Due diligence is the process of “doing your homework” both before you make an offer and after the contract is signed on a property you are thinking about purchasing as an investment, for development purposes, or otherwise. A veteran commercial real estate investor understands the importance of conducting due diligence on a potential investment as a critical component of a commercial real estate transaction.
What is Due Diligence for Commercial Real Estate Deals?
Generally, due diligence is the period of time afforded in a contract for the purchase of real estate allowing a purchaser to enter upon the property to inspect all aspects of said property that the purchaser deems appropriate or necessary. The inspection process will vary depending on the circumstances of each transaction, but these inspections often include:
- Review of the title report and land survey
- Inspecting the physical, environmental, and ecological condition of the property, including zoning restrictions; and
- If there is an existing building or other improvements on the land, assessing all existing structures and mechanical systems for damage and repairs.
Contract Negotiations
A due diligence period should be negotiated into the real estate contract to allow enough time to study, examine and inspect all aspects of the property. A typical timeframe is between 30 and 60 days; however, longer or shorter time periods can and should be negotiated depending on the needs of the parties and particulars of the property. A well-negotiated contract will allow the purchaser to terminate the contract during the parameters of the due diligence period if it determines, in its sole discretion, that the property is not suitable for its particular needs, is determined to be a high financial risk, or will not be a profitable investment.
Title Searches and Surveys
After opening escrow, a prospective buyer should order a title search, commitment, and survey. The title report provides crucial information about the commercial property, including details on the current and past owners and the existence of any encumbrances, encroachments, liens, and easements on the property. In conjunction with the title report, a professional survey of the property should be performed by a registered surveyor. The survey can provide information on the property boundary lines, access roads, location of easements, lot size, rights of way, soil conditions, and flood zones. Review of the title and survey reports can also be extremely beneficial to commercial investors and developers in terms of determining feasibility of the site plan or development plans.
Zoning
Purchasers need to consider whether their intended uses for the property are permitted in the particular zoning district, and if they are purchasing a property with an existing building or structure, whether such structures meet current zoning requirements. Commercial real estate attorneys can review local zoning ordinances and solicit zoning approval from the governing municipality, ensuring the property is compliant.
For new buildings, investors should review all occupancy certificates, indicating compliance with the relevant codes. For undeveloped land, the zoning review process will be much more thorough, and will likely involve other professionals such as engineers and planners to determine whether the purchaser’s future development plans are feasible in the particular zoning district.
Lease History
Investors looking to purchase a commercial property for income-producing purposes need a thorough review of all leases. Every lease must be analyzed to determine the potential rental income that can be expected, whether there are any defaults by the current landlord or tenants, and whether any renewal or other purchase options exist that could affect the purchaser’s future plans for the property. Another best practice conducted by commercial real estate lawyers in conjunction with the review of the lease itself is to review the seller’s operating statements and financial records. Such financial inspection can shed light on cash flow, gaps in rent payments, and can help the new landlord build rental income models.
Physical and Environmental Due Diligence
As part of the due diligence period, the real estate contract should provide access to the property prior to closing in order to allow engineers and other consultants to come onto the property to perform inspections. Examining the property’s current condition and reviewing its original plans and specifications is important to determine whether the property was built according to code and is structurally sound. For certain acquisitions, an evaluation of the property’s interior and exterior may be called for to determine items for immediate or long-term repair.
Environmental investigations are another important part of the due diligence process and a purchaser will need to determine whether obtaining an environmental site assessment will be necessary or beneficial. Such assessments, commonly known as Phase I reports, provide information on the historical use of the property and its adjacent parcels, as well as the potential for any environmental contamination from past use. The current environmental state of the property is important given that remediation efforts can be costly should any environmental contamination be discovered.
Wrapping Up – Hire a Competent Real Estate Lawyer
Each commercial real estate transaction presents a unique set of circumstances with many moving parts. An experienced commercial real estate attorney can walk you through the specifics of the due diligence process, including negotiating the contract, inspecting title, survey, and environmental reports, overseeing all paperwork, making recommendations, and ultimately, protecting your interests to ensure you are making an informed and conscious investment.
Ringenberg-Rattner Law
Ringenberg & Rattner Law is a boutique law firm in Omaha that specializes in real estate and corporate law. Contact our experienced team of lawyers in Omaha today to schedule a consultation. Our areas of practice include real estate, business, and banking.
