What Is Due Diligence, and What Are the Key Elements?

Purchasing a commercial property can be a very intimidating process; however, feel secure in the fact that, even if you have a property under contract, you still have a set amount of time to completely check out the property and make sure it is going to reap the profits you whole heartedly intend to get!

Contrary to the laws and rights of residential real estate, commercial real estate is purely “caveat emptor” or buyer beware. There is very little protection for the commercial real estate buyer and investor. Properties are sold “As Is,” and if there is a problem with the property, no matter how small or big, or even if the seller is privy of such problems, the buyer alone is responsible for identifying the problem and choosing what to do about it.

As a buyer, consider it as an advantage as opposed to a downfall of commercial real estate, because with the responsibility in your hands, you are more likely to do a more thorough job than any seller would do. You will find out things that will either support or hinder your case to purchase the property!

When you accept full responsibility for a property, the rewards are so much greater both emotionally and monetarily.

Because of this additional risk and lack of disclosure agreements, a set period of time is created for an inspection and investigation. This period is known as due diligence, and is probably the most important step in determining if the property you have placed under contract really is as it appears.

The due diligence period can protect the buyer from many problems that can arise after the deal has closed. Many of these problems amount to one thing: the amount of money it will take to remedy the problem. In my experience, the due diligence process can save you from multi-million dollar mistakes that could leave you in the red.

Due diligence can protect the buyer from willful misrepresentation and nondisclosure by the seller or seller's agents and brokers. A good rule of thumb is to never believe anything the seller or seller's agent says until you have verified all information for yourself.

If something does not seem right to you about the property at any point during the due diligence process, you can walk away from the deal and have your deposit refunded if it is before the time, as designated in the contract, that the deal has gone “hard”- the point where your risk involves more than just time and the money for inspection.

So what are some actions that you can expect from the process both on the seller's and buyer's part?

During the due diligence period, the seller takes the property off the market while the buyer has a team perform the actual due diligence process. The property remains off the market until the buyer either walks from the deal due to the discovery of a problem or property information that he or she initially was not aware of, or until the deal closes.

The last thing you would want to do is purchase a property you knew had a problem simply because the upside looked so great! You must always be able to walk from a deal if the problem is just too much to overcome.

Be prepared to employ professionals to get the job done right.

The actual due diligence process entails detailed and professional work in which you will have to employ more than one expert to perform. Although due diligence can be a complex or simple process, depending on the property and how much a buyer initially knows about it, one should never fear due diligence. When the right people are hired, and you inspect all the necessary aspects of a property, due diligence will tell you everything you need to know about the property, and enable you to make an educated decision on whether or not to buy.

The best way to perform due diligence is to hire experts and professionals who are always doing due diligences. They are often very experienced and know what to look for in a property, and where possible trouble areas could arise. Before deciding on a team, be sure to review what it is they do inspect, and, more importantly, what they don't inspect. If something is missing, add it to the list before moving forward.

Don't leave any stone unturned! It can save you money in remedying a problem in the future.

Some key elements regarding due diligence are:

Property's boundaries and codes. A property's boundaries may include:

Easements- parts of the property that must be shared by an adjacent property Encroachments- pieces of an adjacent property that move onto the subject property.

For example, shared roadways and utilities are very common in commercial real estate. These things must be in place for the property to serve in the way the buyer intended. A buyer does not want to be surprised after the fact of certain encroachments that may impede development.

Zoning and intended use. A property must be up to all codes, including:

Building codes Fire codes Zoning laws City ordinances

If the building is filled with asbestos or is in need of an in-house sprinkler system in case of a fire, then you will be responsible for making the property code ready, and no longer in violation. Bringing a property up to code can be a very expensive endeavor, and not one that would want to be undertaken unless previously addressed and planned for.

The property's zoning dictates what the property can be used for. Zoning laws and ordinances can greatly differ from city to city, so it is absolutely crucial that zoning is verified by the city via a member of the due diligence team. Intended use must also be addressed, as city planners can use intended use clauses to control development in the community beyond the broader zoning laws.

What is a great way to protect your self from zoning problems?

Create a contract that is written subject to or contingent upon the verification of both zoning and intended use, as it should meet the expectations of the buyer's wants and needs for the property. Purchasing a property that cannot be used for what was originally intended can be a difficult situation. The last thing a buyer wants to do is fight with the city to get the zoning or intended use as originally thought (often caused by the misleading information of a broker or agent).

Physical environment. The physical environment can be the most important aspect of a property, and must be completely investigated.

The soil, topography, shape, size, exact location, buildings and even the animals that live on the property have to be addressed.

The soil can be contaminated; there could be asbestos in the walls, and there could even be endangered species protected by the government- i.e. allowing no development to come within 100 feet of a spotted owl!

Length of time. The length of the due diligence period is determined in the contract agreed upon by both buyer and seller.

A short due diligence is generally considered anywhere from 30 to 90 days. Shorter due diligences are usually favored by sellers, as it means a shorter closing time.

If a property is more complex, with a lot of acreage, or in an exotic location, it may be necessary to increase the due diligence time. Extensions can be made by agreement of both parties, and often have a monetary risk paid by the buyer.

One word of caution: don't ever be surprised as to the issues that may come up.

Who knows the trials and tribulations a due diligence team may run into during the inspection? Concentrate on the remedy, if there is one, and determine if it is worth the time and money to fix the problem, or if is better to just walk from the deal and find another property.

The key word for due diligence is verify.

Verify everything about the property including leases, rental agreements, contracts, title, liens and debt. Always have a new survey performed, so that it, too, can be verified. Many of these documents can be fraudulently prepared, outdated, or even given to a buyer in error.

Use due diligence as a tool to reveal the property and everything about it, so there will be less problems that arise in the future- or at least surprise problems! Remember, multi-million dollar investments must be based on hard facts and truths, not on unverified information or word of mouth.

You will feel more secure in every property when you know it from the beneath the soil to the highest rooftop.

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