Understanding the Ins and Outs of Due Diligence

If you are buying or selling property in North Carolina you need to understand the ins and outs of Due Diligence.  It’s a wrinkle in the Offer to Purchase brought to us a couple of years ago by the good folks in Raleigh.

In the most general of terms, whether you are buying a home, a car, or a stock, “doing due diligence” is thought of as the time you do your research about whatever it is you are buying. In real estate, it means that and a lot more and it has some major implications.

Before the real estate commission changed our contract, an Offer to Purchase was usually contingent on a buyer getting financing and on inspections.  Typically a buyer and seller would agree that a buyer could bail on a contract if the buyer was unable to get financing with the terms they were looking for or if the repairs exceeded a certain dollar amount. The repair contingency was especially problematic. There was a specific list of things that a buyer could expect a seller to repair, but 99% of buyers ignored that list and asked for anything and everything. The seller wasn’t required to do the repairs.....but the buyer didn’t have to buy, either.

Today’s Due Diligence feature allows a buyer to bail out on a contact for any reason at all as long as they do it before a certain date, time being of the essence. 
The contract leaves space for a due diligence fee, but all to often it's ignored. Whereas the escrow amount is held in a trust fund and credited back to the buyer at closing, a due diligence fee is money that the buyer pays directly to the seller which they keep regardless of whether the property closes or not. From a buyer’s perspective, what this all means is that if they wake up one morning and decide they don’t like the color of the house, they can decide not to buy it and they have nothing to lose. In today’s vernacular, they don’t have any skin in the game. Our Offer to Purchase was already a very buyer friendly contract and with this new due diligence feature it’s a love fest.  But for the seller.....not so much.

From the seller’s perspective, due diligence creates a number of challenges that favors the buyer and leaves a seller in a precarious position. It starts when the contract is signed.  The MLS status is changed to “In Due Diligence” and the home no longer shows up as active. Anyone doing a search would not see that the home is “technically” still on the market or that the seller would likely entertain back up offers so more than likely, showings stop. Plus, the time frame for a buyer due diligence period is entirely negotiable. It could be two weeks for a cash deal....it could be 45 or 60 days. It’s whatever the two parties agree to. But here’s the catch for sellers.  They have no guarantee that their buyer will go through with the deal at the end of this due diligence period.  Meanwhile, their home is off the market, and their future is in limbo.

Recently an agent I know had her seller’s home under contract.  It was a 45 day due diligence period and as that deadline approached, the sellers moved all of their belongings out of the house and into storage in anticipation that they would be moving. The due diligence deadline came and went. A week before the closing, the buyers walked. Luckily this savvy agent had gotten a hefty due diligence fee written into the contract and the sellers received some compensation along with the escrow amount. It doesn’t always work out that way. In another case, involving a land purchase, the buyers wanted the seller to do a variety of things that cost the seller a good bit of money. The seller, moving forward in good faith did all those things. A few days before the end of due diligence, the buyers walked and in this case, there was no due diligence fee for the seller.

Some agents are also writing contracts where the due diligence period ends one day and the closing is the next.  Shame on any seller’s agent who allows their seller to accept this as part of the contract because it creates an impossible scenario. If you are a seller, how fast are you willing to move out, knowing that the deal may fall through. Then there are the attorneys. There is title work to be done before a property can close and no attorney I know would be willing to do that before the due diligence period has run out and there is some reasonable expectation that the property will close.  Expecting a property to close the day after due diligence is simply ludicrous and no home seller should sign a contract like that.

For the most part, the NC Offer to Purchase does little to protect the seller and if asked, I would tell the real estate commission that they need to do more.  Why are sellers treated so differently than buyers?  If a buyer can bail out for any reason, then shouldn’t a seller have that same option? If the buyer can walk because they found a house they like better, shouldn’t a seller be able to walk if they find another buyer with a better offer? Frankly, I don’t think any party should have a carte blanche pass for walking out of a contract without a really good reason and without compensation to the other side.  I don’t know if a mandatory due diligence fee equal to some percentage of the offer price is the right idea, but it’s a place to start.  I’m sure the real estate commission thought they were making things simpler by eliminating the financing and repair contingency. In some respect they have, but at what cost to the seller.   In the meantime, if you are selling your property in North Carolina, make sure you understand the implications of due diligence and how to protect your interests. If your listing agent hasn’t explained all the ins and outs and what you stand to gain and lose, make them explain it. If they can’t, then maybe it's time you got an agent who has your best interests at heart.