What Happens During the Due Diligence Period on a Residential Purchase?
Whether you’re buying or selling real estate, it is exciting to finally have a signed sales contract in your hand. But of course, something can still go wrong in the “due diligence period.” This is the period between signing the contract and the removal of the buyers’ contingencies, before actually closing the deal, during which buyers and sellers perform actions needed to complete the sale.
There are various contingencies which may be included in the sales contract. The contingencies discussed below are pre-written into the California Association of Realtors standard residential purchase agreement (used in the overwhelming majority of home resales in California), unless negotiated out by the parties. During the due diligence period, difficulties in any of these areas can complicate the transaction. Remember that these are contingencies, not conditions, and have no effect unless they are exercised; the escrow can close without any contingency being exercised.
Financing. Most buyers need to use some form of financing in order to purchase real estate. Sales contracts generally acknowledge this fact and include a contingency stating that the sale will not proceed if the buyer cannot obtain appropriate financing. The buyer is given a certain amount of time to secure financing. While it can be frustrating for sellers to lose a sale due to buyers’ inability to secure financing, there is generally no way to force a buyer to pay without financing. From the buyers’ perspective, obtaining a commitment for financing during the financing contingency period and then having the funding actually materialize are both potential issues.
Inspections. When a buyer makes an offer on a property, the offer generally includes a contingency relating to physical inspections of the property. Since many problems are not readily apparent, during the due diligence period the property is typically inspected by the buyer’s retained home inspector for issues such as foundation problems, issues with plumbing and electrical wiring, to name just a few. Buyers may also conduct additional inspections such as pool inspections or Wood Destroying Pest inspections. The agents also have an obligation to view the property and point out any visible issues with the property but they are not professional inspectors and should not be used as a substitute for a professional inspection. If defects or repairs are noted during the physical inspections, the buyer can request that the seller fix these defects or give the buyer a credit. While the seller is not obligated to make any repairs or provide any credits, they can do so in order for the sale to be completed. Typically the inspection contingency will allow a buyer to cancel the transaction if the property is not acceptable to the buyer, as long as the cancellation is in “good faith,” i.e. related to an actual condition found at the property.
If the buyer cannot complete necessary inspections within the due diligence period, the buyer can request an extension on that contingency. The seller does not have to agree to extend the contingency and can provide the buyer with a notice requiring the buyer to remove the contingency. If the buyer does not remove the contingency after being provided notice by the seller, the seller can cancel the transaction. These are just a few of the issues that can arise during the due diligence period.
Disputes over contingency removal typically lead to fights over the right of the seller to keep the buyers’ deposit. Principals to a residential transaction should only consider litigation (usually preceded by mandatory mediation) after consulting with a skilled real estate attorney who can advise the parties on their rights and an appropriate course of action.