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How to do your homework: Due diligence checklist for commercial real estate

Commercial real estate (CRE) investment is for the experienced, which is why it is important to work with a company like NAI 1st Valley that can guide you every step of the way. Every investment carries risk, including real estate investments. A prime safeguard in CRE investing is called due diligence. It is a period of time during which the purchaser can physically enter, examine, and inspect the property structures. Just as important, if not more so, this is the time when you can inspect the fundamentals of all seller financing and compliance obligations. These include potential liens, possible encroachments on the property, lease obligations to the tenants, and any potential liabilities from previous owners’ activities. 

Oft-misunderstood by non-professionals during due diligence periods is the examination of zoning restrictions. Commercial real estate has its own zoning codes in most cities and towns across the United States. Zoning codes help establish specific districts for similar use properties. For example, residential districts are typically separated somewhat from commercial districts; there are also multi-use districts, where commercial, retail, and light industrial businesses may be located alongside residential properties. Zoning codes are also intended to separate heavy manufacturing industry from residential environs.

You might assume since the property housed a billiards club you can lease it to a coffee shop and gallery, but…can you? You must ensure that any proposed business activities are allowed for by your commercial property’s zoning regulations and property codes. You don’t want to find out down the road that your proposed tenants and activities will not be allowed or will take months, or even years, for approvals. Verify the time frames for city approvals for building permits and business licenses. Environmental suitability assessments might also be required by your lender before financing the transaction. NAI 1st Valley brokers have established reputable contacts in its CRE network including environmental engineering firms that can provide such assessments.

Whether you are new to commercial real estate (CRE) investing or are a seasoned investor, the same rules apply. You must fully understand the property you are acquiring:

  • Perform due diligence.
  • Follow the principles of sound investing.
  • Understand the changing nature of commercial real estate.
  • Know how to structure leases that will work best for you as the CRE owner.
  • Evaluate the commercial property’s existing cash flow:
    • Revenue
    • Contractual rent
    • Speculative rent
    • Operating expenses
    • Capital expenditures and leasing costs
    • Debt service

At NAI 1st Valley, our brokers educate both new and experienced investors about what to ask and consider before investing. We weigh the risks and benefits of selling your commercial property asset versus the risks of holding onto it. 

With over 100 years experience in the commercial real estate industry, our insights allow us to design your CRE portfolio to make the most of current market trends. We understand how what is attractive in the market right now may change and what types of properties are best suited for those potential changes.

Due diligence and the principles of sound investing

Due diligence is a critical stage in any commercial real estate acquisition in which you as the potential buyer have received all the necessary documentation. Take this opportunity to thoroughly review and verify any potential trouble spots regarding the actual property, its title, the current tenant relationships and the potential need to negotiate new tenant leases. 

Here are just some of the important documents to review during the due diligence period:

  • Title policy
  • Property descriptions, surveys and topographic studies
  • Construction blueprints
  • Engineering plans
  • Legal description of property
  • Zoning compliance certificate and zoning approvals including variances and any pending applications
  • Time frames for city approvals for building permits and business licenses
  • ADA compliance

It is vital that you as a CRE investor understand these principles in depth. Many investors prefer to enlist our real estate expertise to handle the day-to-day management of their investment properties, making these investments truly passive income in that the investor’s prime responsibility lies in collecting their payments. 

Hiring a Property Management Company: NAI 1st Valley’s Property Management Services

Since CRE is for experienced investors, NAI 1st Valley Management makes it easy for you by managing the property risks so that you can relax and just manage your investment income. We have over 100 years combined experience handling successful CRE and negotiating troublesome contracts. One of the first things we ensure is that you have the right tenants. This is one of the most crucial steps to ensure your investment is soundworthy, secure, profitable and worry-free. 

Having the right tenants vastly increases the value of the commercial property. CRE is valued on the property’s revenue—i.e., the cash flow generated by the commercial property. Therefore, you create stronger cash flow and higher values by having the right tenants. You will also benefit from lower turnover costs. CRE has much lower vacancy rates due to the typically longer commercial leases than are seen in average single tenant leases. 

In addition to performing due diligence and negotiating beneficial leases for you as the owner of your commercial property, we secure the best qualified tenants, provide property management and maintenance services. We do it all as your property management company. Learn more at 1st Valley Management!