Commercial real estate investing is full of opportunity but as with all opportunity comes risk.  One question I am often asked, especially by new investors is, “Other than the market risks, what are the other potential risks in buying commercial real estate?”  Most of these are first time investors  or 1031 exchange buyers coming out of family land or other family assets.  I thought that it might be helpful to create a list of the top 5 due diligence items need to be addressed to detour some easily avoidably but potentially costly pitfalls.

1. Confirm the Square Footage –

   The majority of investors rely on the square footages included in the tenant’s leases assuming that the tenants did their due diligence.  However, that is not often the case.  It is important to either do a quick measurement yourself or hire an architect or an engineer to verify.  You want to make sure that you’re getting what you’re buying.

2. Tenant Estoppel Certificates –

   A tenant estoppel certificate is a document signed by the tenant stating that the lease is still in effect, there are no material defects in the property that they are aware of, there are no side agreements with the landlord not shown in the written lease, and neither the landlord or tenant are in default along with several other items.  If you are financing the property, it is likely that your lender will require this anyway.  If not, this can be a lifesaver.  It is not unusual for a landlord to verbally give a tenant a break on rent during difficult times that is not reflected in the lease or maybe the landlord has not made a repair requested by the tenant.  The estoppel will flush these items out so that you know what you are buying.

3. Environmental Assessments-This is an essential due diligence item in my mind.  The potential risk outweighs the minimal cost by too great of an amount.  For example, we were recently selling a piece of farm ground that had never been developed.  All assumed that the property was clean.  However, the environmental assessment showed that the farmer had buried a fuel tank on the property years before and it had leaked.  This would not have been uncovered without the report.  Later this year, I will be dedicating a full post to this topic.

4. Careful Review of Property Operating Statements –

   A careful review of the property’s operating statements can uncover items not readily seen on a property’s surface.  For example, a historical review of the annual income can uncover periods of vacancy or tenant’s failure to pay rent.  There may be an explainable reason for this but it might be that the actual historical occupancy for the property is lower than the market.  On the expense side, it is not unusual for a property owner to understate actual expenses and write them off as unusual or particular to the way that he manages the property, especially in the repairs and maintenance category.  Are those expenses unusual or are these on-going repairs going to continue into the future and need to be built into your financial model.  Comparing those expenses to expenses of similar buildings in the market is also helpful to understand the full picture.

5. Title Review –

   I cannot overstate the importance of a good title company.  Many investors glaze over when it comes to reading and understanding the title report.  However there should be an ample amount of time spent here reading through the easements, development agreements, etc that affect the property.  Many items are easily fixed prior to the acquisition that are very difficult once closing has occurred.  A good title company can help through this process.

There are obviously many other items that need to be addressed when buying a property but I hope that this list is helpful especially to new first time investors or 1031 exchange investors that are entering the commercial real estate arena for the first time.