A due diligence should be conducted on every property that comprises a property fund. This is an evaluation into the details of a potential investment or purchase, which verifies all of the material facts relevant to the investment or purchase. Two aspects of the building must be examined. Firstly, we look at the leases on a particular property and, secondly, the property itself.
When it comes to the value of the leases on a particular property, it is not the bricks and mortar value that are considered, but rather the income that the leases provide. A price is calculated based on these figures. An accurate lease audit is vital when one considers that a purchaser would normally pay 10 times the nett annual income of the lease - there is simply no room for error.
It is within this environment, in which large sums of money are at stake, that corporate governance in the industry becomes an important means of policing transactions around due diligence. A person conducting a due diligence report must be completely independent and unbiased. I have come across a rather concerning trend which may compromise this stipulation. Certain property funds have been offering a "double or nothing" deal when it comes to due diligence. As such, if the property does not pass the due diligence, no fee will be paid to the person who conducts it. On the other hand, should the property pass, double the fee is promised.
How can this process do anything but compromise the objectivity of the person conducting the due diligence, when passing the property becomes a more attractive option?
In the same vein, certain property managers are offering due diligence as a complimentary service to their clients. Essentially I have no problem in offering added-value services to clients. In this case, however, if the property does not pass due diligence, it will not be added to the client's portfolio. If, however, it does pass, the property manager stands to benefit up to three percent of the income generated by that property, as they will be managing it. I believe that objectivity could be compromised in favour of passing the property for financial gain.
It comes down to integrity. Investors are investing a great deal of money and should do so knowing that every nook and cranny of the property has been checked and that the person conducting the due diligence has followed the principles of sound corporate governance.
