One of the most compelling
statements I have encountered about real estate investments comes from Franklin
D. Roosevelt, the 32nd President of the United States. He once remarked, “Real
estate cannot be lost or stolen, nor can it be carried away. Purchased with
common sense, paid for in full, and managed with reasonable care, it is about
the safest investment in the world.”
While this quote touches on several
aspects of real estate, our focus will be on one aspect in this article – due
diligence, which Roosevelt succinctly captured in the following words: “Purchased
with common sense.”
Common sense dictates that anyone
acquiring an interest in a real estate transaction should conduct a detailed
examination, analysis, and assessment of the circumstances of the transaction
object in fact and in law prior to its actual purchase, leasing, or financing.[1]
This is known as due diligence, the cornerstone of every successful real estate
deal.[2]
Your main objective in a real
estate due diligence process will be to analyse the risks and opportunities
specific to the asset under consideration. This includes considering the risks
and opportunities of the location of the real estate; the legal risk; the
capital procurement risk; investment cost risk; profit fluctuations risk;
property management risk; cluster risk; environmental risks; among others.[3]
With regards to the scope of your
due diligence investigation, this will depend on the nature, size, and location
of the property.[4]
For instance, commercial real estate transactions are more complex than buying
residential properties and have many more facets to your investment and negotiations.[5] Also,
within the group of residential buildings, detailed examination requirements
for single-family buildings are different from condominiums.
In considering the above
objective and scope of your due diligence investigation, we will examine this article
under four main headings: (1) Access to the Property, Legal Documents, and
Records; (2) Engage Professionals; (3) Review Reports and Property Records; and
(4) Closing Due Diligence.
Access to the Property, Legal
Documents, and Records
The first stage of a due
diligence investigation is negotiating access to the owner’s property, legal documents,
and business records (where applicable) – without becoming contractually bound
to buy, lease or finance the property.[6]
Depending on the scope of your investigation, this can be accomplished by means
of a simple written agreement between you and the property owner, such as a
term sheet or a letter of intent (LOI). In a more complex real estate deal, you
may have to include it as a contingency clause in the sale and purchase agreement
(SPA). Sometimes, you would be required to draft a separate due diligence
agreement based on the complexity of the deal. Once you have received the
seller’s permission to access the property, its legal documents, and business
records, your due diligence investigation begins.
Real estate is “real”
property. It is not “intellectual” property. It is meant to be seen and
touched. Immobility is the very nature of real estate. Hence, assessing the
location of a property is of utmost importance for a real estate transaction.
You would be surprised at the number of risks and/or opportunities you could
detect by your on-site observations of the property, its location, and your
interviews with residents/neighbours within the property location, if any.
To begin with, you may be able to
detect if there are any encroachments on the property, such as a better title,
an adverse claimant, and/or a simple warning sign. I am sure, at one point in
time, you would have encountered warning signs like “THIS HOUSE IS NOT FOR
SALE! BEWARE OF 419!” boldly written on a property. Any encroachment detected
on the property signals danger which you need to investigate to decide
whether to proceed or exit the deal.
On the issue of a better title,
it is important you understand the land tenure system in place in the
country/state where the property is located. In Nigeria, for instance, the Land
Use Act 1978 is the primary legislation that provides the legal framework for
real estate ownership and other dealings in land in Nigeria. Under the Act, the
land tenure system is divided into three: the deemed right of occupancy; the customary right of occupancy; and
the statutory right of occupancy (otherwise known as Certificate of Occupancy).
Delving into the land tenure system obtained in Nigeria is a lengthy topic
beyond the scope of this discussion. However, we would briefly discuss some salient points on the effect of a Certificate of Occupancy (C of O) in respect
of a claim of title to land.
Your title to a parcel of land or
a real estate asset is your proof of ownership of that land or real estate
property. In Nigeria, as observed earlier, your title can either originate from a deemed right of occupancy, customary right of occupancy or a statutory right of occupancy (C of O). More often than not, there are situations where an entity would have a
customary right of occupancy on a property while another entity would have a C
of O on the same property. Another instance is where there are two or more C of
O on the same parcel of land. How do we resolve such situations?
In the first instance, it has
been held in a plethora of cases, including the recent decisions of the Supreme
Court of Nigeria in the cases of KOLO V. LAWAN[7]
and MAZA V. AWUNA[8]
that a C of O is only prima facie evidence of title. It is a presumption of
title which could be rebutted by a better title established by another person
claiming the land. By virtue of the Land Use Act, the person having the
customary right of occupancy before the commencement of the Act and whose title
has not been revoked, would be deemed to have a better title over the same
land. As a result, the said C of O becomes void and shall be liable to be
revoked.
