Real estate due diligence in M&A transactions

April 2020 | FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

April 2020 Issue

Most mergers or acquisitions, stock purchases or asset purchases will involve some real estate assets. In those instances where real estate is not the key driver of the transaction, the acquirer’s due diligence requirements may be less stringent. Nevertheless, it is prudent to conduct financial, physical and operational due diligence on the target’s real estate, as the results could make or break the deal. Ultimately, real estate can be a liability if it is not properly managed.

“Where an M&A transaction involves real estate, whether freehold or leasehold, it is important to undertake due diligence on the real estate as part of the overall due diligence process,” explains Alicia Albury, a partner at Maddocks. “Real estate due diligence is now recognised as an important risk mitigation strategy and should include financial, physical – both structural and environmental – and legal due diligence. Legal due diligence ensures that the seller has the right to transfer the real estate and informs the buyer in relation to encumbrances on the title, for example easements or restrictions on title, resumption proposals, zoning and other issues that impact ownership and use.”

Due diligence should leave no stone unturned. Issues such as zoning restrictions, potential liens and possible encroachments on the property cannot be overlooked. This undertaking can be challenging in some jurisdictions. In the US, for example, disparate federal, state and local regulations can be burdensome for acquirers.

Equally, structures must be fully inspected to discern whether any repairs need to be undertaken, and the estimated cost. Acquirers must also ascertain any potential liabilities from any previous legal or regulatory violations.

Ultimately, a due diligence plan should ensure that all relevant issues are addressed prior to deal completion. “The plan must be tailored to the jurisdiction in which the real estate is situated and the nature of the real estate assets, but as a general statement for freehold should cover title, resumption proposals, zoning, occupation, rates and taxes, non-compliance notices and any agreements between the seller and any third parties in relation to the real estate,” says Ms Albury. “The plan should include questions to be asked of the seller which address issues that only the seller will know or information that only the seller will have access to, as well as issues that can be addressed through undertaking searches and enquiries of public records.”

“All of the various consultants who are conducting real estate due diligence – financial, physical and legal – should share their draft findings with one another, as issues may be uncovered in one workstream that affects another.”

In addition, due diligence should include analysis of the seller, taking in reputation and track record, with particular attention paid to its financial history and prior use of real estate assets.

Legal due diligence must also be tailored to match the structure of the proposed transaction. There are many issues for acquirers to consider, from environmental matters and title investigations to property searches and reviews of business contracts. “A title identification survey shows the land boundaries and any encroachments on the property by an adjoining property and any encroachments by the property on an adjoining property,” says Ms Albury. “This allows the buyer to determine whether any encroachments are supported by appropriately documented easements. A lettable area survey shows the lettable area of a commercial or retail asset to assist with financial due diligence. Either the seller or the buyer can obtain surveys from an appropriately qualified surveyor, but if the buyer is seeking to obtain the surveys, the seller will need to provide its consent to the surveyor entering the property.”

All of the various consultants who are conducting real estate due diligence – financial, physical and legal – should share their draft findings with one another, as issues may be uncovered in one workstream that affects another. “It is also important for all consultants to be given the details of the transaction, including the transaction structure, so that due diligence enquiries are conducted in this context,” says Ms Albury. “There are different risk and liability issues for a buyer stepping into the shoes of a landowner by acquiring the shares of that company, than in a buyer acquiring real estate by transfer as part of a business acquisition.”

There will always be variables in any real estate transaction, so preparation is key. Acquirers should prepare a unique due diligence plan for each acquisition. Failure to take these important steps can have serious implications.

With any M&A deal, questions concerning leases, building maintenance, and planning and environmental issues, among others, abound. It is vital that acquirers can address these questions to unlock the value of any real estate and limit its potential downside if mishandled.

Richard Summerfield