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A Key to investing in market real estate is performing an adequate Due Diligence Investigation to assure you know all material facts to make a wise venture decision and to conjecture your staggering venture yield.
The following checklists are designed to help you escort a focused and meaningful Due Diligence Investigation.
Basic Due Diligence Concepts:
Commercial Real Estate transactions are Not similar to large home purchases.
Caveat Emptor: Let the Buyer beware.
Consumer security laws applicable to home purchases seldom apply to market real estate transactions. The rule that a Buyer must examine, judge, and test for himself, applies to the buy of market real estate.
Due Diligence: "Such a part of prudence, activity, or assiduity, as is permissible to be staggering from, and commonly exercised by, a reasonable and frugal [person] under the particular circumstances; not measured by any absolute standard, but depending upon the relative facts of the special case." Black's Law Dictionary; West Publishing Company.
Contractual representations and warranties are Not a substitute for Due Diligence.
Breach of representations and warranties = Litigation, time and money.
What Diligence Is Due?
The scope, intensity and focus of any due diligence investigation of market or market real estate depends upon the objectives of the party for whom the investigation is conducted. These objectives may vary depending upon either the investigation is conducted for the benefit of (i) a Strategic Buyer (or long-term lessee); (ii) a Financial Buyer; (iii) a Developer; or (iv) a Lender.
If you are a Seller, understand that to close the transaction your Buyer (and its Lender) must address all issues material to its objective - some of which want information only you, as Owner, can adequately provide.
General Objectives:
(i) A "Strategic Buyer" (or long-term lessee) is acquiring the property for its own use and must verify that the property is convenient for that intended use.
(ii) A "Financial Buyer" is acquiring the property for the staggering return on venture generated by the property's income stream, and must resolve the amount, velocity and endurance of the income stream. A sophisticated Financial Buyer will likely conjecture its yield based upon discounted cash-flows rather than the must less correct capitalization rate ("cap rate"), and will need adequate financial information to do so.
(iii) A "Developer" is seeking to add value by changing the character or use of the property - commonly with a short-term to intermediate-term exit strategy to arrange of the property; although, a Developer might plan to hold the property long term as Financial Buyer after improvement or redevelopment. The Developer must focus on either the planned convert is character or use can be finished in a cost-effective manner. A developer conducting due diligence will focus on issues piquant shop demand, access, use and finances.
(iv) A "Lender" is seeking to establish two basic lending criteria:
1. "Ability to Repay" - The capability of the property to originate adequate income to repay the loan on a timely basis; and
2. "Sufficiency of Collateral" - The objective disposal value of the collateral in the event of a loan default, to assure adequate funds to repay the loan, carrying costs and costs of variety in the event forced variety becomes necessary.
The whole of diligent inquiry due to be expended (i.e. "Due Diligence") to study any particular market or market real estate project is the whole of inquiry required to answer each of the following questions to the extent relevant to the objectives of the party conducting the investigation:
I. The Property:
1. Exactly what property does Purchaser believe it is acquiring?
(a) Land?
(b) Building?
(c) Fixtures?
(d) Other Improvements?
(e) Other Rights?
(f) The entire fee title interest along with all air rights and subterranean rights?
(g) All improvement rights?
2. What is Purchaser's planned use of the Property?
3. Does the corporal health of the property permit use as planned?
(a) Commercially adequate way to collective streets and ways?
(b) adequate parking?
(c) Structural health of improvements?
(d) Environmental contamination?
(i) Innocent Purchaser defense vs. Exemption from liability
(ii) All standard Inquiry
4. Is there any legal restriction to Purchaser's use of the property as planned?
(a) Zoning?
(b) private land use controls?
(c) Americans with Disabilities Act?
(d) Availability of licenses?
(i) Liquor license?
(ii) Entertainment license?
(iii) Outdoor dining license?
(iv) Drive through windows permitted?
(e) Other impediments?
5. How much does Purchaser expect to pay for the property?
6. Is there any health on or within the property that is likely to growth Purchaser's efficient cost to secure or use the Property?
(a) property owner's assessments?
(b) Real estate tax in line with value?
(c) special Assessment?
(d) Required user fees for principal amenities?
(i) Drainage?
(ii) Access?
(iii) Parking?
(iv) Other?
7. Any encroachments onto the Property, or from the property onto other lands?
8. Are there any encumbrances on the property that will not be cleared at Closing?
(a) Easements?
(b) Covenants Running with the Land?
(c) Liens or other financial servitudes?
(d) Leases?
9. Leases?
(a) security Deposits?
(b) Options to expand Term?
(c) Options to Purchase?
(d) rights of First Refusal?
(e) rights of First Offer?
(f) Maintenance Obligations?
(g) Duty on Landlord to furnish utilities?
