Due diligence in is an opportunity for an investor to confirm if a property is a good investment. Every commercial real estate transaction should have a due diligence period clause. A due diligence investigation period will allows a commercial real estate investor to investigate the property and assess its value before signing a purchase contract.
The due diligence period is usually a 45- to 60-day period and includes identifying any physical, financial, legal, or environmental issues with a building property. A team consisting of a lawyer, accountant, financial advisor, commercial and mortgage brokers, and a property management company can provide an investor with information and analysis and also help establish a property management plan moving forward.
It is critical that a potential purchaser first know the risks, such as market variables, costs versus rate of return, and location.
A commercial broker can help an investor locate a potential investment property and provide a location analysis. Once a property is identified, the investor should consider the nearby competition for the space. How much vacancy is in the area? Will you be the only game in town?
Legal due diligence begins with a title review period reviewing all claims against the property. Next, it is important that the investor work with the attorney to conduct a survey of the property to determine any easement and right-of-way issues and restrictions, and to know whether the building is in compliance with existing zoning regulations.
The investor should know the building’s age, acreage, and square feet. It also helps to get the record of all previous building owners of the property and discover the building history of the structure, e.g., whether is it built on a hazardous waste site. The investor should also know the kind of use the building is set up to accommodate and identify all present uses of the property. Is it a single-use office space? Mixed-use with retail? Can it accommodate medical offices? Restaurants? What type of construction is the building (steel, glass, brick, wood)?
As part of due diligence, the investor should hire a professional inspection company to assist in making a general inspection of the entire property. Walk the property and inspect each unit or space if possible. Look for deferred maintenance issues. This can include determining the condition of the roof, bathrooms and plumbing, paint, finishes, and carpets, and locating any mold or asbestos. You will also want to inspect that the mechanicals, such as sprinklers, HVAC, plumbing, and electricals are working to code. The purchaser might also want to check the structural condition of the building, including walls and floors. Once problems are spotted, the investor should make a remediation list of what will need to be fixed or replaced, and get estimates for repair costs.
The investor should also see if the property has adequate access to public streets. What are the width of these streets? Are there any alleys or pavements that traverse the property? Is the property near public transportation?
For a physical inspection, the purchaser, if possible, should always want to inspect the property in the rain to look for roof leaks, determine if windows are leaking that will need caulking, and see if the drains work properly, i.e., is there standing water in the parking lot.
Also. count the number of regular parking spaces that the building has and make sure the number is in accordance to the square footage ratio assigned by the county.
After inspection, a thorough review of all of the seller’s existing building leases is required. This includes the status of leases, the cash flow and creditworthiness and of each tenant, and the delinquency rate (there shouldn’t be any delinquency if the building is being managed properly).
A thorough review of all of the seller’s existing building contracts will be required. This includes a review of:
- Verifying the income of the building against its operating expenses by reviewing billing receipts.
- Copies of bills, such as water, sewer, and electric bills. Are energy-saving measures in place, such as energy-efficient light bulbs?
- Copies of property taxes, agricultural taxes, and any special taxing from the district or county where the building is located.
- Any pending lawsuits or unpaid taxes/fees.
- Inspection documents for elevator and fire, i.e., are they up to date?
- Service contracts, such as elevator, cleaning, trash removal, and pest control.
- Seller’s insurance policy.
- Notices of any environmental conditions
- Handicap regulations. Make sure the property is in compliance with Americans with Disabilities Act (ADA) codes, e.g., what is the turning radius getting in and out of bathrooms? Are there access ramp? Verify that there are clearly marked handicap spaces.
- Construction records. Are there any plans for additional building?
- Liquor, entertainment, and outdoor dining licenses.
The Due diligence process is challenging, but failure to perform in-depth due diligence on a property can have negative financial consequences, so spend the time and resources necessary to conduct it thoroughly. It is advisable to rely on experts to help you. If problems are discovered, you might consider cancelling the deal or getting the seller to renegotiate the purchase price.