When making a real estate purchase,
many details must be scrutinized.
Failing to exercise proper care and planning prior to the completion of a transaction can be potentially catastrophic.
That’s where due diligence comes into play.
Independently verifying all representations
made by a prospective seller and uncovering
relevant information that has not been disclosed — but is important to the buyer —
can help you avoid expensive mistakes.
“Due diligence is a buyer’s investigation
of an income-producing property during
the sale process,” explains Marla Maloney,
a senior vice president and principal with
Colliers Turley Martin Tucker.
Smart Business spoke with Maloney
about due diligence, common mistakes
made during the process and the importance of a strong team of professionals.
How do you make the most of due diligence?
It is important to complete the physical
inspection early in the process to ensure
there is adequate time for inspectors to submit their reporting. If there is additional
research that needs to take place, a structured timeline will allow the buyer to dig
deeper. It is also important to manage the
documentation flow so that there is time to
review the materials.
How long does the due diligence process
usually last?
Typically, the buyer and seller agree to a
30-day period. If the buyer finds significant
deferred maintenance, if there is a hiccup
with financing or if the seller is not diligent
in handing over applicable materials —
leases, surveys, the last elevator inspection,
contracts that are placed on the property
for services, etc. — the buyer will likely ask
for an extension to have time to analyze
and review the documentation as it relates
to the property’s commitment.
What are some common mistakes that are
made during the process?
There is so much exposure for buyers if
they don’t fully understand the implications of code compliance and deferred maintenance. Let’s say a space has been vacant for
a number of years. The previous tenant
might not have been required to have a
sprinkler system, but now it is mandatory.
Maybe the building only has risers, it doesn’t
have sprinklers on that floor, so the previous
owner could have gotten away with it. However, if the code has evolved the new owner
may no longer be grandfathered and may
not be reflecting that cost in its pro forma,
which could significantly affect the deal.
Sometimes, buyers assume unnecessary
liabilities by failing to utilize professionals
to complete their inspections. For example,
a garage consultant should be hired to do
core samplings of the parking garage. In
the Midwest, there is a lot of deterioration
of parking structures from deferred maintenance because of salt and chemicals that
penetrate through the membrane into the
actual structure of the garage. Perhaps on
the outside it looks physically sound, but it
could have a significant amount of deferred
maintenance that will require the parking
garage to be out of service for an extended
period of time.
What type of research should be conducted in
regards to current tenants?
It is important to examine leases and rent
rolls as well as the payment history and
creditworthiness of the existing tenants. It
is a good idea to interview current tenants
because you want to make sure they are
happy and you can learn a lot about their
future plans. A tenant may say it loves the
building and its space, but the building is
100 percent leased and it is a growing company, so when the lease expires in two
years, it will need an additional 10,000
square feet. The writing seems to be on the
wall that the tenant will be relocating so
you need to note this in your pro forma.
How can a company benefit from professionals when going through the due diligence
process?
The benefits far outweigh the costs.
Professionals understand and are aware of
building codes. If you are engaging professionals, they can mitigate potential cost and
help you understand the risks involved with
the property.
Who should be on the professional team?
A real estate professional will act as a
fiduciary on your behalf. An attorney will
pore over the leases and identify the commitments that have previously been made
to tenants. Due diligence includes an analysis of the incoming revenue stream. A tenant may be paying $22 per square foot in
years one through three of its term, and in
year four, the rent may go down. Without an
attorney physically going through the documents this might have been overlooked.
Also, in most cases, an environmental consultant, garage structural engineer, electrical engineer, mechanical engineer, surveyor, insurance broker and appraiser should
be involved.
MARLA MALONEY is a senior vice president and principal at Colliers Turley Martin Tucker. Reach her at [email protected] or
(314) 746-0342.