(h) Real estate tax or Cam escrows?
(i) Delinquent rent?
(j) Pre-Paid rent?
(k) Tenant mix/use controls?
(l) Tenant exclusives?
(m) Tenant parking requirements?
(n) self-acting subordination of Lease to time to come mortgages?
(o) Other material Lease terms?
10. New Construction?
(a) Availability of building permits?
(b) Utilities?
(c) Npdes (National Pollutant extraction Elimination System) Permit?
(i) Phase 2 efficient March 2003 - Permit required if earth is disturbed on one acre or more of land.
(ii) If applicable, Storm Water Pollution prevention Plan (Swppp) is required.
Ii. The Seller:
1. Who is the Seller?
(a) Individual?
(b) Trust?
(c) Partnership?
(d) Corporation?
(e) slight Liability Company?
(f) Other legally existing entity?
2. If other than natural person, does seeder validly exist and is seeder in good standing?
3. Does the seeder own the Property?
4. Does seeder have authority to transport the Property?
(a) Board of Director Approvals?
(b) Shareholder or Member approval?
(c) Other consents?
(d) If foreign personel or entity, are any special requirements applicable?
(i) Qualification to do company in jurisdiction of Property?
(ii) Federal Tax Withholding?
(iii) Us Patriot Act compliance?
5. Who has authority to bind Seller?
6. Are sale proceeds adequate to pay off all liens?
Iii. The Purchaser:
1. Who is the Purchaser?
2. What is the Purchaser/Grantee's exact legal name?
3. If Purchaser/Grantee is an entity, has it been validly created and is it in good standing?
(a) Articles or Incorporation - Articles of Organization
(b) Certificate of Good Standing
4. Is Purchaser/Grantee authorized to own and control the property and, if applicable, finance acquisition of the Property?
(a) Board of Director Approvals?
(b) Shareholder or Member approval?
(c) If foreign personel or entity, are any special requirements applicable?
(i) Qualification to do company in jurisdiction of the Property?
(ii) Us Patriot Act compliance?
(iii) Bank Secrecy Act/Anti-Money Laundering compliance?
5. Who is authorized to bind the Purchaser/Grantee?
Iv. Purchaser Financing:
A. company Terms Of The Loan:
What loan terms have the Purchaser, as Borrower, and its Lender agreed to?
(a) What is the whole of the loan?
(b) What is the interest rate?
(c) What are the reimbursement terms?
(d) What is the collateral?
(i) market real estate only?
(ii) Real estate and personal property together?
(e) First lien? A junior lien?
(f) Is it a particular enlarge loan?
(g) A many enlarge loan?
(h) A building loan?
(i) If it is a many enlarge loan, can the principal be re-borrowed once repaid prior to maturity of the loan; production it, in effect, a revolving line of credit?
(j) Are there reserve requirements?
(i) Interest reserves?
(ii) repair reserves?
(iii) Real estate tax reserves?
(iv) guarnatee reserves?
(v) Environmental remediation reserves?
(vi) Other reserves?
(k) Are there requirements for Borrower to open company operating accounts with the Lender? If so, is the Borrower obligated to claim minimum compensating balances?
(l) Is the Borrower required to pledge company accounts as further collateral?
(m) Are there early reimbursement fees or yield maintenance requirements (each sometimes referred to as "pre-payment penalties")?
(n) Are there reimbursement blackout periods while which Borrower is not permitted to repay the loan?
(o) Is there a Loan Commitment fee or "good faith deposit" due upon Borrower's acceptance of the Loan Commitment?
(p) Is there a loan funding fee or loan brokerage fee or other loan fee due Lender or a loan broker at closing?
(q) What are the Borrower's cost reimbursement obligations to Lender? When are they due? What is the Borrower's compulsion to pay Lender's expenses if the loan does not close?
B. Documenting The market Real Estate Loan
Does Purchaser have all information principal to comply with the Lender's loan conclusion requirements?
Not all loan documentation requirements may be known at the outset of a transaction, although most market real estate loan documentation requirements are fairly typical. Some required information can be obtained only from the Seller. Production of that information to Purchaser for delivery to its lender must be required in the buy contract.
As advice to what a market real estate lender may require, the following sets forth a typical conclusion Checklist for a loan secured by market real estate.
Commercial Real Estate Loan conclusion Checklist
1. Promissory Note
2. Personal Guaranties (which may be full, partial, secured, unsecured, cost guaranties, variety guaranties or a variety of other types of guarantees as may be required by Lender).
