Due Diligence Checklist

By Andrew N. Jacobson, J.D.

"Due Diligence" is a broad term that business and real estate attorneys and
professionals frequently use, but that is often misunderstood by clients. Typically
the term is used to refer to the inspection and investigation of real property,
personal property or a business entity before a buyer makes the final decision
whether to consummate an acquisition, merger, or loan transaction. I
developed the checklist in this article to provide to clients who are planning to
acquire or develop property. This checklist serves several important purposes.
First, it gives the client a structure for analyzing a contemplated transaction.
Although some of the issues will not apply to a particular transaction or be
important to a specific client, the checklist can help the client allocate
responsibilities for specific due diligence tasks. Clearly delineated responsibilities
for both the client and the attorney can help avoid issues from falling between
the cracks in a transaction. Using this checklist can also help avoid
misunderstandings with the client regarding the attorney's scope of work in the
due diligence process and allow the client to identify tasks that need to be
handled by other professionals (e.g., survey, soils, environmental).
Although the checklist in this article focuses on due diligence in the context of
real estate acquisitions, many of the items in the checklist would be equally
relevant in real estate secured loan transactions, commercial leases, or
corporate-level transactions that include significant real estate assets. In
addition, I typically recommend that buyers in a purchase transaction require
the seller to provide copies of all plans, abstracts, maps, reports, surveys, and
tests that the seller has within its reasonable control. These disclosed items often
assist the buyer to quickly identify potential issues of concern with a property.
These documents also provide the benefit of identifying consultants who are
already familiar with the property.
Appendix
Due Diligence Checklist
I. Environmental Factors. This category covers a wide array of issues,
focusing on environmental regulatory schemes that may affect the
property.
A. Phase One Environmental Assessment. A Phase One Environmental
Assessment provides the buyer with a survey/overview of the
environmental condition and environmental history of a particular
property, focusing on the possible presence of hazardous materials.
The report is intended to identify actual and potential problems
(e.g., underground storage tanks, hazardous materials
contamination) based primarily on a review of historical
documentation, regulatory databases and a walk-through
inspection of the site. If problems, or potential problems, are
discovered during the course of the Phase One inspection, the
report will generally recommend specific follow-up testing,
remediation and/or studies. It is important for the buyer to initiate
work on the Phase One report early in the due diligence process so
that the environmental consultant has enough time to complete
the project and, if problems are disclosed, there is adequate time
to follow up with further studies and tests. It is important to note that
a Phase One report typically does not include specific inspections
for asbestos, lead (paint or in plumbing), radon, delineation of
wetlands or review of environmental compliance. If these problems
potentially exist on the property, the buyer should discuss
incorporating coverage of those issues into the environmental
consultant's scope of work for the Phase One report.
B. Phase Two Environmental Report. A Phase Two is typically done, if
necessary, as a follow up to a Phase One report and involves
physical inspections and testing of the property, such as core
samples, ground water testing, typically focusing on the specific
issues of concern identified in the Phase One report. If the presence
of regulated hazardous materials contamination is confirmed by the
Phase Two report, further reporting, monitoring, investigation and/or
remediation may be necessary, based upon the extent and
magnitude of that contamination. If additional investigation and
remediation activities cannot be completed prior to closing, the
parties may need to negotiate an environmental agreement which
establishes an escrow to cover the anticipated costs of such work
and contains an appropriate environmental indemnity which will
survive closing.
C. Asbestos. If asbestos is present or suspected to be present on the
property, it is advisable to engage a consultant to prepare an
asbestos survey and report. Asbestos can be found in a number of
building products used in older construction, including pipe
insulation, plaster, floor tiles, mastic and roofing materials. There are
several important issues related to asbestos: (i) identifying whether
asbestos is present, (ii) identifying the form of the asbestos, and (iii)
determining whether abatement, encapsulation or removal will be
necessary for the buyer's planned use of the property. In the end,
the buyer needs to determine the monetary and schedule effects if
asbestos is present, so that those effects can be factored into the
buyer's purchase decision. It is important to note that required
asbestos abatement work may temporarily affect the owner's ability
to use part or all of the building during the remediation work.
