Commercial Real Estate
Importance Of Due Diligence While Investing In Commercial Real Estate
Oct 1, 2006, 17:03

Commercial real estate has intimidated several investors, as they have a perception that the risks are more than in other areas of real estate. This may be true, but it is one of the best ways to make huge profits. It will indeed not be a good idea for a novice with no experience to invest in commercial real estate. However, if you have a little bit of experience, are knowledgeable about the local market and factors that influence the rates, have the ability to value a property accurately, carry out due diligence, have a good backup team such as realtors, attorneys, have the ability to negotiate and get as low a price as possible, and have the capacity to fund projects within time-bound deadlines, you can succeed. It will help if you are skilled in the art of creative real estate investing, too, as huge profits can be made flipping multi-tenant commercial real estate properties. But the area that requires careful attention is due diligence, as it can help determine if the deal is worth making or not depending on the risks uncovered.

Importance Of Due Diligence

Due diligence is a crucial aspect of commercial real estate investing. The ability to perform extensive due diligence and analyze the effect the information can have on a deal is a necessary quality any successful commercial real estate investor possesses. Investors need to do due diligence during the negotiating period, as it will be necessary to ensure the seller knows exactly what sort of information you seek. If you have trouble with doing due diligence, there are certain excellent firms who can do the arduous task for you. Ample time provisions have to be made such as at least 30 days after all required information and documents have been presented, you could include a clause to extend the date if documents are delivered late without sufficient time remaining to examine them with a clause that the deal cannot go through unless you are satisfied all requirements have been met.

Keep track of each and every bit of information such as the financial records including rent roll, balance sheets, profit and loss statements, tax returns, insurance policies with the latest risk assessment report, any liability documents such as tax liens or other loans with details, deeds of the property, any contracts such as service or advertising contracts, all leases with all details, pay roll registers of the tenants, business license details, phone, water, fire system details, details about property tax records, any history of litigation, and structural and environmental survey reports. Study each document and verify its accuracy.

Leases are very tricky, especially for multi-tenant commercial real estate properties, so study them in detail, using an attorney to find out even the tiniest detail that may influence the decision to invest in the property. Learn all you can about individual tenants, their businesses, their history of rent payments, and factors that may influence their business. Are there any problem tenants with any particular area of conflict? If so, be sure to negotiate a lower price. A sure way to ensure all documents are presented for due diligence is to say that the price will be reduced on account of the risk taken. This will mostly work, as the documents are invariably presented quickly. Study the title deeds and the claims history carefully, and structure a general warranty deed if possible. Concentrate on the structural due diligence, too, by hiring appropriate agencies to do it for you.

The most crucial stage of due diligence is to evaluate the effect the information obtained from doing due diligence has an impact on the pricing of the property. If the risks appear to be greater, a lesser price will be justified. If you have done extensive due diligence, you will have the added advantage of not only convincing loan officers or lenders to grant your loan required to fund the project, but you will also have a means of convincing the owner why the price you quote may be right for the property with its inherent risks.

Perhaps the kind of property, which is relatively less risky, is the triple-net-leased multi-tenant property. The owner has a master lease and subleases to individual tenants. The tenants are responsible for all expenses incurred in operating the property, expenses like taxes and insurance as well as for maintenance of the property. Though due diligence for NNN properties are easier, the fact that tenants are responsible for maintaining can be a cause of concern when you will be investing so much on the property without the ability to control its maintenance.

So for anyone investing in commercial real estate, estimating the importance of due diligence and its effect on the deal are essential criteria for a successful career.

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