3. Loan business agreement (often incorporated into the Promissory Note and/or Mortgage in lieu of being a isolate document)
4. Mortgage [sometimes expanded to be a Mortgage, security business agreement and Fixture Filing]
5. Assignment of Rents and Leases
6. security Agreement
7. Financing Statement (sometimes referred to as a "Ucc-1", or "Initial Filing")
8. Evidence of Borrower's Existence In Good Standing; including
(a) Certified copy of organizational documents of borrowing entity (including Articles of Incorporation, if Borrower is a corporation; Articles of assosication and written Operating Agreement, if Borrower is a slight liability company; Certified copy of trust business agreement with all amendments, if Borrower is a land trust or other trust; etc.)
(b) Certificate of Good Standing (if a corporation or Llc) or Certificate of Existence (if a slight partnership) or Certificate of Qualification to Transact company (if Borrower is an entity doing company in a State other than its State of formation)
9. Evidence of Borrower's Authority to Borrow; including
(a) a Borrower's Certificate;
(b) Certified Resolutions
(c) Incumbency Certificate
10. Satisfactory Commitment for Title guarnatee (which will typically require, for determination by the Lender, copies of all documents of article appearing on program B of the title commitment which are to remain after closing), with required market title guarnatee endorsements, often including:
(a) Affirmative Creditors rights Endorsement (extending coverage over policy exclusion 7 and policy exclusions 3(a) and 3(d) as they reveal to creditor's rights matters)
(b) Alta 3.1 Zoning Endorsement modified to consist of parking
(c) Alta total Endorsement 1
(d) Location Endorsement (street address)
(e) way Endorsement (vehicular way to collective streets and ways)
(f) Contiguity Endorsement (the insured land comprises a particular parcel with no gaps or gores)
(g) Pin Endorsement (insuring that the identified real estate tax permanent index numbers are the only applicable Pin numbers affecting the collateral and that they reveal solely to the real property comprising the collateral)
(h) Usury Endorsement (insuring that the loan does not violate any prohibitions against immoderate interest charges)
(i) other title guarnatee endorsements applicable to safe the intended use and value of the collateral, as may be considered upon reveal of the Commitment for Title guarnatee and seek or arising from the existence of special issues pertaining to the transaction or the Borrower.
11. Current Alta seek (3 sets), [typically ready in accordance with 2005 Minimum standard information for Alta/Acsm Land Title Surveys, certified to the lender, Buyer and the title insurer, along with items 1 through 4, 6, 7(a), 7(b)(1), 8 through 11(a) and 14 from the Surveyor's "Optional seek Responsibilities and Specifications" referred to as "Table A"].
12. Current Rent Roll
13. Certified copy of all Leases (3 sets)
14. Lessee Estoppel Certificates
15. Lessee Subordination, Non-Disturbance and Attornment Agreements [sometimes referred to plainly as "Sndas"].
16. Ucc, Judgment, Pending Litigation, Bankruptcy and Tax Lien crusade Report
17. Assessment (must comply with Title Xi of Firrea (Financial Institutions Reform, saving and compulsion Act of 1989, as amended)
18. Environmental Site Assessment article (sometimes referred to as Environmental Phase I and/or Phase 2 Audit Reports)
19. Environmental Indemnity business agreement (signed by Borrower and guarantors)
20. Site Improvements Inspection Report
21. Evidence of Hazard guarnatee naming Lender as the Mortgagee/Lender Loss Payee; and Liability guarnatee naming Lender as an "additional insured" (sometimes listed as plainly "Acord 27 and Acord 25, respectively)
22. Legal belief of Borrower's Attorney
23. Credit Underwriting documents, such as signed tax returns, property operating statements, etc. As may be specified by Lender
24. Compliancy business agreement (sometimes also called an Errors and Omissions Agreement), whereby the Borrower agrees to correct, after closing, errors or omissions in loan documentation.
It is beneficial to become well-known with the Lender's loan documentation requirements as early in the transaction as practical. The requirements will likely be set forth with some information in the lender's Loan Commitment - which is typically much more detailed than most loan commitments issued in residential transactions.
Conducting the Due Diligence Investigation in a market real estate transaction can be time piquant and costly in all events.
If the loan requirements cannot be satisfied, it is best to make that estimation while the contractual "due diligence period" - which typically provides for a so-called "free out" - rather than at a later date when the earnest money may be at risk of forfeiture or when other liability for failure to close may attach.
Conclusion
Conducting an efficient due diligence investigation in a market real estate transaction to seek all material facts and conditions affecting the property and the transaction is of principal importance.
Unlike owner occupied residential real estate, when a house can nearly always be occupied as the purchaser's home, market real estate acquired for company use or for venture is impacted by numerous factors that may sway its use and value.
The existence of these factors and their sway on a Purchaser's capability to use the property for its intended use and on the Purchaser's projected venture yield can only be discovered through diligent investigation and attention to detail.
The circumstances of each transaction will resolve what degree of diligence is required. The level of diligence required under the circumstances is the diligence that is due.
Exercise Due Diligence.
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