D. USTs and ASTs. If underground storage tanks ("USTs") or
aboveground storage tanks ("ASTs") are located on the property,
there may be affirmative reporting, removal and/or closure
obligations for the property owner related to those tanks. USTs and
ASTs are also often the source of hazardous materials
contamination. If USTs or ASTs have been removed from the
property, the buyer will want to ascertain that proper site closure
procedures were followed and completed in connection with the
tank removal.
E. Lead Paint. The buyer's environmental consultant can also typically
be used to determine whether there is lead paint present on the
property. Lead paint is most problematic in residential settings (i.e.,
multifamily housing) where child safety is a concern and where
federal law requires disclosure to tenants and buyers in residences
built prior to 1978. Lead paint can also be problematic in industrial
settings, since it can significantly affect how repainting and
refurbishing activities are conducted. For example, sandblasting
and removal of old lead paint often will require significant
precautions in order to avoid lead contamination problems.
F. Mold It appears that mold and mildew may develop into an
important issue in the future, similar to the growth of asbestos and
lead paint as issues in the past several decades. Over the past few
years there have been a growing number of lawsuits and insurance
claims across the country related to the level of mold and mildew in
buildings and its adverse effect on health and habitability. In fact,
at least one state is currently considering legislation that would
require written disclosures of mold levels above specified levels in
real estate transactions (transfers and leases) and would impose
affirmative requirements on building owners to control mold levels in
buildings. Buyers should be sensitive to this emerging issue and
check with their environmental consultant regarding any new
regulations related to mold or mildew.
G. Environmental Operating Permits. It is important to determine
whether the existing use of the property requires any environmental
operating permits or triggers any reporting obligations related to air
or water quality. This issue is important regardless of whether the
buyer will continue the existing use. The buyer should obtain copies
of all existing environmental permits, plans and reports and check
with the applicable enforcement agencies to determine whether
there are existing or past violations or nonconformance issues
related to the property. The buyer should also determine
prospectively what, if any, environmental permits and/or reports will
be required in connection with the buyer's intended use of the
property. It is usually good practice to contact the applicable air
and water quality agencies with jurisdiction over the property to
determine procedures and timing for obtaining and/or transferring
any necessary permits. To the extent that the buyer is depending
upon existing permits for its intended future use, the buyer needs to
make sure that the purchase agreement is contingent upon such
transfer and obligates the seller to cooperate in the transfer of such
permits to the buyer. Furthermore, the buyer needs to confirm that
the desired permits can be transferred to the buyer upon closing.
H. Wetlands. The presence of wetland conditions can have a
significant effect on the operation and development potential of a
property. As a result, it is important to check with the applicable
municipality to determine whether any portion of the property is
considered wetlands or shoreline. Wetlands and certain uplands
located near navigable waters are under federal jurisdiction (U.S.
Army Corps of Engineers) under section 404 of the Clean Water Act,
33 U.S.C. 1344, and there may be significant restrictions on the use
or development of land in those areas. In addition, there are
significant regulatory hurdles related to filling, cutting, or relocating
wetlands areas. It is important to remember that wetlands are not
always "wet" or obvious to the casual observer. Generally, the
analysis of what constitutes a wetland is focused on vegetation and
wildlife characteristics, rather than the presence of surface water.
