Commercial Real Estate Due Diligence.

The Timing Could Be Right To Make That Purchase, But Have You Done Your Homework To Ensure It Meets Your Needs?

The Covid-19 pandemic threw the real-estate world into disarray, as people emptied out of offices, hotels, and malls and worked from their homes. That disruption has transformed how people and companies finance, operate, and occupy real estate; with some companies looking to shed properties from their properties from their real estate holdings portfolios. Commercial real estate investors predict up to a 10% fall in property value as a result of the coronavirus pandemic, but prices are expected to recover by the end of next year.

If you are a company looking for opportunities and a deal in the commercial real estate market, now is the time to capitalize on that need while prices are still compressed. In order to protect yourself during the transaction, it is still important to conduct a thorough due diligence to ensure there aren’t any surprises after closing.

The purpose of real estate due diligence is to thoroughly inspect the fundamentals of the property, seller, financing, and compliance obligations to reduce and mitigate financial uncertainties. Buyers must examine zoning restrictions, potential liens, and possible encroachments on the property. Existing structures must be fully inspected to discern needed repairs and their costs. They must determine whether or not they will absorb legacy liabilities from prior owners’ legal and regulatory violations. If the property is largely financed, they need to address their ongoing ability to make required payments to the lender.

Due diligence can be broken up into three main specialized parts: (i) physical; (ii) financial; and (iii) legal.

Physical inspection.

This is where you actually walk around and inspect outside and inside the property. It is advised that you should hire a professional inspection company. We believe that the physical part is the most important of the three because these types of mistakes are the most costly to correct and are the most damaging to the property’s long-term value.

Financial investigation.

When reviewing the financials for a potential transaction, hire an accountant who has real estate investment experience. Accountants aren’t all created equal. Qualify your accountant by verifying they have commercial real estate accounting experience, not just single-family residence accounting experience or general business experience. In some cases, the investment you’re considering may be one of your largest. Would you trust the advice of an accountant with little experience in one of your largest financial endeavors ever? By far, the best way to find a qualified accountant is by referral. Call on one of your investment buddies and check out who they’re using. And again, make sure that referral has commercial real estate accounting experience.

Legal Review and Agreement Drafting.

The most important aspect of legal due diligence is the title examination. Working with an attorney and a title insurance company, they can provide a “commitment” to issue a title policy, sometimes called the “title binder.” They will carefully review the title commitment with you to ensure the seller can deliver clear title.   Perhaps the most important part of the title commitment from a due diligence perspective is “Schedule B” to the title policy. Schedule B-I contains the requirements that must be met for the company to issue the policy and Schedule B-II lists the various exceptions to the title that the title company found when it performed its title search. Common exceptions on Schedule B-II include:

1. Easements
2. Rights-of-way
3. Restrictions or Covenants

By listing various items as exceptions, the title company is telling the insured buyer that these items are not covered by the title policy, and that the title company will not pay a claim or defend against a claim based on these excepted items. In the due diligence context, Schedule B-II provides the buyer with a list of title issues that must be resolved prior to the purchase or they will be issues that the buyer will inherit upon taking ownership. The buyer’s lawyer or the title company will also conduct a lien search and a search for any county or municipal code violations. The buyer certainly does not want to inherit any such violations and should insist that any code violations or open permits be resolved prior to the closing.

Another key part of legal due diligence is the survey. The buyer’s attorney should match the legal description in the proposed deed and in Schedule A to the title commitment to the actual representation of the land on the survey plan. If the legal description uses metes and bounds, the lawyer must find the beginning point on the plan and follow the metes and bounds descriptions to ensure that they match and to ensure that the legal description “closes” (i.e., that there are no gaps in the description). The attorney should locate on the survey plan all of the improvements, such as the buildings, parking areas, and drainage areas located on the land in question as well as such improvements on adjoining land. The attorney should look out for possible encroachments by adjoining landowners on the property in question. All of these issues need to be identified and, if necessary, addressed with the seller prior to closing.

Clearly the level of due diligence will vary with the value of the project. The more money is at stake, the more thorough the due diligence should be. The lawyers at Goosmann Law Firm have handled commercial real estate transactions of all shapes and sizes. We stand ready to assist in all aspects of commercial real estate, from formation of the real estate holding company to financing to closing the deal and look forward to helping you during your pending commercial real estate transaction.