Commercial Real Estate Due Diligence and Considerations
Due diligence is a key and pivotal stage in any commercial real
estate transaction. It is very important that the buyers pay careful
attention and do their due diligence. Due diligence mistakes can cost
the buyers a significant amount and stress if they are not careful.
The key portions of the due diligence are legal, financial, tax, business and environmental considerations. There are various professionals, such as lawyers, real estate agents, accountants, environmental consultants involved in helping the buyer conducts these portions of the due diligence.
When you are potential buyer, you must have all the necessary documentation at hand before you start the due diligence. Therefore, you must have ample time, a minimum of 30 days, after the seller has provided you the documents to review them and conduct your own searches. It must be clearly the specified in the Offer to Purchase that due diligence period will not commence until the date that the seller produces the last of each of documents, records or financial information. The short waiver periods and rush timings do not help in conducting critical due diligence.
The key documents, records and financial information required for a comprehensive due diligence on the purchase of a commercial real estate are as follows:
- Recent Title search.
- Copies of covenants, conditions, easements, restrictive covenants, reservations, rights of ways, etc. affecting the property.
- Recent Survey.
- Zoning and Work Order Compliance Certificate for the property and all zoning approvals (including variances and any pending applications).
- Fire Inspection Report.
- Commercial Building Inspection Report.
- Electrical Safety Authority Inspection Report.
- Environmental Site Assessment (including but not limited to Phase I and Phase II reports)
- Appraisal of the Property.
- Copy of all leases.
- Rent roll, showing current rent, previous rent, delinquencies, security deposits, years of occupancy, lease commencement date, lease termination date and utilities included in the rental amount.
- All security deposits and any other amounts to which any tenant, vendor, or any other party may be entitled.
- Copy of the last three years’ property tax bills, including special assessments, copies of all appeals, related correspondence and appeal results for the property.
- Copies of the prior two years’ utility bills for the property.
- Copies of all service contracts (together with amendments thereto, if any) together with copies of any and all other contracts and agreements relating to the operation, maintenance and repair of the property.
- Financial Statements stating all income and expenses related to the property for a minimum of last three years.
- A list of all personal property, if any, owned by the seller, located at the property, used or useful in connection with its operation and maintenance and included in the sale of the property. Any personal property excluded from the sale must be clearly listed as well.
- Copy of existing insurance policies and certificates and any pending claims against the property.
- List of pending litigation, if any, affecting the property or seller’s ability to convey the property and copies of all the court documents.
Any and all other matters as the buyer may deem reasonably necessary to satisfy itself, in its sole discretion, concerning the property and the status of the property’s title.
If the seller is unable or unwilling to provide above documents, it increases the risk associated with the property and can provide you with an opportunity to renegotiate the price. Do not trust the seller or their representative to disclose all issues. Don’t hesitate to ask the hard questions. We also advise that you do this via email and keep a record of all correspondence in case you end up in the court.
You must be extremely careful while performing your own due diligence on the
Keep in mind that the title insurance company will not cover all the physical defects of the Property.
Make sure each item of due diligence is assigned to your team of advisors such as a surveyor, building inspector, lawyer, environmental specialist, accountant, mortgage agent or real estate agent for review and advise to you.
Before spending your time, money and effort conducting your due diligence, ensure that you have a prior discussion with your mortgage broker or the bank about the loan amount that they are willing to put on the property. All the matters disclosed by the due diligence documents must be honestly disclosed to the lender because the lenders just don’t look at one but many aspects of the property, from the physical condition of the property, environmental reports and lease/sale comparables to the intended use of the property. Always check with them with all these matters in order to avoid costly surprises later.
Lastly, keep in mind that the conduct of due diligence will cost you money and time. However, spending money on due diligence is money well spent as it can save you from costly mistakes later.
If you have any questions regarding commercial real estate buying or selling, please call us at 905-405-8100.