Due Diligence Checklists – For Commercial Real Estate Transactions

Planning to buy or finance Commercial or Industrial Real Estate? Shopping Center? Office Building? Restaurant/Banquet property? Parking Lot? Storefront? Gas Station? Manufacturing facility? Warehouse? Logistics Terminal? Medical Building? Nursing Home? Hotel/Motel? Pharmacy? Bank facility? Sports and Entertainment Arena? Other?

A KEY to investing in business actual property is performing an enough Due Diligence Investigation to guarantee all materials info to make a clever funding choice and to calculate your anticipated funding yield.

The following checklists are designed that will help you conduct a centered and significant Due Diligence Investigation.

Basic Due Diligence Concepts:

Commercial Real Estate transactions are NOT just like massive residence purchases.

Caveat Emptor: Let the Buyer beware.

Consumer safety legal guidelines relevant to residence purchases seldom apply to business actual property transactions. The rule {that a} Buyer should look at, decide, and take a look at for himself, applies to the acquisition of economic actual property.

Due Diligence: “Such a measure of prudence, activity, or assiduity, as is proper to be expected from, and ordinarily exercised by, a reasonable and prudent [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 an alternative to Due Diligence.

Breach of representations and warranties = Litigation, money and time.

WHAT DILIGENCE IS DUE?

The scope, depth and focus of any due diligence investigation of economic or industrial actual property relies upon upon the targets of the occasion for whom the investigation is performed. These targets could differ relying upon whether or not the investigation is performed for the good thing about (i) a Strategic Buyer (or lengthy-time period lessee); (ii) a Financial Buyer; (iii) a Developer; or (iv) a Lender.

If you’re a Seller, perceive that to shut the transaction your Buyer (and its Lender) should deal with all points materials to its goal – a few of which require info solely you, as Owner, can adequately present.

GENERAL OBJECTIVES:

(i) A “Strategic Buyer” (or lengthy-time period lessee) is buying the property for its personal use and should confirm that the property is appropriate for that meant use.

(ii) A “Financial Buyer” is buying the property for the anticipated return on funding generated by the property’s earnings stream, and should decide the quantity, velocity and sturdiness of the income stream. A classy Financial Buyer will doubtless calculate its yield based mostly upon discounted money-flows reasonably than the should much less exact capitalization charge (“cap rate”), and can want enough monetary info to take action.

(iii) A “Developer” is searching for so as to add worth by altering the character or use of the property – often with a brief-time period to intermediate-time period exit technique to eliminate the property; though, a Developer would possibly plan to carry the property long run as Financial Buyer after improvement or redevelopment. The Developer should give attention to whether or not the deliberate change is character or use may be completed in a value-efficient method. A developer conducting due diligence will give attention to points involving market demand, entry, use and funds.

(iv) A “Lender” is searching for to determine two primary lending standards:

1. “Ability to Repay” – The skill of the property to generate ample income to repay the loan on a well timed foundation; and

2. “Sufficiency of Collateral” – The goal disposal worth of the collateral within the occasion of a loan default, to guarantee enough funds to repay the loan, carrying prices and prices of assortment within the occasion pressured assortment turns into vital.

The quantity of diligent inquiry as a result of be expended (i.e. “Due Diligence”) to research any specific business or industrial actual property challenge is the quantity of inquiry required to reply every of the next inquiries to the extent related to the targets of the occasion conducting the investigation:

I. THE PROPERTY:

1. Exactly what PROPERTY does Purchaser consider it’s buying?

(a) Land?

(b) Building?

(c) Fixtures?

(d) Other Improvements?

(e) Other Rights?

(f) The total payment title curiosity together with all air rights and subterranean rights?

(g) All improvement rights?

2. What is Purchaser’s deliberate use of the Property?

3. Does the bodily situation of the Property allow use as deliberate?

(a) Commercially enough entry to public streets and methods?

(b) Sufficient parking?

(c) Structural situation of enhancements?

(d) Environmental contamination?

(i) Innocent Purchaser protection vs. exemption from legal responsibility

(ii) All Appropriate Inquiry

4. Is there any authorized restriction to Purchaser’s use of the Property as deliberate?

(a) Zoning?

(b) Private land use controls?

(c) Americans with Disabilities Act?

(d) Availability of licenses?

(i) Liquor license?

(ii) Entertainment license?

(iii) Outdoor eating license?

(iv) Drive by way of home windows permitted?

(e) Other impediments?

5. How a lot does Purchaser anticipate to pay for the property?

6. Is there any situation on or throughout the Property that’s more likely to improve Purchaser’s efficient value to accumulate or use the Property?

(a) Property proprietor’s assessments?

(b) Real property tax in keeping with worth?

(c) Special Assessment?

(d) Required person charges for vital facilities?

