Due diligence is the process of evaluating the commercial property that you have under contract by checking and confirming information about that property. The importance of due diligence is twofold:
First, you learn specifics about the property which enables you as the Buyer to make an informed decision.
Second, it allows you to uncover potential problems before closing escrow.
The due diligence clause in the Letter of Intent to Purchase allows the Buyer to analyse the property for a free period of time, typically 30 to 60 days.
Here is a sample Due Diligence Checklist which should be submitted as an Exhibit to the Letter of Intent to Purchase and referred to in the paragraph outlining the due diligence to be conducted.
DUE DILIGENCE CHECKLIST
– Preliminary title report and all underlying documents
– Existing title insurance policy and underlying documents
– Existing survey of Property
– Current rent roll indicating rental rates, lease terms, concessions granted, security deposits, renewal options, and any outstanding delinquencies or prepayments
– A list of tangible personal property owned by Seller and used in connection with the ownership, operation, use and maintenance of the Property
– Current ad valorem tax bills and property tax statements
– Historical financial and/or operating statements for the prior three years and current year-to-date statements
– Maintenance/service contracts and agreements and any other contracts relating to the ownership, operation and maintenance of the Property including the standard lease form, pest control, janitorial, and landscape maintenance contracts and agreements
– Liability Insurance Policy and claims records
– Capital expenditure records for the past five years
– Utility bills for the preceding twenty-four month period
– List of vendors and utility companies with account numbers
– Certificates of Occupancy – building and tenants
– Payroll summary for on-site employees
– Phase I, II, and/or III Environmental Report
– Reports, records, and documentation relating to Mould, Mildew and Fungus repairs made to the Property
– All governmental permits or zoning restrictions affecting the Development and occupancy of the Property
– Mortgage payment information (if loan is assumable)
– Assumption papers from lender
– Permitted and As-Built Building Plans – including Architectural, Structural, Mechanical, Electrical, Plumbing, Fire sprinklers, Landscaping and Civil Engineering
– Floor plans
– Site plan
– Tenant profiles or surveys, if available
– Traffic study or report
– Move Out Notice(s)
– Most recent appraisal
– Most recent engineering reports
– Statement of structural alterations made to premises, with plans and permits
– Guarantees and warranties on roofs, and any other portions of the structure or facilities; major repairs, etc.
– Roof inspection reports
– Market surveys or studies of area or comparable properties
– Brochures of project and comparable or competitive projects
– Any other agreements or documents that may affect the Property
Due diligence is a means by which you, the investor, can assess the physical and financial investment worthiness of a property. You or an agent acting on your behalf assembles data to build a “profile” of the property of interest. That profile will include information on:
1. Title and liens – Who actually owns the property and if there any liens placed against that property.
2. Registry of deeds – What are the current mortgage and most recent sale price of the property.
3. Costs – Current property taxes and expenses such as utilities and insurance.
4. Zoning Permits – How is the property zoned? Can it be expanded and/or converted to something else? Identify the setback regulations, the town’s classification of the property and any pertaining limitations. What permits have been pulled for work done on the property?
5. Survey – A survey of the land and any improvements made to it will identify encroachments and physical uses not shown on the title. The survey will show encroachment and whether the property’s “scope of use” as stated in the recorded document “is acceptable based on its location.”
6. Inspection – A thorough property inspection is essential to identify the condition and sufficiency of the structure. The inspection should cover all structural components, HVAC units, the fire repression system, and should document any regulatory or statutory violations.
7. Zoning – Confirms the proper zoning usage, any current or potential violations, agreements (like growth management agreements, covenants, public facilities agreements and current/proposed fees, etc.).
8. Leases – If the investment means assuming existing leases, all existing leases should be evaluated.
Nothing takes the place of actually inspecting the property and the area, meeting with other owners and renters, and getting a feel of the community in which, the property is located. You also will want to know what the city has in mind for the development future of your property neighborhood.
Is the community thriving, are more people (including businesses) moving out of rather than into the area? What are current rents in comparable properties and what have been the recent sale prices of properties similar to yours.
It all matters
The information you gather through the due diligence process will give you a profile of financial well-being (both property and community). You will have a better sense of the current and potential profitability, and whether the property of interest is well over or under-priced.
Each piece of information will help you assess the viability of your investment, avoid a costly mistake, and potentially shield you from getting caught up in legal or financial problems not of your making.