February 27, 2023 by Matthew Fraker
Due Diligence in Real Estate
Due diligence is an investigatory period in real estate transactions wherein the Buyer can freely conduct inspections and decide whether or not to move forward or back out. The 7/2022 North Carolina contract titled Standard Form 2-T: Offer to Purchase and Contract defines due diligence in paragraph 1(h), “Buyer’s opportunity to investigate the property and the transaction contemplated by this contract…to decide whether Buyer, in Buyer’s sole discretion, will proceed with or terminate the transaction.” In real estate, due diligence has two negotiable parts: the period and the fee. Due diligence statutes and regulations vary depending on the state in which you are selling or purchasing. This article will focus exclusively on due diligence in North Carolina, as such.
Due Diligence Period
The due diligence period is a negotiable amount of time that may or may not be secured by a negotiable fee (due diligence fee), allowing the Buyer the right to investigate or examine the property. Investigations include, but are not limited to, hiring experts to conduct examinations, during which the Buyer can unilaterally terminate the contract for any reason. In other words, the due diligence period allows the buyer time to investigate the property to see if the property is acceptable to or meets the Buyer’s needs, and if not, back out of the transaction. It is also a period for the lender to convey critical loan information to the Buyer that may affect the Buyer’s ability to perform their obligations under the contract. For example, it would benefit the Buyer to know whether or not the property appraised during the due diligence period, allowing enough time to reach a solution.
Due Diligence Fee
Per paragraph 1(i) of the OTPAC, the due diligence fee is “A negotiated amount, if any, paid by Buyer to Seller with this Contract for Buyer’s right to terminate the Contract for any reason or no reason during the Due Diligence Period.” Technically, a due diligence fee is unnecessary to secure a due diligence period or go under contract; however, it is ultimately up to the listing side to accept a contract with no due diligence fee. It is always best to consult your agent regarding these matters, as every situation differs. It’s imperative to remember that while a buyer can back out for any reason during the due diligence period, the due diligence fee is forfeited to the Seller. Per paragraph 1(i) of the OTPAC, “The Due Diligence fee shall be non-refundable except in the event of a material breach of this contract by Seller, or if this contract is terminated under paragraph 23(b) or as otherwise provided in any addendum hereto.” Paragraph 23(b) is titled Breach by Seller.
Due Diligence Inspections
It is ultimately up to the Buyer to decide what they want to do regarding inspections, professional or otherwise, after considering advice from their agent. The Real Estate Training Manual reads, “a buyers agent also owes his or her buyer-principle the standard agency law duties, meaning that a buyer’s agent has an even higher level of responsibility for advising and assisting the buyer in the due diligence process.” The contract elaborates on the types of inspections the Buyer can perform. Paragraph 4(b) of the OTPAC outlines the buyers’ scope of authority to conduct inspections, “Buyer or Buyer’s agents or representatives, at Buyer’s expense, shall be entitled to conduct all desired tests, surveys, appraisals, investigations, examinations, and inspections of the Property as Buyer deems appropriate…” The Buyer should also meticulously inspect the property with their agent. Depending on the property, there are various inspections a buyer can conduct. To name a few:
Property Inspection:
The residential property is inspected thoroughly by a licensed home inspector who compiles a report and (hopefully) delivers it to the buyers promptly before the end of the due diligence period.
Wood-Destroying Insect report:
An inspection by a licensed pest control inspector to check for the presence of wood-destroying insects. The North Carolina Real Estate Training Manual elaborates, “…licensed pest control operator, who prepares an inspection report on a standard form pursuant to regulations of the North Carolina Structural Pest Control Committee.”
Appraisal:
If the Buyer is applying for financing, it is almost certain that the lender will require an appraisal by a licensed or certified appraiser. The lender wants to know if the property is worth the Buyer’s offer. The lender will order the appraisal and send the report to the Buyer well before the end of the due diligence period so the Buyer can discuss their options if the property doesn’t appraise.
I would be remiss if I didn’t mention that while the Buyer is free to conduct inspections or hire professionals to inspect, they are still responsible for damage caused to the property by inspectors or themselves outside of damage caused by “accepted practices.” Paragraph 4(e) of the OTPAC states the following, “Buyer shall, at Buyer’s expense, promptly repair any damage to the property resulting from any activities of Buyer and Buyer’s agents and contractors, but Buyer shall not be responsible for any damage caused by accepted practices either approved by the N.C. Home Inspector Licensure Board or applicable to any other N.C. licensed professional performing reasonable appraisals, tests, surveys, examinations and inspections of the property. This repair obligation shall survive any termination of this contract.”
Termination
Suppose the Buyer is dissatisfied with the property and decides they want to back out. In that case, it’s of utmost importance that the Buyer terminates before the end of the due diligence period. Per a disclaimer under section four of the contract, “If Buyer is not satisfied with the results or progress of Buyer’s Due Diligence, Buyer should terminate this Contract, PRIOR TO THE EXPIRATION OF THE DUE DILIGENCE PERIOD, unless Buyer can obtain a written extension from Seller. SELLER IS NOT OBLIGATED TO GRANT AN EXTENSION.” Furthermore, please note that the mailbox rule DOES NOT apply to a termination notice. According to the Modern Real Estate Practice in North Carolina, the mailbox rule stipulates that a message “….is considered as having been delivered when mailed, not necessarily when actually received….”
Again, states have different rules regarding due diligence in real estate. While having a basic understanding of this is essential, buyers and sellers should always consult with their broker or agent.
The content published in this post and other posts on this site are for informational purposes only and should not be interpreted as investment, tax, financial, or legal advice.
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