substances as the Phase I and II reports do not cover these items.
When physically examining a property, an inspector may identify encroachments and boundary problems or uses that are incompatible with your understanding of the size, condition, or ownership of the property.
It is important to fully inspect the property, as well as conduct a comprehensive environmental impact assessment. Think about future uses and what scenarios or discoveries might be the worst. If it is not prohibitively expensive, try to cover these areas in your investigation. By doing due diligence in advance, your agency can avoid most of the surprises and potentially dangerous headaches when buying real estate.
This article first appeared in PublicCEO July 8, 2021 Reprinted with permission.