Due Diligence Explained

Due Diligence ExplainedDue Diligence is a negotiated period of time in exchange for a negotiated amount of monetary consideration (if any), between buyer and seller.  The due diligence clause of the Residential Offer to Purchase and Contract is the “option” clause of the contract.

The purpose of due diligence is to give the buyer an opportunity to investigate the property (allow time to get the home inspected and appraised, for example), in order to make an informed decision to either move forward with the purchase of the property or terminate the contract.  Although the Offer to Purchase clearly states that the “property is being sold as in in its current condition”, the home inspection may reveal hidden defects or material facts about the property that were not known to either the buyer or seller at the time the contract was executed.  If such concerns arise, the buyer will typically submit a Due Diligence Request and Agreement form to the seller (prior to the expiration of the due diligence period) in order to renegotiate the contract for consideration of repairs or concessions, rather than terminate. The seller then has the option to either renegotiate the contract or not.  If the seller agrees to renegotiate the contract (make repairs, reduce purchase price, or pay closing cost, for example), they will need to sign the Request Agreement before the expiration of the due diligence period. If the seller refuses to make any concessions, then the buyer has the option to proceed with the purchase or terminate the contract (In fact, the buyer has the option to terminate the contract prior to the expiration of the due diligence period, without any reason, and before entering into a written and signed Due Diligence Request Agreement).  In the event the buyer terminates the contract, they will forfeit their due diligence money as it is non-refundable. Their earnest money deposit is refundable however, as long as the buyer terminates prior to expiration of the due diligence period.

When negotiating the due diligence period and amount of money, the buyers typically want a three week examination period with as little money down as possible.  Reasons for this include allowing sufficient time to get the home inspector and appraiser out to the property and complete their reports. Since the buyer incurs these expenses, as others, they are not looking to invest a lot of money that is non-refundable should the home inspection uncover a bunch of issues.

From the seller’s perspective, they are looking to be compensated appropriately for tying their home up under contract during the due diligence period.  Should the buyer decide to terminate the contract, the due diligence money is the seller’s compensation for the inconvenience of having taken their home off the market.  Therefore, it is in the seller’s best interest to get as much due diligence money as reasonably possible. It basically boils down to how much the due diligence time is worth to the buyer and the seller, with consideration of fairness taken into account in regards to their respective interest.  

Since buyer and seller are often at odds over what’s in their best interest, obtaining a reasonable and appropriate amount of compensation can sometimes be challenging for the seller.  For example, if the home has been on the market a while and there is only one interested buyer in the property, the seller may be in a weaker position to negotiate the most favorable terms to them.  However, if the home is a new listing and priced to sell and/or has multiple offers, then the seller is in a stronger position to negotiate the most favorable terms to them.

In a perfect world, all sellers would have a pre-home inspection done on their home and repair all serious/material issues before they list it for sale.  All repairs that were made and any that were not, would then be disclosed to the prospective buyer before entering into a contact. In this situation, both parties would gain a peace of mind knowing what the home’s current condition is while increasing the odds that the sale will close with mutual satisfaction.

However, since we live in the real world, some sellers do not want to spend the money to have their home inspected since they may not have the money nor be interested in spending the money to have any repairs made.  While I understand this position, especially if the seller doesn’t have the money, it can end up costing them more money in the long run having to renegotiate the contract (or cause the buyer to terminate the contract) than if they made repairs prior to listing their home for sale.

At the end of the day, if both buyers and sellers enter into a contract in good faith and feel like they are being treated fairly, then most sales end up closing.  The sales that typically don’t close are usually the result of one or both parties engaging in win-lose negotiating tactics, or from having unreasonable expectations.  If either the buyer or seller (or both) feel that they are being treated unfairly, they will typically try to find a way to respond in kind, causing the sale to implode.

In summary, negotiating the due diligence part of the contract is a function of time in relationship to how much it is worth to the respective buyers and sellers.  In other words, the less time desired should equate to less due diligence money down, whereas the more time desired should equate to more due diligence money down.  

If you are ready to buy or sell, call  Mary Staton or Bert Ward - they’ll be happy to answer any questions.

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