Key Due Diligence Tips for Buying Commercial Property (Pt 2)

Due Diligence Tips Part 1
Key Due Diligence Tips for Buying Commercial Property (Pt 1)
February 21, 2019
old-3608950_960_720
Retirement strategy – 5 reasons retirees choose commercial property investment
May 7, 2019

Key Due Diligence Tips for Buying Commercial Property (Pt 2)

Commercial Property DD Tips Part 2

Due diligence is a significant stage in the commercial property investment process. Early investigations of a property can uncover hidden traits left out by the sales brochure.

Part one of our key due diligence tips for buying commercial real estate explained the physical and environmental factors that could sway your investment decision (or strengthen it).

In part two, we cover the items which might need a technical eye to review. Paperwork and fine print can contain vital information about what can and can’t be done after you’ve committed to the property purchase.

  1. Check the contract

A contract of sale for a commercial property is usually much heavier than what you’d be given buying residential real estate. This is thanks to lengthy clauses regarding due diligence conditions, your rights as buyer and the property’s leases.

Now that the seller has agreed to your offer, the clock is ticking. So, to make sure you know how to manage your time, note the key dates of the purchase relating to property inspections, the due diligence period, settlement and settlement extensions.

Ensure that all plans for the building (i.e. electrical, construction, plumbing, etc) are available for you to review. This is imperative if you’re looking to make any upgrades on the land.

The contract of sale also points out your ability to terminate the deal if unsatisfied with your due diligence. And remember, if you’re unhappy with any of the clauses, you’ll usually have the right to propose a variation.

When you’ve performed your contract checks and are pleased with the outcome, it’s time to find the lease agreements.

  1. Audit the lease documents

A large part of your decision to buy the property may be because of the strength of its tenants. So, it is crucial to verify that the information in the lease documents is accurate.

Firstly, check the rental income. It should agree with the tenancy schedule and all rental increases should have been made as scheduled (whether as an annual percentage or in line with the Consumer Price Index).

An audit of the lease documents may also mean reviewing the creditworthiness of the businesses occupying the premises or finding confirmation that they’ve been appropriately vetted. If you find a tenant is in arrears, you’ll want to bring this up with the vendor. Late payments aren’t necessarily a deal breaker but can tell a story about the performance and behaviour of a tenant.

Also obtain the details of any bonds, deposits or bank guarantees that are held, as these safeguard your yields if a tenant breaches their lease terms – and you should be fully aware of what these terms are and know what constitutes a breach.

  1. Review the property title

It might sound trivial but ensure you are contracted to buy the right property by checking its correct legal description. A copy of the Title Deed will be your guide, which can be found via a current title search.

One of the most important checks to make on your title search is whether the property has any encumbrances over it, such as:

  • Covenants: Restrictions for using the property for certain purposes.
  • Easements: A right to provide another party legal access to the property.
  • Caveats: A formal notice or warning lodged against the title of a property.

Encumbrances like these are reasonably common. But while most won’t affect the value or your purchase of the asset, some will.

Caveats can arguably be the most troublesome. They can stop any person from dealing with a property, including the owner. Any party who holds some sort of identifiable interest in the land can lodge a caveat (like a mortgagee, tenant, guarantor or buyer) and they will usually do so to protect their interest or prevent improper dealings.

Some caveats can be a burden to remove, so look before you buy.

  1. Confirm the zoning restrictions

Checking the current zoning is vital to making sure the business activities on your property are allowed. Among other uses, a property might be zoned for retail, industrial or office (or a combination) and tenants must comply with that prescribed usage. Get in touch with local authorities to make sure the intended property usage complies with its zoning.

Also pay attention to any restrictions on the land, especially if your acquisition strategy involves adding value to the property. For example, a new pylon for signage might seem like a great tact to attract a brand-conscious tenant. But the local council might think otherwise if your plan doesn’t comply with frontage restrictions.

  1. Understand who owns what

A business might want to make improvements to a property’s floor space with a fitout. If an existing tenant wants an upgrade to the premises to make it their own (or maybe they already have), you’ll want to understand who fronts the bill and who owns what.

Tenants are usually responsible for these installation costs but go back to your lease agreements to ensure whether this is the case. It’s not uncommon for a landlord to contribute to some, if not all, of the fitout costs, especially in a soft leasing market where incentives are given to attract tenants.

Your concern might be less about who owns the fittings and fixtures of the fitout, and more about the tenant’s obligations to cover costs of returning the space to its original condition. So, inspect the ‘make-good’ provisions in the lease, which sets out that a vacating tenant must bring the property back to its original state when it was leased. The make-good clause can be a contentious area, so check that it’s been documented well.

The contracts and regulations associated with commercial real estate can be complex, and professional legal advice should always be sought to remove the uncertainties from your investment.

Due diligence is a serious task for commercial property investors, but also a necessity for a successful investment. For more information on how Performance Property Advisory can help you invest in commercial property, get in touch today.