Can virtual due diligence become the norm in private real estate?

Limited scope is an issue, but virtual methods of due diligence have had a positive effect on the overall process.

For many, ‘virtual due diligence’ is an oxymoron. Before the pandemic, remote or virtual due diligence was practically unheard of, but a new paradigm has taken shape as the new normal of our post-pandemic world sets in. What was once disliked has become an innovative prospect as stakeholders look to save on rising closing costs.

Limited scope is the most glaring issue with any virtual diligence effort. Looking through the lens of a camera over an internet connection or reading metrics on a computer screen does not create an accurate or complete picture of assets or facilities.

Seeing key details often requires proximity and access that virtual methods do not promote. Personal interaction with stakeholders is crucial in assessing the trustworthiness of potential partners and investments. Those efforts require time and effort from costly professionals internally and at banks, title companies and other institutions.

“When you think about changing that to do something better, there are a lot of people to switch over; that is a big challenge,” Bryan Routledge, associate professor of finance at Carnegie Mellon University, says. “It is hard to know if the cost savings are enough to justify switching systems.”

Less is not more

Due diligence requires sharing sensitive financial, legal and proprietary information, exposing businesses and assets to data theft, hacking or other forms of unauthorized access. Virtual data rooms can act as a digital broker enabling each party to submit confidential documents and information for the other to review in a secure digital environment.

Decentralized record-keeping via blockchain can help keep banking information and other sensitive data private by using a public ledger that can be easily audited.

Digital tools exchange documents instantly, reducing the time it takes to gather, review, send and receive crucial information. By helping to speed up the process with technology, difficult and expensive conversations surrounding period extension can be avoided.

Forced to adapt to a global pandemic, private real estate markets tentatively embraced new site and managerial due diligence methods by scheduling virtual tours and more virtual meetings to keep deals moving, realizing the benefits and limitations of each. It is unlikely that these methods will replace traditional due diligence, but they have become proven cost-effective tools in limited cases going forward.

Speed and efficiency do not always make the deliberate process of due diligence better. Accuracy and veracity are not to be rushed. Doing so can increase the risk of errors and inaccuracy, the very thing due diligence is intended to prevent.

Technology-based automation can cut down on costly transaction costs and duplicated efforts, but it may not make sense as a priority from a business perspective until rising closing costs eat into margins. Those fixed costs are currently viewed as part of doing business rather than a major pain point that needs to be addressed, even if savings can be generated.

“Economic history tells us the fact the transaction cost is high does not mean showing up with technology is going to make it better,” Routledge explains. “What is better is not always clear; it is different for each business. Technology is not going to fully replace the important business step of due diligence.”

Less is not more in the world of due diligence. Efficiency innovations boost cost-savings, reach and accessibility and can make the due diligence process better when added to existing efforts, but replacing those existing efforts with a digital toolkit does not serve stakeholders. Due diligence is the last place businesses should be trying to cut corners. Embracing innovation with strong cybersecurity can transform the due diligence process by enabling parties to make more informed decisions in an increasingly connected digital world.