Due diligence in commercial real estate refers to the buyer’s responsibility of doing thorough research on the property being purchased. Buying a large commercial real estate asset is a major decision. Before signing on the dotted line and becoming the legal owner of a property, make sure to vet the property and it's operating numbers prior to completing the purchase. Here is a general due diligence checklist.
1. Marketplace and City Trends
Get a firm understanding of the real estate market trend in your desired location. There are multiple ways to accomplish this. You can work with a real estate agent (or more) to get a feel for the pulse of the area. YOu can do online researching by checking home prices and school reviews (Trulia, Zillow, and Redfin). If you can get a hold of an appraiser, even better, they will know the economic trend in your area. Is the city growing?
2. Walk-Through
Once you have a property under contract, you must walk through and inspect the property with a fine tooth comb. Do not simply believe the seller when he or she describes the condition of the property. Have a look around, talk with tenants, get a feel for how the property has been taken care of.
3. Inspection
Hire a professional inspector. Expect it to cost some money, but they will save you so much more money than you taking a leap of faith on buying a property based on the seller's claims. Assess the building's structural integrity (foundation, walls, roof, stairs, appliances etc) and make sure you are walking around with your inspector. DO NOT skip this part. You learn so much about the potential property purchase by walking around with the inspector and observing the property's daily function.
4. Zoning Laws
A common issue that crops up when purchasing a new property is a zoning violation. Confirm the zoning designation of your desired property, and make sure its current use complies with the rules. Be mindful of agreements that may affect the future of the property, such as public use agreements.
5. Title Research
Do not underestimate the importance of researching the title of a property before purchasing. This is where your trustworthy escrow/title company comes into play. They will help confirm the property’s legal description and boundary lines, real property, liens, encumbrances, usage rights, and more. They will also tell of red flags that appear in their research such as mechanical liens etc.
6. Appraisal
Don’t pay too much for a property because you blindly trust the price that’s on the listing. Hire an appraisal to give you an unbiased, third-party estimate of the true value of the property.
7. Environmental Assessment
Invest in a professional environmental assessment. This will reveal any potential environmental hazards or issues that exist on the property, such as a gas leak, hidden oil container, wetlands, or use of the property for manufacturing in the past.
8. Financing
Unless you have all the cash to purchase the property in one lump sum, you will want to look into lender financing, typically in the form of a conventional loan or private money. Oftentimes, the bank or lender will conduct its own investigation of the property’s title and land surveys. Research multiple lenders and mortgage options to make sure you receive the best terms and interest rates.
9. Title Insurance
Title insurance can give you peace of mind as a buyer. It guarantees a clean chain of title and protects you, the new owner, from claims to the title. It allows you to avoid potential problems such as the following:
Unpaid back taxes
Pending legal actions against the property
Old mortgages
Forgeries
Claims from heirs
10. Review Numbers
Never believe the proforma numbers. Always perform your own analysis and double check all of the rental income, utility charges, tenant database, and operating expenses.
Summary
The due diligence process is one of the most important steps to completing your real estate transaction as intensive as it might be. It is worth the effort to help safeguard your investment. Refine your due diligence checklist as you continue purchasing more properties. You will learn new tips and tricks as you buy more properties as each transaction has it's own story to unfold.
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