Commercial Real Estate Due Diligence - dummies

By Peter Conti, Peter Harris

Part of Commercial Real Estate Investing For Dummies Cheat Sheet

Due diligence is the process of “doing your homework” on the property that you’re thinking about buying as an investment. It’s the process of checking, double-checking, and confirming any important information that was used to determine whether the property is a good, average, or bad deal.

Due diligence can be broken up into three main specialized parts: physical, financial, and legal.

Physical inspection

For the physical part of due diligence, where you actually walk around and inspect outside and inside the property, 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.

The best way to find a property inspection specialist is through a referral by an individual or a company that has experience with this part of due diligence. You can also ask your local commercial real estate broker for a referral. If you have no luck there, try entering the key word “commercial property inspection” into your favorite search engine. A handful of sites is bound to pop up.

Financial investigation

When it comes to the financial part of due diligence, hire an accountant who has real estate investment experience. Accountants aren’t all created equal. Qualify your accountant by verifying that he or she has 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.

Here’s a tip to stand on: Don’t believe any financial information or books and records given to you by the seller. Double-check everything. Turn things inside out and hold each financial statement up to the light for proof. We recommend that you get deeply involved in the financial aspect of due diligence. Verify each dollar of income reportedly coming in and verify every dollar reportedly spent on the property by reviewing actual billing receipts.

Legal inquiries

The legal side of due diligence is most often done by an attorney and aided by a reputable title/escrow company. These folks look at things such as the following:

  • Defects on the title and survey

  • Any potential environmental problems

  • Proper and improper special uses and encroachments that affect the property

These are all potential deal killers.

Be sure to have tenant leases thoroughly reviewed and audited. After all, when you buy a commercial property, you’re essentially buying the leases and the property comes for free. Contracts imposed on the property, such as employment contracts, service contracts, and warranties, all need to be scoured over with a fine-toothed comb.

All attorneys are not created equal. Attorneys specialize in areas of law. Please don’t have a family law attorney represent you when purchasing a large shopping center. That’s like having a foot doctor give you an eye examination. Instead, hire a real estate attorney. The real estate attorney that you hire doesn’t have to be local, but needs to be familiar with laws in the state in which the property is located.

As for selecting a title/escrow company, that’s a little easier than selecting an attorney. Title and escrow companies, by law, are neutral parties; they can neither favor the buyer nor the seller (nor the real estate agent). If you enter the key words “commercial title companies” into your favorite search engine, you’ll get a few to start with. We find it advantageous, however, to work with an office that’s local and is familiar with closing practices of that city or state.