While all real estate acquisitions should be subject to meticulous and comprehensive due diligence, commercial real estate can be especially complex, with additional factors such as leases, rent rolls, and tenant estoppels needing special scrutiny.
A lax due diligence process can spell disaster for even the most seasoned commercial real estate investor or buyer. This is why proper due diligence is so important. Conducting thorough due diligence limits surprises, reduces risk, and generates invaluable insight into the opportunity.
An air-tight checklist will guide you through what can at first appear to be a daunting task. Regardless of property type or location, a comprehensive commercial real estate due diligence checklist should include the following six key elements:
1. Collecting Property Information
Basic data on the property is the backbone of your due diligence. Record information like lot and building size, number of floors, unit count, property type, parking, zoning, and current use.
Next, cross-check broker- or seller-provided information with public data and field measurements. Investigate any discrepancies vigorously, and don’t trust any piece of information that cannot be independently verified.
3. Evaluating Building Systems
One can break down even the most complex structures into their components. Inspectors and other experts are essential to assess each element of a building, so tap into your network and always hire vendors experienced in dealing with local building codes.
Inspect or hire experts to examine structural systems, electrical, plumbing, gas, heating/cooling, roof, windows, sprinklers, drainage, fire protection, elevator, and any common area amenities. Understand how utilities are brought to the building and metered, not just who pays the bills.
3. Conducting Inspections and Reviewing Reports
Remember, do not take everything for face value. Be sure to conduct the proper inspections and review all reports to ensure there aren’t any major issues underneath the surface. Additionally, don’t forget to review non-physical items like building permits and violations.
4. Gathering Tenant Information
Most purchase agreements require that a seller disclose all legal contracts with tenants, including leases and any associated amendments. Review these very carefully, tying the financial terms (rent, security deposits, utility obligations, etc.) in each contract to the rent schedule provided.
In many cases, an attorney can aid in this review at a relatively low cost. In addition to leases, request that tenants provide an estoppel certificate to confirm lease terms, as well as a certificate of liability insurance. You will thank us later.
5. Obtaining Seller Disclosure
Required seller disclosures vary widely by property type and deal specifics, so collect as much as is feasible without expending negotiating equity on non-essential items. Review historical operating statements, capital improvement schedules, service agreements, completed building permits, drawings, plans, and request information related to any lawsuits that may impact a commercial property.
6. Updating Your Business Plan
It’s easy to be so focused on inspections, reports, and leases that you forget to think about what happens the day after closing. Due diligence is as much about looking for pleasant surprises as it is bad ones. Refresh your capital improvement plan and rent projections as you find out more about the property.
Conclusion
If you are purchasing a commercial property, remember that it is crucial to ensure the due diligence associated with the purchase is conducted in a complete and thorough manner. After all, the due diligence process, and a buyer’s comprehensive performance of this phase can mean the difference between a successful purchase and severe buyer’s remorse.
Photo by Austin Distel on Unsplash
