Why You Must Perform Due Diligence in Your Commercial Real Estate Deals

If you are purchasing your first building, your due diligence obligation might seem overwhelming. Admittedly, none of the documentation involved in due diligence is fascinating reading material. And while inspecting ducts, pipes and elevator shafts, you may feel that you’re in over your head in more ways than one. But these inspections, reports, documents, and drawings will help you become a savvy, experienced, knowledgeable investor, which is the only real insurance for long-term success. That thought should make the dry, technical language, legalese, old blueprints and strange ducting a bit more palatable.

Learning how to perform due diligence can mean the difference between success and failure in commercial real estate investment. The general meaning of due diligence describes the process of obtaining knowledge about something you are purchasing before signing the contract to buy it.

Performing due diligence serves two purposes. The first is to relieve the buyer of any risk involved in making a purchase without sufficient knowledge of what they’re really getting into. The second is to relieve the seller of any liability that could result from the buyer not having this kind of information available. Due diligence is an example of a “win-win” for both parties in a transaction.

When purchasing a commercial property, an offer is normally presented, which is contingent on the buyer’s ability to perform full due diligence within a certain period, often 30 days or less. In commercial real estate, it is understood that the buyer needs access to certain documents and property of interest to conduct a physical inspection. Once examinations have been completed, the buyer has the right to withdraw the offer without penalty if they are not satisfied with the financial, legal or physical condition of the property.

If you’re the buyer, the most important documents to request during the due diligence period include the following: income or operating statements that show all gross rental income and expenses, general ledger reports with detailed descriptions of expenses, maintenance and repair reports, soil and geological reports (including Phase I and possibly Phase II environmental site assessment reports), structural engineering reports, any previous appraisal reports, all current and existing leases and the rent roll that shows all leased and vacant spaces. All financial reports should include the last three years including the current year.

Potential buyers can also request any available building and engineering plan drawings that are available, including original plans and those made for recent improvements to the building. Most investors choose to request a current title report on the property to make sure there are no surprises arise in that area.

The second aspect of due diligence is conducting a full, thorough physical inspection of the property, including the exterior and interior walls, windows and doors, roof and foundation, HVAC system, elevators, electrical and plumbing systems, parking areas and all leased spaces.

While due diligence may often feel like a standard and mundane task, working with a seasoned commercial real estate broker will not only help tackle any challenges that may arise, but they can also help guide you into making the best decisions with your investment.

The article was published in the Houston Business Journal print edition (June 9 – June 15, 2017) on pg. 20.