Today let’s talk about due diligence.
Simply put, this is a time frame allotted for a buyer to study a purchase. Generally, there is no obligation to proceed if something untoward is discovered. Also referred to as a contingency period, a “free look,” or in some cases, an option, these 30-75 day periods are chock full of action.
As a buyer of commercial real estate, you’ll either occupy the premises or simply collect rent from the tenant. Regardless, your consideration of the buy should revolve around three things: physical, financial and utility.
Physical aspects are things such as the roof, mechanical systems, construction quality, title and age. Financial characteristics include the amount of rent the tenant is paying, operating expenses, finance-ability and capitalization rate.
Finally the utility. Can your operation function successfully? Will the property have broad appeal to the next occupant? And what about the location?
You’ll need to engage some consultants to construct your due diligence package. If you’re lucky, the seller will pass along a good portion of the deliverables. If not, you’ll start from zero.
My best example: We once closed a deal in 15 days. Why? The seller had bought the property a year earlier and was able to send us everything we needed to analyze the purchase.
So, prospective buyers, what will you need?
—A physical inspection or a property condition assessment
—Environmental Phase I – also known as an ESA – environmental site assessment
—Mandatory disclosure form
—Property information sheet
—Soils, geotechnical information
—A preliminary title report
—Appraisal – if you’re borrowing money
—Existing loan information – if you’re assuming financing
—Plans, permits, and approvals
—Income and expenses
—Copies of leases, and estoppel certificates
—Financial information on the tenants and guarantors
—Association documents, CC and Rs
Once all of these are compiled, keep three things in mind when deciding to go forward and complete the transaction.
Time frames: Loan approval and the components of that approval — appraisal, environmental, financials take time. In most instances, it’s about 45-60 days if you and your lender are in sync and you provide your lender a complete package of information for your loan approval.
Make sure your agreement with the seller allows you adequate time for your loan approval and that you can extend the time frame if needed. While your lender is crunching the numbers, the appraiser is scouting the market for comparable sales, the enviro engineer is reviewing the records of previous hazardous uses; you and your team can busy yourselves conducting the balance of the investigation.
Responsibility: Ultimately, the responsibility of analyzing the purchase is yours, but you will want to engage a bevy of consultants to provide reports for you. Your lender will generally hire the appraiser and environmental engineer.
I would suggest that you have a commercial building inspector check out the building. You probably will want your lawyer to review the title report and discuss with you the most advantageous ownership entity for you.
If you are planning to make changes to the building, an architect’s guidance is invaluable. The architect can also help you with city permitting and ADA path of travel concerns. Building those new offices or adding a truck loading dock will require a licensed general contractor. Team with one early – maybe have the contractor check out the condition of the building for you as well as the commercial inspector.
Recourse: Typically, you conduct your due diligence — loan, property condition, title, permitting, etc. — and conclude that you are a go or no go for launch.
Make sure your agreement allows you to cancel the sale, for free, if something is amiss such as the property is environmentally contaminated, cannot be financed, is too expensive to improve, or the city will not allow you to occupy the building with your use.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at [email protected] or 714.564.7104.