Due diligence may be seen as a necessary evil by some lenders, but that is not the right attitude, says Jon Rowling
? Due diligence was seen by some as an unnecessary delay, and many transactions were completed without it ? The changing market conditions have brought about a change in approach ? Due diligence highlights negative issues, but it can also find value, identify positive action and give buildings a new lease of life |
Since the summer of 2007, the term “sub-prime” has come to epitomise the worst aspects of the world of property. Although the word has almost exclusively been used to describe the finances surrounding property purchases, what of the buildings themselves?
From a building surveyor’s perspective, sub-prime could refer to a building with problems that cannot be resolved without capital expenditure by its owner. How can these and their related costs be anticipated? The answer lies with due diligence.
At the height of the property boom, with prices seemingly set to rise forever, due diligence became, for some lenders, no more than a box-ticking exercise before approving a loan and signing the cheque. The unrecoverable costs were cancelled out within a short time as capital values rose, and if the property in question was in a state of disrepair, redevelopment was a genuine option.
Allied to this was a sense, especially in the case of properties that had been bought and sold a number of times, that technical due diligence was an unnecessary delay, and many transactions were completed without it. Where property portfolios changed hands several times, it was tempting to assume that everything was fine. Even if that were not the case, the net effect of a few problem buildings was reduced within the portfolio as a whole. However, familiarity breeds contempt and any portfolio will normally contain one or two surprise packages.
Change in attitude
A changing market has brought a change in approach. Investors are keen to ensure that they will not be liable for bills as soon as they purchase a property and funders are anxious to keep risk to a minimum, which is where due diligence surveyors become a crucial factor.
The due diligence process identifies not only patent defects, namely evident deterioration for which the tenant is often liable, but also latent defects, where the problem has not become physically obvious, but will do so in the future. Latent defects, such as design faults, poor workmanship and inappropriate materials, are of particular interest to investors and funders because, more often than not, the liability resides with the property owner rather than the tenant.
It is commonly believed that the UK’s rigorous building regulations and inspection programmes have resulted in excellent levels of construction and a relative lack of defects in commercial property. This framework may have improved construction methods, but latent defects are far from rare. Some recently encountered problems include:
? a warehouse built on a sloping site, with the well-built floor slab following the gradient;
? cantilevered balconies constructed from deleterious materials;
? buildings containing end-of-line mechanical and engineering equipment that will be expensive and difficult to maintain;
? a mechanical and engineering plant built into the structure of the property, preventing it from being removed;
? the use of curtain walling, which has been known to fail; and
? missing structural bracing to portal-framed warehouses.
Cost implications
None of these problems by itself will necessarily make a building undesirable, but each has significant cost implications. A comprehensive due diligence survey by an experienced building surveyor will not only identify these issues but also put a price on solutions. In a market where “sweating your assets” is of paramount importance, it is essential to have as much information as possible at one’s disposal.
However, due diligence does not highlight only negative issues; it can find value, propose positive action and give buildings a new lease of life. For example, an obsolete 1960s office building was transformed by the installation of a raised floor and under-floor air-conditioning. The improvements, identified as part of the due diligence process, moved the building into a completely different market, where it proved to be in high demand.
Of course, issues unearthed by a building surveyor can interest the funders. Parties should ensure that they employ a building surveyor at the outset and choose one who is able to see past the technicalities and offer constructive advice. Only technical due diligence can provide the information investors and funders need.
Jon Rowling is a partner at Malcolm Hollis LLP