I. Shorelines and Watersheds. In addition to the wetlands issue, certain
states and municipalities also have special regulations that pertain
to property located near certain bodies of water or within certain
watersheds. For example, in South Carolina, land within a certain
distance of the ocean is subject to overlay regulation by the South
Carolina Coastal Council. Similarly, land within the Lake Tahoe
watershed (both in California and Nevada) is subject to overlay
regulation by the Tahoe Regional Planning Agency. Buyers should
assume that any construction activities on or near water (e.g.,
docks, boat ramps, rip rap) may be prohibited or subject to
substantial regulation. Similarly, land that drains into certain
watersheds may be subject to substantial water quality restrictions
that can significantly limit construction activities (e.g., excavation)
during certain times of the year. For example, in many parts of
California there are restrictions on grading and excavation during
the winter rainy season.
J. Flood Zones. Buyers should check with the local planning agency to
determine whether any portion of the property is located in a
designated flood zone. Flood zone designation can adversely
affect the development potential, applicable building standards
and the availability of financing, as well as insurance requirements
and costs.
K. Endangered Species. In some areas of the country, the presence of
endangered or potentially endangered plants and animals may
significantly restrict the development potential and value of a
property. Typically, initial inquiries on this subject can be made at
the local planning agency to determine whether there are species
of concern in the area. If there is the potential for the presence of
such species or habitat on the property, the buyer should consider
retaining an appropriate consultant to examine the property for the
presence of the species and/or habitat in question. While the
endangered species issue is typically related to undeveloped
properties, it can also affect fully-developed properties. For
example, in one instance, the owner of a high rise urban office
building ran into endangered species hurdles related to building
signage caused by the presence of falcon nests in the crooks of
some of the existing letters on the exterior of the building.
L. Seismic Safety Zones. Some states in seismically active areas of the
country (e.g., California) maintain seismic safety zone maps, similar
to flood zone maps. Typically, seismic safety zones run in strips along
known fault lines, often extending a set distance outboard of each
side of the fault. If applicable, the buyer should determine whether
any portion of the property is located in a seismic safety zone, as
such designation can adversely affect the development potential,
applicable building standards, availability of financing and
insurance requirements for the property.
M. Water Rights. The buyer should determine the scope and nature of
any water rights related to the property. Like seismic safety zones,
water rights tend to be an issue only in certain parts of the country,
particularly in the arid portions of the western states. If a property is
fully serviced by water and sewer utility service, water rights for
usage typically will not be an issue for the buyer. Water rights can
take several forms, but the two most common are the right to
appropriate water for use and the right to access and use water for
recreational purposes (e.g., deeded lake access). If important
water rights for the property have been separated from the fee
interest or come from an off-site source, the buyer will want to make
sure that the purchase agreement adequately addresses the
transfer of necessary rights to the buyer at closing. For example, if
subsurface water rights are held by a third party, the buyer will need
to make sure that an adequate source of water is available for the
buyer's intended use of the property. Similarly, if the property relies
on an easement for access to recreational water facilities, the
buyer will want to make sure that the access easement is covered
by title insurance.
N. Oil, Gas, Mineral, and Timber Rights. It is important to determine
whether the property to be acquired excludes mineral, oil or gas
rights or is subject to third-party timber rights. To the extent that the
mineral, oil and gas rights have been severed from the fee
ownership, it is critical to determine to what extent, if any, those
severed rights affect the use of the property by the buyer. For
example, surface rights may accompany oil and gas rights.
However, because of the dynamics of oil and gas deposits, in
combination with lateral extraction technologies, it is often possible
to extract oil and gas from under a property without entering onto
the surface of that property or otherwise disturbing the occupant of
the property. On the other hand, timber, sand and gravel rights
would all include surface use of the property and may be more
likely to have a significant effect on the use and value of the
property.
O. FAA Restrictions. Properties located within a few miles of an airport
are often subject to significant FAA restrictions as to height and use,
particularly if a property is located within a takeoff or approach
path for a runway. For example, high occupancy uses (e.g.,
theaters, stadiums) and residential uses are typically not permitted
within a certain distance of an airport in these areas. In addition,
many properties located near airports are subject to overlay height
restrictions that may be more stringent than the height restrictions
established in the applicable zoning code.
