Due diligence is a process through which commercial real estate investors can protect themselves from buying properties that might turn out to be bad investments. In a bid to know how much time they have to do this, many investors ask, how long is the due diligence period in commercial real estate?
How Long Is the Due Diligence Period in Commercial Real Estate?
Usually, the due diligence period for commercial property lasts for a period of 30 and 60 days. The due diligence period, also known as the investigative period, should be long enough for a buyer to conduct the necessary investigation and inspections to ascertain whether or not a property is a good choice.
The length of the due diligence period for commercial property is subject to change, depending on the specific needs of the buyer. This is because, during this period, the buyer has to determine whether the property suits the particular requirements for the business it is intended for. The time needed for this varies from business to business.
When Does the Due Diligence Period Begin?
Since due diligence is used to determine whether or not a commercial property is a good deal, it is best carried out as early as possible in commercial real estate to determine its track record. Due diligence could be carried out either before or after the signing of the purchase and sale contract.
If carried out after signing, then the buyer has the right to terminate the contract while the due diligence period is still ongoing, on the grounds that the property does not suit his exact needs. If carried out before the signing of this contract, however, the seller might require some form of purchase agreement signed to protect his interest.
Factors That Affect the Length of Due Diligence Period
As mentioned earlier, the duration it takes for due diligence period to be fully executed for commercial real estate is subject to change, because the specific requirements that need to be satisfied vary based on the intended use. Here are a few factors or best practice that could either make the due diligence period shorter -less than 30 days- or longer -more than 60 days-:
Many states have specific laws guiding the process of acquiring a real estate property and by extension, commercial property within their jurisdiction. These laws affect real estate transactions within the state, and by extension, could affect the length of time it takes to carry out due diligence in commercial real estate.
How Can State Laws Make For a Longer Due Diligence Period?
Using Kentucky as an example, where the state laws require that a municipal lien search has to be conducted before the closing of all real estate transactions carried out within the state. This implies that people looking for investment in a commercial real estate opportunity or commercial property in Kentucky in a bid to meet this requirement, might need a longer due diligence period.
How Can State Laws Make For a Super Fast Due Diligence Period?
State laws could also help in promoting a quick diligence period. In states where the laws are more lax, and for example, do not require real estate investors to carry out a municipal lien search or some other formality, due diligence could take a shorter time, possibly only about 30 days to complete. A real estate attorney can help out here.
While purchasing a commercial property, a zoning review has to be done and zoning rules have to be put into consideration to ensure that the intended use of the property falls in line with the land use classifications.
How Can These Regulations Make Due Diligence Period Longer?
During commercial due diligence, it could be discovered that a property cannot be used as a result of zoning regulations. When this happens, the buyer could either choose to make changes to the property or to its intended use, hence requiring extra time to apply for the necessary permits and licenses, which would consequently drag out the due diligence period.
How Can These Regulations Make Due Diligence Period Super Fast?
If the intended use of a commercial property fits into the zoning regulations, the buyer is free to go ahead with purchase without any restrictions as regards land use including undeveloped land. This saves the time that the buyer would have otherwise spent trying to alter the property to suit the rules, hence making the due diligence shorter than usual.
During your thorough due diligence period, it is advisable to contract the services of a professional broker, such as Si Vales Valeo Real Estate, to assist you with CRE analysis and negotiate deals with the professionals you need to ensure the due diligence is carried out correctly for your real estate investment.
Step By Step Process Of Due Diligence In Commercial Real Estate
Due diligence in commercial real estate involves a comprehensive investigation of the property and the deal’s terms to evaluate the risks and benefits of the investment. Here’s a step-by-step process of commercial real estate due diligence:
The first step in the process is to review the property’s legal documents, including the lease agreements, lease payment history, title reports, property surveys, zoning codes, and environmental reports.
The buyer’s attorney will review these documents (including the loan documents and financing options) to identify any legal or financial issues that may arise during the transaction. This plays a crucial role in investment decisions as it can impact investment goals and business licenses.
The second step is to conduct a physical inspection of the property for risk assessment. A property inspector or civil engineer will evaluate the property’s physical condition and provide a report to ensure you get a fair deal.
This physical assessment includes reviewing the property’s building and structural components, such as the roof, foundation, HVAC, electrical and plumbing systems, other factors like whether lead based paint was used, and any other amenities, such as pools, elevators, and parking areas (as is found in an apartment building).
Conducting a proper environmental review involves evaluating the property’s environmental condition, including the potential presence of hazardous materials, such as lead, asbestos, or mold. An environmental consultant will review the property and conduct soil and water tests to identify potential hazards. The neighbor’s property may be used for assessment as well.
The purpose is to assess the environmental risks associated with the property and determine the extent of any remediation or mitigation necessary. The environmental reports could also factor into property management.
