Performing the appropriate commercial real estate due diligence before purchasing is an essential part of successful real estate investment. Due diligence can help you avoid any potential costly and unpleasant surprises when you take ownership of your new property. In this series of blogs, we will look at the key items in a buyer’s due diligence checklist: title insurance and surveys; building and environmental inspections; zoning and existing leases; and financing.

Commercial Real Estate Zoning

Perhaps the most important due diligence which should be conducted on any prospective property is confirmation of the property’s zoned uses. If a property can’t be used for the purpose you envision, then its value decreases exponentially. You should look into any agreements which might restrict future uses, including (but not limited to): growth management agreements, covenants, public facilities agreements, and pending zoning changes.

Denver’s commercial real estate zoning code differs from those of the rest of the state in many important ways. For more information on the county of Denver’s particular zoning code and subdivision regulations, check out our previous blog discussing the topic here.

Existing Leases

Analysis of any existing leases can be the most time-consuming part of conducting the necessary due diligence, but it is also crucial to determining whether a property is truly valuable. If a property has long-term leases with established tenants who routinely pay in full and on time, then it is worth more than a property with high turnover or problem tenants. You should read over the initial leases, as well as any lease-related communications, operating budgets, or other written agreements, and research the credit histories of each tenant whose lease you would assume as the new property owner. It can also be helpful to interview your prospective tenants to find out their opinions of the property and its condition.

It is important to keep in mind that commercial leases differ from residential leases in four main ways:

1. They are subject to fewer consumer protection laws, such as security deposit caps or privacy protections.
2. There is no standard (or boiler-plate) lease agreement. They are customized to the individual needs of each landlord and tenant, so close reading is essential.
3. They are typically for longer terms and more legally binding, requiring large amounts of money to break them.
4. There is more willingness and room for negotiation between landlord and tenant as it is generally the beginning of a long-term relationship and business owners often have special needs or requirements for their space.

While reviewing leases beforehand may seem tedious, it can give you information about previous or ongoing maintenance issues, tenants who are behind in rent or involved in other problems, and your expected monthly cash flow.

Denver is currently experiencing a landlord’s market in both commercial and multi-family real estate. This means that rental properties, both apartments and commercial spaces, are in higher demand than there is supply. It is expected that the Denver market will continue to experience this level of demand for the foreseeable future.

While all due diligence provides you with invaluable information, researching a property’s zoning and current tenants will give you a better idea of whether the property will conform to your expectations and business plan. It’s much less expensive to discover that a property can’t be used as you wish before you make an offer than after you close on the sale.

This blog was written by Bob Amter, President of Montegra Capital Resources, LTD., a Colorado hard money lender.  [google_authorship] has been in the private capital lending business for 41 consecutive years.