The economic downturn has created two schools of thought: one that holds back and one that sees opportunities to buy at a lower cost. The market for real estate to build or lease facilities is full of bargains and pitfalls.
Remember the old saying, “Don’t fall in love with it until you own it”? Due diligence is the most vital part of any commercial real estate transaction. A successful due diligence process may uncover some previously unknown information about a transaction.
Unlike residential property, which is bound by very strict disclosure rules, commercial property is sold almost exclusively “as is.” The initial purchase and sale defines, but is not necessarily limited to, the earnest money provisions, the due diligence period, conditions for acceptance, and the timeline for when the money goes “hard.” It is the buyer’s responsibility to assess the condition of the property during the due diligence period.
Many buyers assemble a due diligence team and work together through all of the potential issues that could arise. A due diligence schedule is usually drawn up to itemize all events and help keep the management team and the board of directors informed. It also provides a tool for the negotiation team and takes pressure off the executive team and the client.
The team works for you. Be sure the team is always on your side, looking for due diligence issues that need to be addressed. The foundation that gets laid at the beginning of a project is often times the most important work that is done in understanding what the challenges of a project will be.
The due diligence process can be cumbersome, and involves many common pitfalls. Developing an emotional attachment to the property during the due diligence process can create a tendency to skip over some necessary items. One should never assume that the property can meet the facility design parameters. In fact, never assume anything in the due diligence process. Another common pitfall is allocating inadequate resources for discovery. A discovery involves legal and technical resources, such as surveys and legal fees, and none of them should be overlooked due to costs involved. Be ready to put forth the money in order to get the most out of your search. Like anything else, the due diligence process often results in getting exactly what you paid for. Preliminary site planning should be a part of due diligence, to ensure that the site will accommodate all of your plans for it. This is best done before the purchase is finalized and you are out a lot of money, stuck with a property that isn’t suitable for your building plans. Lastly, do not assume that price negotiations end when the initial purchase and sale agreement is signed.
Conditions unknown are often discovered, and good due diligence will reveal issues that impact the ability to develop or occupy the property. These may or may not have cost impact and are often a basis of final price negotiation prior to the buyer’s release of contingency or acceptance of the property.
Key points in a successful due diligence process:
- Avoid rushing in too fast — allow sufficient time to complete a thorough discovery process (allow a minimum of 30 days after the delivery of the last document on your list)
- Engage a team of experienced development partners that work for you (allow the team to address the complex engineering & legal discovery issues in order to mitigate risk and expose potentially expensive problems)
- Prepare preliminary site plans and explore your options
- Meet during the discovery process with local planners and utility providers in order to review your design concepts
- Include legal counsel early in the process; don’t rely on the real estate broker to navigate contractual issues
Ordinances and development regulations are constantly changing, so don’t assume that your information is current. An attorney experienced with commercial transactions and land use will act as the watch dog for process and protocol throughout the transaction. The role of the attorney in this process is to navigate the condition of the documentation, while the real estate broker takes care of other matters. An attorney does not have the same interest in having the property change hands; he/she is not earning a commission on the sale as a real estate broker is. An attorney representing the buyer is the key individual who essentially validates that exchange of property as “free and clear” of encumbrances.
During the course of a transaction, be very careful to communicate exactly as the agreement requires. It is common for buyers to negotiate a great deal and then give the seller an out by not meeting the notification requirements of the agreement, only to have the seller wiggle out of the deal and sell to a more attractive or less diligent buyer. There is little money better spent than that spent on an experienced attorney acting solely in the buyer’s interest.
Other aspects of the due diligence process involve further legal aspects. The Purchase & Sale Agreement are “standard forms” and critical provisions in the process. A title report can back up documentation and may even reveal things about the property that one would never be able to obtain otherwise. Oftentimes, a property is found to be encumbered by easements, rights of access, or other recorded agreements that would not be revealed by a physical survey alone and difficult or impossible to incorporate in planning if available only via the title report or recorded description.
The due diligence period is really your opportunity to understand not only what needs to be done but also the cost impact of it.
Jim Haack, CEO email@example.com
Momentum Builds www.momentumbuilds.com
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