Ensuring Investment Success: Comprehensive Due Diligence Strategies for Commercial Real Estate – Part 1

Navigating the complex landscape of commercial real estate investments requires a meticulous and comprehensive approach known as due diligence. This process is vital for assessing all aspects of a potential property purchase to ensure that it meets the investor’s needs and expectations while minimizing risks associated with the investment. Due diligence in commercial real estate is not just a precaution; it’s a critical step that can dictate the success of an investment.

The due diligence process extends beyond simple financial evaluations and includes a thorough review of physical property conditions, legal standings, market dynamics, and much more. Each component—from scrutinizing tenant agreements and service contracts to environmental assessments and zoning compliances—plays a crucial role in painting a full picture of the property’s potential and pitfalls.

A Detailed, In-Depth Look at Due Diligence for Commercial Real Estate

In this comprehensive series, we will explore the key areas involved in due diligence for commercial real estate. These include detailed inspections of property and building conditions, verifying title and ownership, financial analyses, market and area studies, tenant and lease examinations, assessments of environmental factors, and reviews of operational effectiveness. Additionally, we will delve into the importance of technology and data infrastructure in modern real estate investments and the essential practices of risk management and insurance coverage analysis.

Whether you are a seasoned investor or new to commercial real estate, understanding the breadth and depth of due diligence can significantly influence your decision-making process and investment outcomes. Let’s embark on this detailed exploration to equip you with the knowledge and tools necessary for successful real estate investments.

Commercial Property and Building Inspections

Property and building inspections are critical components of the commercial real estate due diligence process. These inspections help identify potential problems that could affect the value or usability of the property. Here’s a detailed breakdown of five key inspections:

1. Physical Inspection of Commercial Buildings

Structural Integrity

Inspect the foundations and load-bearing structures, specifically inspecting for cracks, settling, and other signs of structural failure. Walls and ceilings are inspected for signs of water damage, mold, and structural wear. Finally, the roof is inspected for leaks, poor drainage, and the general condition of the roofing materials.

Systems Inspection

  • HVAC: Assess the age, maintenance history, and functionality of heating, ventilation, and air conditioning units.
  • Plumbing: Check all pipes and fixtures for leaks, proper function, and compliance with current standards.
  • Electrical Systems: Ensure all wiring, outlets, and service panels are up to code and in good working condition.
  • Elevators and Escalators: Review maintenance records and inspect for operational safety and compliance with regulations.

Safety Equipment

Inspect sprinklers, fire extinguishers, and alarms to ensure they are functional and compliant with local fire codes.

Security Features

Evaluate the adequacy of locks, alarms, cameras, and other security systems.

Accessibility

Check compliance with the Americans with Disabilities Act (ADA) including access ramps, bathroom accessibility, and signage.

2. Environmental Assessments

Asbestos and Lead Paint

Inspect older buildings for asbestos material and lead-based paint, which can be a health hazard and require removal.

Radon and Mold

Test for radon gas levels, inspect for mold, both of which can affect air quality and cause health problems.

General Environmental Compliance

Ensure the building complies with environmental laws related to hazardous waste, air quality, and water quality.

3. Land and Site Inspection

Soil and Geological Conditions

Conduct soil tests to detect contamination or poor soil conditions that could affect building stability. Also, evaluate the geological landscape to assess the risk of natural disasters such as earthquakes or landslides.

Topography and Drainage

Review the property’s elevation and drainage systems to ensure they are adequate to prevent flooding and water accumulation.

Parking and Landscaping

Inspect parking lots for adequate capacity, surface condition, and compliance with lighting and accessibility standards. Check landscaping for maintenance issues and potential improvements.

4. Compliance Checks

Building Codes

Verify that the building meets all local, state, and federal building codes which affect safety and functionality.

Zoning Laws

Ensure the property’s current and intended use are permitted under local zoning laws.

5. Inspecting for Future Considerations

Maintenance and Upgrades

Identify areas that may require future maintenance or upgrades, which could impact the budgeting and valuation of the property.

Adaptability

Consider how the property might be adapted for different uses in the future, evaluating structural and systemic flexibility.

