The diligence budget for the deal you close is only part of the bill. The rest was spent on the deals you did not close, and it belongs in the same calculation.
For the deal you close, about 1 per cent of the price in this illustrative case: 310,000 on an illustrative 30,000,000 acquisition. But a buyer who wins one bid in four, and completes 80 per cent of the deals it takes into exclusivity, spends 542,500 per completed acquisition, 1.81 per cent of the price, because the work on lost and aborted deals has to be paid for by the deals that close.
Worked in full in Real Estate Transaction Due Diligence by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Ask a transaction team what diligence costs and they will show the budget for the current deal: legal, survey, valuation, tax, a few smaller reports. That is the right number for the investment committee paper on this asset. It is the wrong number for deciding how much work to do before exclusivity, and for setting a platform's acquisition cost assumptions, because most of the money is spent on deals that never close.
| Workstream, after exclusivity | Cost |
|---|---|
| Legal (title, leases, contracts) | 110,000 |
| Building and services survey | 58,000 |
| Tax and structuring | 35,000 |
| Valuation | 22,000 |
| Market and tenant covenant | 15,000 |
| Measured survey | 8,000 |
| Environmental Phase I | 6,000 |
| Insurance review | 6,000 |
| Post-exclusivity budget | 260,000 |
| Pre-exclusivity work per bid (desktop legal, model, initial survey) | 50,000 |
| Headline cost of the deal | 310,000 |
Two pipeline assumptions complete the picture: one bid in four wins exclusivity, and 80 per cent of exclusive deals complete. When an exclusive deal aborts, half the post-exclusivity budget has typically been spent.
Pursuits per completed deal = 1 ÷ (win rate × completion rate) = 1 ÷ (0.25 × 0.80) = 5.0
Cost per completed deal = pre-exclusivity spend × pursuits + post-exclusivity budget + (1 − completion) ÷ completion × abort share × post-exclusivity budget
In Excel, with pre-exclusivity spend in B1, win rate B2, completion B3, abort share B4 and post-exclusivity budget B5: =B1/(B2*B3)+B5+(1-B3)/B3*B4*B5.
Five pursuits are needed for each completed deal, and 1.25 exclusivities. The pre-exclusivity spend across those five pursuits is 250,000. The closed deal's own budget is 260,000. The aborted exclusivities add 32,500 per completed deal: a quarter of an abort, at half of 260,000. Total: 542,500.
| Component | Cost | % of price |
|---|---|---|
| Headline budget for this deal | 310,000 | 1.03% |
| Pre-exclusivity spend across five pursuits | 250,000 | |
| Post-exclusivity budget, this deal | 260,000 | 0.87% |
| Aborted exclusivities, per completed deal | 32,500 | |
| Cost per completed acquisition | 542,500 | 1.81% |
The true cost is 1.75 times the headline, or 181 basis points of the price, and 46.1 per cent of it was spent before exclusivity, most of that on bids that went to someone else. On a 1,800,000 net operating income, and before purchaser's taxes and other fees, the yield on total cost moves from 6.00 per cent on the price to 5.94 per cent with the headline diligence budget and 5.89 per cent with the full one. That last figure is the one an acquisitions platform has to earn across its deals.
| Case | Cost | % of price |
|---|---|---|
| Win one bid in two | 417,500 | 1.39% |
| Win one bid in four, base case | 542,500 | 1.81% |
| Win one bid in ten | 917,500 | 3.06% |
| One in ten, pre-exclusivity spend 20,000 | 542,500 | 1.81% |
| One in ten, pre-exclusivity spend 100,000 | 1,542,500 | 5.14% |
| One in four, pre-exclusivity spend 20,000 | 392,500 | 1.31% |
| One in four, 90% completion | 496,667 | 1.66% |
The win rate dominates. In a crowded auction where one bid in ten succeeds, every 50,000 spent before exclusivity costs 625,000 per completed deal, and the total reaches 3.06 per cent of the price. A buyer bidding into that market with 100,000 of pre-exclusivity work per bid spends 5.14 per cent of the price on diligence for every building it buys. Cutting pre-exclusivity spend to 20,000 brings the one-in-ten buyer back to exactly the base case cost. Improving completion, by contrast, matters much less: from 80 to 90 per cent saves 45,833.
The common mistake is to budget acquisitions on the headline figure, 1.03 per cent, when the platform spends 1.81 per cent for every building it actually buys. The opposite error is to treat the multiplied figure as the cost of the bid in hand: the expected cost of spending 50,000 on one bid is 50,000, and once spent it is sunk and irrelevant to whether to proceed. What is multiplied is the cost per completed acquisition, which is the figure that belongs in a platform's budget and in the decision of how much work to do before exclusivity. Keep the two apart. A sunk cost should never push a team to complete a deal; a high cost per completed acquisition should push it to bid on fewer.
Spend where the probability is high. The arithmetic argues for thin work before exclusivity and thorough work after it, when the probability of completion is 80 per cent rather than 20. A building survey commissioned after exclusivity is paid for 1.25 times per completed deal; the same survey before exclusivity is paid for five times.
Divide pre-exclusivity spend by the probability of completing, add the closed deal's own budget and the expected cost of aborted exclusivities: 542,500, or 1.81 per cent, against a 1.03 per cent headline here. The free workbook for the book attributes a diligence budget to the findings each workstream produced, and a related article shows what the exercise recovered.
For the deal itself, about 1 per cent on this illustrative mid-sized asset: 310,000 on 30,000,000 in the illustrative case, of which legal is 110,000 and the building and services survey 58,000. Counting lost bids and aborted deals, the cost per completed acquisition is 542,500, or 1.81 per cent, which is the figure a platform should budget against.
As little as the bid requires, because it is divided by your win rate. At one win in four and 80 per cent completion, every 50,000 spent before exclusivity costs 250,000 per completed deal. At one in ten, cutting pre-exclusivity spend from 50,000 to 20,000 lowers the total cost per completed deal from 917,500 to 542,500.
Normally the buyer, and the buyer bears them whether or not the deal completes. Cost-cover agreements, where the seller reimburses abort costs if it withdraws, reduce the 32,500 per completed deal lost to aborted exclusivities in the illustrative case, but rarely cover the larger cost of losing competitive bids.
This article is one calculation from Real Estate Transaction Due Diligence. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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