(i) Drainage?

(ii) Access?

(iii) Parking?

(iv) Other?

7. Any encroachments onto the Property, or from the Property onto different lands?

8. Are there any encumbrances on the Property that won’t be cleared at Closing?

(a) Easements?

(b) Covenants Running with the Land?

(c) Liens or different monetary servitudes?

(d) Leases?

9. Leases?

(a) Security Deposits?

(b) Options to Extend Term?

(c) Options to Purchase?

(d) Rights of First Refusal?

(e) Rights of First Offer?

(f) Maintenance Obligations?

(g) Duty on Landlord to supply utilities?

(h) Real property tax or CAM escrows?

(i) Delinquent hire?

(j) Pre-Paid hire?

(okay) Tenant combine/use controls?

(l) Tenant exclusives?

(m) Tenant parking necessities?

(n) Automatic subordination of Lease to future mortgages?

(o) Other materials Lease phrases?

10. New Construction?

(a) Availability of building permits?

(b) Utilities?

(c) NPDES (National Pollutant Discharge Elimination System) Permit?

(i) Phase 2 efficient March 2003 – Permit required if earth is disturbed on one acre or extra of land.

(ii) If relevant, 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) Limited Liability Company?

(f) Other legally present entity?

2. If apart from pure particular person, does Seller validly exist and is Seller in good standing?

3. Does the Seller personal the Property?

4. Does Seller have authority to convey the Property?

(a) Board of Director Approvals?

(b) Shareholder or Member approval?

(c) Other consents?

(d) If international particular person or entity, are any particular necessities relevant?

(i) Qualification to do enterprise in jurisdiction of Property?

(ii) Federal Tax Withholding?

(iii) US Patriot Act compliance?

5. Who has authority to bind Seller?

6. Are sale proceeds ample to repay all liens?

III. THE PURCHASER:

1. Who is the Purchaser?

2. What is the Purchaser/Grantee’s actual authorized identify?

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 approved to personal and function the Property and, if relevant, finance acquisition of the Property?

(a) Board of Director Approvals?

(b) Shareholder or Member approval?

(c) If international particular person or entity, are any particular necessities relevant?

(i) Qualification to do enterprise in jurisdiction of the Property?

(ii) US Patriot Act compliance?

(iii) Bank Secrecy Act/Anti-Money Laundering compliance?

5. Who is permitted to bind the Purchaser/Grantee?

IV. PURCHASER FINANCING:

A. BUSINESS TERMS OF THE LOAN:

What loan phrases have the Purchaser, as Borrower, and its Lender agreed to?

(a) What is the quantity of the loan?

(b) What is the rate of interest?

(c) What are the reimbursement phrases?

(d) What is the collateral?

(i) Commercial actual property solely?

(ii) Real property and private property collectively?

(e) First lien? A junior lien?

(f) Is it a single advance loan?

(g) A a number of advance loan?

(h) A building loan?

(i) If it’s a a number of advance loan, can the principal be re-borrowed as soon as repaid previous to maturity of the loan; making it, in impact, a revolving line of credit score?

(j) Are there reserve necessities?

(i) Interest reserves?

(ii) Repair reserves?

(iii) Real property tax reserves?

(iv) Insurance reserves?

(v) Environmental remediation reserves?

(vi) Other reserves?

(okay) Are there necessities for Borrower to open enterprise working accounts with the Lender? If so, is the Borrower obligated to take care of minimal compensating balances?

(l) Is the Borrower required to pledge enterprise accounts as further collateral?

(m) Are there early reimbursement charges or yield upkeep necessities (every typically known as “pre-payment penalties”)?

(n) Are there reimbursement blackout durations throughout which Borrower isn’t permitted to repay the loan?

(o) Is there a Loan Commitment payment or “good faith deposit” due upon Borrower’s acceptance of the Loan Commitment?

(p) Is there a loan funding payment or loan brokerage payment or different loan payment due Lender or a loan dealer at closing?

(q) What are the Borrower’s expense reimbursement obligations to Lender? When are they due? What is the Borrower’s obligation to pay Lender’s bills if the loan doesn’t shut?

B. DOCUMENTING THE COMMERCIAL REAL ESTATE LOAN

Does Purchaser have all info essential to adjust to the Lender’s loan closing necessities?

Not all loan documentation necessities could also be recognized on the outset of a transaction, though most business actual property loan documentation necessities are pretty typical. Some required info may be obtained solely from the Seller. Production of that info to Purchaser for supply to its lender should be required within the buy contract.

As steering to what a business actual property lender could require, the next units forth a typical Closing Checklist for a loan secured by business actual property.

Commercial Real Estate Loan Closing Checklist

1. Promissory Note

2. Personal Guaranties (which can be full, partial, secured, unsecured, fee guaranties, assortment guaranties or a wide range of different forms of ensures as could also be required by Lender).

