Due Diligence & Legal Considerations in Commercial Real Estate
Due diligence in real estate is the process of evaluating and inspecting a property before purchasing it. It involves both an evaluation of the property and an evaluation of the seller of the property. The goal of due diligence is to satisfy the buyer that they are aware and capable of addressing any potential issues that might arise concerning the property or the transaction.
During a commercial real estate transaction, a buyer is usually given a specific due diligence period during which they are permitted to undertake certain reviews of the property. This timeframe is usually specified in the purchase and sale agreement. It is during this period that a buyer may walk away from the transaction, often for any reason.
Inspections and Reviews During Due Diligence
Due diligence is an important part of the commercial real estate buying process. The due diligence period, also called the inspection period, includes things like evaluating whether the property will meet a buyer’s specific needs, the condition of the property in general, and the cost to maintain the property in its desired state. For example, there may be conditions on the property, such as an old HVAC unit in need of repair, that are not immediately apparent. Or a buyer may need to add additional safety features to the property in order to use it in the way they intend or to bring something up to code.
Due diligence will generally include a title review and a survey of the property. The title report will show any easements, covenants, or restrictions, among other things. A buyer can also look into the zoning laws and restrictions applicable to the property if their intended use is different from the current use. They should also be aware of any applicable environmental regulations and address any survey issues. It is worthwhile to investigate applicable building codes, since they might restrict how a buyer can change the property in the future. If available, reviewing a list of permits that have been applied for on the property may reveal valuable information about the property’s history and condition. A buyer might inquire about property taxes and prepare for the chance that the property taxes could increase if the property’s assessed value increases.
A buyer should weigh these conditions and consider whether it would be worth negotiating the cost of improvements in the contract or having the seller undertake certain repairs themselves. In some instances, it will be more beneficial for a buyer to simply pass on the property and look for a different one. Due diligence helps a buyer determine whether they will be paying more money than the property is worth.
Specific Inquiries for Investors and Business Owners
If the buyer is purchasing the property for investment purposes, they should ask the seller to make financial disclosures, such as income statements, cash flows, and balance sheets, to get a more informed sense of the return the property may produce. They should also review any current contracts associated with the property, such as leases and service contracts. Buyers should plan for unanticipated losses. For instance, a big tenant may move out of a space that proves hard to refill. Buyers should carefully review all tenant leases and talk to the seller about any foreseen issues, but it is impossible to avert every risk.
If a buyer is purchasing the property for their own business use, they should consider whether the size and location are adequate for their intended growth. A business owner may save money in the long run on costs associated with purchasing new property if they purchase a property with space to grow. They will also want to make sure that the location of the property is suitable for growing their market and for the way in which they run their business, while taking into account that the surrounding area, including nearby businesses, could change over time.
