Don’t cut corners on due diligence in commercial real estate transactions

People routinely involved in commercial real estate transactions recognize the due diligence stage as one of the most critical times. Typically occurring for an average of 30-90 days after the signing of the initial contract, the due diligence phase is often when most deals fall apart, if they are going to do so.

Why? Because it’s when most of the dirty laundry comes out and property defects, title liens, easements, zoning issues and environmental problems are often uncovered. Any one of these problems could be a deal breaker, depending on the amount of money required to fix them. In some cases, the disclosure of such “flaws” might not prevent the deal from moving forward, but they could provide leverage to the prospective buyer who could use them to renegotiate the terms of the sale.

The size and scope of the deal will ultimately dictate everything included as part of the due diligence search, but most times, at minimum, a title review is conducted that examines such things as property lines, easements and boundaries.  A physical inspection of the roof, plumbing and other mechanical systems should always be undertaken. It’s equally critical to verify that the property is zoned for the intended purposes.

If the property is located on wetlands or other environmentally compromised areas, a whole other set of due diligence requirements applies. The scope of the environmental assessment often depends on the age of the property and its previous use, which will dictate if a Phase I and Phase II environmental report is necessary, including possible required soil testing.

Easements, although not necessarily problematic, should be considered, because they may provide access to third parties which could interfere with intended operations. Sometimes the problem is short-term only, such as in the case of an old mortgage that was not properly released and now complicates clear titling. The goal is to wind up with as clear a title as possible.

The type of financing made available for the transaction will also affect due diligence, as different lenders require different things during the process. If there are tenants on the property, their leases should also be reviewed to ensure you understand the rights and obligations associated with them. There may also be covenants and use restrictions that need to be understood as these could dictate hours of operation, landscaping requirements, truck access limits and the like.

The need to do proper homework cannot be over-emphasized. Many properties look great from a distance, but a more careful look might unveil what they’re really worth or what might be required to adequately prepare them for their newly intended purpose. The property may be located in a flood zone, for example, and the lender may require extra flood insurance, which is very expensive.

Environmental issues are often the most costly and difficult to remediate, but they aren’t necessarily deal breakers. They must be considered in the final negotiations, however, as their costs can escalate quickly.

To help ensure a successful transaction, consider these tips:

• Don’t fall in love with a specific property until the due diligence has been completed because then you may not be able to walk away even when you should.
• Hire the right deal team. This is not the time to skimp. You need people who do this for a living because, chances are, you don’t. Make sure your brokers, surveyors, environmental specialists, attorneys and accountants are well versed in commercial real estate and have the experience and resources to accurately assess whether you can afford the property and make money on it.
• Look at the whole picture. This means looking at the property from a financial and operations perspective to ensure it’s right for you.
• Develop a cost plan in advance that outlines under what circumstances and at what costs you’ll be willing to walk away from the deal.
• Build in added costs for assessments and possible remediation into your budget.
• Don’t be afraid to renegotiate the deal based on what you’ve learned during the due diligence period.
• Be realistic. Most due diligence processes uncover something, as there are few perfect properties.

Source – Crain’s Cleveland Business  |  Image – Western Investor

Environmental due diligence is a critical component of any property transaction where potential environmental risks are a concern and is required as part of acquisitions, mergers and divestitures with the assessment focused on identifying actual or potential environmental liabilities arising from current and historical property usage and determining the costs of addressing these liabilities. The assessment generally includes a wider regulatory assessment to include planning permission compliance, permits and licences as applicable.

To help clients minimise risks and protect themselves from liability, Verde Environmental Consultants provide a clear understanding of the impacts with predicted costs. Our tailored advice is commercially focused, clearly communicated, delivered on time and backed with appropriate levels of professional indemnity cover. 

View our range of Environmental Due Diligence services.

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