Like most high-dollar investment opportunities, commercial real estate presents significant risks. To mitigate these risks and maximize the potential for returns on the initial investment, commercial real estate transactions demand that interested parties conduct extensive research prior to signing a purchase agreement. Legal due diligence is the process whereby a potential buyer evaluates a potential investment in a commercial property to confirm its value as represented by the seller and to uncover any problem areas that might need to be addressed. The commercial business attorneys at Harrison Law, PLLC, provide a wide spectrum of legal services in all aspects of commercial law, including helping real estate buyers and sellers conduct their legal due diligence before engaging in commercial real estate transactions. Call (480) 320-2310 to schedule a consultation.
Commercial Real Estate
In commercial real estate, due diligence typically involves reviewing relevant information about the property provided by the seller, verifying its accuracy, and sometimes conducting further independent investigation, as needed. Many different activities may go into the due diligence phase of a project, including assessing the condition of the property, examining its market value, analyzing financial performance, and reviewing legal documents, among others.
Commercial real estate is often rented to industrial or other tenants, so due diligence may also include an assessment to determine what local ecological requirements and zoning regulations may affect future tenancy agreements. After due diligence is completed, the potential investor should have a comprehensive understanding of the property’s potential.
The Financial Impact of Commercial Real Estate
According to the International Monetary Fund, the total value of the commercial real estate market (CRE) in the United States is roughly equal to 100% of the country’s GDP, making CRE a major factor in the American economy. Unsurprisingly, commercial real estate purchases tend to constitute large items in investment portfolios, both private and corporately owned. Investors looking to purchase a commercial real estate property may understandably be cautious as a result.
Due diligence in commercial real estate investment helps uncover issues with a property before the prospective investor transfers any funds. This type of investigation helps investors mitigate risks by identifying any potential issues that may arise in the future. For instance, it may be discovered that the property has zoning restrictions that would limit its use. Another example is if an investor discovers that the property has environmental hazards that would disrupt business operations. Identifying these issues early on can help an investor to negotiate a favorable deal or decide to walk away from the investment altogether.
What Is The Due Diligence Process?
In real estate transactions, due diligence typically means examining the parcel of land involved in the property, the integrity, amenities, and adaptability of all structures on it, and crucial factors for the eventual use of the property, such as ease of access, environmental impact considerations, and state or local regulations that may impact the range of industries for which the property might be further developed. Exploring a property from as many angles as possible helps investors get an idea of what the potential risks and rewards of the investment are. In transactions involving commercial real estate, due diligence may also give the prospective buyer the leverage to negotiate better terms for the acquisition.
Activities that may be part of this detailed investigation include but are not limited to:
- Rigorous review of the property’s physical condition
- Examination of the property’s market value and legal status
- Site inspections and environmental assessments
- Review of income and expense statements and leases
- Examination of title and survey reports
- Verification of property tax and assessment records
Who Conducts Due Diligence?
Commercial due diligence is typically performed by a team of professionals composed of real estate brokers, appraisers, attorneys, and accountants. The job of each of these experts is to provide a detailed report of the property’s current state as well as its future potential. Depending on the property’s complexity, the services of inspectors, engineers, and environmental specialists may also be requested.
Independent reviews from trained professionals in these fields may be especially important when the property in question is designed or optimized for industrial applications that may require environmental impact assessments. A commercial business attorney who specializes in handling environmental compliance may be able to help you determine which assessments are most appropriate for the commercial real estate transactions you are considering.
How Long Does Due Diligence Take?
The duration for legal due diligence in commercial real estate transactions typically ranges anywhere from 30 to 60 days. Several factors influence the length of the process, including the specific requirements stated by the buyer and seller, the complexity of the agreement between the parties, whether or not any legal permits or government approvals are required, and many more. If you want to explore your options for investing in commercial real estate in Arizona or need help with legal due diligence, consider contacting Harrison Law, PLLC to schedule a consultation to discuss your needs.
Checklist for Conducting Due Diligence
The checklist below covers the necessary steps for conducting due diligence from the perspective of the investor:
- Gather and organize the paperwork. Each real estate transaction is unique, but the paperwork in such transactions often includes leases, appraisals, zoning documents, governmental documents, tax forms, photos of the property, property title, environmental reports, and any other relevant documents. Collecting and organizing these documents so that they are readily available to all involved in the due diligence process is a sensible first step.
- Explore your financing options. Determine the amount of capital at your disposal and, if necessary, assess your borrowing capacity. In many instances it can be helpful to look into financing options from various lenders, and determine which options are more favorable. According to the American Bar Association, lenders may require additional documents in commercial financing, including an environmental indemnity agreement, an estoppel certificate, a guarantee of the loan, and others.
- Inspect the property. Potential buyers will need to undertake a thorough property inspection early in the due diligence process––examining each building’s structure, testing for lead or asbestos, and taking other steps to assess the property’s condition and ensure there are no obvious issues. You can either do this yourself––as long as you have the necessary skills to perform the assessment––or hire a professional inspector.
- Bring in site consultants. Consider bringing in site consultants who can provide additional expertise on market analysis, environmental issues, and other necessary evaluations. Site consultants can help identify potential risks and opportunities and provide cost projections, among other things.
- Find an architect and engineer. An architect and engineer will examine the property’s structure, design, and systems. Their insight is valuable because they can provide an assessment of the building’s condition, the required renovations or updates (if any), and any potential zoning or code compliance issues.
- Address the legal issues. Now it is time to address any potential legal issues that have been uncovered in due diligence. Determine if there are any errors or omissions in the documents and assess any potential liability risks. Seek the assistance of a lawyer who has ample experience in transactions involving commercial real estate to complete this step.
- Close the deal. Often due diligence results in a series of communications between the potential buyer and the person or organization offering the property for sale. Once both parties have approved all the findings and any issues uncovered during due diligence have been satisfactorily resolved, it is time to close the deal, which usually involves finalizing any financing arrangements, signing the contract, and transferring ownership of the property.
Get Help With Legal Due Diligence for Commercial Real Estate Transactions
The benefits of completing a comprehensive appraisal outweigh the risks of neglecting it. Because legal due diligence is an exhaustive and all-encompassing review, buyers and sellers often do not realize what goes into this process. The results-driven and competitive attorneys at Harrison Law, PLLC, assist both individuals and small/large organizations throughout all stages of commercial real estate transactions. Call (480) 320-2310 to receive a consultation to get help with your real estate matters.
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This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
