What is real estate due diligence?

Due Diligence

 

I was asked to perform some due diligence work on a property in Kuala Lumpur to properly assess its value and thought I should share what due diligence really means within a real estate context.

According to Investopedia, Due Deligence is an investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regards to a sale. Other legal definitions includes “the care a reasonable person should take before entering into an agreement or a transaction with another party”.

In short, for the purchaser of a property, it is about making sure that you get what you think you are paying for. So in this article, we will explore the due diligence you need to take when buying real estate.

A. Legal Due Diligence

Legal due diligence is the exercise of verifying two things – the legality of the property and the legality of the seller/owner.

1. Verifying the legality of the property and owner/seller with individual land title or strata title (Malaysia Context).

In the process of conducting legal due diligence, you may request for the ownership documents from the seller or real estate agent and conduct a search on the title at the land office. Things to look out for in the title search:

  1. Does the title correspond to the name and identification of the seller/owner?
  2. Status of the title ie. Freehold or leasehold. If it is leasehold, what’s the expiry date?
  3. Particulars of the title ie. Title no., Lot no., District, Sub-District, State
  4. Check if there are any encumbrances. Is the property charged to a bank or some other companies or parties? It is common for a property to be charged to a bank as security due to financing by the seller. But if the property is charged to someone else other than a bank, conduct further research and find out the reason and detail of the charge.
  5. If the title has a private caveat, discuss with the seller how to go about getting it remove.
  6. If the title is free from any encumbrances, be extra diligent. If the property is charged to the bank, the original title deed will be with the bank. If the property is not charged to the bank, it is easier for someone to forge a title with a fake identity card and attempt to sell the property to you. So then seek verification on the title deed with the State or District Land Office.

At the same time, conduct searches on the owner. If the owner is an individual, conduct:

  1. Bankruptcy search and you may try conducting a CTOS search on the owner, which will reveal the owner’s credit worthiness.
  2. If the owner is bankrupt, the property will most likely not be “free and clean” and the buying process will present more hurdles.
  3. Remember that the court is trusted to protect creditors and not getting you a great deal on the property.

2. Verifying the legality of the property and owner/seller under a Master Title (Malaysia Context).

If the individual title or strata title of the property is yet to be issued by the Land Office, the property is held on a master title. So proof of ownership is then by way of principle documents and here are things that you need to look out for:

  1. The principle documents will be the Sales and Purchase Agreement (between the seller and developer) and the Loan Agreement (between the seller and the seller’s bank).
  2. If the seller claims that he has fully settled his loan with the bank, then request a copy of the receipt and reassignment between him and the bank.
  3. If the owner had purchased the property from a previous owner, the documents to request are as follows:

a)     Principle Sale and Purchase Agreement between the developer and the first owner;

b)     Principle Loan Agreement between the first owner and his bank;

c)     Receipt and Reassignment between the first owner and his bank;

d)     Sale and Purchase Agreement between the first owner and the seller (who is the second owner)

e)     The Deed of Assignment between the first owner and the seller, with full stamp duty paid – this is proof that ownership of the property has been passed from the first owner to the seller.

f)     The Loan Agreement between the seller and his bank.

3. What happens if there are missing documents?

As these documents constitute the entire history and trail of ownership of the property, the complete set of principle documents are required when you purchase. So for any missing documents, you need to trace the parties involved in that transaction.

The party that misplaced the documents needs to make a police report on the missing documents. The owner of the document need to make a statutory declaration declaring ownership of the documents and declare the documents being missing or misplaced. With the police report and statutory declaration, the lawyers that prepared the documents who have sighted the original can endorse on the copy of the documents as certified true copy.

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B. Physical Due Diligence

This is the exercise of verifying the physical aspects of the property by conducting the actual site visit and inspection. This is the fun part and here are things you need to verify: 

  1. The address of the property
  2. Existing occupants and are they legal tenants occupying the property.
  3. Inspect the state and condition of the fixtures and fittings.
  4. Do a run-through within and around the outside perimeter of the property and take note of any defects. You may request the vendor to rectify them before handing over the property to you.

C. Financial Due Diligence (Malaysia Context)

If you need a bank loan to finance part of the property, check with your bankers whether you qualify for the margin of finance that you desire and require. You need to also further verify further whether the margin of financing is against the Sales and Purchase Agreement or valuation.

If the loan approved at 90% on valuation, and the valuation is less than the purchase price on the Sales and Purchase Agreement, you will need to pay up the difference between 90% of the purchase price and 90% of the valuation. This is also known as the differential sum and it is generally paid to the seller’s lawyer midway through the transaction before your bank releases the redemption sum to the vendor’s bank.

Don’t forget to take note of the legal costs for the Sales and Purchase Agreement and Loan Agreement. If you’re purchasing the property from a developer, generally the legal fees are borne by the developer. The legal costs for the loan documentation however, is yours to pay.

Finally the implementation of the Goods and Services Tax (GST) will start from 1st April 2015 and as such you will need to pay a 6% tax on the purchase price of all commercial and industrial properties.

So certainly there’s more to due dilgence than what we’ve covered and if you think I’ve missed out something, feel free to let me know through the comment section below. Thanks for reading and happy investing.

Rui is a licensed real estate salesperson in Singapore and is the editor behind Property Pinpoint’s blog. His real estate experience stamps from his time at Jones Lang LaSalle and ERA realty, where he quickly developed a devoted client base, savvy negotiation skills, and a thorough knowledge of the International real estate scene.

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