What Gets Reviewed in DD?
In previous posts, we talked about the due diligence period – also known as the feasibility period – which is the time allowed for a land buyer to vet out all issues and assumptions. The due diligence process requires effort and money, which is not usually expended until a seller has accepted a buyer’s offer. These due diligence periods typically last from 30 to 90 days, depending the project complexity or status, and will allow the buyer to thoroughly research a variety of topics to help ensure future project profitability.
One key topic is the project entitlements. If the project has already been approved by the local jurisdiction, a buyer will want to understand what exactly got approved and the project conditions that accompanied the approval. If the property has no approvals and the buyer is planning to submit for entitlements, the potential for an approval needs to be thoroughly researched and analyzed. The entitlements have a direct impact on both revenue and costs.
The review of title is very critical to understand what recorded and unrecorded documents may encumber the property and impact development. Early in the due diligence process, a preliminary title report will be generated by the title company, requiring a thorough review by the buyer. Often an attorney experienced in title matters and a civil engineer may assist in reviewing the title report and underlying title documents.
If a site has no physical improvements, the site work and improvements need to be analyzed for costs and construction issues. These site improvements would usually include the grading, underground utilities, streets, and other common area. A civil engineer and cost estimator are key consultants who help with this review. If the buyer is purchasing finished lots, this due diligence topic tends to be quite a bit simpler.
Another very key topic is the market analysis, which will be the review of the local market conditions, projected pricing, sales absorption rates, product/floorplans, lot premiums, and possible market appreciation. In some cases, the developer or builder will conduct this market analysis in-house – but often an outside market consultant will complete a market study to confirm all of the assumptions that drive the project revenue estimate.
One of the final steps in the due diligence process is the financial analysis and project pro forma. With the revenue and cost assumptions having been analyzed, a project pro forma or cash flow will be prepared to assess whether the land price is economically feasible and that the project will provide for adequate profitability. This pro forma is only as good as the assumptions, which is the reason for a thorough due diligence process.
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