Last month I wrote about the importance of due diligence before a contract is signed when purchasing commercial property. This month’s article discusses a buyer’s due diligence after the contract has been signed but prior to closing and taking title to the property.
As stated in last month’s article, a buyer must perform due diligence to ensure she is aware of all material facts concerning the investment property. The extent and scope of the due diligence differs with each property depending on the goal of the buyer. To this end, a buyer must first determine if she will be the end user or if she expects a return on her investment via an income stream from rentals? Will the property be held long term or short term? Is a business being purchased in conjunction with the real property?
Once you have signed a contract to purchase commercial property, you (the buyer) will need to revisit the questions set forth in my article last month and conduct a more thorough investigation of those matters. In addition, you must perform additional due diligence on the property prior to the expiration of the inspection period so the following questions can be answered:
- Are there any title concerns? A thorough review of the title commitment and all of the documents referenced therein is critical. Some title concerns may include: mortgages, liens, judgments or assessments against the property, probate issues, pending lawsuits or foreclosure suit. Although the contract will provide a buyer with a period of time for title review, the contract should be drafted so the title review period coincides with the due diligence or inspection period to provide the buyer with more flexibility.
- Are there any survey concerns? The survey should be ordered as soon as possible after the contract is signed and should be reviewed in conjunction with the title commitment. This allows you to determine if there are easements, encroachments or other matters that need to be addressed.
- Is there insurable access to the property? Many people believe that if there is a road to the property, access is not a concern. Actual access to the property is much different than insurable access to the property. If there is not insurable access, you may encounter problems in the future when you attempt to develop, finance or sell the property.
- Do current zoning and land use classifications allow you to use the property as you intend and what are the permitted uses for adjacent properties? You should request a zoning verification letter from the applicable municipality to obtain valuable information as to the pertinent zoning and code related matters.
- Are there any environmental concerns? To answer this question, a “Phase I environmental assessment” should be obtained. Depending on the results of the Phase I report, a Phase II environmental assessment may be required. Do not assume that because the property has never been used as a gas station, dry cleaning business or other type of business that has a higher likelihood of contamination that there are no environmental concerns with the property.
- Are there code enforcement liens, expired permits, unsatisfied development or easement obligations, unpaid municipal liens for such things as water, electricity, sewer or gas that may create potential legal liability for you, as the successor owner? Some code enforcement liens may attach to all property owned by that property owner and is not limited to the property that is in violation of the code. This is referred to as “cross attaching.” If the seller owns property with a cross attaching super priority code enforcement lien against one parcel and you purchase another parcel from the seller, the property may be subject to the lien.
- Are there any major issues with the building, roof, electrical, plumbing, fire sprinklers, elevator, HVAC, etc? You should obtain inspections so you can evaluate any repairs that may be required.
- Are there tenants? If so, carefully review each lease agreement to determine the landlord and tenant obligations, if the tenant has a right to purchase or relocate, if tenant has exclusivity, if tenant paid a deposit or advance rents. You should also obtain a tenant estoppel letter and rent roll.
- Are you purchasing a business along with the real property? If so, the business will have its own laundry list of due diligence matters you must investigate, which are beyond the scope of this article. Some real property related concerns you should consider are: what type of business or related licenses will be required, is a liquor license required, is outdoor dining permitted, is music permitted, is a drive-through permitted?
- How will you take title to the property? This should be determined before you close on the property to avoid incurring additional costs post closing, such as additional documentary stamp tax and related costs.
Bottom Line
The above list is not exhaustive but illustrates the depth of due diligence that is required by a buyer concerning commercial real property. Yes, you may spend tens of thousands of dollars on due diligence investigations and ultimately elect to terminate the contract. That is the purpose of due diligence — so you can fully evaluate the property and the risks and costs involved should you purchase the property.