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What Type of Due Diligence is Necessary in Today’s Market?

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The commercial real estate market can be a tough environment as many experienced first hand with the market crash. Over the past few years, as the market has rebounded, commercial real estate has risen to new heights in cities across the United States. Los Angeles, Seattle, Denver, Atlanta, and Dallas are just a few of the cities where commercial real estate investments are not only thriving, but also helping to transform the cities.  In this fast paced market where acquisitions and dispositions are king, due diligence can make or break a deal. As a crucial aspect of the buy-sell process  owners, developers, and investors need to stay on top of and be in the know with regards to what factors are most impactful during transactions.

Which information must be reviewed?

1. Financial data. Request at least three years’ financial statements, all loan documents, tax returns and bills, and any information on capital improvements. Consider how you could operate the property more efficiently, but don’t be overly optimistic when estimating economies of scale and synergies with other similar properties.

2. Tenants and leases. Obtain a certificate of occupancy for the property, lease agreements and data on tenant mixes. Compile rent rolls to assess future rental income and lease terms. For leases nearing expiration, consider whether to renegotiate terms or replace undesirable tenants.

3. Insurance and title policies. Scrutinize policies and riders as well as related risk assessments and claims history. If the policy hasn’t been updated to reflect current market values, the property may be overinsured.

Should you go beyond traditional due diligence?

Qualitative assessments of the property are as important as quantitative data. Always visit the property, focusing on competing properties, traffic patterns and any neighborhood characteristics that could change your assumptions. For example, if a competitor has recently renovated, it might affect market rents or force you to improve your property.

Know the comparables in the area, including current rental rates, selling prices, market saturation and vacancy rates. Outdated or dissimilar comps can lead to poor investing decisions.

Then inspect individual units. Look for attributes that make a unit hard to lease, such as an unusual layout. Or you might discover that a tenant business is struggling. Can you count on that business to renew its lease or keep up with rent payments and maintenance?

Finally, talk with tenants to find out if they’re satisfied with the property and management, or if they have complaints that could affect renewal decisions.

What else should due diligence cover?

Due diligence should also extend to zoning and land use issues, such as judgments, claims and liens; third-party contractual obligations (such as construction warranties); and environmental issues. More due diligence is required if the property is distressed. Neglected properties risk tenant default and might not comply with building and other codes. You can still land a good deal — just work with your real estate and financial professionals to identify and reduce the risks.

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