What to Know About Due Diligence in Commercial Property Transactions
When one purchases a commercial real estate property, it goes without saying that they are making a substantial financial investment. They are putting their finances on the line and may face litigation if something goes wrong.
Thankfully, there are some built-in protections that potential buyers can avail themselves of before the transaction closes. They can conduct due diligence to learn more about the property and various issues that can cause problems after the deal closes.
Never overlook due diligence in commercial real estate transactions. This process ensures you thoroughly investigate the property and uncover potential issues or risks before finalizing the deal. By conducting proper due diligence, you can minimize the chances of encountering costly surprises down the line.
Due diligence is more than just kicking the tires. It is about going under the hood of the property to learn about any significant issues, such as those involving safety, financial risks, and even possible lawsuits.
You only get one chance to perform due diligence before closing the deal. Otherwise, the seller can stick you with losses if the property has a problem.
A commercial real estate attorney will advise you on the due diligence process, and you should consider hiring them to perform due diligence for you because they know what to look for and have experience in this area.
A commercial real estate lawyer’s work can take possible hassles off your plate and save you money.
One of the key benefits of having a lawyer on your side during the due diligence process is their experience in legal matters. They understand real estate law and can guide you through the various legal aspects of the transaction.
From reviewing contracts and leases to conducting title searches and resolving zoning issues, a lawyer can handle all the legal aspects with utmost precision.
As a potential property owner, you are already spending enough money to make the purchase. Hiring a commercial real estate lawyer ensures the deal’s success.
What Is Due Diligence, and What Does it Mean for Your Commercial Real Estate Transaction?
Due diligence can help you stay out of trouble ahead of time. This process describes the work you put in on the front end before the deal closes, and by conducting thorough due diligence, you can mitigate risks, make informed decisions, and ensure a successful commercial real estate transaction.
You will perform due diligence on the transaction’s counterparty and the property involved in the deal. The goal is to learn as much as possible in advance to avoid potential problems before they arise.
You should only go through with a deal if no unmanageable risks hurt your investment or you addressed the ones you have learned about in the due diligence process.
What Types of Due Diligence Will You Perform in a Commercial Real Estate Transaction?
Knowing the party you are doing business with when engaging in a commercial real estate transaction is essential. Many lawsuits arise because business parties do not always know each other at the time of the transaction, and they only discover issues when there are difficulties after closing the deal.
You may want to research the following things about the other party to your commercial real estate transaction:
- Whether they have a history of litigation with business partners
- Their financial stability
- History of compliance with the law
- Their general reputation
- Learning who owns and controls the business
In addition, you should perform the following types of due diligence for the property itself.
Environmental Compliance
The property’s prior owner should have followed all environmental rules and regulations. Unfortunately, there are scenarios under which you are liable for cleanup costs if the preceding owner has emitted toxic pollutants. You must evaluate any contamination risks and the potential for a possible cleanup.
You may need to perform environmental due diligence in a commercial real estate transaction:
- Phase I is when you will identify potential environmental concerns. Here, you will review historical records to learn about compliance, interview parties with knowledge, and perform your own reconnaissance on the site. This step of due diligence is to know whether there are any problems with the site and their extent.
- Phase II due diligence is necessary when you learn of potential environmental concerns. You will need to dig deeper to confirm whether there is contamination. Your due diligence may involve a physical sample test of the soil to determine whether toxins are present.
Title and Ownership Due Diligence
When purchasing any property, you need to ensure that you have unencumbered ownership of it. There may be various title issues, meaning the owner should not transfer the property.
For example, someone may have placed a lien on the property, whether because of unpaid taxes or because the prior owner did not pay a contractor for their work. Liens attach to the property itself, so you are subject to them if you bought the property without realizing that there was an encumbrance.
Performing a title search is one of the forms of due diligence that you will do before the deal can close. Not only is it wise, but a lender will also require a thorough title search before you can obtain a commercial mortgage.
A title search can reveal any liens or legal controversies about the ownership of the land. A commercial real estate lawyer can conduct the title search on your behalf. Even if you have performed a thorough title search, it is prudent to purchase title insurance, and a commercial lender may even require it.
Zoning and Land Use Compliance
Just because a property is commercial does not mean you are guaranteed to use it however you choose. Land use and zoning laws can dictate allowable uses of property in a given area, and regulations can restrict specific types of usage in an area.
