iFunding Weekly Educational Newsletter

Part 1: Introduction to Due Diligence in Commercial Real Estate

Due Diligence – What is it?

Purchasing a property without conducting proper due diligence is like buying a used car without looking under the hood……what looks like the greatest deal can turn into your worst nightmare. Good due diligence consists of a thorough review of the physical, legal and financial risks of a potential investment property before committing to the deal.

The due diligence process serves to confirm all the material facts related to a property that could cause a buyer to hesitate from consummating the deal at the price and on the terms proposed by a seller. At a minimum, due diligence for a commercial real estate acquisition should consist of: (1) an environmental assessment; (2) title and municipal records review; (3) a survey; (4) an engineering and building inspection; (5) a zoning review; and (6) review and confirmation of financial data, each of which will be separately addressed in this Seven Part Series.

Due Diligence Contingencies in Contracts

A buyer can either conduct due diligence before entering into a contract with the seller or after the contract has been fully executed. If a buyer wants to conduct due diligence after a contract is fully executed, the buyer should have a due diligence contingency in the contract. A due diligence contingency is a length of time specified in the contract for the buyer to carry out and perform due diligence. If the buyer is not satisfied with its due diligence the contract contingency gives the buyer the right to back out of a deal without penalty (i.e. the buyer will get its contract deposit back). Contingencies are important for buyers who cannot predict with certainty the physical, legal and financial conditions of the property prior to entering into a contract. If a buyer enters into a contract that does not have a due diligence contingency and then uncovers a material issue the buyer will either have to proceed to the closing and accept the risk or terminate the contract and loose the deposit. Due diligence contingencies can vary greatly depending on the facts of each transaction, however there are two main categories: a general due diligence contingency and a specific due diligence contingency.

General Due Diligence Contingency or “Free Look”

For the buyer a general due diligence contingency in a contract is preferable to a specific due diligence contingency. For a general contingency the language in the contract is drafted to allow the buyer the ability to conduct all forms of due diligence (within reason) that the buyer needs in order to feel comfortable to proceed to the closing. This type of general contingency is known as a “free look” because it allows the buyer to terminate the contract for any reason or no reason and still receive a full refund of any earnest money deposit.

Specific Due Diligence Contingency

Specific due diligence contingencies are tied to narrow investigative procedures like environmental assessments, zoning studies, financing or building conditions. A specific due diligence contingency is most beneficial to the seller because it only allows the buyer to terminate the contract under limited conditions. For example, a specific due diligence contingency could contain an environmental provision that only allows the buyer to cancel the contract in the event that a Phase I Environmental Site Assessment recommends a Phase II Environmental Site Assessment (which involves testing) (Environmental Due Diligence will be covered in more detail in Part 2 of this Series); or a specific due diligence contingency could contain an engineering provision that only allows the buyer to cancel in the event that the building inspection reveals structural issues with the roof, walls or foundation (Engineering and Building Inspection Due Diligence will be covered in more detail in Part 5 of this Series). From the buyer’s prospective a specific due diligence contingency is a much riskier contingency than a “free look” because if due diligence reveals a material problem beyond the scope of the limited conditions, the buyer either loses its deposit or is forced to close and then is stuck with the problem.

Seller’s Tips

  • Use specific due diligence contingencies in the contract
  • For each type of due diligence, clearly identify the reasons under which a buyer can terminate the contract and draft language as narrowly as possible
  • Require the buyer to provide appropriate insurance for all of its consultants naming seller as additional insured
  • Make sure that the buyer indemnifies the seller for any damages or liabilities that arise out of testing and that seller will repair all damage at its expense
  • If buyer wants a right to extend the diligence period, require a non-refundable payment

Buyer’s Tips

  • Get a “free look” general contingency which allows termination of the contract for any reason or no reason
  • For all forms of due diligence contingencies make sure that the contract requires the seller to assist the buyer in conducting the due diligence by providing documents in the seller’s possession such as existing property files, reports and permits
  • If the buyer is allowed to apply for permits or make any applications before closing the contract should grant the purchaser the authority to act on behalf of the seller when dealing with third parties such as municipalities
  • Try to get a right to extend the due diligence period, without a non-refundable penalty
  • For each type of specific due diligence, clearly identify the reasons under which a buyer can terminate the contract and draft language as broadly as possible

In the Concrete Jungle

In New York City buyers of real estate have been hoarding their cash reserves since the financial crisis in 2008. As a result, there is huge amount of cash chasing after very few deals which has placed a lot of the control in the hands of sellers. In New York City sellers therefore heavily favor entering into non-contingent contracts (often referred to as “all-cash” contracts) and have forced buyers to conduct as much due diligence as possible prior to entering into a contract. One reasonable solution is for the seller and buyer to enter into a non-binding letter of intent, which has an exclusive period during which the seller will only sell to that buyer. This allows the buyer a certain amount of time (usually very short) to conduct limited due diligence before entering into a binding contract. However, letters of intent should be used with extreme caution as courts may enforce them as binding contracts, especially with respect to any promise by the parties to “act in good faith”.

