Due diligence often gets short shrift because it’s the hard work, boring side of commercial real estate investing, but this research is often what separates the successful investors from the failures. 

In regards to commercial real estate, the due diligence process refers to prospective buyers evaluating a property before its purchase. This comprehensive evaluation includes analyzing financial, legal, and physical aspects of the property with the goal of finding the potential risks and rewards, ensuring that the buyer makes an informed investment decision.

Here are ten common mistakes that proper commercial real estate due diligence can help you avoid:

1. Calculating incorrect property values

It’s always safer to be conservative in your valuations of a commercial property. Accurate evaluation of a property requires homework: pull up sales comps of recent commercial real estate transactions, check out other similar properties on the market, and talk to local commercial brokers about local property values.

2. Misunderstanding underwriting guidelines

Before you spend too much time conducting due diligence on any one particular property, it’s a good idea to run it by the lender you plan to request your loan from to find out how much they would consider lending you for it. Federal restrictions have forced bank lenders to be much more conservative in their commercial real estate lending since 2008, so if the property won’t fit into these guidelines, you’ll want to determine whether it would be a good candidate for a hard money loan.

3. Not checking whether the property is up to code

It’s a good idea to have a professional, such as a contractor, inspect the property conditions, looking out for spaces that may have been built out without a permit, to make sure it complies with municipal building codes as well as ADA codes to help you avoid costly legal issues after closing.

4. Overlooking nonstandard provisions in existing tenant leases

If you’re purchasing a rental property (retail or multifamily), it’s important to read over the leases for cancellation provisions, contraction provisions, fixed rents, and caps on expenses that can be passed on. All of these can affect the value and income-producing potential of your property.

5. Assuming your lender will accept your third-party reports

Before arranging for any third-party reports (e.g., environmental reports, condition assessments or appraisal reports), ask your lender if they have a preferred appraiser, engineer or inspector that they can recommend so that you don’t have to pay for additional reports later on. Additionally, private lenders will often conduct their own appraisals as part of their underwriting process. 

6. Trusting the seller to disclose issues with the property

This mistake goes back to the key behind thorough due diligence: assume nothing. As the buyer, the onus is on you to uncover any problems or issues with the property, so don’t be afraid to ask the seller hard questions and get answers in writing. You should request copies of all financial statements in case you need to refer to them again later to make an informed decision.

7. Missing mistakes in the closing statement 

Before giving your final approval on the closing statement, make sure to look it over for any items that might have been missed by the seller. These are most relevant for income-producing properties and can include letters of credit or certificates of deposit that need to be signed over from the former landlord to the buyer, leasing commissions that are owed on recently signed leases, tenant improvement allowances that are still owed, and service contracts  from vendors that need to be evaluated by the new owner.

8. Failing to look into the competition 

Get to know the entire neighborhood that your property is in. Does the municipality’s zoning regulations significantly restrict who can be a tenant on your property? Are there other income-producing properties that it will be competing with? What are the other commercial properties selling or leasing for? Who are their tenants? The presence, or lack thereof, of competition can affect the value of your property.

9. Not visiting the property in person

While photographs can help you pitch your loan request to your lender, you shouldn’t rely on them to evaluate a property. Visit it at different times of day and different days of the week to make sure that you have a good idea of what happens on the property and in the surrounding neighborhood. Visiting in person also gives you an opportunity to see the property’s physical condition in person to make sure the photographs match reality.

10. Opting not to conduct thorough walk-throughs for rental properties

Walk-throughs are most important for multifamily properties, but even office buildings could be hiding improvement issues that could end up costing you later on. It’s also an opportunity to get to know the existing tenants and figure out the kinds of improvements that they would most appreciate.

While the due diligence period may seem long and drawn out, it’s extremely important for commercial real estate investors to complete. If you have more questions about conducting due diligence for commercial real estate purchases or our private capital loan programs, contact Montegra at 720-893-8807 or online.