Why should you conduct a Due Diligence in a real estate acquisition?

Are you acquiring real estate through shares in a property-owning company? If so, conducting a thorough Due Diligence (DD) is essential. When you buy shares, you acquire the company as it is, including all assets, rights, and liabilities. A well-executed DD helps you avoid unpleasant surprises after completion.

Here is what you need to be aware of before submitting an offer.

Real estate is often sold as shares – and that increases your risk exposure

Commercial properties are frequently sold through shares in a single-purpose company that owns the property.

This structure is often tax-efficient:

• The buyer avoids paying stamp duty.
• the seller may benefit from tax exemption under participation exemption rules.

While this can be advantageous for both parties, it also means that you are buying the entire company, not just the property. This makes a thorough review critical.

Also read: Letters of intent in property transactions—what to know before signing

Include the right conditions when submitting your offer

When submitting an offer, you should always include appropriate conditions:

1. Condition precedent: Due Diligence

Your offer should be conditional upon a satisfactory Due Diligence review before the final sale and purchase agreement is signed.

The review provides insight into:

• legal matters relating to the company
• financial and tax positions
• technical condition and regulatory status of the property
  
  

If the DD uncovers risks or deficiencies, you may:

• withdraw from the transaction, or
• negotiate a price reduction or other compensation

These discussions take place before signing the final agreement.

2. Condition precedent: Financing

Financing a share acquisition can be more challenging than financing a direct property purchase. Banks typically lend less when shares are used as collateral.

In some cases, banks may take security over the underlying property, but this is limited by the company’s dividend capacity. If the property has a low book value, this can significantly restrict available financing. As a buyer, you may then need to provide more equity or alternative security.

3. Other common conditions

If the buyer is a limited company, the acquisition often requires board approval. You should therefore include a condition precedent for such approval. Confidentiality provisions regarding the offer and negotiations are also commonly included.

What should a Due Diligence cover?

A proper DD usually consists of three main components:

Technical Due Diligence

This review assesses:

• the technical condition of the building
• expected maintenance and future investment needs
• zoning plans and development potential

Material deficiencies may justify withdrawing from the transaction or negotiating a price reduction. For development projects, the review may also include an assessment of design documentation and cost estimates.

Financial Due Diligence

This is particularly important in share deals. Key focus areas include:

• tax and VAT positions
• depreciation basis
•  financing structure

A common issue is that the property may be fully or partially depreciated for tax purposes. While you pay market value for the shares, depreciation continues from the historical book value. This can have significant tax implications and should be reflected in the purchase price negotiations.

Legal Due Diligence

You should, among other things, review:

• encumbrances on shares and property
• zoning and public law requirements
• title and ownership
• lease agreements, guarantees, and payment history
• insurance and material supplier contracts

The objective is to ensure that the company owns the property outright, and may use it as intended, and that the expected cash flow is both real and sustainable.

Due Diligence secure your real estate acquisition

A thorough Due Diligence provides control, negotiation leverage, and security when acquiring real estate through a share deal. The earlier risks are identified, the better positioned you are to make informed decisions.

Are you considering a real estate acquisition? Feel free to contact us for a non-binding discussion on how we can assist you through the process.