Due Diligence Checklist for the First Time Commercial Real Estate Buyer!

Due diligence is the process of doing your homework on the property that you’re thinking about buying as an investment. It’s the process of checking, double-checking, and confirming any important information that was used to determine whether the property is good, average, or a bad deal.

The following list regarding due diligence is not all encompassing and you should explore every detail on a property before pulling the trigger. It is also important to recognize what you know and don’t know. Hiring the right advisors (accountant, inspector, and lawyer) is very important and valuable. While being expensive, remember this: “Being cheap is sometime expensive”. The due diligence items usually fall into three categories: Physical, Financial, and Legal.

Physical Due Diligence:

• Site plans and specifications: This group of documents includes all the construction documents, building plans and schematics, floor plans, and use of the land documents.
• Photos of the property: Photos of the exterior, interiors, and the surrounding land and structures should be taken.
• Structural Inspection: Inspect the walls, roofs, and foundation.
• Interior Systems Inspection: Inspect the interior of the property for wear and tear, including items such as doors, windows, and weatherproofing. Then inquire about the age of the roof, any building code violations, its federal compliance, and the site improvements.
• Mechanical and Electrical Inspection: Make sure that every mechanical and electrical system is inspected. Such systems include heating, ventilation, air conditioning, plumbing systems, and all electrical power systems and controls.
• List of Capital Improvements Performed: Obtain receipts and documents for any capital improvements that were made. Collect these for any improvements over the past five years.
• Pest Inspection: On some types of building, an inspection for pests, such as termites, may take place. Most apartment buildings have this inspection done as part of a lender requirement.
  

Financial Due Diligence:

• Income and Expense Statements: You should obtain annual income and expense statements for the past three years.
• Rent Rolls: A rent roll is essentially an attendance sheet for all tenants. It displays the tenant name, unit space, amount of rent paid, move-in date, lease expiration date, and security deposit.
• Tax Returns: Obtain the property’s tax returns for the past three years. Add up all the income and expenses shown on the tax returns. These numbers should match those from the seller’s income and expense statements.
• Lease Agreements: A lease agreement can be a complex legal document. If all of the leases are the same, such as in an apartment building, have an attorney review the fist few to make sure they’re valid.
• Utility Bills: Obtain the past two years’ worth of actual utility bills for the property. These bills include electricity, gas, water, sewer, trash, telephone, cable and Internet service bills. Compare the totals of each utility category to the seller’s total given on the expense statements.
• Property Tax Bills: Obtain the past two years’ worth of property tax bills. Verify the amounts with those given on the seller’s expense statements.

Legal Due Diligence:

• Environmental Inspection: The environmental inspection most often used is called a Phase I Environment Site Assessment. During this inspection the inspector explores the past use of the property and the surrounding area, looking for onsite and offsite environmental problems and liabilities.
• Survey and Title Inspection: With this inspection, a title company can verify the property size and that the title report has the same description as the survey. You can also review any easements or encroachments.
• Inspection for Building Code Violations: If a violation occurs after a building is built, it’s called a non-conforming use and is considered to be grandfathered in.
• Zoning Code: You need to review the town’s zoning ordinances to make sure that the property’s use complies with what it’s legally zoned for. Its used illegally the property can be shut down.
• Insurance Policy: The property’s insurance policy can be a treasure trove of information if you can get the claims history.
• Licenses, Permits, or Certifications: Often times, you’re required to post business licenses, permits or certificates. Make sure that you’re proactive in notification of new ownership to avoid hefty fines.
• Service and Vendor Contracts: Review all service and vendor contracts to make sure that you have the right to choose or discontinue the services. These services may include maintenance and landscaping.
• Personal Property Inventory: Obtain a list of all personal items, such as equipment, tools, computers, furniture, supplies and appliances, that re to remain with the new owner. Document all these personal items in writing or consider them gone.
• Police Reports: Determine past and current police reports by calling the local police department. Review the type and frequency of calls to the property. Know what’s going on before you buy.

Now, remember that this list is a start and not all encompassing. Your commercial real estate team should consist of a good lawyer, commercial real estate broker, inspectors, and financing partner (I know a good one!). Good Luck.