If you are planning to purchase a property, whether it is residential or commercial, then it is highly recommended you carry out proper due diligence on the purchase.
In this article, we set out some tips to allow yourself an opportunity to work out if the property is right for you before the agreement is unconditional. Ultimately you want to reserve the option to pull out of the purchase if your investigations uncover an insurmountable problem.
Make sure your agreement contains an effective due diligence clause
The sale and purchase agreement should include a robust due diligence clause if you want an opportunity to fully investigate every aspect of the property before you commit yourself to the purchase.
A standard sale and purchase agreement requires a vendor to make several warranties, and several of those warranties require a vendor to provide the purchaser with certain information about the property. For example, a vendor must tell a purchaser if they have received a notice from NZTA that the Transport Agency intends to take part of the property to build a new road.
However, these standard warranties only go so far. The default terms of the sale and purchase agreement would not require the vendor to volunteer a blow-by-blow account of every potential issue with the property.
It is therefore important that your contract contains a robust due diligence clause. If Cavell Leitch is given an opportunity to review the agreement before you sign it, we will be able to tailor a due diligence clause that suits your circumstances. It is important that the clause is broad enough to allow you to dig further as new information on the property comes to light.
What should a due diligence clause cover?
As a minimum we suggest that a due diligence clause should achieve the following:
- You should be given sufficient time to investigate the property. Depending on the nature of the property, you may need at least 20 working days to get comfortable that this is the right property for you (and also give you enough time to convince other stakeholders such as your bank).
- The clause should allow you to satisfy yourself as to any aspect of the potential purchase that you consider relevant, rather than just being restricted to a couple of matters. We comment below on some of the areas we suggest a prudent purchaser should look into.
- The due diligence clause should allow you and your contractors or advisors access to the property, or to anyone who holds information about the property (which could include the current insurer), to complete your investigations. If the property is tenanted, then the clause should require the vendor to help arrange your access at a time that suits the tenant.
- The due diligence clause should require the vendor to supply you with any information you request within a reasonable timeframe so you can maintain momentum. We think it would be reasonable to expect an answer within 5 working days of you asking the vendor for more info.
- We would ideally tailor the agreement so that you would only pay your deposit once you are 100% satisfied with your due diligence investigations.
Make sure you ask for the information you need.
A recent High Court decision, Sullivan v Wellsford Properties Limited, highlighted that a purchaser must ask the right questions, or suffer the consequences. The case involved a property for sale that had multiple tenants. The sale contract allowed the purchaser to complete due diligence investigations, and as part of that process, the purchaser asked the vendor whether there had been any disputes with past tenants of the property about the level of outgoings.
However, the purchaser failed to ask the purchaser whether there were any disputes about outgoings with the current tenants of the property. The purchaser also failed to make a general request for all information about the property's outgoings.
It turned out that a current tenant had, in fact, disputed its share of the outgoings, and the property was significantly less profitable as a result.
The High Court decided that the onus was on the purchaser to ask the right questions, and only then would the burden switch back to the vendor to answer those questions fully and honestly. A vendor could be held liable for misrepresentation if they do not provide all of the information requested.
What should your due diligence investigations cover?
What areas your due diligence investigations should cover will differ on a case-by-case basis based on your circumstances and experience, and the type of property you're looking to purchase.
Typically, however, we would suggest that you look into the following:
- The property's title to see what rights you property has/is subject to.
- The local Council's information on the property, the majority of which would be summarised in a LIM report (although you may need to obtain a copy of the property file for further information, such as copies of the building consent documents).
- The strength of any leases of the property should be assessed. This could extend to performing credit checks on the tenants, and also examining any service contracts currently in place to service the building or the tenancies.
- It may pay to obtain a building report to identify any current or future maintenance or safety issues. For example, you would want to know if there is any asbestos present on the property.
- The relevant zoning rules should be examined to see what activities are permitted on site.
- Your bank may require you to obtain specific valuation advice in relation to the property and any plant or equipment being sold as part of the purchase.
- It may be necessary to request copies of existing engineering, geotechnical or contamination reports for the property (or commission your own).
- If you have a specific use in mind for the property, then you'll need to check the property's utilities are sufficient. For example, you may need to check the power supply will be sufficient to operate your machinery from the site.
How Cavell Leitch can assist you with your due diligence investigations:
Cavell Leitch has assisted our clients with their due diligence investigations for close to 95 years.
- We've seen it all, and we have an in-depth knowledge of how the market operates. We're able to use that experience and expertise to guide you as to the pertinent questions which you should be answering to maximise your opportunities and minimise your risk.
For example, we recently advised a client who was seduced by what appeared to be the prospect of very high returns for a property. However, we were able to spot that the building was very specifically designed for its current tenant. If that tenant was to leave, and our investigations uncovered there was a likelihood of this happening, then the building would likely need an expensive re-fit to suit a new tenant. When the refit costs were taken into account, the return for our client would not be so attractive
- Cavell Leitch will tailor our advice to suit you. We can prepare a full due diligence report which uses plain English to summarise each aspect of the property in as much detail as you require. Alternatively, if you are an experienced operator, you may prefer us to only highlight potential fish-hooks and provide practical and commercial advice on their likely impact on you.
Cavell Leitch is able to provide expert advice on a number of areas. For example:
- If you are concerned to ensure you would be able to operate your business from the site, then our resource management team can detail exactly what the property's zoning rules will and will not allow you to do.
- If your plans for the property include completing major works then Cavell Leitch can provide specialist construction and development advice to steer you through the process.
- If you are purchasing the property with others, then Cavell's business, trusts or relationship teams can help you put a framework in place from the outset which sets out each parties' rights and responsibilities.
- If you are looking to take on key staff as part of the transaction, then our employment team can help you form those employment contracts.
We can utilise our network of other professionals to put you in touch with whatever additional advice you may need. This might include specific engineering advice, valuation guidance, or financing, insurance or property management assistance, etc.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.