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March 17, 2023

Why is Due Diligence Important?

By

Tim Clarke

Why is Due Diligence Important?

In 2011, the North Carolina Real Estate Commission added a new term, "due diligence," to the NC Standard Offer to Purchase and Contract Form 2-T, in an effort to protect both buyer and sellers.

At that time, many NC Realtors found this new concept unconventional, difficult to grasp and frankly, ridiculous. This was a time amid the "Great Recession" and in the midst of a heavy buyer's market.

Side note, the state of North Carolina was one of the states least affected by the recession. The "sub-luxury" markets all over the state stabilized rather than declined.

At any rate, once the due diligence clause was introduced, it was perceived to have very little practical value and was easy for buyers and sellers to omit because there was minimal buyer competition.

Before 2011, the only money needed from a buyer to secure a ratified purchase agreement is "earnest money".

Earnest money is used to demonstrate "good faith" to a seller and demonstrate a buyer's willingness to complete the purchase. Earnest money also serves as "liquidated damages" to compensate a seller for lost time and potential buyer opportunities if the contracted buyer backs out.

Now, if everything goes well, and the transaction makes it to the closing table, the earnest money is returned to the purchaser as a seller credit.

However, things don't always go as planned. This is why buyers and sellers sometimes find themselves on the short end of the stick. Hopefully, after you continue reading, you'll have a better insight into what due diligence is and how it works.

How Does the Due Diligence Fee Work for Sellers?

The due diligence fee is paid directly to the seller, who deposits and keeps the money? The buyer will have that amount credited back to them at closing if the deal closes but it is initially for the seller to keep.

Prior to due diligence style transaction, if the buyers' financing falls through for whatever reason, the earnest money will be returned to them.

Buyer financing can fall through due to job loss, lender error or a variety of other reasons related to their debt-to-income ratios changing.

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For a seller, it's a serious drawback when a deal falls apart.

Imagine the stress of putting your house on the market; cleaning and preparing the house to be shown, abruptly leaving your home to accommodate every random showing, finding ways to kill time during those random occurrences, and praying for a buyer to write an acceptable offer.

Imagine finally receiving that offer and notifying other interested buyers to look somewhere else by removing the house from the market.

At a typical purchase timeline of 30-45 days, imagine finalizing the plans for moving; securing the next home, aligning intricate moving logistics, and everything else involved with uprooting.

Imagine hustling to complete seller-required tasks and successfully negotiating a win-win then at the last minute, the buyer's financing falls through.

This was a very common occurrence amid the recession and when it happens, the buyer gets a full refund of earnest money.

A situation like this leaves the seller without anything to display other than wasted time, lost opportunities, and no compensation for liquidated damages.  You can probably picture how terrible this would be for the seller.

As a listing agent, I want the buyer to appear serious and financially positioned to make a substantial due diligence fee and a relatively quick due diligence period.

If the buyer finds the house to be attractive enough to complete the purchase without regard to the seller denying repairs, then a high due diligence fee will get the attention of the seller.

Also, if the transaction goes south, the seller will be compensated for the time that has passed.

The buyer's willingness and ability to follow through on his or her promises is what convinces a seller when the due diligence period is short.

A seller would entertain a longer due diligence period, depending on the amount of the due diligence fee.

On the other hand, the seller may want to finish due diligence as quickly as possible but the due diligence fee amount will encourage the seller to consider time length.

How Does the Due Diligence Fee Work for Buyers?

Sellers aren't the only ones who gets benefits from due diligence. The pendulum swings both ways.

Prior to 2011, if a contracted buyer identifies a major defect and the seller denies repairs, the buyer stands to lose their earnest money upon buyer termination.

Due diligence is essentially protection for earnest money.

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Buyers can lose their earnest money if after inspections (at the buyer's cost) requests are made for repairs and the seller declines to make repairs.

At that juncture, the buyer is faced with either completing the purchase or terminating and wrestling with the seller for their earnest money back.

When a purchase contract is terminated, most escrow holders won't release funds without it being mutually agreed upon in writing.

While the buyer could back out of the contract and attempt to recoup their earnest, they would still have lost time and the costs for discovery such as a home inspection (+/- $550).

Additional expenses might have been incurred as the appraisal (+/- $450), survey (+/- $500), or other expenses such as termite (+/- $75), radon (+/- $125), septic inspection (+/- $250), and well test (+/- $400) if needed.

If the buyer wanted to stay in and continue to close, they would eventually have to pay to fix those identified defects afterward.

To address these issues, the NC Real Estate Commission developed a revised Offer to Purchase and Contract, including a "due diligence fee" and "due diligence expiration date" in addition to the earnest money.

There are several ways to handle and negotiate the due diligence and earnest money amounts.

As a buyer, it is ideal to keep the due diligence fee and earnest money amount as low as possible, without offending the seller or giving the impression of wasting people's time.

A lower commitment lowers the risk of loss for the buyer.

If the seller declines repairs, the buyer can easily back out, thus encouraging the seller to be less stern.

Ideally, a good agent would structure the due diligence period to be as long as possible. In that circumstance, the buyer has ample time to perform an extensive discovery with the confidence of having control of the transaction.

*Pro Tip* The lengthy time can also serve as leverage against the seller in negotiations.

At the end of the day, sellers want to sell their property, not collect due diligence fees.

Before making an offer, try asking the listing agent questions to discover the seller's motivation for selling.

You may get lucky and identify a seller's desperation.

What Happens When Due Diligence Expires?

The due diligence fee is agreed upon by both parties but is initiated in the buyer's offer.

A due diligence fee also includes a due diligence period. Within the due diligence period, the buyer can conduct a professional assessment at the buyer's expense (inspections, appraisals, title and deed searches, surveys, insurance, etc.), and within that period, the buyer has the right to back out for any reason.

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If the due diligence period passes (5:00pm of the agreed due diligence date) and the buyer elects to terminate, the buyer will not only lose their due diligence fee but also their earnest money (which is held in escrow).

There is no longer a financing contingency with a due diligence-style contract.

At the very least, the buyer will regain his earnest money if he backs out before the expiration of the due diligence period.

It's imperative to keep track of this due diligence date (our agents put the due diligence date in their calendar with multiple notifications).

If more time is needed, it is accustomed to negotiating a due diligence extension with the seller before the expiration of due diligence (sellers typically cooperate if the buyer is proactive).

Failure to get an extension can result in the forfeiture of earnest money.


Hopefully, this adds color to the different aspects of due diligence and earnest money.

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It may feel complicated and unfair if you're on either end of a transaction, but it makes a lot of sense if you can reach a win-win solution.

Your Realtor should be able to answer any question you may have.

If you're unsatisfied with what your broker is telling you, contact the Broker in Charge directly.

You may also contact the NC Real Estate Commission, but it should never really get that far.

Furthermore, prior to submitting the initial offer, it is a good practice to ask the listing agent a lot of questions related to areas of concern.

The buyer has more liberty with the new contract, and the seller is safeguarded from losing money if financing falls through.

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