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Real Estate Due Diligence

By - King Stubb & Kasiva on November 3, 2022

A steep increase in real estate transactions, including buying, selling, leasing, and financing of properties shows that real estate is one of India's fastest-growing industries. In the last few years, there have been large-scale land purchases from rural, urban, industrial, and commercial centers. Such a high increase in the real estate transaction values and the overall industry growth has made it necessary for the parties involved in such real estate transactions to do their due diligence before entering into any deal.

Real Estate Due diligence done by the parties ensures them of the risks involved, the requirement of the safeguards to protect themselves from such a risk and consequently reduce the said risks in the transaction. A due diligence exercise is the most important part of a real estate transaction. The due diligence process can impact the transactions largely by determining the viability.

What does real estate due diligence mean? Due diligence in India is of utmost importance to prevent any undue losses due to properties not having clear title and due to category of land being agricultural when one is buying the land for commercial purpose. Further, banks also conduct due diligence to assess risk, confirm their customers credibility, and reduce bad debts etc. Factors like Derivation of Ownership, Authority to transfer the title of real estate property Transfer within a particular category, ‘Sub-lease for a specific purpose’ etc. need to be considered while conducting Due Diligence.

Table of Contents

Types of Due Diligence

From the Real estate perspective there are 4 major types of due diligence. These are follows:

  1. Market Due Diligence- Early in the investing real estate lifecycle, market due diligence is performed with the goal of evaluating the market's quality where the property is situated. One may choose thriving, developing economies because they offer the greatest potential for commercial property prices and tenant rents to increase under our stewardship of the asset.
  2. Financial Due Diligence- The term "underwriting" a deal also refers to performing financial due diligence. A crucial step in figuring out a property's fair market worth and possible return is projecting its future cash flows. It is typical practice to draught an initial cash flow prediction and then utilise financial due diligence to confirm or refute the underlying assumptions. A proforma projection of the property's earnings, costs, net operating income, and debt payments is required to determine possible investment returns.
  3. Legal Due Diligence- Some aspects of legal due diligence take place concurrently with physical due diligence, with the aim of ensuring that the title to the property can be successfully transferred to the new owner and to check that the property is commercial or an agricultural land. Legal due diligence in India is very important to assess the clear title of the transferor. In India due to various personal laws, the flow of title would be complicated. Legal Due diligence will ensure clear title of the transferor and ensure that the land or building will be fit and proper for the use of the transferee and will ensure that the transferee will have clear title over the property after the property is transferred.
  4. Physical Due Diligence- Physical due diligence involves a thorough inspection of the property to verify that it is safe for habitation, that no significant unforeseen repairs are required, and that neither the current nor former occupants have contaminated the surrounding area. Further, to check that there are no encroachments to the property.

Components of Due Diligence

The main objective of real estate due diligence in India is to check the title of the present/ past owners, any encumbrances on the property and any statutory legislations to be followed. To reach these objectives following components are important to be looked upon:

  1. Derivation of Ownership- A property can be derived in multiple ways. For instance-
    • Property through sale: The beneficiary must check the registered sale deeds and the title papers of the previous title ownership holders if the title of ownership of property is acquired through the sale. Additionally, the beneficiary is to receive all vested rights to the property.
    • Property through gift: If a property's title of ownership is acquired through a gift registered gift deed must be reviewed.
    • Property through a will: If the title is through a will, then one must check the validity of provisions concerning the law in force and further the competency of such will approved by the court.
    • Property through lease: If the title is obtained through leasehold rights then, the transferee must review the lease deed, the party's rights, and the fulfilment of all duties about its transfer.
  2. Authority to transfer the title of real estate property- To lawfully transfer ownership of the property to the beneficiary, it is important to review the authority in the executed instrument. Further, the transferor must be of sound mind and legal age to enter into a contract involving the sale or purchase of the property.
  3. Encumbrances over the immovable property– Depending on the transaction it may be necessary to inspect the encumbrances over the property to any bank from the office of the Sub Registrar of properties of that particular jurisdiction by obtaining a non-encumbrance certificate. Further, the CHG-1 form submitted to the Registrar of Companies and an encumbrance certificate must be obtained if the firm/ company creates any charges over property [1]
  4. Transfer within a particular category- According to local state laws in several states, property belonging to STs, SCs, or other underprivileged classes is transferred to other such tribes and not to the general class. The previous title records of the property will also be looked at as part of the due diligence process and if any previous title owner is discovered to be a member of the SC, ST, or another backward class such property will be transferred to the government.
  5. Sub-lease for a specific purpose- In India, the government offers leaseholders property that is designated exclusively for agricultural use and that can also be subleased for agricultural use. Such sublease agreements shall not be for any other commercial or residential uses while conducting due diligence on the agricultural land.
  6. Development over the property- Verifying the legality of the building or development of the property in compliance with the state laws in their particular jurisdiction is important throughout the due diligence process.
  7. Government approvals and authorizations- It is important to inspect all necessary government authorizations building/industrial permissions, insurance policies, taxes, environmental compliances etc.
  8. Acquisition process- The law governing land acquisition in India limits the original owner's ability to sell their property. When performing due diligence, it is important to confirm that the real estate property is not the subject of any acquisition procedures. If a transaction is made on real estate that the government has already acquired, the transaction will be considered void from the start and cannot be legally enforced.
  9. Publication- The beneficiary may publish a notice in at least two local newspapers, endorsing the beneficiary's genuine title ownership, to be on the safe side and avoid any unregistered transactions.

Conclusion

Given the foregoing, it is essential for any person while buying or leasing a real estate to exercise legal due diligence before engaging in any transaction involving real estate property or establishing any kind of charge over the property, whether it be for the purpose of a sale, purchase, lease, or mortgage. Any such record or information on real estate property that may have an effect on the transactions and nature of the property must be looked into and evaluated. Before engaging in any such transaction involving the property, it is also advisable to make sure that any chain deeds, title documents, encumbrance certificates, insurance policies, and government authorizations comply with the law.

FAQs

Is due diligence mandatory in India?

Due diligence is necessary for every organization or individual before entering into any business, real estate, mergers, buying or selling shares etc. It is the first step to identifying the risks involved and finding out ways to reduce their impact.

Why due diligence is important in commercial real estate?

Due diligence is necessary to understand your limited/restricted rights in the given commercial space in shared buildings as well as to decrease and alleviate financial concerns in high-value purchases. Before entering into any commercial property transaction, one should give a reasonable real estate due diligence period to prevent any losses.

What issues are you looking out for in due diligence?

To find any problems with the title, ownership, rights of the parties, legal disputes or any encumbrances to prevent a disastrous business deal. To gather knowledge that will be valuable in appraising the sale and to confirm that the real estate deal is for the benefit of the parties involved.

[1] https://www.mca.gov.in/mca/html/mcav2_en/home/mcaservice/companyservices/chargemana
gement/chargemanagement.html


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