P. Noise Restrictions. If a property is located near a major freeway,
railroad line, airport or other major noise generating use, there may
be use restrictions and/or additional construction requirements
related to sound mitigation. Local planning agencies will typically
be able to assist the buyer in locating relevant sound contour maps
related to the noise generating source. These sound counter maps
indicate the relative decibel level by contour. Often, there will be
significant requirements and/or restrictions on portions of a property
that are within certain zones on the sound counter map.

II. Code Compliance And Physical Condition. This category focuses on the
specific physical condition of the property to be acquired.
A. Code Compliance. The buyer should confirm that the existing use of
the property complies with applicable zoning, building and life
safety codes. This includes checking with the applicable jurisdictions
as to applicable zoning for the property. It often is useful to review
both planning department and building department files and
records for the property. These files may contain important
information related to the property, such as conditions for use
permits or records of past building code violations. If the current use
of the property does not comply with the current zoning, it may still
be permitted but have significant restrictions. When zoning for a
property changes, existing uses and structures which do not comply
with the new code requirements are usually "grandfathered" in as
nonconforming uses or noncomplying structures. However, these
codes usually place significant restrictions on any expansion of the
nonconforming use or additions to existing noncomplying structures
and often will not permit reconstruction of a nonconforming use or
noncomplying structure after casualty damage. While
improvements are typically considered code compliant if the
improvements complied with the codes that were in effect at the
time of construction, this is not the same as complying with current
code requirements, which are often more stringent. In addition,
renovations to existing buildings often can trigger code compliance
requirements that are more restrictive. Life safety and handicap
access upgrades triggered by renovations to a structure can be
expensive (e.g., adding sprinklers, providing handicap accessible
bathrooms and/or elevators) and add significant amounts to the
total project costs.
B. Structural Inspection. If there are existing improvements on the
property, the buyer should consider having a qualified engineer or
building inspector determine the condition of those improvements
and identify any potential problem areas, such as deferred
maintenance and necessary repairs. The buyer will want to
determine the cost and schedule effects of any necessary repairs to
the property. If work is being performed on the improvements prior
to closing, the buyer should obtain copies of any design or
construction contracts and determine whether the seller's rights
under those contracts are assignable to the buyer. The buyer should
also determine whether the contractor(s) have been and are being
paid and whether proper lien waivers have been (or will be)
obtained by the seller for work performed prior to closing and that it
obtains adequate protection from any mechanic liens related to
pre-closing work on the property.
C. Handicap Accessibility. In addition to the physical inspection, it is
important to determine whether existing improvements on the
property comply with applicable handicap accessibility
requirements, including the Americans with Disabilities Act ("ADA"). It
is important to remember that a change in use or construction of
additional improvements may trigger significant additional
handicap accessibility compliance requirements. For example,
under the ADA, "public accommodations" (i.e., retail, restaurants
and other businesses generally open to the public) have more
stringent standards than other commercial facilities. Consequently,
an existing commercial building may be in compliance for its
existing use, but not for a new use which constitutes a public
accommodation under the ADA.
D. Site Improvements & Drainage. Depending on the nature of the
property, the buyer should consider inspecting the nonbuilding site
improvements (e.g., drainage system, retaining walls) both as to
condition and design, paying particular attention to potential
drainage and subsidence issues (e.g., ponding water, storm water
control and/or soil erosion).
E. Roads. The buyer should check whether the property has adequate
access from public streets. If new or additional access is required,
speak with the applicable public works department to determine if
additional access is possible and the procedure, cost and lead time
for establishing the necessary access. It may also be worthwhile to
consult with the applicable local and/or state agency to determine
whether there are planned road improvements, which may affect
the property. Projected road improvements or realignments could
significantly enhance or diminish the desirability of the property. For
example, installation of a median strip on a road often limits or
eliminates access by left turns.
