Commercial Real Estate Buyer’s Checklist – Week Two – Due Diligence Team
Commercial Real Estate Transactions can be difficult to navigate. This is the second article in a several week series regarding the Commercial Real Estate Buyer’s Checklist aimed at simplifying your next commercial real estate purchase.
Commercial Real Estate Buyer’s Checklist – Week Two – Due Diligence Team
Before we get started on the Due Diligence Team, let’s first explain what “Due Diligence” is. “Due Diligence” is the research that a commercial real estate buyer and their Due Diligence Team must conduct, after they have gone under contract to purchase a property, to verify if they should proceed with the transaction. The good news is that most commercial real estate contracts allow for a feasibility period which provides the buyer and their due diligence team the appropriate time to fully research the countless variables associated with the decision to proceed or pass on a commercial real estate acquisition. The feasibility period’s time frame is largely dependent on the type of property being acquired. Some commercial real estate transactions take longer to research fully than others. A majority of the commercial real estate transactions that I am involved in provide contractual language allowing the buyer to back out of the contract prior to the end of the feasibility period and still have their earnest money fully refunded (less any option money). A great deal of the Due Diligence research starts prior to Making an Offer (Click Here to read last week’s article on Making an Offer). There are certain items that are difficult to know until a full due diligence study is completed, but a seasoned commercial real estate broker can save the buyer a great deal of time and due diligence research expense by pointing out any known potential hurdles prior to making an offer. Most educated sellers are understanding when a buyer terminates a contract due to unknown issues that are found during the due diligence period that can not be resolved. Sellers are not nearly as understanding when a buyer backs out of a contract based on items that should have been understood prior to an offer being presented. Due to the significant cost of due diligence research, a buyer shouldn’t go under contract unless they are fully prepared to close the transaction. The feasibility period is meant to confirm a purchase, not to make the initial decision to buy. The seller also owns a great deal of responsibility regarding the likelihood of a commercial real estate closing occurring. Most successful commercial real estate transactions (win-win for buyer and seller) occur when an educated seller and their representatives provide a fully detailed explanation of their property prior to a deal being made….and are “prepared to sell”. Being prepared to sell is an entirely different subject to be discussed later (it starts “way before” a transaction occurs), but for the purposes of this discussion “being prepared to sell” is having all of the buyer’s required due diligence documents ready for their review prior to a contract being dually executed by both parties. Now that we have a better understanding of what due diligence is, let’s move on to the team that the buyer needs to assemble to help them with researching the property after a contract is accepted.
#3 - Commercial Real Estate Broker - If you have gotten to this point (working on due diligence research for a property that you are under contract to purchase), hopefully you already have hired a commercial real estate broker to represent you in the transaction. The Due Diligence period is where the best commercial real estate brokers set themselves apart from the average commercial real estate representatives. In today’s world of buyers having much more access to finding properties, (Click here to read an article relating to changes in the brokerage world) one of the commercial real estate broker’s main jobs is to be the quarterback of the due diligence team. The commercial real estate broker doesn’t need to know all of the answers to issues that arise while researching the property, but he or she must be skilled at “finding” answers. He or she must also be willing and experienced enough to ask the tough questions necessary to protect their client’s investment. The commercial real estate broker must be gifted in problem solving and an expert in communication. The commercial real estate broker needs to not only help the buyer coordinate the vendor’s access to information, but they must also remain “on top of” the vendors to make sure that they complete their work inside of the critical dates established in the contract. He or she is also responsible for making sure that open communication occurs with the seller and their representatives. There will likely be uncomfortable information that must be communicated by the commercial real estate broker to the rest of the buyer’s due diligence team, the buyer, the seller (and/or their representatives), the title company, and other parties in the transaction. The best commercial real estate brokers keep deals together for their clients through their ability to communicate and problem solve as they take charge of the transaction.
#4 - Commercial Real Estate Attorney - Hopefully you read last week’s article regarding “making the offer” and decided to engage a commercial real estate attorney to assist in reviewing (and/or negotiating) the language associated with your purchase contract. I typically recommend that my clients (buyers or sellers) hire seasoned commercial real estate attorneys to aid them during the feasibility period of the contract. Much like you wouldn’t hire your dentist to complete brain surgery, don’t get fooled into thinking that any attorney can represent you well in a commercial real estate transaction. If you don’t already have a commercial real estate attorney, I recommend searching for a commercial real estate attorney that has specific experience with the property type that you are acquiring. For example, if you are buying a commercial land tract, I would recommend hiring an attorney that works regularly on commercial land transactions. If you are buying a net leased investment property, I suggest hiring an attorney that is experienced in researching net leased investment acquisitions. What are some examples where property specific knowledge would help? A commercial real estate attorney experienced in closing land transactions should be proficient in understanding/negotiating easements and an attorney experienced in net leased investments should excel in understanding lease document language and how it relates to their client’s investment acquisition. Unfortunately, there are too many property specific legal situations to mention in one article. Please make sure to hire an expert to represent you. Some commercial real estate attorneys are great at communicating. If your attorney is not good at “playing nicely with others” but is great at reviewing language…it will be even more important for you to hire a commercial real estate broker that is an excellent communicator. Often a commercial real estate broker gifted in communication skills can relay your attorney’s comments to the other party in a manner that might be better received. The art of understanding “how” a message is communicated can often be more important than “what” is actually being communicated. There is a place and time for competition in commercial real estate, but the best transactions (win-win for all parties) occur when each party focuses more on completing each other and working together as a team to achieve the common goal of closing a deal.
