In a highly competitive real estate market, acquisitions of commercial, retail, and industrial buildings complete in days. Unfortunately, this doesn’t leave much time for commercial real estate due diligence.
Why does this matter? The due diligence process is a buyer’s final chance to ascertain risks that might jeopardize an asset’s revenue potential before a deal closes. During this time, the buyer can inspect a property and decide if they wish to proceed with the sale.
But some real estate investors rush the process and leave out critical steps in their haste to close a deal. This leads to unplanned expenses, liability, stalled leasing deals, and significant stress on the property team.
To improve your commercial real estate due diligence process and avoid ultimate buyer’s remorse, focus on the following key areas.
Physical Condition
The due diligence process should include a thorough inspection of a property’s physical condition, including all structures and mechanical systems.
This might involve:
- Engaging engineers or structural consultants to verify assets are built to code.
- Requesting an inspection of the building’s key equipment, such as HVAC, boilers, and plumbing. For more on successful inspections, read Building Engines’ 5 Minute Guide to Standardized Building Inspections.
- Creating a renovation budget listing critical repairs or upgrades to interior units, the exterior façade, or amenities. Factor these costs into your negotiations.
- Providing a plan to adapt or develop any vacant land adjacent to the property if applicable.
Financial Reporting
To avoid underperformance, a robust commercial real estate due diligence process must verify that an asset can realistically meet revenue goals.
This can be done by:
- Benchmarking building operating expenses, including staff salaries, insurance costs, capital improvements, etc. against comparable properties
- Reviewing the most recent tax statements and related information
- Auditing existing vendor contracts
- Using an appraiser to help determine the appropriate purchase price
- Auditing leases to understand tenant rent roll, then conducting market research to determine if rents are competitive in the current market
Environmental Considerations
Trends suggest a more sustainable future for commercial real estate. So, it’s important to verify that any new acquisition meets zero-net emissions goals, government mandates, and tenant demand for more sustainable building operations—within the confines of your budget.
Begin by:
- Conducting an Environmental Site Assessment (ESA), or Phase 1 report. This includes an analysis of the property’s soil to identify any environmental contamination.
- Requesting a Phase 2 ESA if recommended in the Phase 1 report
- Auditing the efficiency of electric, plumbing, HVAC, and other key systems to identify if any sustainability upgrades may impact contract negotiations
- Determining if tax breaks or other financial incentives for green property management have all been leveraged
Legal Landscape
A surprise lawsuit can turn a big deal into a major bust. Before your next acquisition closes, understand any legal issues that could come back to haunt you.
This might involve:
- Reviewing the property’s pending litigation list (if applicable)
- Checking for open claims against the property
- Verifying the adequacy of current insurance coverage
- Engaging legal counsel to review tenant leases and prepare lease summaries
Nail Your Next Acquisition
Poor due diligence can turn profitable deals into expensive mistakes.
Picture this: You just found a seemingly perfect addition to your portfolio. But in the scramble to complete the sale before other buyers close in, you rush the due diligence process. You take it on good faith the building’s key equipment is in acceptable condition.
It isn’t. Above the building’s tidy grounds and first-rate amenities, the rooftop HVAC system is on its last legs. Dozens of units need to be replaced, at an average cost of $30,000 per unit. HVAC upkeep is one of the highest costs in the typical CRE maintenance budget, so this system simply can’t be overlooked during due diligence.
Commercial real estate has its share of lemons. To avoid post-sale HVAC surprises and learn more about nailing your next acquisition, read the HVAC Due Diligence Checklist.
