Chartered Financial Analyst Level 2

Explanation

Due diligence in real estate equity investments serves several important purposes, but its primary purpose is to identify problems not disclosed by the seller.

Key Points:

• Option A (verify audited financial statements): While financial statement verification is part of due diligence, it's not the primary purpose. Audited financial statements are typically already verified by auditors.

• Option B (identify problems not disclosed by the seller): ✅ CORRECT - This is the core purpose of due diligence. It involves uncovering hidden issues such as:

  • Physical property defects
  • Environmental hazards
  • Legal title issues
  • Zoning restrictions
  • Tenant problems
  • Maintenance issues

• Option C (verify the funding sources): This is typically handled during the financing phase, not as the primary focus of due diligence.

Why B is Correct:

Due diligence is essentially an investigation process where the buyer independently verifies all material aspects of the property that the seller may not have fully disclosed or may not even be aware of. This protects the investor from unexpected liabilities and ensures the investment meets their risk-return expectations.