A commercial real estate due diligence checklist can help potential investors uncover hidden risks, validate the property's value and avoid costly surprises. No matter what type of commercial real estate you’re buying, such as an office building or industrial space, using a commercial real estate due diligence checklist is an important step in the buying process.
If you want to build a real estate portfolio, a financial advisor can work with you to identify investments and manage risks.
Due Diligence for Commercial Real Estate
Unlike residential real estate, commercial properties are typically more complex, involving multiple tenants and higher financial stakes. Commercial real estate is also a long-term investment, often requiring substantial capital.
Without conducting thorough due diligence, you might face unforeseen liabilities such as structural issues, legal disputes or unfavorable commercial lease agreements.
Performing due diligence before buying commercial real estate gives you a complete picture of the property’s condition, financial performance and legal standing.
Basics: Commercial Real Estate Due Diligence Checklist
Due diligence for commercial real estate will require you to assess the property. This will help you identify potential risks or issues before completing a purchase. Here are three types of information to request and review:
Building information: Request all architectural plans, inspection reports and permits for any repairs or renovations. Look for signs of wear and tear, and pay particular attention to the building's roof, plumbing, electrical systems and safety codes.
Operating information: Common expenses include hiring property managers , utilities, taxes and insurance. Gather several years worth of this data to see if costs align with industry standards. You'll also want to evaluate the income generated by the property, especially rent payments to assess whether the property is providing a sufficient return on investment.
Tenant information: It’s important to verify the stability of the tenant base, as this directly impacts the property's cash flow . Review all lease agreements, rental rates, lease expiration dates, renewal options and payment history for defaults or late payments. Look for any clauses that may affect the property's future value, such as early termination rights or rent concessions. If the leases are close to expiring, be sure to understand the implications of potential vacancies on the property’s future income.
Digging Deeper: Commercial Real Estate Due Diligence Checklist
For a deeper level of due diligence, you will need to focus on uncovering more detailed information about the property’s financial health, legal compliance and potential liabilities. Here are six additional things to request and review:
Title search and verification: Conducting a title search helps ensure that the seller has the legal right to sell the property. The title report should reveal any ownership disputes, unpaid property taxes or liens from creditors. Purchasing title insurance is also recommended to protect against any unforeseen title disputes or claims that could arise after the purchase.
Zoning compliance: Verify that the property's current and intended use complies with local zoning regulations. Work with a real estate attorney to verify compliance and address any zoning restrictions that could impact future plans, such as expanding the building or changing its use.
Property surveys and boundary verification: A survey provides an accurate representation of the property's boundaries. It ensures the building and any additional structures, such as parking lots, fall within the legal property lines while revealing potential encroachments or easements that could limit development. Identifying boundary disputes early on can save significant headaches and legal costs.
Insurance coverage: Review the current insurance policies on the property to determine whether the existing coverage is adequate. In addition to the standard policy, verify that there is sufficient disaster insurance if the property is in an area prone to floods or earthquakes.You should also check for pending claims that could affect the property's insurability or increase premiums.
Review of legal contracts and agreements: Commercial properties often come with various legal agreements, such as service contracts (for cleaning, security, etc.), vendor contracts and maintenance agreements. Determine if any existing contracts will transfer with the property, and look out for unfavorable terms or services in any long-term contracts. In many cases, rental property tax deductions can offset some of these costs.
Environmental assessments and reports: Environmental assessments may be required to check for contamination or hazards, especially for properties like industrial facilities, gas stations or dry cleaners. A Phase I Environmental Site Assessment (ESA) can help identify potential issues, and if contaminants are found, a more thorough Phase II ESA may be required. If environmental issues are discovered, remediation could be costly, and you should factor these potential costs into your decision-making process.
Frequently Asked Questions
Is Due Diligence Necessary for All Commercial Real Estate Transactions?
Yes, conducting due diligence is a crucial step in all commercial real estate transactions. It helps uncover potential risks, ensures the property meets legal and financial requirements, and provides a comprehensive assessment for investors.
How Long Does the Due Diligence Process Take?
On average, the due diligence process may take anywhere from 30 to 90 days but can vary depending on the complexity of the property, the buyer's experience with the process and applicable state and local laws.
What Are the Most Common Red Flags During Commercial Real Estate Due Diligence?
Common red flags include unresolved legal disputes, tenant payment issues, environmental contamination and discrepancies in the property’s financial records. Identifying these issues early on can help avoid costly mistakes.
Bottom Line
A detailed commercial real estate due diligence checklist can help you gather information to protect your financial interests. Reviewing the building's condition, financial records and legal documents helps you understand potential risks. This process can help you avoid surprises and reduce the chance of costly problems later. Thorough due diligence confirms the property is a solid investment before you commit.
Real Estate Investment Tips
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