The purpose of CRE Due Diligence is to attempt to avoid unpleasant surprises as to the condition and use of the property and to explore what will be required as you enter into your business or development venture.
The key to a successful investment in CRE is performing adequate Due Diligence prior to becoming legally bound to purchase the property.
If negotiating the purchase price is the heart of the deal, due diligence is the circulatory system through which the blood flows. If there are clogged arteries (or in this case structural, zoning or other developmental problems) you may be facing the cost of major surgery if you close the deal.
Due diligence begins after your offer to purchase has been accepted. Typically, you will have 45-60 days in which you, your agent and your hired professionals can inspect the property.
Consumer protection laws which typically apply to home purchases seldom apply to commercial real estate transactions. The age old adage “let the buyer beware” most certainly applies to the purchase of CRE.
Contractual Representatives, Brokers, Agents and/or Warranties are NOT a substitute for comprehensive due diligence; Breach of representations and warranties equate to time, litigation and money…something no businessman can afford.
The scope, intensity and focus of a Due Diligence Analysis will depend upon your objectives. Are you buying for your own use, will you lease to others or are you planning to develop?
Having a comprehensive checklist is the key to success. There are many checklists available through a quick Google search. Choosing the one which represents your goals is vital.
This is often the first consideration with CRE. Codes, zoning, DHEC, EPA, ADA, FAA and other government entities can stop a businessman or developer dead in his tracks…
It’s imperative to check with local zoning officials to determine what you need for occupancy permits required to operate your business. This would include such things as building or remodel permits, use permits, fire codes, DHEC or ADA. State or Federal requirements or restrictions such as EPA or FAA restrictions are also vital to your due diligence.
\What’s on the Title?
A review of the property’s title will help you find potential problem areas that could include liens, deed restrictions, easements, mineral rights, etc. Make sure you understand your rights. For example, easements may either benefit you or hinder your use.
Know who is responsible for shared repairs and maintenance (if applicable) and how that relates to planned expansion.
To Survey or Not to Survey
Not all surveys are created equal; some only offer the boundary lines of a property. The best survey, however, is one which shows property lines, exterior building lines, paving, curbing, catch basins, parking, fencing, utilities, landscaping, as well as easements or encroachments. Other areas that can be included would be parking, expandability and storm drainage.
When buying commercial property, even if everything appears clean, you may want a Phase I Environmental Site Assessment. The purpose of a Phase 1 ESA is to identify existing or potential environmental conditions. Determining the surrounding land use can be a vital part of the property assessment as the risk of contamination can increase significantly if the surrounding area or properties have documented or potential contamination. During a Phase I, agencies such as fire, water & health departments, petroleum tank management associations, etc., are contacted to gather current and historical information concerning the property and the neighboring area(s).
If Phase I recommends further inspection, you move on to Phase II, which involves taking soil, water, concrete & potential asbestos-containing material samples. Phase III is the actual cleanup of any problems the Phase I & Phase II studies have revealed.
Inspect the Building
If the property has a structure or building, its inspection will be quite possibly, the most time-consuming and expensive part of your due diligence.
Major issues include the Condition and Life Expectancy of:
the roof system & storm drainage
the flooring; both structural and visual
the foundation and structural components
the mechanical components such as fire suppression, HVAC, plumbing,
electrical, range hood, cooking equipment, exit signs, ADA access, etc.
Also, the estimated cost of up-fitting the building for your intended use is a vital consideration.
It is recommended that you hire professional inspectors for each component and have them give you fully comprehensive reports on their findings. If their findings come back with problem areas, get at least two estimates for each of the suggested repairs.
Operational Review of Multi-Tenant Property
If you are planning to purchase a multi-tenant CRE property, whether office or retail, the value is determined, in part, by the degree of risk associated with the duration and stability of the income streams which the property generates.
Literally every document regarding the building, its operation and its tenants must be examined.
The leases are extremely important as they can harbor problematic situations enshrouded in vague wordage: First options on purchase, first right of adjacent space, tenant ownership of fixtures, agreements for owners to do expensive annual maintenance, agreements to prevent like businesses in the building. If you do not understand every portion of every lease, you will be buying a money stream "in the dark.”
Sooner or later, to generate immediate income, most commercial property owners find themselves in a position to sign a tenant at any cost and, though they may later regret concessions they have made, the lease agreements are binding and will pass to new owners.
A true NNN (Triple Net Lease) is generally when one tenant leases an entire building and the tenant is responsible for all expenses of operating the property: insurance, taxes and 100% of the maintenance. Rarely will you find a true NNN, multi-tenant property. Most of the time, you will find what could be known as modified NNN leases which include CAM (common area maintenance) charges whereby multiple tenants share the maintenance expenses and this is where you may find vague or ambiguous wording.
However the leases are written, just be sure you read every word of every lease. Make notes of things you need to clarify. Then have another qualified person do the same thing; compare notes and go after the answers.
It is far better if you have thoroughly done your research and are able to ask enough probing questions of the owner that he discloses details he wouldn’t ordinarily tell you. Also, these questions may bring back the memory of a fact or quirk in some system that you wouldn't otherwise have found out about. So ask questions, and then ask more. This is the only chance you will have to do this. After you close, he may not return your calls.
If the property has a Property Manager other than the owner, it is a good idea if you sit down with them to discuss payment histories. And, if the owner or manager does not have detailed payment records or statements, you now have to consider the property to be a far more risky investment.
What if there are problems?
If problems or obstacles are discovered that have serious economic or use impact on the property, you will have to decide whether to walk away from the deal or renegotiate the price.
Do you Have All the Answers?
There is no way you will ever get all the answers. But the more questions you ask, the better informed you will be when you are making your final decision.
We at McCoy Wright Realty strive to help each of our clients in their quest for Comprehensive Due Diligence by making suggestions, referrals and offering experienced assistance along the way.