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The Due Diligence Process Preparation in [Commercial] Real Estate Transactions
In every conveyance of real estate, whether it be an apartment lease, a residential home purchase, a commercial business lease, the purchase of a strip mall or the purchase of a Manhattan skyscraper, the prospective purchaser or renter must conduct some level of due diligence toward investigating the quality, both physical and intangible, of the real estate they are being conveyed.
The foregoing list represents a progressive continuum dictating the depth to which that investigation should be conducted. An apartment renter, for instance, “kicks the tires” by walking into the apartment (usually with the salesperson in tow), looking in all of the rooms, turning some lights on and off and maybe checking the garbage disposal; the purchaser of the Manhattan skyscraper has a little more to do, not only because of the substantially larger investment he is making, but because of the permanence of the tenancy and substantial increase in potential liability to third parties using the property.
It is important, however, to remember that the foundational logic for conducting the property investigation at both ends of the continuum remains the same: you need to know the characteristics of the real estate being conveyed, so that you can adequately balance the risks and confirm that the superficial level of value represented by the purchase price or rental rate matches the reality of the condition of that real estate. The importance of keeping this in mind, especially in the larger transactions, is that every transaction is different and so must be viewed, not entirely through the lens of a Due Diligence Checklist, but as its own transaction, with its own unique potential pitfalls.
Preliminary Due Diligence
A great deal of the process of real estate inspection often begins before the offer to purchase real estate (or even a letter of intent outlining the terms of the proposed purchase) is signed, by visiting the site and having discussions with real estate brokers and sellers. This preliminary process should not be skipped or given abbreviated attention because it can be invaluable to establishing the informal connections necessary to obtain the information that will ultimately be sought. It can also point to some questions or investigative paths which might otherwise seem unfruitful, but which uniquely shed light on this transaction.
In addition to the obvious (contingency period length and access to information), during negotiation and drafting of the real estate sales contract, as it relates to the due diligence investigation, it is important to recognize the sticking points as to representations/warranties and provision of seller’s property-related information. Negative reaction on these issues by the seller often implies very telling red-flags related to property condition.
Review of Seller Documents
Once the real estate sales contract is signed, the race begins to garner the maximum amount of information, keeping cost efficiency in mind, but focusing on maximizing efficiency of time, as the investigatory period is invariably shorter than the purchaser would prefer. Assuming adequate document retention by the seller, a thorough review of their documents can save a great deal of time, effort and money that would otherwise be spent by purchaser procuring the same information.
Be sure to ask the seller for all documents and things the seller received (or should have asked for) during his due diligence process when he purchased the property (especially if acquired relatively recently). Such a list might include:
- Current tenant information
- All present uses of the real estate
- Any third party reports or inspections initiated by seller
- Any surveys of the land and improvements in seller’s possession
- Seller’s current policy of title insurance
- Any applicable condominium documents
- Notices of any pending or threatened litigation or governmental action relating to the real estate or seller
- Notices of any environmental conditions
- Notices of any new or special assessments or taxes
- Copies of all current bills for the property
- Service contracts
- Evidence of current zoning
- As-built plans and specifications
- All construction related documents including warranties
- Evidence of insurance.
You (or an agent on your behalf) should review each of these documents or items independently to identify the potential problem areas which require deeper investigation.
After receipt and review of the seller delivery documents, it is time for you to go beyond these documents into your own independent investigation of the condition of the real estate using what you have gleaned to this point to navigate the appropriate course of that investigation. Our Due Diligence Checklist is a great resource to guide you in your particular property investigation journey, but engaging a real estate agent or attorney to help you in this process is highly recommended.
Your goal in the due diligence process is to make sure that the property you think you are getting is actually the property being conveyed. Remember, each transaction has its own unique set of obstacles and considerations, so give each purchase the unique respect it deserves. Armed with this information and guidance, you are well on your way to ensuring the purchase of a sound investment. Best of luck on your next purchase!
Visit our Real Estate practice area for additional information on conducting the due diligence process in Real Estate transactions.