In commercial real estate, due diligence is the homework you should do before purchasing a property. Due Diligence should be completed before finalizing an agreement for purchase. It involves the systematic review and analysis of the property to confirm the aspects of a deal as presented by the selling agent are valid. Four areas for due diligence are physical, financial, environmental, and legal. The time to complete due diligence is between 30 and 60 days. In instances, such as a rezoning, environmental remediation or complex financing, a longer time can be negotiated between the parties.
In examining the physical aspects of the property, the process may start with obtaining copies of property surveys, photos, site plans, zoning, engineering reports and building drawings and any certifications such as LEED. Architectural and structural issues should be looked at. These include, building façade, roof, internal walls, floors and ceilings and amenities within the building. Driveways, walkways, ramps, and stairs should be inspected for their condition and functionality. All mechanical and electrical systems, such as power and water and wastewater capability, Internet and fiber optics, and HVAC. Do all existing systems complying with current regulations, if not, required actions and costs to rectify?
For financing your business plan and cash flow projections should indicate what you can afford including future borrowing capacity. In a tenanted building you want to see the rent roll, operating expense statements, assess the quality of the tenants, lease terms and review all leases. It important to note any capital expenditures required. Are there changes you can make to reduce expenses or raise rents? It is best to be in contact with your lender to confirm that they are onboard to finalize the financing based upon your discovery.
Many lenders require a that a property have no environmental issues. Some lenders may require a phase 1 and/or a phase 2 environmental report to satisfy their comfort level in financing the property. In Ontario there two options when conducting assessments. One is based upon Canadian Standards Association (CAS) Z769-00 standard and the other option is based upon Ontario Regulations O.Reg. 153/04 and 511/09. The CSA is primarily used for real estate transactions. Use of Ontario Regs option is most frequently used for zoning, building permits, and Records of Site Condition.
A phase 1 environmental report assesses current and historical uses of the property and its surrounding area to determine the potential for contaminated soil, ground water, asbestos and lead based paints. A phase 2 environmental report is based upon findings from a phase one environmental. It is used to determine if contamination exists and to what extent. Phase 2 reports are used where there is an adjacent site or the prospect site had uses that had potential for contamination such as manufacturing, dry cleaning, service station or properties with above or underground storage tanks.
It is critical to have a lawyer involved in the process to ensure there are no issues with title, easements, zoning, permits, encumbrances, liens, landlord tenant disputes or disputes with neighbouring property owners. Lawyers can review current leases, draft new leases, and prepare legal documents for the deal such as the agreement of purchase and sale and consult with lenders on financial factors necessary for closing the deal.
Finally, it is important to have your due diligence process well organized in terms of records keeping and timelines. Many processes can run concurrently. Make sure each task is assigned to someone with clear task-completion deadlines and regular follow up with them regularly. If possible, ask existing tenants and employees what they like or do not like about the property. What could be improved. It’s sometimes amazing what people will suggest!
