Commercial Real Estate Due Diligence Guidelines
By Jack Sternberg,
a nationally recognized expert
on real estate investment
http://www.askjacksternberg.com
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When buying commercial properties, due diligence is even more important
than it is with residential properties. That's simply because there's
so much more money at stake.
In the worst case, unexpected repairs and expenses can empty your pockets
in the blink of an eye. At the other end of the scale, it can create a
long-term and slow-motion drain on your bank account that ends up with
the same result-money gone and a clunker property on your hands.
I'm sure you can see my point - never, ever acquire a commercial property
without closely checking its condition first. By doing that, you'll end
up with an investment which can produce considerable profit and appreciation
over the long-term. In this article, I'll outline the basic due diligence
required for the physical inspection of commercial buildings.
Who Should Inspect Commercial Buildings
If you're new to commercial investments, then definitely hire a professional
to inspect the building you're considering. The building structure and
the HVAC, electrical and plumbing systems are much more complicated than
those found in residential properties and require specialist inspectors.
Therefore, it's wise to hire an experienced contractor, architect, or
other expert to do the jobs for you. Verify references and contact other
investors to see what kind of job the specialists have done for them so
you can hire the best.
When you work with specialists that do a great job at reasonable prices,
treat them well and fairly. Remember, your reputation is everything, especially
in the commercial or industrial market, so you want to guard it at all
costs. Getting a bad reputation in the commercial market is a particularly
deadly sin since it can dry up funding sources in a hurry, not to mention
the fact that "movers and shakers" will not want to work with you.
Maintenance Types
There are two types of maintenance in commercial and industrial investments.
One is deferred maintenance. This refers to any major or minor defects
in a building.
Naturally, you want these defects exposed before you invest any money
in a building. For example, one of the first things to have checked is
the condition of the roof. The damage caused by water leaks to electronics
and wiring can create some very expensive repair bills.
The other type of maintenance is routine. Just what it sounds like, this
is such regular activity as cleaning, painting, servicing of HVAC, escalators,
elevators, fire safety systems, etc.
Since laws require regular maintenance, check all the building logs to
make sure routine checkups have been completed, but don't take the log
entries for granted! Always talk to the companies doing the maintenance
to ensure the work was really done.
If you've already found that equipment hasn't been kept in great shape,
hire a different company to do inspections to make sure that you're getting
objective opinions.
Talk to the tenants as well to get their opinions of the maintenance.
This is not only a chance to get a realistic picture of the building,
but it's also a chance to build good relationships with them should you
decide to purchase the property.
Routine Items You Can Check Yourself
Quite often, defects are obvious and don't need the trained eye of a professional
inspector. During a walk-through, you can check for the following items:
Ceilings - look for evidence of stains or broken tiles that indicate leaks
from the roof. *
Walls - check for significant cracks caused by uneven
settlement of the foundation.
Floors - warping or cracks can indicate problems with
the way they were laid or with the foundation.
Rest rooms - check out the condition of the plumbing to
make sure it's not leaking, rusted, or otherwise not performing property.
Security components - these should all be functioning
properly; e.g. doors lock as they should, exit signs are illuminated,
stairways are in good shape, etc.
Lighting - interior and exterior. All lights should be
working.
Door hardware - by this, I mean automatic and/or hydraulic
door openers and closers should be functioning well.
Paint - at points like common areas, check to see if the
paint is in good shape and doesn't show peeling, "alligatoring,"
and the like.
Tenant spaces - check their condition very carefully.
After all, if they're not in great shape, the tenants will want you to
fix them up once you take ownership of the building. Make a list of maintenance/repair
items and get bids from contractors to see what the costs will be.
Grounds - check to see what kind of shape they're in.
This not only includes landscaping, but the condition of parking lots,
curbs and the like.
Red Flags
Never put your money into any property with one or more of the following
problems: Asbestos Dry rot Duct contamination Hazardous waste pollution
Lead contamination Mold, etc.
If you find these problems, cancel the escrow and look elsewhere! You want
to buy a profitable property, not a money pit.
Purchase Agreement Recommendations
Always write a condition into the agreement that requires the seller to
do one of two things before the close of escrow: Correct all problems, or
Lower the price so you can do the repairs. The advantage of this strategy
is that you can hire your own contractor to do the repairs, and you'll know
they'll get done correctly.
What To Do Once You've Purchased the Commercial Building
Once you've bought the building, you want to keep it in the best shape possible
at the lowest cost possible. For office buildings, your "foot soldiers"
in the maintenance war are the maintenance staff. Make sure they understand
their duties clearly and carry them out on a regular, scheduled basis.
If you have an industrial property, shopping center or similar property,
then your manager should oversee the maintenance staff.
Commercial Real Estate Due Diligence Guidelines
Maintenance may seem expensive, but it's a lot less expensive than having
those income-producing tenants bail on you because you've let the building
run down.
The tenants should pay for these costs through the lease. As long as the
expense is reasonable, they'll be happy to pay for maintenance and repairs
since it directly affects their bottom lines.
Key Idea: Never, ever acquire a commercial property without
checking its condition thoroughly first!
Jack Sternberg is a nationally recognized
expert on real estate investment and the creator of the renowned "Buyers
First Program" who's been in the business for more than 30 years. Sternberg's
deals have totaled over $750 million and he's been to the closing table
more than 1,500 times. For more, visit http://www.askjacksternberg.com
Published - October 2008
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