In addition, a zoning variance may allow you to use the property for your intended purposes, even though laws in the area restrict some uses.
Your uses must follow the local and state laws. Otherwise, you are subject to legal action and can incur substantial losses on the property. The property should not cost nearly as much if laws do not allow your intended usage.
You need to know the laws before you purchase the property and have a strategy for dealing with any restrictions that can impact your usage.
Structural and Physical Inspections
You must know if the existing buildings on the property have the necessary structural integrity. You must inspect the structures visually and physically to learn about their condition.
Further, the buildings on the property must comply with the prevailing building codes. As the property’s new owner, you are responsible for compliance and must make any repairs to the buildings if they are not up to code.
You must learn the applicable building codes and physically inspect the property to understand whether there are any violations.
If you detect any potential issues before the deal closes, you can insist that the seller make the necessary repairs. You may even adjust the property’s purchase price if you choose to complete the deal with defects in the structures.
Contractual Reviews
The existing owner may have entered into contractual agreements regarding the property. If you purchase a building with existing tenants, one or more lease agreements will likely survive the deal’s closing.
As the new property owner, you inherit these contracts and must follow their terms just as the original owner did. You cannot remove tenants and terminate their leases if they have binding contracts. You need to familiarize yourself with the terms of the leases because you may face litigation if you do not follow them.
The leases may have specific clauses regarding the rent. There are potential prohibitions on raising the rent by more than a certain amount that escalators may govern. Existing tenants have the right to these contractual protections even if a new owner buys the property.
Review Existing Compliance
There are potential outstanding regulatory issues with the property you need to know about before buying it.
For example, the property may not comply with the Americans with Disabilities Act, and you may face ongoing fines that regulators will assess. In addition, the building may have existing permits that impose conditions you must follow.
You may have to deal with a history of non-compliance with laws and regulations as the new property owner.
You may have to perform due diligence in other areas depending on the facts and circumstances of your situation and the specific property. Organize yourself before beginning due diligence.
You should know the documents you must request and the questions you must ask.
Then, if issues arise during due diligence, you need to prepare to follow up and ask more questions. Your thoroughness will ensure you learn everything you need to know before deciding to negotiate the terms of the deal or walk away from it altogether.
How a Commercial Real Estate Attorney Can Help with Due Diligence
You may turn to a commercial real estate lawyer to conduct due diligence for you. The due diligence process is time-consuming, and you may not know precisely how to spot problems that can jeopardize a deal. There are many facts of due diligence, and you need someone who can spot the issues and look at them individually and in conjunction with other problems.
In other words, you must have someone who can take an on-ground view and look at things from the 30,000-foot view. When you hire a commercial real estate lawyer and allow them to conduct due diligence on your behalf, they will begin with a plan using their knowledge of this process.
Not only can a commercial real estate lawyer help you learn about potential issues, but they also understand the gravity of any potential problems and how they may affect your transaction.
They can foresee legal risks you may assume as the new property owner and know how they can affect your bottom line. They have the experience and knowledge to identify potential red flags or hidden risks associated with the property.
By thoroughly examining the property’s financial records, leases, and contracts, they can uncover any possible liabilities or problems that are not immediately apparent.
A commercial real estate attorney can also help negotiate potential solutions with the other party after you have learned of issues during the due diligence process. For example, if you assume liability when the deal closes, you can negotiate a downward purchase price or an indemnity agreement with the other party.
Ultimately, deciding whether to go ahead with a deal is your choice. However, you need to know everything possible before making the final commitment. You are still on the hook to make mortgage payments on the property and may even take on additional liability.
You must factor everything in when deciding whether to close the deal. Depending on the contract terms, you may still want to back out of the transaction after you have completed due diligence.
If you try to exit the transaction, a commercial real estate attorney can assist you in handling any issues, including potential lawsuits and countersuits.
Conducting due diligence is a critical step in any commercial real estate transaction. By enlisting the help of a skilled attorney, you can feel confident knowing that they are handling the process thoroughly and efficiently. They can provide valuable legal guidance, identify potential risks, and negotiate on your behalf.
Investing in legal representation during the due diligence phase is an investment in your commercial real estate venture’s success and peace of mind. Do not hesitate to contact a lawyer before embarking on your next commercial real estate transaction.