A buyer under offer at 24,000,000 runs the diligence, finds six things, and
negotiates four of them into the deal. The price falls by 690,000, the entry yield
goes from 6.00% to 6.18%, and the committee paper reports 18 basis points as the
return on the exercise — in the only unit a committee recognises. The number is right.
As a measure of what the diligence recovered it is short by 13 basis points.
Three of the four instruments never touch the yield
Look at what came out of the negotiation, rather than at what came off the price.
Instrument
Value to the buyer
Reaches the entry yield?
Price deduction — roof and lifts, taken on the day
690,000
yes
Retention — the seller funds the compartmentation
175,000
no
Indemnity — expected value of the rent review
280,000
no
Policy premium — paid by the seller
38,000
no
Total recovered
1,183,000
Four instruments came out of the negotiation. One of them is cash off the price on completion day; the other three are contingent, and an entry yield is a spot measure.
Only 58.3% of what was recovered reaches the entry yield. The retention, the
indemnity and the policy premium are worth 493,000 between them and are invisible
to a spot measure, because a yield divides today’s income by today’s price and
three of these four instruments pay later or pay conditionally.
Price
Entry yield
Improvement
Before diligence
24,000,000
6.00%
—
After the price deduction only
23,310,000
6.18%
18 bp
Adjusted by the full recovery
22,817,000
6.31%
31 bp
The exercise is reported at 18 basis points. It is worth 31 basis points.
The understatement is 13 basis points on 31 — the reported figure
captures a little over half of the result. This is structural, not careless: it is exactly why
the right way to present the ask is as a composed schedule of instruments rather than as a
single total, and why the yield line belongs underneath that schedule instead of standing in
for it.
Which workstream actually produced the findings
A diligence budget is usually approved as one line. Split it against the findings and it
becomes ten decisions, each with a return.
Workstream
Fee
Value recovered
Return
Findings
Building and services survey
96,000
865,000
9.01×
roof, lifts, compartmentation
Legal title and leases
84,000
318,000
3.79×
rent review, mezzanine consent
Environmental desk study
9,600
0
—
none on this deal
Intrusive ground investigation
24,000
0
—
not commissioned
Measured survey
19,200
0
—
none on this deal
Financial and tax structuring
60,000
0
—
none on this deal
Insurance review and placement
14,400
0
—
none on this deal
Counterparty and source of funds
19,200
0
—
none on this deal
Valuation for lender
24,000
0
—
none on this deal
Contract and disclosure
72,000
0
—
none on this deal
Total
422,400
1,183,000
2.80×
Ten workstreams, six findings. Attribution turns a budget line into ten separate decisions.
The exercise as a whole returned 2.80 times what it cost. The building survey
alone returned 9.0 times — it produced three of the six findings, including
both that reached the price.
Eight of the ten workstreams recovered nothing on this deal, and they
consumed 57% of the budget. That is not an argument for cutting them, and reading it that way is
the standard error: a workstream is bought for the finding it might produce, and it is
sized against that finding’s expected value. Which is a calculation, and it is almost
never performed.
The one workstream that was dropped, priced
Here is that calculation done once, on the investigation this deal skipped. An intrusive
ground investigation costs 24,000. It pays for itself when the probability of contamination times
the remediation it would reveal exceeds that — so the break-even probability is the cost
divided by the remediation, and nothing else.
If contaminated, remediation of
Break-even probability
Expected loss at 2%
at 5%
Investigation pays at 5%?
250,000
9.60%
5,000
12,500
no
500,000
4.80%
10,000
25,000
yes
1,000,000
2.40%
20,000
50,000
yes
2,000,000
1.20%
40,000
100,000
yes
4,000,000
0.60%
80,000
200,000
yes
The investigation costs 24,000. Break-even probability is simply that cost divided by the remediation it would reveal.
At a million of remediation the investigation is worth commissioning if you think the
chance of contamination exceeds 2.4%. It fails only if you believe both
that the probability is at the floor of what anyone means by low and that the
remediation would be small: at two per cent it still pays above 1,200,000 of
remediation.
The usual reason for skipping it is the timetable — three to five weeks, and the
commonest cause of a missed exchange — and that is a defensible reason. It is just never
tested against money. And the timetable objection has three answers already on the instrument
list: delay the exchange, exchange conditional on the report, or take a retention sized to the
remediation range. Accepting the risk is a decision; a reason that is not a number is not a
reason.
Two numbers that get set and never sized
The reporting threshold. Items above 50,000 get reported. On this deal that
suppresses exactly one finding — the mezzanine consent, worth 38,000, or 3.2% of the whole
recovery. Small. But notice what the threshold is applied to: the cost of the remedy.
The mezzanine is worth 38,000 only because the instrument chosen was an insurance policy; the
consequence of the underlying defect is removal and loss of income. A threshold on the cost of
the remedy systematically suppresses the findings whose remedy is cheap and whose exposure is
not.
The warranty basket. At one per cent of the price that is 240,000, and
three of the five findings would not clear it on their own. They did not have
to, because they were taken in cash and escrow instead — 865,000 of the recovery is immune to
a basket by construction. That is the whole purpose of the instruction to convert findings into
price and retention rather than leaving them in a warranty, and here it is worth the difference
between recovering them and not.
And one sentence that is arithmetically wrong
It is often said that spending 80,000 before exclusivity in a four-bidder process “has an
expected cost of four times its apparent one”. It does not. The expected cost of making
the bid is 80,000: you spend it whether you win or lose, which is what makes it sunk. What is four
times apparent is the cost per completed acquisition, 320,000 — a real number, and
the right one for a committee, but an acquisition cost rather than an expected cost.