In the second situation on two or
multiple C of O on the same parcel of land, the Court of Appeal held in a
recent decision in the case of IBRAHIM v. MU'AZU & ORS[9] as
follows:
“Where two
or more persons claim title to land by virtue a certificate of occupancy, the
first in time takes precedence over and above the former. Furthermore, the law
is trite, any title or right of occupancy acquired over a parcel of land when
there is in existence another certificate of occupancy, which has not been
revoked in accordance with the law, the latter title cannot be valid in law.”
In the Nigerian real estate
industry, it is a prevalent practice, particularly among property owners and
developers, to publicly advertise real estate assets for sale while assuring
prospective buyers that the property holds a C of O as their title. However, building
upon the above discussion regarding the significance of a C of O in
establishing ownership rights to land, it is crucial to emphasise your responsibility
of conducting thorough due diligence examinations. This examination is
necessary to ascertain that there is no better title to the property in
question.
Further to accessing the
property, you need to gain access to the legal documents and records of the
property. These documents include the title documents, the necessary government
permits and approvals, mortgages and any other “voluntary” liens against the
property, and so on.
If the property is a condominium,
you will need to inspect the deed of restriction, the facilities management
agreement, among other relevant documents. For income-producing properties, you
should require access to the business records, including accounting records,
rent roll, tenant files, and other information.
During my professional
experience, I had the opportunity to engage in a complex multimillion United
States Dollars real estate deal. The deal centred around the acquisition of a
multi-floor commercial building located in one of the most luxurious commercial
cities in Nigeria – Victoria Island, Lagos. In the SPA, we included a
contingency clause on due diligence stating that the seller should furnish us with
several crucial documents. These documents encompassed the building plan
approval, duly issued by the Lagos State Ministry of Physical Planning &
Urban Development, all plans, designs, specifications, drawings, 3D sketches,
engineering calculations, bills of quantity, and other data in any document
connected to the building and its construction. By including this condition,
our client was afforded the opportunity to thoroughly evaluate the potential
risks and opportunities associated with their investment before committing to
the contractual obligations underlying the transaction.
It is important to consider that
when granting you access to the property, legal documents, and business
records, the property owner typically demands indemnification and insurance
coverage to protect against potential losses, damages to the property, or
injuries to on-site personnel that may arise during your due diligence
inspections. Additionally, the seller may insist on a confidentiality
agreement, which would require you and your agents to maintain the
confidentiality of any findings resulting from tests or searches conducted on
the property. The specific requirements for indemnification, insurance, and
confidentiality may vary depending on the size and nature of the property.
Engage Professionals
A prudent investor also engages
professionals with the requisite experience to assist in identifying any legal
or financial risks posed by your investment. A real estate deal can be simple
or complex. And there is only so much you can do by yourself. The more complex the
deal becomes, the more experts you may need to bring on board to assess your
risk exposure to it. A variety of professionals in the real estate industry you
can engage include, but are not limited to:
1. Legal practitioners to investigate and review
title documents to the property at the relevant land registry, inspect relevant
government permits and approvals, prepare, review and negotiate the title documents
and agreements (contracts and deeds), and supervise your entire transaction process;
2.
Land surveyors to determine if the real estate is free from government acquisition, match the coordinates on the
survey plan attached to the title document, verify property boundaries,
encroachments, and the compliance of existing structures with the permits and
zoning regulations;
3.
Engineers to inspect the physical condition of
the real estate, and to assess the performance and remaining life of any
infrastructure, structures, equipment, and systems;
4. Architects to compile a snagging list, to
confirm existing “as-built” conditions, to conduct design feasibility
assessments for any contemplated land development or building renovations, to
assess the property’s compliance with building plan approval.
Professionals in the field
possess the expertise and experience to thoroughly examine the provided (legal)
documents, ensuring their authenticity, accuracy, and compliance with relevant
laws. Engaging the services of these professionals is crucial in order to
mitigate the risk of potential financial loss associated with entering into a
real estate transaction without their involvement.
The occurrence of building demolitions
in Nigeria is not an unfamiliar topic. In April 2023, the internet was abuzz
with reports of 13 buildings being demolished in Ajao Estate, Lagos State.
Gbolahan Oki, the General Manager of the Lagos State Building Control Agency
(LASBCA), highlighted during a press briefing that these buildings lacked the
necessary approvals and were situated within restricted areas near the airport,
with some even encroaching upon aviation fuel pipelines.[10]
You will experience a sense of
defeat when your property investment is unexpectedly subjected to
government-led demolition shortly after its acquisition. Accordingly, it is
advisable to engage professionals before embarking on a real estate transaction
and prior to making any financial commitments. Seeking expert opinions after
making partial payments or signing documents is akin to putting the cart before
the horse. Such actions can lead to severe consequences and should be avoided.
Review Reports and Property
Records
This is the stage where you
decide whether to proceed or exit the deal. You may also decide to renegotiate
the deal based on a piece of new information you may have gathered from the
reports and the property documents.
