Best Practices for Due Diligence

The following are among the steps that should be taken to achieve best practices in performing due diligence in the purchase and sale of commercial real estate:

• City authorities are more likely to grant condo conversion permits when the local occupancy rates are 5% or greater. Typically, developers must dedicate a significant percent of their condo conversions to affordable housing. Much of the funding for condo conversions has been coming from developers' joint-venture partners and foreign investors, not from the developers' own money. It is important to determine if buildings targeted for condo conversion have seperable heating and electrical systems. Condo developers often designate budgets to buyout existing tenants.
• Problematic ground leases are often deal killers. Sellers should be aware of the accounting issues that confront potential buyers. For instance, REITs are restricted as to the income that they can receive. Tax-exempt organizations have issues with unrelated business taxable income and pensions have ERISA considerations that complicate deals.
• Some of the benefits of conducting pre-emptive due diligence include: a) the seller becomes more educated about their own buildings; b) the buyers become more comfortable with the properties and they often bid more aggressively; c) minimizes or eliminates price retrading; d) accelerates the sales process; and, e) achieves an early non-refundable deposit.
• In terms of minimizing title insurance premiums, costs savings may be achieved on transfer taxes by considering acquisition of the ownership entity rather than the actual real estate. Cost savings may be achieved on mortgage taxes by assigning the existing loan documents and mortgages securing them.
• Commercial real estate investors may find that the information that they retain relative to their deals may become a liability. Lawyers are already beginning to question whether such information may be subpoenaed. Should the commercial real estate sector encounter weakness, real estate investors may find that the information that they retain used against them in cases alleging mismanagement and poor stewardship of investor assets.
• Among the issues of most concern when engineers conduct physical evaluations of buildings are mold (particularly in the case of multi-family buildings); roofing; oriented strand board (which increases the risk of mold and structural defects); seismic issues on the west coast and curtain wall. Buyers should be very careful that the buildings they buy are in compliance with all applicable fire codes (some of these fire codes are on the books but not currently forced). A great deal of information about the building can be obtained from tenant interviews. Engineers should be consulted not solely to learn about the current state of the buildings (such as does the electrical system work), but also about the future potential of the building (such as is there sufficient electrical capacity).

These were some of the issues that were addressed at our September Commercial Real Estate Due Diligence Conference. Recorded proceedings are available by contacting neomi@incrementaladvantage.com.

To find out more on IncreMental Advantage's Commercial Real Estate Due Diligence Conferences on January 22-23, 2007 (Newport Beach, CA) and May 7-8, 2007 (Chicago, IL), visit www.incrementaladvantage.com/conferences or contact Neomi at neomi@incrementaladvantage.com or 609.919.1895 x100.