Getting a commercial property under contract is an important step, but it is not the point where a buyer should stop asking questions. In many ways, that is when the deeper investigation begins.
Due diligence gives you time to verify the assumptions you made when evaluating the property. That can include confirming how the property can be used, understanding its physical condition, reviewing financial information, and identifying issues that could become expensive after closing.
The goal is not necessarily to find a reason to walk away. It is to understand exactly what you are buying while you still have an opportunity to address problems.
Due Diligence Should Start Before You Write the Contract
The due diligence conversation really begins before an offer is made.
Before getting emotionally attached to a property, determine what your deal breakers are. What issues would cause you to renegotiate the purchase price? What would require the seller to provide a solution? And what would make the property no longer work for you?
Having those answers in mind can make it easier to evaluate new information objectively once inspections, documents, and reports begin coming in.
Once the property is under contract, some of the major areas to investigate include:
- Zoning and permitted use
- Physical condition
- Environmental concerns
- Utilities and access
- Title and survey issues
- Property financials
The exact due diligence process will vary depending on the property and how you intend to use it.
Confirm That the Property Actually Works for Your Intended Use
One of the first questions buyers should answer is whether they can legally and practically operate their business at the property.
Zoning and permitted use are an important starting point, but they are not the only considerations.
Depending on the property and your business, you may also need to evaluate parking requirements, access, utilities, fire and building codes, signage, loading areas, and improvements required for your specific use.
Ultimately, the buyer needs to confirm that the property will work for the business and that the necessary permits, licenses, and approvals can be obtained.
Do that homework early rather than discovering a major limitation after you have already invested significant time and money into the transaction.
Look Beyond the Property's Condition Today
One issue commercial buyers can underestimate is deferred maintenance and future capital expenses.
A building may be functional today while still having major expenses approaching over the next several years.
The roof, HVAC systems, parking lot, electrical systems, drainage, and other major components all have useful lives. Understanding their condition can help you estimate what expenses may be coming after the purchase.
Those costs do not automatically make a property a bad investment. But they should be part of the equation when determining what the property is worth to you.
A building that appears to be a good deal can look very different once you account for a roof replacement, major HVAC work, or another significant capital expense shortly after closing.
Review the Documents Behind the Property
For an occupied investment property, due diligence involves more than inspecting the real estate itself.
You are also buying an income stream.
Buyers should consider reviewing items such as:
- Leases and lease amendments
- Rent rolls
- Operating expenses
- Property tax records
- Utility information
- Service contracts
- Tenant deposits
- Tenant payment history
The goal is to verify that the income and expenses you used to evaluate the investment are supported by the property's actual records.
Buyers should also ask whether the seller has a current survey and whether there are easements, access agreements, reciprocal use agreements, maintenance agreements, or other documents that affect the property.
Every transaction is different, so the documents you need to review will depend on the asset.
Use the Right Inspectors and Specialists
Commercial properties can require several different professionals during due diligence.
A professional property inspection, environmental review, survey, and title review are often important parts of the process.
Depending on the building, additional specialists may be needed to evaluate the roof, HVAC equipment, electrical systems, structural components, sewer, septic system, or other major features.
Some property types can require even more specialized review. For example, when evaluating a restaurant property, it may be important to inspect the grease trap and confirm that it meets current requirements.
The point of these inspections is to learn the good, the bad, and the ugly before you own the property.
What Happens When Due Diligence Uncovers a Problem?
Discovering an issue does not always mean the transaction is over.
Environmental concerns, structural or roof problems, access issues, title problems, zoning limitations, or discrepancies in rental income and expenses can all materially affect a deal.
Once an issue is identified, the buyer can evaluate how significant it is and what options may be available. Depending on the circumstances, that could mean renegotiating, asking for a solution, delaying closing, or deciding that the property no longer makes sense.
That is one of the main purposes of due diligence: uncovering those facts while you still have the ability to make an informed decision.
A Real Example: An Encroachment That Nearly Stopped a Closing
A recent transaction we worked on shows why this process matters.
During due diligence, we discovered that part of an addition to the building had actually been constructed over the property line.
The encroachment created a significant issue with the lender and nearly prevented the transaction from moving forward.
Instead of immediately killing the deal, the buyer and seller were able to work toward a solution. Ultimately, the parties agreed to remove a portion of the building in a way that did not create a significant impact on the property's overall value.
The issue delayed the closing, but the transaction eventually made it to the closing table.
Had the encroachment not been identified during due diligence, the buyer could have inherited a much more difficult problem after purchasing the property.
Sometimes due diligence reveals an issue that ends a transaction. Other times, identifying the problem early gives everyone enough time to find a workable solution.
Advice for First-Time Commercial Property Buyers
If this is your first commercial property purchase, one of the most important things you can do is use the due diligence time you negotiated.
Start immediately.
Depending on the property, your team may include your commercial real estate broker, attorney, lender, property inspector, environmental consultant, and other specialists.
Give those professionals enough time to complete their work and give yourself enough time to understand what they find.
Most importantly, do not rely solely on assumptions.
Verify them.
Due diligence is your opportunity to determine whether the property you thought you were buying is actually the property you are getting. Problems are generally much easier to address before closing than after the property belongs to you.
Once you sign on the dotted line, those problems become yours.
Buying Commercial Property in Alabama?
Every commercial property has its own set of questions, risks, and opportunities. Working with the right team can help you identify what needs to be investigated before you commit to a purchase.
Right Space Commercial helps buyers evaluate commercial properties for sale throughout our Alabama markets, from identifying potential properties through the purchase process.
If you are considering buying commercial property and are not sure where to start, contact Right Space Commercial to talk through what you are looking for and the next steps.