A recent professional experience
to illustrate the above point is a due diligence investigation my firm tasked
me to conduct at the Federal Housing Authority (FHA) in FESTAC, Lagos, on a
client’s behalf. Our client expressed interest in acquiring a house allocated
to the current owner by FHA. To initiate the process, we obtained a copy of the
seller's letter of allocation and proceeded to FHA for further examination.
Upon payment of the requisite
search fees and other associated charges, FHA granted us access to the seller's
file with the Authority. Thoroughly scrutinising the contents, we discovered a
defect in the seller's title to the house arising from non-payment of the
Capital Development Levy/Contribution to Estate Rehabilitation, Consent Fee,
and Ground Rents imposed on the property. Consequently, should our client
choose to proceed with the transaction, they would be obligated to settle these
outstanding fees, which had accumulated over the years and amounted to a
substantial sum in millions of Naira, in order to obtain valid title to the
house.
We promptly communicated our
findings to our client. While they were open to proceeding with the
transaction, this new information became the basis for renegotiating the
purchase price of the house. The options presented were either for the house
owner to settle the outstanding fees owed to FHA or to accept a reduced
purchase price, enabling our client to assume responsibility for the
outstanding fees. Ultimately, the seller chose the latter option, and we
successfully concluded the transaction.
Expert reports should inform your
decision on whether to proceed, exit or renegotiate a transaction. If the
reports are deemed satisfactory, proceeding with the deal should be appropriate.
Where the reports reveal defects, depending on the seriousness and your risk
tolerance level, you may decide to renegotiate or exit the deal. Of course,
where you discover fraud, run away!
Closing Due Diligence
Having made the decision to
proceed with the deal, congratulations on reaching this milestone! However, it
is essential to address one final step: the closing due diligence process.
Throughout my professional experience, I have observed numerous buyers neglecting
this crucial aspect of real estate transactions.
One crucial error to avoid in a
real estate transaction is prematurely paying the full purchase price without
ensuring that all pending obligations have been fulfilled and all necessary
documents have been received from the seller. Failing to address this situation
can result in significant time wastage and considerable complications.
Depending on the complexity of
the transaction, there are certain obligations and documents that you would
require from the property owner to secure vacant possession of the property and
establish a valid title to the real estate. These documents may include the
seller's tax clearance certificate, means of identification, and other
pertinent records. It is your responsibility to ensure that the seller fulfils
their obligations and provides you with the necessary documents either before
the payment of the final instalment of the purchase price or concurrently with
the payment.
To safeguard against potential
issues, it is prudent to incorporate a contingency clause within the SPA that
encompasses the performance of obligations and the delivery of title documents
as prerequisites for closing the transaction. Failure to include such
provisions and ensure the actual fulfilment and delivery of all essential
documents can have severe consequences, including chasing the seller for performance
or document delivery.
According to renowned economist
Christopher Thornberg, “This is a real-estate-driven economy from top to
bottom.” Regardless of who you are or what your occupation may be, real
estate is a necessity. Accordingly, you must keep the above discussion in mind
when engaging in any real estate transaction. Always remember the popular Latin
phrase in all your real estate dealings – caveat emptor (let the buyer
beware). The full expression is caveat emptor, qui ignorare non debuit quod
jus alienum emit which translates to “let a purchaser, who ought not to
be ignorant of the amount and nature of the interest which he is about to buy,
exercise proper caution.”[11]
[1] Management
for Professionals (2018). Real Estate Due Diligence: A Guideline for
Practitioners. Edited by Tobias Just and Herman Stapenhorst. Springer: Switzerland.
[2] Mary
Ann Hallenborg (2016). Real Estate Due Diligence: A Legal Perspective.
Routledge: New York, United States.
[3]
Management for Professionals (2018). Real Estate Due Diligence: A Guideline
for Practitioners. Edited by Tobias Just and Herman Stapenhorst. Springer:
Switzerland.
[4] Mary
Ann Hallenborg (2016). Real Estate Due Diligence: A Legal Perspective.
Routledge: New York, United States.
[5]
Brian Hennessey (2018). The Due Diligence Handbook For Commercial Real
Estate: A Proven System to Save Time, Money, Headaches and Create Values When
Buying Commercial Real Estate. Yajna Publications: United States.
[6] Mary
Ann Hallenborg (2016). Real Estate Due Diligence: A Legal Perspective.
Routledge: New York, United States.
[7] (2018)
LPELR-44378(SC)
[8] (2022)
LPELR-58909(SC)
[9] (2022)
LPELR-57755(CA); See also EJIRO v. OCHAI & ORS (2021) LPELR-54190(CA)
[10] https://www.vanguardngr.com/2023/04/why-we-demolished-13-buildings-at-ajao-estate-lagos-govt/
Accessed on 18/06/2023.
[11]
H. Broom, Latin Maxims 769, 7th Ed. 1874.
: A COMPREHENSIVE NOTE){kind=link}
Let's Get Connected