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Commercial Properties-Due Diligence Guidelines

Mar 26, 2008
When you buy a commercial property, due diligence is even more vitally important than it is with residential properties simply because there's so much more money at stake.

In a worst-case scenario, unexpected repairs and expenses can empty your pockets in a heartbeat. At the other end of the spectrum, it can create a long-term, slow-motion drain on your finances that ends up with the same result-money gone and a white elephant on your hands.

I'm sure you can see my point-never, ever acquire a commercial property without closely checking its condition first. By doing that, you'll end up with an investment which can produce considerable profit and appreciation over the long-term. In this article, I'll outline the basic due diligence required for the physical inspection of commercial buildings.

Who Should Inspect Commercial Buildings If you're new to commercial investments, then you definitely need to hire professionals to inspect the building you're considering. The building structure and the HVAC, electrical and plumbing systems are much more complicated than those found in residential properties and require specialist inspectors.

So, hire an experienced contractor, architect, or other expert to do the job for you. Check out references and contact other investors to see what kind of job the specialists have done for them so you can hire the best.

When you find specialists that do a great job at reasonable prices, treat them well and fairly. Remember, your reputation is everything, particularly in the commercial market, so you want to protect it at all costs. Getting a bad reputation in the commercial market is particularly deadly since it can dry up funding sources in a hurry, not to mention the fact that "movers and shakers" will not want to work with you.

Maintenance Types There are two types of maintenance in commercial and industrial investments. One is deferred maintenance. This refers to any major or minor defects in a building. Naturally, you want these defects exposed before you invest any money in a building. For example, one of the first things to have checked is the condition of the roof. The damage caused by water leaks to electronics and wiring can create some very expensive repair bills.

The other type of maintenance is routine. Just what it sounds like, this is such regular activity as cleaning, painting, servicing of HVAC, escalators, elevators, fire safety systems, etc.

Since laws require regular maintenance, check all the building logs to make sure routine checkups have been completed, but don't take the log entries for granted! Always talk to the companies doing the maintenance to ensure the work was really done.

If you've already found that equipment hasn't been kept in great shape, hire a different company to do inspections to make sure that you're getting objective opinions.

Talk to the tenants as well about their views of the maintenance. This is not only a chance to get a realistic picture of the building, but it's also a chance to build good relations with them should you decide to purchase the property.

Routine Items You Can Check Sometimes, defects are obvious and don't need the trained eye of a professional inspector. During a walk-through, you can check for the following items: * Ceilings-look for evidence of stains or broken tiles that indicate leaks from the roof. * Walls-check for significant cracks caused by uneven settlement of the foundation. * Floors-warping or cracks can indicate problems with the way they were laid or with the foundation. * Rest rooms-check out the condition of the plumbing to make sure it's not leaking, rusted, or otherwise not performing property. * Security components-these should all be functioning properly; e.g. doors lock as they should, exit signs are illuminated, stairways are in good shape, etc. * Lighting-interior and exterior. All lights should be working. * Door hardware-by this, I mean automatic and/or hydraulic door openers and closers should be functioning well. * Paint-at points like common areas, check to see if the paint is in good shape and doesn't show peeling, "alligatoring," and the like. * Tenant spaces-check their condition very carefully. After all, if they're not in great shape, the tenants will want you to fix them up once you take ownership of the building. Make a list of maintenance/repair items and get bids from contractors to see what the costs will be. * Grounds-check to see what kind of shape they're in. This not only includes landscaping, but the condition of parking lots, curbs and the like.

Red Flags Never put your money into any property with one or more of the following problems: * Asbestos * Dry rot * Duct contamination * Hazardous waste pollution * Lead contamination * Mold, etc. If you find these problems, cancel the escrow and look elsewhere! You want to buy a profitable property, not a money pit.

Purchase Agreement Recommendations Always write a condition into the agreement that requires the seller to do one of two things before the close of escrow: * Correct all problems, or * Lower the price so you can do the repairs. The advantage of this strategy is that you can hire your own contractor to do the repairs, and you'll know they'll get done correctly.

What To Do Once You've Acquired the Commercial Building Once you've bought the building, you want to keep it in the best shape possible at the lowest cost possible. For office buildings, your "foot soldiers" in the maintenance war are the members of the maintenance staff. Make sure they understand their duties clearly and carry them out on a regular, scheduled basis.

If you have an industrial property, shopping center or similar property, then your manager should oversee the maintenance staff.

How to Pay for Maintenance Costs Maintenance may seem expensive, but it's a lot cheaper than having those income-producing tenants bail on you because you've let the building run down.

The tenants should pay for these costs through the lease. As long as the expense is reasonable, they'll be happy to pay for maintenance and repairs since it directly affects their bottom lines.

Key Idea: Never, ever acquire a commercial property without checking its condition thoroughly first!
About the Author
Jack Sternberg is the creator of the renowned "Buyers First Program". As the "gurus' guru", he is well known by the professional creative real estate community as "Obi-Won Kenobi". Having been a full time investor since 1977, Mr. Sternberg has been "at" the closing table more than 1,500 times. Mr. Sternberg has the depth of experience that lend value to his associations. Contact Mr. Sternberg at www.askjacksternberg.com
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