Importance of Due Diligence in making Real Estate Investments

Introduction

One of the most important steps throughout the real estate investment cycle is conducting due diligence. Real estate investors must investigate the physical and financial facts to find out its prospective value and verify the seller’s claims. In the process, there is a period in which a potential buyer can carry out their investigation to receive full disclosure of the facts and conditions of a potential asset before completing a transaction with a seller. In Pakistan, a lack of transparent real estate practices makes it even more critical for buyers to conduct due diligence in real estate related transactions. Non-transparent practices in the sector have blurred the lines between legal and illegal developments. In recent years, development authorities have started to act against illegal projects, highlighting the need for due diligence for buyers and sellers.

Why Due Diligence is Important?

Conducting due diligence before investing in real estate is one of the most crucial steps for successful investing. The absence of this step or its neglect can lead to heavy financial losses for the buyer and ultimately lead to loss of investor confidence in the sector. In a 2013 survey on global real estate customers, 44% of real estate investors were unsatisfied with their property deals. Lack of access to verified and correct property and real estate details leads to a broken and fragmented fact-checking and verification process, which ultimately snowballs into poor investment decision making.

In Pakistan, the lack of due diligence is common amongst real estate investors. It has also led to the increase in illegal housing societies, unplanned Katchi Abadis, and subdivisions with sub-optimum utilisation of agricultural land. In Karachi, 60% of the city’s residents live in informal settlements (katchi abadis). In addition, 69% of housing societies in Pakistan are illegal, and most of the real estate investors avoid or neglect the due diligence part of the real estate investment process. This fact also points out how real estate investors and property dealers coax illiterate or unknowledgeable people into investing their life savings into an investment that is not verified or approved by relevant authorities.

What is Included in Due Diligence?

Due diligence should be performed by all parties involved in the real estate investment process. Under a real estate investment, one of the most important documents a builder or developer must hold is a No-Objection-Certificate. A NOC is a document that contains fundamental information about the parties involved in the construction/establishment of a particular residential or commercial real estate project.  The NOC is issued for various agreements like rental agreements, traffic offences, investigations, and admissions, among other things. Besides a NOC, a title document is also an important document. Property’s title server is necessary to prove the ownership of a property and serve as a legal statement of the property’s title. To trace the ownership history of any given property back to its original seller, a mother deed is required. The document enables anyone to know the list of owners of a particular property/real estate. This can help individuals become aware of any significant facts about their properties before they make a purchase. In the case of residential property financed under a housing finance scheme, a bank approval certificate is also a relevant document. This means that the bank has checked and scrutinised all compliance issues with the pre-ordained construction laws of the local authorities. Lastly, the encumbrance certificate is also included in the relevant documents for due diligence before buying a property. The document is proof that no transaction rests against any given property like a mortgage, title transfer, or any pending loans.

Conclusion

Due diligence allows you to make an informed decision about whether a certain investment is suitable for you or not. There is a list of documents and verification procedures that needs to be done by the buyer and the seller before entering a real estate investment. In Pakistan, the lack of due diligence by most real estate investors has resulted in the proliferation of illegal housing schemes and projects. Real estate investors are required to acquire essential documents like a NOC, bank approval certificate, mother deed, amongst others, to verify and check the financial investment background of the given property.