Due Diligence Checklists – For Commercial Real Estate Transactions
Planning to purchase or finance Commercial or Industrial Real Estate? Shopping Center? Office Building? Restaurant/Banquet property? Parking Lot? Storefront? Gas Station? Manufacturing facility? Warehouse? Logistics Terminal? Medical Building? Nursing Home? Hotel/Motel? Pharmacy? Bank facility? Sports and Entertainment Arena? Other?
A KEY to investing in commercial real estate is performing an adequate Due Diligence Investigation to assure you know all material facts to make a wise investment decision and to calculate your expected investment yield.
The following checklists are designed to help you conduct a focused and meaningful Due Diligence Investigation.
Basic Due Diligence Concepts:
Commercial Real Estate transactions are NOT similar to large home purchases.
Caveat Emptor: Let the Buyer beware.
Consumer protection laws applicable to home purchases seldom apply to commercial real estate transactions. The rule that a Buyer must examine, judge, and test for himself, applies to the purchase of commercial real estate.
Due Diligence: “Such a measure of prudence, activity, or assiduity, as is proper to be expected from, and ordinarily exercised by, a reasonable and prudent [person] under the particular circumstances; not measured by any absolute standard, but depending upon the relative facts of the special case.” Black’s Law Dictionary; West Publishing Company.
Contractual representations and warranties are NOT a substitute for Due Diligence.
Breach of representations and warranties = Litigation, time and money.
WHAT DILIGENCE IS DUE?
The scope, intensity and focus of any due diligence investigation of commercial or industrial real estate depends upon the objectives of the party for whom the investigation is conducted. These objectives may vary depending upon whether the investigation is conducted for the benefit of (i) a Strategic Buyer (or long-term lessee); (ii) a Financial Buyer; (iii) a Developer; or (iv) a Lender.
If you are a Seller, understand that to close the transaction your Buyer (and its Lender) must address all issues material to its objective – some of which require information only you, as Owner, can adequately provide.
(i) A “Strategic Buyer” (or long-term lessee) is acquiring the property for its own use and must verify that the property is suitable for that intended use.
(ii) A “Financial Buyer” is acquiring the property for the expected return on investment generated by the property’s income stream, and must determine the amount, velocity and durability of the revenue stream. A sophisticated Financial Buyer will likely calculate its yield based upon discounted cash-flows rather than the must less precise capitalization rate (“cap rate”), and will need adequate financial information to do so.
(iii) A “Developer” is seeking to add value by changing the character or use of the property – usually with a short-term to intermediate-term exit strategy to dispose of the property; although, a Developer might plan to hold the property long term as Financial Buyer after development or redevelopment. The Developer must focus on whether the planned change is character or use can be accomplished in a cost-effective manner. A developer conducting due diligence will focus on issues involving market demand, access, use and finances.
(iv) A “Lender” is seeking to establish two basic lending criteria:
1. “Ability to Repay” – The ability of the property to generate sufficient revenue to repay the loan on a timely basis; and
2. “Sufficiency of Collateral” – The objective disposal value of the collateral in the event of a loan default, to assure adequate funds to repay the loan, carrying costs and costs of collection in the event forced collection becomes necessary.
The amount of diligent inquiry due to be expended (i.e. “Due Diligence”) to investigate any particular commercial or industrial real estate project is the amount of inquiry required to answer each of the following questions to the extent relevant to the objectives of the party conducting piccadilly grand