3. Loan Agreement (typically integrated into the Promissory Note and/or Mortgage in lieu of being a separate doc)

4. Mortgage [sometimes expanded to be a Mortgage, Security Agreement and Fixture Filing]

5. Assignment of Rents and Leases

6. Security Agreement

7. Financing Statement (typically known as a “UCC-1”, or “Initial Filing”)

8. Evidence of Borrower’s Existence In Good Standing; together with

(a) Certified copy of organizational paperwork of borrowing entity (together with Articles of Incorporation, if Borrower is an organization; Articles of Organization and written Operating Agreement, if Borrower is a restricted legal responsibility firm; Certified copy of belief settlement with all amendments, if Borrower is a land belief or different belief; and so forth.)

(b) Certificate of Good Standing (if an organization or LLC) or Certificate of Existence (if a restricted partnership) or Certificate of Qualification to Transact Business (if Borrower is an entity doing enterprise in a State apart from its State of formation)

9. Evidence of Borrower’s Authority to Borrow; together with

(a) a Borrower’s Certificate;

(b) Certified Resolutions

(c) Incumbency Certificate

10. Satisfactory Commitment for Title Insurance (which can usually require, for evaluation by the Lender, copies of all paperwork of report showing on Schedule B of the title dedication that are to stay after closing), with required business title insurance coverage endorsements, typically together with:

(a) When out there, Affirmative Creditors Rights Endorsement (extending protection over coverage exclusion 7 and coverage exclusions 3(a) and three(d) as they relate to creditor’s rights issues)

(b) ALTA 3.1 Zoning Endorsement modified to incorporate parking

(c) ALTA Comprehensive Endorsement 1

(d) Location Endorsement (road deal with)

(e) Access Endorsement (vehicular entry to public streets and methods)

(f) Contiguity Endorsement (the insured land includes a single parcel with no gaps or gores)

(g) PIN Endorsement (insuring that the recognized actual property tax everlasting index numbers are the one relevant PIN numbers affecting the collateral and that they relate solely to the true property comprising the collateral)

(h) Usury Endorsement (insuring that the loan doesn’t violate any prohibitions in opposition to extreme curiosity prices)

(i) different title insurance coverage endorsements relevant to guard the meant use and worth of the collateral, as could also be decided upon evaluation of the Commitment for Title Insurance and Survey or arising from the existence of particular points pertaining to the transaction or the Borrower.

11. Current ALTA Survey (3 units), [typically prepared in accordance with 2011 Minimum Standard Detail for ALTA/ACSM Land Title Surveys, certified to the lender, Buyer and the title insurer.

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 simply as “SNDAs”].

16. UCC, Judgment, Pending Litigation, Bankruptcy and Tax Lien Search Report

17. Appraisal (should adjust to Title XI of FIRREA (Financial Institutions Reform, Recovery and Enforcement Act of 1989, as amended)

18. Environmental Site Assessment Report (typically known as Environmental Phase I and/or Phase 2 Audit Reports)

19. Environmental Indemnity Agreement (signed by Borrower and guarantors)

20. Site Improvements Inspection Report

21. Evidence of Hazard Insurance naming Lender because the Mortgagee/Lender Loss Payee; and Liability Insurance naming Lender as an “additional insured” (typically listed as merely “Acord 27 and Acord 25, respectively)

22. Legal Opinion of Borrower’s Attorney

23. Credit Underwriting documents, such as signed tax returns, property operating statements, etc. as may be specified by Lender

24. Compliance 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 useful to become familiar with the Lender’s loan documentation requirements as early in the transaction as practical. The requirements will likely be set forth with some detail 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 commercial real estate transaction can be time consuming and expensive in all events.

If the loan requirements cannot be satisfied, it is better to make that determination during the contractual “due diligence interval” – which typically provides for a so-called “free out” – reasonably than at a later date when the earnest cash could also be vulnerable to forfeiture or when different legal responsibility for failure to shut could connect.

CONCLUSION

Conducting an efficient due diligence investigation in a business actual property transaction to find all materials info and circumstances affecting the Property and the transaction is of vital significance.

Unlike proprietor occupied residential actual property, when a home can practically all the time be occupied because the purchaser’s residence, business actual property acquired for enterprise use or for funding is impacted by quite a few components which will have an effect on its use and worth.

The existence of those components and their have an effect on on a Purchaser’s skill to make use of the Property for its meant use and on the Purchaser’s projected funding yield can solely be found by way of diligent investigation and a spotlight to element.

The circumstances of every transaction will decide what diploma of diligence is required. The degree of diligence required underneath the circumstances is the diligence that’s due.

Exercise Due Diligence.

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