You’ve found a commercial property you’d like to buy. You have a good feeling about the location, and the price is right. Maybe the building is under performing, and you have a plan about how to turn it around and add value. But, as with any investments, doing your homework before investing can mean the difference between success and failure.
That’s why the due diligence process is of the utmost importance in any commercial real estate transaction. Knowing what to look for in the areas of location, zoning, finance, tenancy, physical inspection, property management, and others, increases the likelihood of investment success. This post covers some of the primary areas of focus of due diligence for commercial real estate deals.
We’re not going to publish our full due diligence checklist here, because it’s too detailed for the purposes of this post—our checklist has 157 items on it. Instead, we’re going to go over some of the major categories, and highlight items in each category that proper commercial real estate due diligence requires.
Here are the some of categories our checklist covers:
Acquisition Actions & Documentation – This initial part of the process includes such items as selecting counsel to prepare, review, and negotiate the purchase and sale agreement. A key focus and decision here should be whether to use the Seller’s Purchase and Sale Agreement or use your own.
Title/Survey/Zoning Matters — This step includes selecting the title company you plan to use, ordering and reviewing current title commitments and underlying documents, ordering a new ALTA survey, checking for restrictive covenants, easements, or agreements, and obtaining releases from all current lien holders.
Tenant/Lease Matters — An important part of any due diligence involves a detailed review of all current tenant leases on the property, including information as detailed as tenant sales reports, account receivables, credit information, and security deposits.
Financial Matters — A thorough review should be performed of all financial matters related to the building, such as property taxes, historical cost of utilities, and all other operational expenses for the building. Then, these operating expenses are compared to other comparable buildings in the area to ensure the numbers are in line. This is also a good time to consider and budget for energy saving projects.
Service Contracts — The next step in the process is to examine all current service contracts to confirm which ones can be terminated without penalty, and to determine which ones will be assumed by you once you purchase the property.
Litigation — This very important step features a review of all pending litigation involving the property, including any currently open claims against the property.
Insurance — Obtaining current evidence of insurance information for the building will help you obtaining a new insurance quote, which should include property, general liability, and umbrella coverage. Earthquake coverage may also be considered.
Personal Property Inventory — A review of the Seller’s personal property list and a follow-up inspection will ensure no key items have been omitted from the personal property list, and making sure that all personal property is in good operating condition.
Physical Property Inspection and Review — One of the most important due diligence categories is an inspection of every aspect of the physical property from roof to foundation, and everything in between . Make sure to hire an experienced professional to prepare a detailed Property Condition Report that addresses all major building systems for the property. Major issues with elevators and HVAC that are not discovered during due diligence will wreak havoc on your projected returns on investment. Environmental assessments, building permits, and confirmation of sufficient parking are all a part of this step.
Government Review — This part of the process helps to ensure the building is properly zoned (and doing research to ensure no re-zoning is expected), and a check of the validity of all building licenses and permits.
Property Operations and Management — Once the sale closes, having a strong property management company and leasing company to manage and secure tenants for the building is key. Start interviewing teams as soon as possible so they are ready to hit the ground running when the sale closes. Theses teams will also prove valuable during your due diligence.
Financing Matters (if applicable) — If the buyer is putting new financing in place or assuming existing financing, this part of the process includes consulting with lenders, submitting the loan application, and finalizing the loan.
Closing and Miscellaneous Actions — The final part of the due diligence process includes compiling all previously mentioned documentation to prepare for the closing, ensuring all income and expenses are properly pro-rated through the closing date, and following through to ensure a smooth closing.
After reviewing these categories, it should be clear that there are a multitude of disciplines and areas of expertise required to successfully complete an acquisition. The team that’s typically involved will include lawyers, accountants, lenders, physical, seismic, and environmental consultants, leasing brokers, and property managers. Many investors will need someone qualified and experienced to coordinate all these different disciplines so they can close a transaction on a timely basis.
As a trusted due diligence consultant, RMC Realty Advisors provides the necessary resources to critically evaluate real estate investments. Our expertise doesn’t only come from being able to find answers to critical questions—it’s knowing which questions to ask in the first place that can be crucial for the success of real estate investments.
Our Due Diligence services include (but are not limited to):
- Engaging and coordinating physical, environmental, and seismic consultants, then reviewing, analyzing, and summarizing published findings
- Critically evaluating financial underwriting assumptions, then performing sensitivity analyses to effectively underwrite acquisition opportunities
- Developing operating budgets, multi-year cash flow projections, and asset valuations
- Preparing cost-benefit (hold/sell) analyses to support property repositioning, rehabilitation, and other capital improvement programs
Contact us today to get started.