RICS draft guidance note - Technical due diligence of commercial property, 5th edition

3 Types of inspections

3.1 The property lifecycle

This guidance note considers four key types of technical due diligence process for commercial property during its typical lifecycle, each of which will have a slightly different emphasis. These are:

  • acquisition (including financing or refinancing)
  • occupation and operation
  • disposal and
  • refurbishment or development.

3.2 Acquisition

The process of undertaking technical due diligence on the acquisition of commercial property is the most common of the four categories and is undertaken on behalf of an investor taking an interest in part or whole of the property. The process of technical due diligence may determine:

  • whether significant defects exist in the structure, fabric and services installations (the latter if instructed to be undertaken by a specialist) of the property
  • whether there are legal implications of the defects or other deficiencies such that the property does not comply with statutory obligations or there are any illegal works present
  • risk associated with the tenancies in relation to recovery of capital expenditure and operational expenditure and future reinstatement liabilities
  • whether the property is suitable for the client's intended use (if known) and
  • whether there are any potential life safety issues.

Where there are deficiencies, estimates of the remaining life expectancy of key elements may be provided, along with information regarding the scope and costs of repairs required.

It is important to remember that legal and investment aspects of the acquisition are also being considered by other specialists on behalf of the client. The technical aspects should be considered in the context of this bigger picture and should require all these advisers to liaise with each other.

3.3 Occupation

In addition to the issues outlined in section 3.2, if occupation by the client is contemplated the technical due diligence process needs to identify and advise on any restrictions on its intended use. These can extend beyond the client's anticipated responsibilities under the lease, such as upgrading to meet current health and wellbeing, fire, flood or site-specific requirements. The extent of the occupier's responsibility to insure, repair and maintain the property under the lease, or other occupation arrangement, need to be considered in the context of the physical condition of the property.

The report may highlight issues that will cause delay to the client's occupation, and capital expenditure before and during occupation. For example, if repairs are required before the property can be occupied, early awareness will enable the client to:

  • program for any delays (this is important where there is time pressure to relocate from another property taking into consideration the fit out required to the new property)
  • renegotiate lease liability terms or
  • secure capital contributions from the landlord to enable the occupier to undertake the necessary works.

Where a client proposes to occupy only part of a property and will share in the cost of upkeep of the whole, RICS members should assess the likelihood of any major repairs necessary to the fabric of the entire property and its services that could have a significant impact on the service charge or other property outgoings.

Any assumptions of responsibility should also be clarified, which may go beyond 'normal' lease terms (e.g. responsibility for maintaining and complying with health, safety and fire legislation, energy rating minimum requirements, etc.).

3.4 Disposal (vendor's survey)

The primary purpose of a vendor's technical due diligence before a proposed sale is to identify significant physical defects or any statutory non-compliances that may affect the value of the property on the open market.

Vendor's technical due diligence normally precedes a valuation. The valuation can then provide an opinion on the value of the property having regard to its condition. However, a vendor may undertake technical due diligence as a standalone process so that information on the physical condition of a property can be made available to prospective purchasers in an attempt to expedite the sale process.

 

It is typical for the client to request that a vendor's report be assignable to the purchaser. In these circumstances, the RICS member or RICS regulated firm should ensure that their (and their subconsultants) professional indemnity insurance provider is satisfied with such an arrangement, and any conditions clearly stated upon instruction of such an assignment. The RICS member or RICS regulated firm should be aware that readdressing the report is unlikely to maintain the contractual links, as the report would have been prepared for the vendor, not the purchaser.

Subsequently, the RICS member or RICS regulated firm is likely to be required to enter into a third-party agreement with the potential purchaser, which may also extend to the funders. This is usually undertaken in exchange for a nominal payment. The third-party agreement is usually by way of a 'duty of care' or 'reliance' letter.

A vendor's survey should include the same salient issues as the acquisition survey on behalf of an investor, including:

  • significant physical defects in the structure, fabric and services components and associated cost for remedial works
  • issues relating to statutory and legal non-compliance that may prevent occupation or affect the value of the property
  • costs relating to shortfall in tenancy repair, decoration and reinstatement obligations and
  • review of documentation with the intention to identify all relevant data, locating any missing information early in the due diligence process.

3.5 Development

The role of a technical due diligence process as part of a development feasibility is to establish the potential value and viability of development projects.

Input from specialists will be required to provide comprehensive advice to a client, and this advice needs be reviewed, analysed and compiled into a report providing the client with a summary of the key issues to be considered through the development process.

Clients may subsequently instruct the RICS member or RICS regulated firm to project monitor or act as their client representative for the development. This could extend to the review of the design, specification and plans, and monitoring the works against agreed contracts as they proceed. This is common where a client enters into an agreement to fund, purchase or lease a development that has yet to be built or redeveloped.

RICS guidance note Project monitoring, 1st edition is available for reference.