Commercial real estate sellers have a duty of disclosing the known defects of the property being sold to potential buyers. The defects may include physical defects, legal defects, and financial defects. However, commercial real estate buyers should never rely solely on the word of the seller to determine whether or not to complete a transaction. It is important to do your own due diligence.
What is Due Diligence?
It refers to the process of verifying all the statements of fact as well as the potential drawbacks of the property you intend to buy. It is not a simple matter and is not cheap too. However, it is still important because failure to do in-depth due diligence on a property can easy bankrupt you. So, never skimp when it comes to this issue.
If you find something wrong with the property during the due diligence, you can either approach the seller for the purpose of renegotiating the contract or cancel the deal completely. If you discover that the seller made an intentional misstatement of the facts pertaining to the property, you can actually sue for reimbursement of the due diligence costs and probably other damages too.
Important Due Diligence Guidelines
Due diligence is extensive and requires experts to do the research for you. Here are the most important commercial real estate due diligence steps to follow:
1.Title Inspection and Survey
Due diligence usually begins with the title inspection and survey because there’s no reason to proceed with the rest of the steps if something is wrong until it is resolved. Once you sign the contract, you should use your title company to run a search on the property for encumbrances and liens and ensure that the title has a clean chain.
The title company will order an abstract report along with a survey on the property. The two documents can help you know whether the property has any liens on it, encumbrances, easements, inaccurate legal description, or whether any errors were made along the chain of transfers of the property. If the title is discovered to have a defect, the seller has to correct it before closing.
- Environmental Inspection
The Environmental Inspection report explores the property’s past use and the past use of the surrounding areas searching for any potential onsite or nearby liabilities and problems with the environment. The report costs several thousand dollars and a considerable amount of time to complete and should be done once the status of the title has been determined.
The inspection is done to find out whether the property either poses a threat to its surroundings in any way or contains any hazardous materials. The report might be expensive, but it can be even more expensive to clean up an environmental hazard.
- Inspection for Building Code Variations
The most common forms of building code variations include unauthorized construction, substandard plumbing or electrical work, or the use of improper materials during construction. If a violation is discovered, it should be presented to the seller for approval by the City Board of Directors or cured by tearing down or gutting the structure.
- Zoning Code Compliance
Each property has a specific use permitted by the city zoning board. The city’s zoning ordinances have to be reviewed to ensure that the use of the property is in compliance with what it is legally zoned for. This is particularly important when you are buying vacant land and have plans to conform it to your preferred use.
- Service and Vendor Contracts
Ensure that you review all the vendor and service contracts that may be attached to the property and ensure that you have the right to choose to discontinue the services if you please. The services may include landscaping, maintenance, food supply, and cleaning. It is also important to check whether the equipment is still under warranty and whether the warranty is transferrable.
Obtain a list of all the personal property items including computers, tools, equipment, supplies, furniture, and appliances that will be remaining with the property once the transfer is complete. The items should be itemized and then included in the contract to avoid confusion after closing.
- Physical Due Diligence
Physical due diligence is more than a simple walk through of the property with a building inspector. The walk through is just one part of the physical due diligence that should be competed. Here are the rest of the physical due diligence essentials: photos of the property, site plans and specifications, structural inspection, pest inspection, capital improvements, mechanical & electrical inspection, and interior systems inspection.
The physical due diligence inspections are used to determine the future upgrade and maintenance costs of the building. It is important to make a list of any short-term and long-term projects the building will require and factor these into your costs when determining how much to pay for it. If you find something that impacts the building’s value significantly you can either try to approach the seller with the information and try renegotiating or you could simply back out of the deal.
- Financial Due Diligence
The financial aspect of due diligence focuses on the property’s financial condition. It is useful for determining whether or not the property is showing a profit and the actions you can take to ensure that it is profitable. It involves scrutinizing tax returns, rent rolls, income and expense statements, lease agreements, utility bills, omitted expenses, and property tax bills.
The financial due diligence is very important when it comes to determining whether the property you intend to buy has a positive cash flow or whether owning it is costing you money each month.
The Bottom Line
The real estate market is rising in many U.S. cities and this is creating a surge in the commercial real estate transactions. The current state of the real estate market makes this the perfect time for investors to explore the financial risks and value of investing in commercial buildings for sale in Cincinnati. However, it is important to avoid rushing headlong into commercial real estate transactions without comprehensive due diligence to avoid being frustrated and losing a lot of your hard-earned money.