DUE DILIGENCE IN PURCHASING COMMERCIAL REAL ESTATE
By: John B. Newman
Once a buyer has identified a building to purchase, whether it is a warehouse, an office building or a multi-family residential building, he must perform due diligence before consummating the sale. The scope of due diligence depends upon the nature of the property being purchased so that, for instance, the due diligence in connection with the purchase of a vacant 300,000 square foot warehouse would undoubtedly be move involved than the due diligence in purchasing a two-family residence. However, many of the principles remain the same.
Building Conditions — All of the functional systems of the building must be evaluated by appropriate professionals. These include the roof, heating, ventilating and air-conditioning equipment, electrical and plumbing. Similarly, exterior conditions such as loading docks, landscaping, lighting and parking areas must be evaluated. Signs of potentially substantial problems such as cracked support walls, should be fully investigated.
Leases — Copies of all leases should be obtained and studied. It is important to understand where the responsibilities of the tenants end and the responsibilities of the landlord begin. In order to make a projection of the operating income of the property, all expenses paid or payable by the landlord should be reviewed as well as the payments by the tenants so that the buyer can determine whether or not the tenants are paying what they are obligated to pay. Care should be taken to review the leases for options to renew and to determine if they have been exercised. Similarly, any rights of first refusal or options to purchase should be clearly understood. Estoppel certificates should be obtained before closing.
Environmental — It is important to obtain a competent environmental review of every property before its acquisition because if there are any hazardous substances on or under the property, the new owner may be liable for their cleanup. Most commonly buyers engage qualified environmental consultants to perform what is called a Phase I environmental investigation. This includes review of records at the state and federal offices having jurisdiction over the property to determine if there are or were any files pertaining to this property or any neighboring properties. The neighboring properties are important because contamination can flow by ground water or surface water from one property to another. The Phase I investigation also includes an examination of the property for areas of environmental concern. If such concerns are identified, the consultant may recommend further testing, some of which may involve excavation and lab testing and all of which is expensive. These are commonly called Phase II investigations. It is essential that the environmental risk in proceeding with any transaction be completely appreciated before proceeding.
Land Use — A buyer must determine what are the permitted uses of the property and whether or not the property is in compliance with all applicable zoning laws. Care must be taken to look not just at the existing uses but the buyer’s anticipated uses to be sure that they are permitted. This is particularly critical if the property is vacant or the buyer intends to occupy itself. As part of such review, the buyer should try to determine if there are any applications pending for development or for variances on any neighboring properties which could adversely affect the subject property. While the buyer should review the zoning code, together with any files of the Building Inspector, Zoning Office or Planning Board regarding the subject property, there is rarely a good substitute for meeting with building inspector and other town officials and asking pertinent questions. Use of the OPRA statute, which allows the public to obtain public documents, is also valuable to obtain information regarding the property and adjoining property.
Title and Survey — Besides the minimum, obtaining marketable title, it is important to be sure that there are no easements or restrictions or subsurface conditions which could interfere with the use of the property or adversely affect its value. There may be restrictions on the type of use which are far more restrictive than the zoning ordinances. There may be set backs which are inconsistent with planned expansion for the property. There may be underground pipelines or easements for same which likewise interfere with the existing or anticipated use of the property. All of these items must be explored and understood before proceeding with the purchase.
This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.