Role of Diligence in Commercial Real Estate
Real estate due diligence has a role of importance that nobody would avoid. In the residential real estate market, the buyer of a home performs due diligence, or real estate verification, depending on titles and other documents, and weighs the benefits and drawbacks of purchasing the property. However, investing in commercial real estate does not require as much emotional commitment compared to buying a home. Most of the time, return on investment (ROI) drives the search for commercial spaces.
In commercial real estate, the lease model may be less formal. Since the person living there may not be the legal owner, they may not care much about the project’s specifics. Records show fewer litigations about commercial property transactions than residential property transactions.
Common Issues with Leasing or Purchasing Commercial Real Estate
Big-ticket litigation involving the purchase of commercial space is, however, much more valuable. There have been numerous instances of facts being underreported and commercial properties being mis-sold. For instance:
- Ramesh Bansal signed a contract to rent a business space on Noida Expressway. It was a nine-year locked-in deal, and the owner gave a discount for the first year. Bansal was happy with the deal he made. But he lost faith when he discovered that the office space had been empty for over a year and that the owner, struggling to pay EMI, had given a 3-year rent discount. Bansal felt cheated by this.
- Rashmi Yashi thought she was getting a good deal when she was given a lease for a cafe on the ground level of a shopping center in Gurgaon. She was never told, though, that two well-known coffee shops would also open on the same floor. This ruined the offer for her since it could mean fewer people were coming to her coffee shop.
There have also been times when real estate agents hid the truth about the market and only gave the seller’s point of view. In some cases, people have spent a lot of money on store locations in shopping areas, only to find out later that other stores in the shopping center were being sold for very low prices. Such cases show that a business owner or tenant should be more careful before buying or renting a space.
Major Parts of the Due Diligence Process
You should pay attention to 3 main parts of the due diligence process:
- Physical Process
- Financial Process
- Legal Process
Physical Due Diligence
You can’t buy a commercial property without doing your due diligence, which includes a thorough look at its physical condition.
Physical due diligence will assist you in determining whether or not the commercial property you intend to purchase has been properly maintained. If not, you could use this knowledge to better negotiate with the seller or cancel the sale.
Hiring a professional inspection company specializing in physical due diligence can be very helpful in ensuring that every aspect of the property has been carefully inspected and assessed. The inspection firm should conduct inspections including but not restricted to:
- Building and property condition assessments
- Risk evaluations
- Analysis of facilities management
- Key performance indicators for property management
- Replacement cost projections
Financial Due Diligence
Financial investigation is one of the key steps in the due diligence process. Financial due diligence entails examining a property’s cash flow to see if the cash flows match the seller’s claims and assess the rent roll’s viability.
Before finalizing the purchase of a commercial property, a thorough examination of the asset’s financials should be made to reduce risks. Do not trust the seller’s provided books and records. You must double-check the property’s financial statements by confirming each reported penny as coming in and being spent there.
Since this process entails several audits, including contract audits, lease audits, rent roll analyses, cost analyses, market analyses, etc., it is beneficial to work with a professional with expertise in commercial real estate accounting.
Legal Due Diligence
This step in the due diligence procedure focuses on the various jurisdictions that might have the power to oversee a property. Performing legal due diligence entails:
- Title Investigation
- Survey report
- Examination of current permits
- Tax and lien issues
Buying a commercial property may lead to several issues without adequate legal due diligence. Your investment property may be at risk due to potential deal-breakers such as environmental issues, title or survey flaws, legal and illegal special uses, and intrusions that affect the property.
So, before you accept the sale and purchase agreement, you should find a real estate attorney, a title insurance company, and a commercial real estate (CRE) broker committed to reducing or finding these risks.
Commercial Property Due Diligence Checklist
Here’s an illustration of a checklist for doing your due diligence. This list has all the things you need to do before you buy a commercial property:
Assemble and arrange all of your papers
You can include leases, property surveys, appraisals, photos of the property, government documents, the property title, environmental reports, tax forms, property condition reports, construction documents, zoning documents, or additional documents the seller may have.
Examine each document
When you’ve gathered all the paperwork, thoroughly research and comprehend each piece of paper.
Choose a financing strategy
If you haven’t already, discuss the project with a lender to ensure you have the funding.
Check the property out
Spend time there and ensure no obvious problems by looking at every possible aspect. The property inspector and anyone else you deem significant should be part of your team. You can also inquire about their opinions of the building from business owners, tenants, or staff members, which might yield some unexpected insights.
Site consultants should be hired
An environmental engineer should first examine the property’s present and previous uses to check for contamination of the water, soil, asbestos, lead-based paint, and other materials. This is known as a Phase I Environmental Assessment. Hire a surveyor to find out if the property touches a neighbor’s property. Last but not least, traffic engineers can examine the flow of vehicles into or out of the property and identify any potential infrastructure problems.
Take care of any legal matters
A commercial real estate lawyer should be retained to ensure that neither the seller nor the property is subject to any liabilities or other legal issues.
Seal your deal
After you’ve done all of the above, you can eventually close on your business property.
The role of Due diligence is that it is needed not only to reduce and eliminate financial risks in high-value deals but also to find out what your rights are in a provided commercial space in a shared building. Putting a lot of money into buying or renting a commercial space is also a person’s way of making a living.
For more information on due diligence and the role of it in commercial real estate, you can contact our experts at Bhive.