Importance of due diligence and property condition reports in commercial real estate

INTRODUCTION

Due diligence simply refers to the steps taken by a person or an organization to investigate and satisfy legal requirements when buying or selling something i.e. property. In residential real estate, due diligence is usually done conclusively due to the complexity of property however in commercial property, sometimes the process is done in a hurry due to excitement and the nature of property i.e. less complex. Due diligence should however be done conclusively regardless of the kind of the property being bought. This is because a seller always knows more about the property than the buyer and in most cases may not disclose all the required information. A thorough investigation is therefore required to uncover as much as possible.

MARKET ANALYSIS

Commercial property due diligence involves a number of steps. The first level is usually market analysis. The main aim of this step is to confirm that a commercial property is commercially viable i.e. there is a market that will serve the property. Market analysis involves analysis of demographic, geographic and socio-graphic data to ascertain that the market meets the criteria of investors.

FINANCIAL AND OPERATIONAL ANALYSIS

After market analysis has been carried out, the next steps involve analysis of financial, operational, legal and physical conditions of the commercial property. Financial and operational analysis is aimed at valuing a property based on the income the property generates. Financial and operational analysis aims at collecting all the necessary information that is needed to accurately calculate the net operating income of a commercial property. It is however important to note that different commercial property owners operate differently thus financial and operational analysis is based on how the new owners intend to operate the property. The results of the analysis therefore indicate the projected performance of the property under new ownership and management. LEGAL ANALYSISAfter market, financial and operational analysis has been carried out; the next step is legal and physical analysis. This is where property condition reports come in (physical analysis documents) and legal analysis documents such as lease agreements, tenant files, rent rolls e.t.c. Legal analysis reports/documents show basic information that is crucial in case there is a need for any legal action to be taken i.e. tenants name, rent amount, lease expiration date e.t.c.

PHYSICAL ANALYSIS

Physical analysis documents on the other hand i.e. property condition reports reveal any physical deficiencies that a property may have. When doing physical due diligence real estate (commercial property) this step is very important especially if the current owner claims that the property is in good physical shape. A property condition report will identify all physical deficiencies i.e. any conspicuous defects, deferred maintenance on the property’s components, material systems or equipment. In short, the property condition report reveals all physical repairs that a property may need i.e. routine maintenance, normal operational maintenance, miscellaneous minor repairs etc. In summary, the property condition report is the last due diligence document that gives an accurate value on a commercial property. It is therefore an important due diligence real estate document that has to be prepared thoroughly.

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