Due Diligence in Commercial Real Estate

How you attend to due diligence means you’ll either make money or lose it when you "land" on a commercial real estate investment. After signing a purchase contract, it’s the responsibility of a buyer to inspect, explore, and analyze. Here are my five tips to keep in mind during the typical 30 to 60 days of due diligence:

1.      If you land on a property that might work, start the process. Get it under contract ASAP and work through the due diligence types listed below. Don’t get hung up in “analysis paralysis.” You can withdraw from the deal if you're not satisfied with your investigation.

2.     It’s up to you to examine, judge, and decide if the deal works for you. However, get the right people on your team with the right expertise. Have realistic expectations and know that your decisions should be guided by the current market. Know that sometimes listening to an opinion from someone who hasn't been through the entire search process can be problematic.

3.     Each deal is unique. Be thorough and look at details. Cutting corners may cost you in the end. Due diligence is an intricate step and should be handled as such.

4.    Think long term. Make sure the property type matches your overall investment strategy. Also consider if you sell your business, you could lease the property at current rates and still get an excellent cash-on-cash return.

5.     Prevent additional costs at closing. Make sure all tax issues are resolved and be sure all permits, utility bills, executed maintenance contracts, etc. are settled.

Four Types of Due Diligence

Physical and Structural

A property condition assessment with a qualified professional (building engineer or property manager) provides necessary physical and structural information. Full property inspections report structural integrity, including electrical, plumbing, HVAC, roofing, elevators, structural walls, waterproofing, pavement, ADA compliance, fire safety, etc. You’ll have a better understanding of what improvements, renovations, and repairs are needed and balance those against the investment opportunity.

Legal and Title

Legal and title due diligence ensures the seller has the authority to enter the transaction, and there are no liens from unpaid taxes, easements, or charges. This search will also show any outstanding permits that may be out on the property, but it is best to check with the city. With the help of a CRE lawyer, accountant, or business advisor, review the title, ALTA Survey (detailed land parcel map), and zoning compliance. Legal and title due diligence is often required by financial lenders prior to transaction approval. If you find title issues, the seller must eliminate the encumbrances.

Financial and Operations

To be sure the property will be an asset rather than a liability, review all property financial statements. These include historical cash flow statements, vendor contracts and liabilities, property taxes, rent rolls, and lease terms. You may also want to interview primary tenants. Hopefully, you’ll uncover potential future profit and tax benefits from ownership of the property.

Environmental

Potential risk of contamination is unveiled during environmental due diligence. Get your hands on a Phase 1 Environment Site Assessment (ESA) to review past and present operations and uses of the property and evaluate potential risk of contaminated soil and/or groundwater. An ESA is a legal and technical investigation and follows state and federal environmental laws. The seller may have already have an ESA, but if not, you need to be sure commission it.

Conclusion

Due diligence is a way to limit post-transaction surprises. If you’re interested in a property, due diligence is your safety net so don’t get stuck in analysis paralysis. Start the deal but be sure to have the right people on your team to prevent additional costs at closing and with the property later on. Each deal is unique so be sure to examine all four types of due diligence (physical and structural, legal and title, financial and operations, and environment) closely. Keep your investment goals in mind and leave no stone unturned. You want to use every possible resource to make sure you land on the right deal and the right property.

Jeff Salzbrun is the owner/broker of Commercial Equities Group (CEG). As a veteran-owned real estate brokerage, CEG has been involved in thousands of sale and lease transactions, ranging from single offices to 250,000+ square foot buildings. At CEG, we get your deal done. We know space, and we know the CRE business.

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