Due Diligence When Buying Commercial & Residential Real Estate
One of the main reasons for preliminary due diligence is important in commercial and residential real estate transactions is so that the buyer can properly assess the property’s value to formulate an offer strategically. Many of the documents that allow you to explore a property’s net profitability are only available to the buyer after an offer has been made. However, fundamentally, when valuing commercial property, income production is critical. The key ratio to determine here is the Net Operating Income (NOI), which is equal to income minus operating expenses (not including taxes and interest), and should be one of the key factors in determining how much you are willing to pay for the property.
Commercial real estate
The primary reason critical reason due diligence for commercial real estate is so important is to ensure that the buyer knows exactly what he/she is purchasing. The stipulated period usually begins after the prospective purchaser has made an offer, the seller has accepted the offer pending the due diligence period, and the buyer has placed a down payment in an escrow account to be applied towards the purchase and lasts anywhere from 30 days to more than nine months. It should involve physical inspections of the real estate, an assessment of related-environmental conditions, a review of the title, zoning requirements, contracts, leases, and surveys, partially through a review of documents the seller provides. These should include copies of:
• The deed;
• Information on current tenants;
• Existing, actual uses of the property;
• Zoning documents indicating allowable uses of the property;
• Any seller inspections;
• Land and improvement surveys;
• Current title insurance;
• Other insurance;
• Any notice of pending legal and/or government action;
• Environmental assessments;
• Any special assessments or taxes;
• Copies of any property bills;
• Any service contracts;
• All construction plans in the seller’s possession; and
• Warranties for any construction.
Beyond the document review, the buyer should conduct an independent investigation. You can request that the seller conduct, and/or pay for some of the third-party assessments you may want to inspect, and negotiate them into the contract.
Residential real estate
Just like with commercial real estate, you should thoroughly assess the value of and market for a residential real estate property before making an offer. With residential real estate, there are fewer objective measures of valuation of property, especially single-family residences. If the family is a multifamily unit, review the income the property generated in tandem with property taxes, and utilities. With single-family residences, comps, real estate appraisals, and local real estate trends are your best bet for valuing the property.
The due diligence period for residential real estate purchases typically lasts 30 days, with 10 to 15 days to inspect. During this period, you should review:
• The deed and title review
• Surveying documents;
• Zoning documents;
• Property inspections;
• Property appraisals;
• Environmental assessments; and
• Insurance documents, and any other available documents.