Due diligence is a critical part of underwriting a deal. This is the time where the buyer can examine all areas of the property that weren’t accessible in the marketing process.
A typical inspection period lasts 30-45 days. During this time, the deal sponsor spends money on third-party consultants, travel, and other pursuit costs to uncover any potential risks in the asset. It can be expensive, but money spent here can save millions in the future.
I will highlight the three most important tasks to perform during an inspection period – forensic analysis, refine the business plan and shop financing. Armed with this knowledge, you will be able to manage due diligence easily and effectively.
Forensic Analysis
An initial evaluation relies on information provided by the seller to a broad buyer cohort. This represents the most limited set of data required to get a feel for whether the opportunity is worth pursuing further.
Any investor may ask deeper questions during the marketing process, but some questions just won’t get an answer for confidentiality reasons. Those topics are too sensitive to reveal without a commitment to buy the property.
Your inspection of the tangible and intangible property may include:
- Financial deep dive
- Property executive interviews
- Engineer tours
- Insurance quotes
- Property tax projections
These inspection tasks are all aimed at filling the gaps that are left over from your initial evaluation.
You need to maintain a critical eye, but keep your mindset focused as you manage the due diligence process. The goal is to improve the deal, not kill it.
Refine the Business Plan
Your business plan is incomplete when you make the offer and negotiate a purchase agreement. It’s based on more assumptions than solid facts.
Forensic analysis helps fill in the missing pieces.
New information will spark your imagination to improve the business plan. Look for ways to optimize operations or value engineer the renovation scope. Some of this may be out of your control, but you can control your response to the findings.
The two biggest mistakes I’ve seen in business planning for real estate deals are:
- Not writing the plan in a shareable format
- Not updating the formal plan after due diligence
Your business plan is a living document. It should evolve with your understanding of the property. Consider the mental model for business planning from famed investor Marc Andreessen: “strong opinions, loosely held.”
Shop Financing
Financing is the third most important activity during your inspection period. You want to determine with a high level of certainty that you have enough cash to close.
Cost of capital is potentially one of the most impactful assumptions made in your initial evaluation. This is the time to prove it out.
I am a big fan of outsourcing the debt and handling equity in-house.
Brokers do a great job shopping your deal to a wide range of lenders that they work with daily. However, equity is a marriage that shouldn’t be rushed or arranged. Investors need to get to know the deal sponsor over a longer period.
Investors and lenders need the time between expiration of the inspection period and closing to perform their due diligence. Therefore, you need to get them up to speed as quickly as possible.