F. Railroads. If applicable, check with railroad(s) regarding access to
sidings and mainlines located on or near the property. Contact the
applicable railroad to determine whether there are existing access
and trackage agreements and whether those agreements are
assignable in connection with a transfer of the property. Determine
whether existing stubs and sidings are sufficient and, if not, the cost,
process and lead times for constructing additional sidings or stubs to
the property.
G. Circulation/Parking/Loading. It is important to determine whether
the property has sufficient parking (auto and truck) for the buyer's
intended use. Similarly, the buyer should determine whether the
property has sufficient truck loading facilities and check for any user
specific concerns (e.g., dock high loading turning radii for trucks)
and whether the vehicular circulation on the property is adequate
for the intended use.
H. Public Transit. The servicing of a property by public transit can have
a significant effect on the value and desirability of a property for
certain uses. For example, proximity to a lightrail station is often an
asset for an office development. Consequently, the buyer should
determine how the site is presently serviced by existing public transit
and whether there are significant plans for changes in public transit
that may effect the site.
I. Utilities. The buyer should check with the applicable utility providers
to determine whether the property has adequate service levels
available and determine the procedures for entering into provider
agreements with the appropriate utility providers. It is important to
determine whether development of the property may be affected
by any utility-related moratoria or allocation programs, particularly
with respect to water and sewer. If inadequate service exists or new
service is required, the buyer should determine availability, timing
and costs of upgrading the existing utility service.
J. Wells. As part of its due diligence inspections, the buyer should
determine whether there are any wells (water, oil, gas or
monitoring) located on the property. In many states, the presence
of certain types of wells must be disclosed by the seller prior to
closing. Operating wells may require permits and inoperative wells
may require sealing and/or regulatory closure. If there are or have
been oil and gas wells on the property, there may be soil and/or
water contamination in connection with the operation of those
wells. If water for a site is provided by an on site well,
quality/potability and quantity (i.e., gallons per hour) need to be
determined. In some instances the output of the well may limit the
permitted development of the property.
K. Crime Statistics. Depending on the buyer's intended use for the
property, it may be worthwhile to check crime statistics for the
neighborhood. This may be particularly important when the buyer is
not familiar with the area in which the property is located. For
example, the relative safety of a neighborhood can be a significant
factor for a hotel, restaurant or retail operation. Most cities and
counties compile annual crime statistics that list the number and
type of crimes, as well as the precincts in which the crimes
occurred.
L. Leases and Contracts. The buyer should require the seller to
promptly provide copies of all leases, licenses and contracts that
affect the property. If there are leases on the property, the buyer
should also require the seller to provide estoppel certificates (e.g.,
no defaults, no prepaid rent, status of security deposits and the like)
from each of the tenants prior to closing and have the seller
provide a current rent roll for the property. Where rental property is
involved, the buyer should make sure that the purchase agreement
places appropriate restrictions on the seller's ability to enter into
new leases or to modify or terminate existing leases. Issues of
concern to the buyer related to existing leases include the rent
structure, duration, renewal rights, expansion rights, termination
rights, free rent, security deposits, TI allowance obligations, rights of
first refusal, exclusive use rights and options to purchase. If there are
service contracts on the property (e.g., HVAC maintenance, snow
removal, landscaping and the like), the buyer should review these
contracts to determine whether they can be canceled at or prior to
closing and/or be assigned to the buyer (if desired).

III. Title Issues. The title review process is used to determine the condition of
the title to be transferred to the buyer at closing as well as identifying
potential title problems. Typically, the buyer and its attorney will work with
a title insurance company to review the status of title, resulting in an
owner's policy of title insurance that is issued at closing. However, in a
minority of states the title review process is still performed primarily by
attorneys, generally resulting in the issuance of an attorney's title opinion.
