Due diligence involves identifying and assessing the risks involved in a transaction to determine whether they can be adequately addressed before becoming a problem. In the context of commercial real estate, due diligence can be broken up into 3 broad categories: transactional, property, and financial due diligence. Both sellers and purchasers must perform due diligence, however, this article will primarily address the due diligence that purchasers must perform.
Transactional Due Diligence
- Title Research – this research focuses on issues such as the true identity of the owner or owners, whether the seller has the authority to transfer the real estate, and whether any liens or other clouds on title are in place. A title insurance policy will protect the purchaser from many potential risks including forged deeds, easements, unrecorded liens, and other several other sources of liability. However, savvy parties should never solely rely on a title insurance policy because every title insurance policy contains a number of exclusions from coverage. For example, laws and regulations that restrict the use of land and the government’s right to eminent domain are typically excluded from coverage. Creditor’s rights are also excluded. Performing due diligence into the state of the title will allow a buyer to take extra precautions such as purchasing endorsements to increase the coverage allotted to them under a title insurance policy.
- Survey – Ascertaining the true boundary of the property and the existence and the location of any easements can save the buyer significant time and expense in the event that these issues become contested.
Property Due Diligence
- Building Inspection – The majority of the income from a commercial real estate transaction will generally come from the revenue generated from the building on the property. The building should be inspected to assess whether the infrastructure will require further investment or repair to bring it up to building code requirements. Additionally, a buyer will want to make sure that the building has adequate access for consumers and delivery trucks; adequate parking and public transportation access; and fully complies with the Americans with Disabilities Act.
- Use – The applicable zoning and other land use regulations in place should be reviewed to determine whether the buyer could be prevented from engaging in their intended use of the property. Whether any environmental issues would prevent the use of the property should also be ascertained.
Financial Due Diligence
- Financing transaction – A thorough analysis of the terms of any loans that need to be obtained should be carefully carried out to assess whether early repayment penalties or other hidden costs could make the transaction less desirable.
- Financing construction and operation – Whether reserves or funds can be obtained to construct and operate the project and still yield adequate earnings should be investigated. This may also require an investigation into current leases and whether existing tenants can be replaced. It also requires an inquiry into whether public money can help to offset development costs that may provide economic benefit to the public.
- Market demand – one of the biggest problems between the years 2000 through 2010 in U.S. commercial real estate projects was a lack of proper market analyses and due diligence.
Orange County Commercial Real Estate Attorney
The Law Offices of Tony T. Liu offers commercial real estate due diligence services to domestic and outbound real estate investors. To learn more contact us at (714) 415-2007.