Good Resources

A helpful list of documents that a buyer should consider requesting from the seller prior to committing to any commercial real estate deal is here.

Disclaimer

The information in this blog post (“post”) and website is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. By using this website and post you understand that there is no attorney client relationship between you and Tomlin Law, PLLC. No information contained in this post should be construed as legal advice from Tomlin Law, PLLC or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction. Although the information on this blog is intended to be current and accurate, it is not guaranteed or promised to be current, accurate, or complete. This blog contains links to other web sites. Tomlin Law, PLLC makes no guarantees or promises regarding these web sites and does not necessarily endorse or approve of their content.

Here is your opportunity to be an equity owner in iFunding!

The iFunding team is excited to announce that we are raising a round of financing for our own company. What better way to do this than to use the same crowdfunding principles that we live by day-to-day? You can read all the investment details at www.crowdfunder.com/ifunding. We encourage investors to consider participating directly in our company’s success by owning equity in iFunding.

Our Expansion Plans

After a year of raising tens of millions of dollars for nearly thirty real estate projects, and introducing the industry’s first mobile investment app, iFunding is ready for its next growth stage:

  • Real estate operations, including market analytics, deal sourcing, due diligence, entity setup, legal filings and compliance, financial reporting will be scaled up to manage more deal flow.
  • Greater ease-of-use features and richer deal information will be deployed on our web and mobile platforms.
  • Marketing, especially online real estate education programs, and digital/social outreach will spread the word about crowdfunding to more investors and property developers. Meanwhile, an account management team will work with the most prominent investors and family offices.

Learn More

Those who are accredited investors are invited to read our investment materials and participate in our corporate fundraising via www.crowdfunder.com/ifunding. Individuals will be asked to verify their “accredited investor” status via online income verification or a letter from your lawyer or CPA. And, if you haven’t already, take a moment to acquire a free account here at www.ifunding.co to be able to browse our real estate investment opportunities.

Financing Strategy

Because much of iFunding’s business model is based on receiving a profit when our real estate investors do the same – we feel this approach aligns our incentives with our investors – capital is needed to expand operations in this stage of our growth. We are now raising $1 to $2 million ($1 million is our target, $2 million is the cap), which will bridge the capital already contributed by select customers, business partners and colleagues of the firm, and an A Round planned for 2015. We feel this is the most effective sequence of funding in order to facilitate growth while managing the strategic direction of the company. As the future A Round will leverage venture capital and real estate industry financing, effectively, individual investors can benefit from crowdfunding to participate now at preferential terms, with a low minimum investment ($10,000).

Market Growth

Our founders, William Skelley and Sohin Shah, were recently reflecting on how quickly the real estate crowdfunding market has grown, since their idea for the company emerged in 2012. “There were a lot of people who thought that real estate crowdfunding couldn’t become a reality, as recently as 2012 when we were starting up. It’s been amazing how knowledgeable investors and leading-edge developers have supported crowdfunding and iFunding so confidently.”

The market effectively went ‘live’ a year ago, when companies including iFunding started listing their first investment opportunities. Our average internal rate of return in the first projects that have been completed is more than 20%. More recently, the analytics firm Crowdnetic determined real estate to be the largest industry participating in “private securities, publicly raised” (i.e., crowdfunding). Given that total worldwide real assets are worth more than $25 trillion; over $150 billion in real estate is transacted each year; and at least $25 billion of that is from individuals, we see plenty of room for future growth.

With Appreciation

We’d like to thank several partners that have assisted with this fundraising round.

  • We chose to list the investment at Crowdfunder, because Crowdfunder’s site makes it easy to read about and compare business equity investments, communicate information with potential investors, and because of their reach. It is the number one ranked equity crowdfunding site on Google, with over 77,000 registered users and $56 million committed across investments-to-date.
  • Further, we have partnered with Accredify to manage verification one’s “accredited investor” status. Investors generally need to demonstrate a certain level of income or liquid assets in order to participate in private securities. The Accredify site allows an investor to either use an easy and private verification of income against tax records, or to upload a verification letter from one’s CPA or attorney. That single verification can be used with a wide range of investment sites, including but not limited to iFunding’s.
  • Finally, our thanks goes to Tommy Hawkins of Hawk IV Productions for producing our introductory video on the investment site.

The iFunding team will continue to work every day on expanding access to quality real estate investments, and providing greater value to you. We welcome questions via 844-367-4386 or investors@ifunding.co.

My First Experience at NYTech Meetup

I went for my first ever NY Tech Meetup (NYTM) on Tuesday, October 9th 2012 at the NYU Skirball Center for the Performing Arts after my business partner at iFunding recommended that we attend it. The Meetup is a great platform for new and upcoming technology companies that get 3-5 minutes to win the hearts and minds of a wide audience, while simultaneously gaining exposure to a huge crowd. It is an excellent opportunity to meet people from different backgrounds and see what others are doing in the extremely vibrant NYC tech scene.

-A wonderful opportunity to hear about new ideas, technologies and make connections.