A. Title Insurance Commitment. Commonly, the initial step in the title
review process is the issuance of a title insurance commitment, or
preliminary title report, depending on the state where the property
is located. This initial document provides documentation of the
current state of title for the property and includes the precise legal
description of the property. The title commitment/report can be a
vital indicator of title problems (e.g., some or all of the property is
not owned by the seller). The commitment/report also provides the
buyer with a list of all current exceptions to title on the property such
as unpaid taxes, easements, options to purchase, mortgages,
judgment liens, liens, restrictions, equitable servitudes and other
significant encumbrances and may contain information regarding
appurtenant benefits to the property, such as access easements. It
is usually prudent for the buyer to obtain copies, where available, of
any item which is listed as an exception to title in the
commitment/report, particularly any items which will remain on title
after closing (e.g., easements, CC&Rs and/or equitable servitudes).
B. Abstracts. With the ever-increasing use of title insurance, abstracts
of title have become a less relevant factor for the buyer, as the title
insurer will often base the title commitment on a previously issued
title insurance policy or a tract search of the public records.
Although some attorneys still issue title opinion letters, many
attorneys no longer will provide this service. In addition, most buyers
prefer to have title insurance rather than rely on an attorney title
opinion. If there is an abstract of title for the property, it is a good
idea to get the abstract prior to closing, as a historic record for the
property.
C. Registered Land. When dealing with registered property (i.e.,
Torrens), the buyer should carefully review the certificate of title as
part of the title review process. All of the recitals and memorials on
the certificate of title will generally be listed in the schedules of
exceptions on the title commitment/report. As a rule of thumb, it is
easier to remove a memorial than a recital. However, where a
recital and some types of memorials need to be removed (e.g., an
abandoned easement, obsolete railroad mortgage), it may require
a quasi-judicial proceeding (in some states referred to as a
proceeding subsequent) to amend the certificate of title to remove
the offending reference. As this proceeding typically cannot be
done prior to closing, the parties can either adjust the purchase
price to compensate the buyer for the issue or the seller can enter
into a letter of undertaking or other post-closing agreement that
obligates the seller to diligently take the actions necessary to clear
the certificate of title.
D. ALTA/ACSM Survey. In connection with obtaining an ALTA
("American Land Title Association") owner's policy of title insurance,
the title insurance company will require an ALTA/ American
Congress on Surveying and Mapping Land Title survey of the
property ("ALTA Survey"). An ALTA survey is a comprehensive survey
of the existing, as built, state of the property, which locates the
parcel boundaries, existing improvements, adjacent infrastructure,
and recorded and apparent unrecorded easements and interests.
ALTA surveys often are one of the most useful documents in the due
diligence process, especially when they include one or more of the
optional levels of detail available. First, with the physical survey, the
buyer can review and confirm that it matches the property the
buyer intends to purchase. It is often quite difficult from the legal
description in the purchase agreement (particularly metes and
bounds descriptions) for nonsurveyors to determine the precise
location of the property. Second, an ALTA survey provides the buyer
with the precise location of utility and other easements and physical
encumbrances which are described in the exception schedules in
the title commitment, as well as illustrating the precise location of
physical improvements located on the property. Once again, since
it is often difficult to determine the location of utility easements
based on the metes and bounds descriptions in the public records,
the ALTA survey is quite useful in disclosing potential issues or
problems with the property (e.g., a utility easement running across
an area where buyer wishes to construct improvements,
encroachments onto or from adjacent properties). Finally, an ALTA
survey may disclose physical encroachments that are not indicated
in the title commitment. These can include boundary fences that
do not correspond with the true boundary, potential prescriptive
easements and physical encroachments of improvements onto or
from the property in question. Obtaining an ALTA survey should be
initiated early enough in the due diligence process so that there is
adequate time to address any title problems disclosed in the survey
prior to the end of the due diligence period or closing.
