By Mike Migone, CCIM
Senior Investment Advisor
Investing in commercial real estate (CRE) can be a lucrative venture, but it comes with its share of risks and challenges. Paying heed to due diligence is one of the ways to help mitigate those factors. It’s important to keep an eye on certain details throughout the course of a deal to make it as trouble-free as possible.
Don’t miss the window
When you’re in the midst of a CRE transaction, there’s often a specific window of opportunity for getting a deposit back if the deal falls through for some reason. It’s crucial to understand and adhere to the terms of the agreement regarding deposits. Failing to do so could result in a substantial financial loss.
Insurance and zoning surprises
Before processing with a deal, be sure to examine the property’s insurance rates. These costs can significantly impact your investment’s profitability. Look out for any sudden increases in rates, as this could indicate potential issues with your property’s history, location, or condition. Do thorough research to ensure quotes you receive are reasonable and align with your budget.
Zoning regulations can be another complex and often overlooked aspect of real estate transactions. A property that seems perfect for your business today may not comply with local zoning laws, potentially limiting your future use of the property. Make sure to research the property’s current zoning and any potential zoning changes in the area.
Careful property inspection
A comprehensive property inspection is a non-negotiable step. Engage a qualified inspector to assess the property thoroughly. A qualified professional can identify any structural, mechanical, or environmental issues affecting the property’s value or your ability to use it for your intended purpose. The inspection results will provide valuable insights and negotiating points in the deal.
Due diligence is equally essential when it comes to financing a CRE deal. Carefully evaluate your financing options, including interest rates, loan terms, and the impact of these terms on your overall investment. A complete analysis of financing should take into account the potential impact on cash flow, debt service coverage, and the long-term sustainability of your investment.
Compliance with local, state, and federal laws is vital, obviously. Look for any legal issues related to the property, including but not limited to environmental regulations, building codes, and lease agreements. Failing to address legal matters can lead to costly disputes and, in some cases, property forfeiture.
Lease, expenses and income
It is important to look for an leasing issues that might affect the property’s overall value. You don’t want any surprises after the fact, such as early termination clauses, caps on a tenant’s expenses or a tenant having the right of first refusal option to purchase the property.
For leased properties, it’s highly recommended to review income and expenses. On the expense side, there are often fees for property management, vacancy loss, repairs, and maintenance, along with reserves for capital improvements that may be excluded by the seller.
Concerning income, make sure there’s a wall of separation between rent and sales tax on incoming cash. Confirm any expenses that might be added to the cash flow, expenses that do not apply to you (e.g., interest payments on loans).
In addition to the above points, there are several other due diligence factors to consider during the process. For example, checking ahead of time on environmental factors can prevent some serious headaches. Investigate potential environmental risks associated with the property, such as soil contamination or the presence of hazardous materials.
It’s always a good idea to perform a market analysis, too. Assess the current and future market conditions, including supply and demand trends, economic indicators, and potential changes in the area.
Finally, have a clear exit strategy in place to address scenarios where you may need to sell the property or exit the investment.
In the world of CRE, knowledge is power, and due diligence is one key to that knowledge. By diligently examining these factors, investors and advisors can make well-informed decisions that protect their investments and lead to profitable outcomes. Remember, there’s no substitute for having an experienced professional help you through the process. We at SVN Commercial Advisory Group have the knowhow to help clients work through even the most complex deals.
Senior Investment Advisor