You just found the perfect site at the right price, and your model is showing great returns. If you could fast forward one year, you could be celebrating closing on the land and construction loan. Fast forward three, and it’s time to start thinking about disposition. Happy days, right?
Having the perfect site and financial model may be the start of any successful project, but without a substantive plan for a project’s due diligence, a great site can turn into a missed opportunity.
Understanding The Due Diligence Process
Many understand due diligence as a broad term referring to the actions that must take place prior to a financial closing in any real estate transaction.
Typically, after the signing of a letter of intent (LOI), the seller will offer a due diligence period, during which time the buyer has to invest funds to analyze the feasibility of a site. From title searches to surveys, the due diligence process uncovers hurdles that need to be addressed prior to a transaction being finalized. This process becomes even more complicated when development or redevelopment of the property is required as a part of the overall deal.
This article will outline the preliminary steps required in the high-level due diligence process that should be undertaken in the early phases of a project’s due diligence period.
Prior to entering into an LOI, a developer will have run preliminary zoning studies and modeled out the best future use that can fit on a given property. Armed with this information, it’s beneficial to engage an architect or turn to your in-house design team to analyze the information available to ensure that, as the developer, you understand what can be built as of right or what additional entitlement requirements should be requested of the local municipality.
Regardless of what your route here ends up being, a preliminary entitlement, design and permitting schedule should be generated for the developer to fully understand how much time needs to be committed to a project prior to being able to start construction.
The size and number of stories of a building will often dictate the type of construction materials that will be used for the structure (wood, steel, concrete). For instance, if your test fit tells you that three levels are the maximum height of the building, you may consider a wood frame as your cost-effective solution for the structure. This decision will impact the hard cost pricing you receive from your contractor, as there is a notable difference in cost per square foot between a wood and a concrete structure.
Based on the test fit information and basic cost-per-square-foot information, a developer can determine a quick, back-of-napkin understanding of the construction costs associated with their building. Taking the next step here will require the developer to reach out to a construction manager or general contractor (GC) to give credence to that budgeted figure.
GCs are able to estimate the construction costs with a greater degree of accuracy using their historical and intimate knowledge of the subcontract base in any given location. Then, based on the construction type, space planning and site conditions, they should be able to output a more accurate estimate of the build cost of a project.
This information can be fed back into a project’s model to see what impacts (good or bad) this next stage of pricing has on returns.
Environmental testing is a key component of the early stages of a project. A Phase I Environmental Site Assessment (ESA) will give you baseline information about the subject property and let you know if you need to continue your environmental investigation with testing of the site. Phase II Site Investigation testing is often a more substantial investment than Phase I and typically requires signoff from the seller to drill test samples of soil or groundwater on the site.
A desktop geotechnical site assessment can be done in the early stages of the due diligence process. This report can uncover items such as typical soil-bearing capacities and water table elevations and identify any seismic concerns on the site. These key factors will inform the overall structural design of the foundation (i.e., deep vs. shallow foundation systems) and allow you or your GC partner to determine an estimated cost for the underground works.
A more in-depth geotechnical study will be required if you choose to move forward with the project, but depending on your tolerance for risk and the results of the desktop review of the site, this can wait until a later stage of the diligence process. It should be noted that in order to further the structural design of the building, a full geotechnical study is essential.
Survey And Title
Performing a title search is a must in the early phases of development, and—coupled with an ALTA survey—will allow a developer to visualize any potential easements, zoning restrictions and property boundary concerns early on in the project.
Will-serve letters are often obtained by developers at this stage as well. They will simply state if a particular utility (power, gas, water, etc.) is available to service the project site. Understanding if all of your utilities can currently be delivered to your potential project is a critical first step in development, followed by specific utility requirement analysis to determine if off-site improvements should be considered and budgeted into a project.
Throughout the due diligence process, keep a detailed record of the steps undertaken and the results of those steps. Maintaining an organized filing system is a fundamental part of any new development.
Ultimately, the items outlined above can be done with minimal investment and can give you the tools needed to determine if a project warrants further pursuit-funds or if you should focus your resources on that next perfect site.