E. Easements, REAs & CC&Rs. The buyer should make sure to carefully
review any easements, reciprocal easement agreements ("REAs")
covenants, conditions and restrictions ("CC&Rs"), or similar
encumbrances that may affect use of the property. As this type of
encumbrance will continue to burden the property, it is important
that the buyer determine, prior to committing to close, whether it
can live with these applicable encumbrances. Significant
restrictions typically affect multi-parcel developments such as office
or industrial parks with shared facilities. Buyers should be cautious of
provisions in any REA or CC&R that permit further restrictions to be
placed on the use of the property in question (e.g., relocation of
access roads, right of master developer to grant further easements
on common areas, and the like) or expansions of the existing use of
the property.
F. Title Insurance Endorsements. During the title review process the
buyer should check with the title insurer as to the availability of
endorsements for the property. Typically, individual buyers will have
standard title insurance endorsements that they require in
connection with any purchase. It is good practice to explicitly
require the issuance of these required endorsements as conditions
to closing in the purchase agreement. Examples of commonly-
sought endorsements include: (i) a zoning endorsement insuring
that the present use of the property complies with applicable
zoning laws; (ii) a contiguity endorsement that insures that the
parcels comprising the property are contiguous; (iii) a survey
accuracy endorsement; (iv) a location endorsement insuring that
the legal description matches the address for the property; and (v)
a specific access endorsement insuring the property has access
from a public right-of-way. Depending on the context of the
transaction, there may be other endorsements that are desirable or
appropriate. For example, if the property being purchased is
undeveloped, many buyers will require what is commonly referred
to as a "Sear's" endorsement. Although the policy limits on title
insurance are typically based on the purchase price or fair market
value of the property, a Sear's endorsement provides the buyer with
the ability to increase the policy limits of the title insurance
coverage in connection with the construction of improvements on
the property and eliminates the risk that the title insurer will impose
additional exceptions on a reissuance of a policy with higher limits
after completion of construction.
G. Taxes and Assessments. In conjunction with the title review, the
buyer should determine what real property taxes and assessments
will apply to the property after closing. The buyer should pay
particular attention to the presence of any special assessments or
the property being located within a special assessment district.
Issues with assessments often arise in the context of newly
subdivided/platted property where significant public infrastructure
has been or will be constructed. If the property being acquired is
currently, or was recently, agricultural property that is (or has
recently been) converted to a more intensive, non-agricultural use,
there may be significant increases in the property taxes applicable
to the property. A number of states have property tax provisions
that encourage the preservation of agricultural property, sometimes
referred to as "green acres" provisions. These provisions are typically
structured so the preserved agricultural property is taxed at much
lower agricultural rates rather than the higher non-agricultural rates
applicable to adjacent properties and may defer installments of
special assessments until the land is developed. Typically, green
acres provisions will include significant restrictions on conversions of
the property to non-agricultural uses or include substantial penalties
and/or tax and assessment recapture provisions in the event that
the land is taken out of agricultural use. Finally, the buyer should
determine whether the sale of the property will trigger a
reassessment of the property. This issue is of particular importance in
states like California, where Proposition 13 has placed limits on
annual increases in assessments, but requires a reassessment to
market value when a property is sold or transferred. If the property is
income-producing rental property, the buyer should determine
whether there are any applicable state or local rental taxes, as
some jurisdictions tax rental income (e.g., Florida and Arizona).
Many leases in states with a rental tax will require the tenant to pay
the rental tax in addition to base rent and additional rent. Failure to
properly account for rental taxes may skew the projected pro
forma for a property and may result in the buyer overvaluing the
property.

IV. Approvals and Entitlements. If the buyer intends to develop the property,
change the use of the property or make significant changes to the
existing improvements, it is often useful to initiate the entitlement process
during the due diligence period. It is better to find out early if there are
going to be significant roadblocks to the buyer's plans for the property.