The two answer different questions. Is this bid worth making? compares 80,000 against
the value of this bid. Is this strategy worth running? compares 320,000 against the value
of a completed deal. And the argument the sentence was reaching for is stronger than the one it
made: even at one win in two, pre-exclusivity investigation costs more per closed deal than the
entire building survey that produced three of the six findings.
What to change in the committee paper
Report the recovery as a schedule of instruments with the yield line underneath it, not as
a yield line alone — on this deal that is the difference between 18 and 31 basis points.
Attribute each finding to the workstream that produced it, so the budget is renewed as ten
decisions rather than one. And for every workstream not commissioned, write the break-even
probability next to the reason: it is one division, and it converts an accepted risk into a
stated belief.
The workbook behind this article
Every figure above is a live formula in the companion file for
Real Estate Transaction Due Diligence, which reproduces the chapter’s ask line by line, attributes the six findings to the ten workstreams, and prices the investigation the deal skipped. It is free, and it needs no account and
no email address.
Should corporate debt be fixed or floating?78.1818 per cent of gross debt fixed, and a net floating exposure after cash of -608,000.00 — the proportion, not the instrument.
Does an undrawn revolver count as liquidity?67.4567 per cent of the headroom, and it leaves at a fall in annual revenue of 8.4127 per cent — not the 13.3333 per cent the board deck implies.
Does supply chain finance count as debt?66,049,315 released, and leverage of 2.7622× or 3.1362× depending on which balance the test is asked of — the second is a breach at today's EBITDA.
How do you set a minimum cash balance?Three components, 124,596,281 in total — and the double count that turns a margin of 27,403,719 into an apparent shortfall of -3,988,281.
Is a 2/10 net 60 discount worth taking?An annualised 14.8980 per cent against a revolver at 4.50 per cent — worth 5,471,890 a year, and 0.3132 turns of reported leverage.
At what wealth does a family office pay?A five-person office costs the same $2,442,000 at $100m as at $2bn. Against a tiered multi-family schedule the two curves cross exactly once.
Does the fulcrum move with enterprise value?A worked capital structure at three enterprise values. The break migrates from the first lien to the subordinated notes without a single document changing.
How many companies does a reserve pool defend?Holding pro rata to the Series D costs $14.76m per company. A $40m reserve defends 2.71 of forty — and 61 per cent of the cost is the last round.
How much room a 1.15x downside actually leaves79 basis points of margin. The leverage covenant fails first, five basis points before the coverage covenant the chapter reports on, and 4.6 per cent of EBITDA is the whole cushion.
How the GP catch-up is actually solvedMost write-ups state the catch-up formula then hardcode the answer. Set it as a solve and it moves on its own when the carry rate does.
Six ways to state the same fund's return7.12 per cent, 18.04 per cent, or 1.323 times the public market — one fund, one set of flows. The eleven-point gap is the valuation, and it is not cash.
The IRR at which a closed-ended fund merely tiesA drawdown fund advertising 13.25 per cent ties an evergreen netting 8.64. On committed rather than called capital, 78.7 per cent of the edge vanishes.
The month a remediation trigger has to be armed byMonth 8, on a one-year window and a 14-week hiring lead time. The date is 12W − L/4.33 and holds for any portfolio size — the book only changes the euros.
Two routes to the same NAVFive findings in one quarter-end close, and not one of them was a modelling error. Every one was a control that did not exist.
What a CBAM certificate buffer costs to holdCarry and protection are both linear in the buffer, so the break-even probability is identical at 5 per cent and at 30 — and 2027 costs exactly twice 2026.
What a clawback actually collateralises24 million recovers 13.20 net of tax and 7.20 is escrowed. The rule is e ≥ 1 − t, and every euro won on the tax clause lands uncollateralised.
What a co-investment programme actually saves37 basis points, and a 22.8 per cent total-loss rate erases it. At the usual per-deal cap a single failure is 37 per cent of the annual cohort.
What a follow-on reserve is actually worth0.019 turns under plain dilution, 0.285 under pay-to-play. The optimum is a property of the shareholders’ agreement, not of the portfolio.
What a lease mark-to-market is actually worth5,788,000 becomes 807,365 once the over-market stream, the expiry dates and the cost of re-letting are priced — and nothing at all below a 43.7 per cent renewal rate.
What a minimum payment actually does£81.53 leaves the account and £20.46 reaches the debt. On minimums alone the set clears in 258 months and repays 1.78 times what was borrowed.
What a month of delay costs in an enforcement463,000 euros of present value a month. No single error about enforcement, and no pair of errors, moves the indifference point from 58.7 cents to the 72 on the table.
What a pro rata cheque actually costsDefending costs 1.25 times the initial cheque across two rounds, not more in each — and below a 521 exit the follow-on dollars come back worth less than they cost.
What a subscription line does to the IRR20 per cent becomes 38.41 on the same asset while the multiple falls. Two dollars of interest buys 18.4 points, and the longer the line runs the cheaper each point gets.
What one point of fees actually costsOne point on the annual charge turns 738,846 into 567,961 over forty years — 23 per cent of the pot, and 2.43 of wealth lost per 1 of fee.
When the promote stops clearingCarried interest is not proportional to performance near the hurdle. It is a step function, and $2m of headroom is what stands between a promote and none.
Why a secondaries bid-ask gap has no zoneThe seller’s floor and the buyer’s ceiling are one formula at two rates. At equal required returns the zone is exactly zero — here it is 11.02 points apart.
Why refining a due diligence rubric makes it weakerThree of twelve managers carry a terminal flaw and the average approves all three. Splitting eight domains into sixteen makes it easier to hide, not harder.
This note is drawn from Real Estate Transaction Due Diligence. The book is on Amazon.
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