How to do quick and dirty due diligence
You will always have more opportunities than time
It’s hard to not have a good day if you find yourself in Pismo Beach.
If you need to stretch your legs halfway on the drive between Los Angeles and San Francisco, this gorgeous slice of California’s central coast has you covered. You can watch sea otters and surfers playing in the waves, or grab a plate of the area’s famous steamed clams or a bowl of clam chowder. And if you have more time to spend, there are hiking trails, hot springs, and wineries galore.
But if you’re a real estate developer, it’s easy not to have a good day here.
That’s because this is San Luis Obispo County, whose initials (SLO) hint at how hard it is to get a project approved here. For developers, SLO might as well stand for “slow growth.” The area’s residents -- lots of retirees and students among them -- know what a special place they live in, so they keep a watchful eye out for developments that might threaten their quality of life.
If you’re a real estate developer -- here more than most places -- you have to do your homework.
One definitely didn’t.
Right where US Route 101 bends inland from the coast, there’s a tall mountain with ravishing coastal views. One developer thought it would be a great place to build some ocean-view condominiums, but in his haste to close the deal, he overlooked some important details. Like the fact that the property was too steep and too narrow to safely build a road on. Or the fact that the property was in the coastal zone, so any development there would be subject to stringent regulation by the State’s Coastal Management Program.
He paid millions for the property, but for the purposes he had in mind, it was next to worthless.
That’s not a mistake most people can afford to make very often, which is why it’s important to have a system for doing your due diligence.
The problem is, traditional due diligence can be very expensive and time-consuming.
When I led due diligence efforts at an S&P 500 company, it was hard not to get bogged down in details. A 360-degree view of a potential project required collaboration from many different functional areas. But that caused three big problems:
1. Every department had its own pet concerns that it thought were more important than those of other departments, so every project had the potential to lead to political infighting.
2. Because it was all-hands-on-deck, traditional due diligence wasn’t private. Because each functional area recruited lots of hands -- not all equally discreet -- inevitably the project got leaked to consultants, or industry peers, or the press.
3. The result was several competing stories rather than one unified vision. Instead of an integrated go/no-go recommendation that a CEO could make sense of, there was just a long list of caveats, maybes and what-ifs.
Another problem was that it was impossible to perfectly match resources with opportunities.
In a strong economy, there’s lots of eagerness to do deals, and lots of money chasing them, but no time to analyze them. Your talent is preoccupied with other projects, and new potential deals are constantly distracting you.
In a weak economy, there’s no money to do deals, but plenty of idle hands to do them, so the work gets drawn out, regardless of the deal’s merits. It’s a classic case of Parkinson’s Law, which says that people take the time available to them (or more) to accomplish the task at hand.
The pendulum is always swinging between a good and bad economy, and it feels like you’re always getting caught in the middle.
You’re never going to score the perfect timing, so you’re almost tempted to throw in the towel.
The solution is to recognize that there will always be more opportunity than there is time to pursue them all, even in the bad times. Because the velocity of deals has increased so much thanks to technology, the velocity of your analysis needs to match it.
You do that with quick and dirty due diligence.
Just as the early developers of the personal computer developed a Quick and Dirty Operating system, or QDOS, community and real estate developers need quick and dirty due diligence, or QDDD.
In both cases, the point is to get a system up and running quickly, then move on to the good stuff.
The focus of QDDD is what you can do with an asset now, by right -- i.e., without the need for supplemental discretionary approvals by the governing local agency. By right entitlements are the only real value that a property has. Everything else is conjectural or speculative -- or creative marketing by a seller.
By-right entitlements are also often more extensive than project proponents realize.
One of my clients thought they had the perfect site picked out for a high-tech logistics center, but they weren’t sure they could get the city to permit it. They feared the possibility of environmental issues as well as community opposition.
But putting some QDDD into their existing entitlements turned up a decades-old specific plan that showed they could permit the project right now, by right.
So they closed on the property within a month, took another few months to clean up some minor title issues, then sold the property for a $15 million profit.
But that’s just the beginning. Using geographic information systems, or GIS, it’s even possible to automate much of the searching and screening that traditional due diligence used to require -- helping a developer maintain a laser focus on just the opportunities that are most meaningful to their business.
Which is enough to make any developer as happy as a clam.
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