The buyer should check with all applicable jurisdictions (i.e., city, county,
regional and state) to determine in advance, which land use entitlements
will be necessary for the buyer's intended use of the property. In
connection with those entitlements, it is important to focus on the length
of the approval process and to determine whether any significant
exactions (e.g., fees, infrastructure improvements, open space dedication
and the like) will be required in connection with the necessary approvals.
A. Subdivision/Platting. Although elementary, it is important to confirm
that the property being acquired constitutes a legal and separate
parcel. This can often be determined by checking with the
applicable jurisdiction and will generally be confirmed by a title
commitment. Be cautious if subdivision or platting of the property is
necessary to close the purchase transaction or to develop the
property as intended. Depending on the nature of the subdivision
and the state where the property is located, the subdivision or
platting process may involve significant efforts (both time and
money) to complete and may include unanticipated exactions or
conditions of approval. Make sure to determine whether the
property to be purchased is affected by any current or planned
urban growth boundary ("UGB") or other growth control limits or
moratoria that may adversely effect the buyer's intended use for
the property.
B. Historic/Open Space Preservation. Check with the local planning
department and any state or local historical agencies to determine
whether the property is effected by any open space or historic
preservation controls. If the property is in a potential historic district
or area, there may be archeological testing requirements in
connection with any excavation or grading on the property or there
may be restrictions on alterations to structures in historic areas.
C. Required Approvals & Permits. The buyer should determine what
permits will be required for the buyer to operate the property.
Required permits may include some of the following:
1. Use Permits. If the proposed use is not expressly permitted
under the applicable planning code or zoning regulations,
the buyer should determine the procedure and schedule for
obtaining any necessary use permits and/or variances.
Municipalities sometimes will view a conditional or special use
permit as an opportunity to require monetary exactions or
land dedications (e.g., parks, open space) or to impose
"social" conditions upon the property (e.g., hiring preference
for local citizens, inclusionary housing). Consequently, it is
important that the buyer understand both the costs and
significant requirements that will attach to these permits.
2. Variances. If the buyer's proposed improvements do not
comply with the applicable building or use restrictions (e.g.,
height, bulk, set backs), variances may be required. As
variances are typically discretionary in nature, there may be
conditions attached to their issuance. Beware that many
municipalities require a unique hardship to justify the issuance
of a variance.
3. Occupancy. The buyer should determine whether a new
occupancy permit will be required. If so, this requirement may
trigger an inspection of the property by the applicable
municipality, which may in turn create a requirement to
remediate any existing code violations prior to issuance of
any new permit.
4. Business. The buyer should determine whether the applicable
municipality will require a business or operation related permit
or license. It is important for the buyer to make allowances for
the lead time needed to obtain any business permits. Certain
types of business-related permits (e.g., liquor licenses) may
have significant application periods.
5. Signage. Some types of signage may be prohibited by law or
require governmental permits. If there is existing signage on
the property, the buyer should determine whether it will be
able to replace that signage with its own or install additional
signage, without requiring a new permit.
V. Personal Property. Although this checklist is intended to focus on real
property issues, any buyer of real property should also use inspect and
review any items of personal or intangible property which will be included
as part of the purchase as part of its due diligence. For example, the
purchase transaction may include specialty maintenance equipment,
furniture or trade fixtures that are necessary for the buyer's use of the
property. Equipment, furniture and trade fixtures should be inspected for
condition and UCC searches should be conducted to determine whether
any third party has a security interest in any of the personal property
which is to be transferred to the buyer at closing. There may also be
licenses or permits necessary to operate the property or related to the
equipment and fixtures that are deemed personal property (e.g.,
franchise rights, vehicle registration, liquor license). It is important to
determine ahead of time whether such permits and licenses will be
included in the transaction and confirm that these items are in fact
transferable. Buyers should be cautious as the transfer of certain types of
licenses (e.g., liquor licenses) may require significant time and expense.
Published in The Practical Real Estate Lawyer, Volume 17, Number 6, November
2001.
Andrew N. Jacobson is a partner of the firm and member of the real estate
team.