#5 – CPA - The buyer’s CPA should be heavily involved in any decisions regarding the idea of purchasing a commercial real estate property. The buyer’s CPA should be consulted well in advance of making an offer, because he or she owns the knowledge of the buyer’s personal tax and financial situation. The CPA will also need to be available prior and during the due diligence period to complete and/or review property financial projections as well as provide financial advisement relating to how the acquisition affects the buyer’s tax (and financial) position. If a loan is being acquired to purchase a commercial property, the CPA may also be relied on to prepare financial statements for the lending institution to review in their approval decision for the borrower. The financial decision to purchase a commercial real estate property is an important one, so please make sure to engage your CPA early and often.
#6 - Title Company – There are countless documents that must be circulated amongst the parties once a contract is receipted by the title company. My preference is to recommend title companies that excel in communication skills…have strong legal advisers and research teams experienced in commercial transactions…that employ closers and escrow agents that understand the “art” of keeping a deal together. The commercial real estate broker must communicate well with the title company’s representatives while he or she is managing the critical dates established in the contract for the team.
#7 - Surveyor/Civil Engineer - Once a new title report is provided by the title company, either the buyer or the seller will more than likely have to pay to have an existing survey updated or a new survey produced. Although they can be more costly, I recommend for the parties to order an ALTA survey, (Click Here to See an Article that provides the definition of an ALTA survey) because of its more detailed nature. One of the real estate attorney’s biggest roles once a contract is dually executed will be reviewing and analyzing the survey and the title documents. I recommend that my clients hire surveyors and civil engineers that are familiar with the municipality that the property is located in…that excel in providing their services in the time frame that they propose. The type of acquisition will determine additional work that your surveyors and civil engineers might need to conduct regarding due diligence research. This is another vendor that the commercial real estate broker needs to monitor and communicate with, so that he or she can properly inform all parties of their work in relation to critical dates established in the contract.
#8 - Environmental (and/or Geo-technical) Company – Phase I studies are required by most lenders for commercial real estate acquisitions. I always recommend that the buyer order a Phase I study even if there is not a loan involved in the purchase. If the seller has a recent report (less than 12 months old), sometimes the lender will allow for the previous report to be certified/updated to themselves as well as to the new buyer. Assuming that there haven’t been any changes to the property which require a new or updated Phase I report, this type of allowance from the lender can provide a major cost and time savings to the purchaser. The Phase I report is typically the first stage in the property’s environmental due diligence research. The Phase I report aids the buyer and their lender in determining any environmental contamination liabilities. If the property shows evidence of contamination, a Phase II report is often recommended, assuming the buyer feels comfortable that they can mitigate any issues uncovered in the Phase I report. The Environmental and/or Geo-technical company could have more roles in due diligence research depending on the nature of the acquisition. I typically recommend that my clients hire experienced environmental companies that regularly perform work in close proximity to the site in question. Much like all of the vendors mentioned, it is critical that the commercial real estate broker manage the timeliness of the environmental company’s work to match critical dates in the contract.
#9 - Lender – If you have gone under contract and are using debt to acquire the property, hopefully you already have a good understanding of the lending institution’s loan terms and the likelihood of your loan’s approval. Many commercial real estate contracts allow for lending approval contingencies, but please understand that there are countless reasons why you should feel very confident in your potential for loan approval prior to making an offer. The lender is often making a more sizable investment into the property than the buyer, so they will normally be very diligent in their research prior providing final loan approval. A diligent lender can often mitigate some of the buyer’s risk associated with acquisition because of their extensive research. It will be critical that your due diligence team, led by your commercial real estate broker, does an excellent job of communicating with the lender to answer questions and provide information for their review. My recommendation for buyers is to employ lenders with a strong track record of closing properties in the property type that they are acquiring. There are many types of lenders in commercial real estate. I have one client that remains loyal to their personal bank for their acquisitions because of the bank’s track record in closing aggressive loans on a consistent basis. Banks are typically more aggressive in seeking commercial real estate loans for existing bank clients that enjoy a long term relationship with the bank and have sizable deposit accounts. I have another client that relies on his mortgage broker to find him the best deal in the market place for his commercial real estate loans. The key is find the lender best suited for your particular deal.
#10 - Appraiser - The lender will more than likely require a new property appraisal to be completed if there is a loan involved in the transaction. Normally the lender chooses the appraiser. Another one of the commercial real estate broker’s biggest jobs in a transaction is to provide information that the appraiser needs to complete their work. This is a much more critical stage of a commercial traction than residential purchase because of a more limited availability to commercial sale comparables. Most residential appraisals are more simple for the appraiser to conduct because of the multiple listing systems in residential real estate that record and track closed transactions. Commercial Real Estate brokers often play a much larger role in aiding the appraiser in the acquisition of sale “comps” for their research. Since the appraiser is a member of your team that you more than likely won’t get to choose (unless you are paying cash and want an appraisal to protect your investment) it is critical that your other team members work well to communicate with them so that all critical dates are considered.
Item #11 - Architects, Construction Contractors, Structural Engineers, Building Inspectors, etc. - These vendors are all important to certain types of commercial real estate transactions. Much like the other vendors mentioned, it is critical to hire experts that are familiar with the product type that you are under contract to purchase. Please leave questions in the comment section of this article if you have questions relating to these vendors or others questions relating to “specific deal types”…since the answers often are related to the type of property. We may not know your answer, but are confident that we can help you to locate it amongst the many experts that we work with on daily basis.
Next Steps—-Please understand that every commercial real estate transaction is different so it is important that you hire a seasoned commercial real estate due diligence team to help you navigate through the transaction. Although the due diligence team members mentioned above are common to many commercial real estate transactions, I am regularly involved in deals that require different team members. I look forward to following up with you next week to go over site acquisition research.
Stay tuned for Next Week’s Article…..Commercial Real Estate Buyer’s Check List – Site Acquisition Research
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