Making Informed Decisions on Commercial Real Estate Properties

These five inspections are integral to making an informed decision when purchasing a commercial property. They not only help in assessing the current value and condition of the property but also in forecasting potential future expenses and identifying any risks that might not be immediately apparent. Always consider hiring professional inspectors and engineers who specialize in commercial properties to conduct these assessments to ensure a thorough and unbiased evaluation.

Title and Ownership Verification

Title and ownership verification is a critical aspect of the due diligence process. A quality examination of title ensures that the property is legally transferable, free of disputes, and does not carry undisclosed liabilities. Here’s a comprehensive look at what this process typically involves:

1. Title Search and Commercial Property Insurance

Ownership Confirmation

Historical Ownership Review: Check the chain of title to confirm the seller has a clear title. This involves reviewing historical documents to ensure there are no gaps in ownership.

Legal Ownership: Confirm that the seller is the legal owner of the property and has the right to sell it.

Liens and Encumbrances

Search for any liens (e.g., mortgages, court judgments) that might affect the title and need to be cleared before closing.

Restrictions and Easements

Identify any existing easements (for utilities, access roads, etc.) that might impact property use and review any restrictions imposed by previous owners, local laws, or planning regulations.

Check for other encumbrances or covenants that might restrict property use or affect the value.

Title Insurance

Obtain title insurance to protect against losses due to defects in the title not listed in the public records or legal documents.

2. Survey Review

Boundary Verification

Use a recent survey or commission a new one to verify property boundaries and ensure they match the property’s description in official documents. Identify any discrepancies between the surveyed property lines and those described in legal documents.

Encroachments

Check for any structures or features encroaching on the property or onto neighboring properties, which might cause disputes or require removal.

Verify that all buildings and improvements are within the property boundaries and comply with local zoning laws.

Lot Size and Location

Confirm the exact size of the property as well as its geographical location to ensure accuracy in records and compatibility with planning restrictions.

3. Legal and Regulatory Compliance

Zoning and Use Compliance

Ensure the property’s use complies with local zoning laws, which affect what types of activities can be conducted on the property, and check if there are any potential rezoning issues that might affect future property use.

Building Permits and Land Use

Verify that all structures on the property have been built with proper permits and comply with local building codes, and check for any potential land use violations that could lead to fines or mandatory modifications to the property.

4. Addressing Potential Issues

Resolving Title Issues

Work with legal professionals to resolve any issues related to unclear titles, liens, encumbrances, or legal claims before proceeding with the purchase.

Updating Documentation

If discrepancies are found during the survey or title review, update the legal descriptions and other relevant documents to reflect accurate and current information.

Negotiating Solutions

If encroachments or easements are discovered, negotiate with neighbors or other parties to reach an agreement that allows for clear title transfer and use of the property.

Building A Foundation for Commercial Real Estate Investment

Title and ownership verification provides a foundation for securing your investment in commercial real estate. By thoroughly vetting all aspects of the title and ensuring compliance with local regulations, investors can protect themselves from future legal problems and ensure that their property rights are secure. This process often requires the expertise of specialized real estate attorneys, surveyors, and title companies to navigate complex legal landscapes and ensure a smooth transaction.

More On Due Diligence For Commercial Real Estate

That concludes Part 1 in our series on comprehensive due diligence strategies for commercial real estate investment. Watch for Part 2, which will cover financial due diligence and market and area analysis, two more critical components of the due diligence process.

If you’d like more information on Realogic’s due diligence services for commercial real estate, contact us at info@realogicinc.com or 312-782-7325 or visit the due diligence page on our website. Realogic offers a wide range of due diligence services to help commercial real estate investors accurately and thoroughly evaluate properties, including:

You can choose the specific due diligence service or services you need or we can oversee the entire due diligence process for you by leveraging our strong relationships with best-in-class specialized providers, including environmental, legal and insurance diligence experts.

About The Author

Mike Phelps is Realogic’s General Counsel. Mike has over 20 years of commercial real estate experience, including with financial modeling and analysis, analysis of acquisitions and dispositions, due diligence, underwriting, development and review of financial proformas and Argus/Dyna training. In his current role, he supports each of Realogic’s business lines and provides counsel on corporate, employment and compliance issues. He is also responsible for negotiation of contracts, master service agreements, software licenses and subscriptions and other intellectual property matters. Mike welcomes your comments on his post. He can be reached at mphelps@realogicinc.com