The buyer will review the entity’s financial status within this time period or real estate due diligence timeline, including the income statement, cash flow, and balance sheet to eliminate financial uncertainties.
This analysis will help the buyer understand the property’s current and potential financial performance, such as rent roll, property tax payments, rental income increases and expense reductions, since this can impact future financial stability and is necessary for assessed valuation.
The market analysis involves evaluating the local commercial real estate marketplace to identify trends, opportunities, or challenges that may impact the property’s value or performance and its financial merits. The analysis includes reviewing comparable properties, vacancy rates, rental rates, rent roll or tenant’s rental payment history, and market demand for the property type.
These factors may be very informative for adequate to determine if it would be an income producing property. These are factors that have to be checked off on the commercial real estate due diligence checklist.
The buyer’s attorney will review the purchase agreement, lease agreements, existing permits, past litigation history, property records, property descriptions, and any other legal documents and material correspondence associated with the transaction.
They will identify elements affecting such as any legal risks or issues, including liens, encumbrances, and zoning or relevant property codes, violations and avoid legal issues. If there was a previous property manager, they could be contacted as well.
Closing the Deal
Once the process is complete, the prospective buyers can move forward with the purchase agreement, negotiate any necessary changes, and close the deal. This process involves transferring the funds and the legal ownership of the property.
During your detailed due diligence period, it is advisable to contract the services of a professional broker, such as Si Vales Valeo Real Estate, to assist you in these investigation processes and negotiate deals with the professionals you need to ensure the due diligence is carried out correctly and that you are getting an otherwise profitable deal.
Environmental Investigations in the Due Diligence Process
Environmental investigations are an essential component of the process for commercial real estate transaction negotiations because of the potential risks environmental contamination poses to human health and the environment. Environmental investigations/ environmental assessments or an environmental suitability assessment typically involve a Phase I Environmental Site Assessment (ESA) and, if necessary, a Phase II ESA. These steps are necessary to ensure the property’s long-term value and viability, and site consultants may be involved.
A Phase I ESA is a preliminary investigation that includes reviewing historical records, regulatory databases, and site inspections to identify potential environmental contamination in commercial properties. If the Phase I ESA identifies any potential issues, a Phase II ESA may be necessary to conduct further testing and sampling to determine the extent of the contamination. This would be at the sole discretion of the expert.
During the process, the buyer or their environmental consultant will typically require access to the commercial properties and review all relevant documentation, including regulatory agency files, environmental assessments, and permits. The environmental consultant will also conduct interviews with current and former owners, occupants, and other stakeholders to understand the property’s environmental history comprehensively. All of these are a part of the due diligence checklist, even before the money deposit.
Seller’s Requirements During the Due Diligence Process
The seller or current owner plays a critical role during the process in commercial real estate transactions since it is the seller’s possession. The seller’s primary responsibility is to provide accurate, complete, and up-to-date information about the property to the buyer. This includes physical conditions, environmental hazards, legal documents, and financial reports. Some of these documents in the due diligence checklist include the following:
- Tax bills (necessary to avoid tax issues)
- Financial statements and reports
- Existing leases/ tenant leases and lease payments
- Zoning documents
- Title insurance policy (from a title insurance company)
- Title report
- Government permits
- Service contracts
- Surveys and site plans
- Approvals and certifications
- Architectural drawings
During the estate due diligence process, the seller and seller’s attorney should be prepared to respond to any questions or concerns the buyer may have as they may be liked to the purchaser’s intended use of the property. This may involve providing additional documentation or arranging for further inspections before proceeding with the purchase and sale agreement. The seller should be available to answer questions promptly and openly to help move the transaction forward.
Sometimes, the seller may be required to make repairs or address environmental hazards discovered during the due diligence. The seller should be prepared to negotiate these repairs or provide compensation to the buyer to ensure that the deal proceeds as smoothly as possible. This would be at the sole discretion of both parties.
This section provides answers to questions that you might have as regards due diligence.
Can I Back Out of a Commercial Real Estate Deal After Due Diligence Period?
Yes, you can decide that you no longer want to purchase a commercial real estate property, even after the agreed-upon due diligence period is over. However, you would be doing this at the risk of losing your earnest money deposit, except if you have proof that the seller hid important property problems, such as a property title issue or title defects.
What Is a Due Diligence Fee?
Due diligence fee is an amount of money a buyer might be asked to pay to a seller for the due diligence period. This fee is to serve as compensation to the seller for taking his property off the market for the buyer to conduct inspections and is usually refunded to the buyer at closing. This is not common for residential property.
All real estate transaction differ based on type, location, market trends, pricing, and many more, and should therefore have their distinctive legal due diligence. The length of time this period takes should be largely dependent on the buyer’s unique requirements and should not be tailored to fit any other standards.