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Commercial Property Due Diligence Secrets

Aug 4, 2008
When you take a property under Contract, you know very little about its specifics. You might have a Financial Statement and a Rent Roll in your hands ... and maybe you have done a drive by inspection. But this is only enough information to make a minimally intelligent offer. You must understand a whole lot more about the property to know its real value.

That's what Due Diligence is for.

A thorough Due Diligence process remove risk from your investment. You get thirty days to learn enough to understand exactly what you're getting into, and exactly what it will take - under YOUR management - to make a profit.

We always advise our mentor clients to use a specific Four-Part Due Diligence Process because we have found there are four ways Risk can damage your returns.

- Market Risk
- Financial Risk
- Tenant Risk
- Physical Risk

These four Risk threats interlock like pieces in a puzzle. Our four-part Due Diligence process ensures that you look at each property puzzle from the four different angles.

And the order is Very Important. As you do each separate step of our Do the Diligence process your property must pass the current step to go onto the next one.

Example: If you discover the market risks are too high, it really doesn't matter what the financial proforma says or what the property's physical inspection reveals. The market will sink that investment, so stop the process right there and go ask for your earnest money back.

Here are the Four Parts in more detail:

Step #1:

Market Due Diligence:

Check your assumptions about the market in which the property is located.

- What are the population and job growth projections?
- What are the market rents and occupancies for similar properties?
- What are rent growth projections?
- What phase of the market cycle is this market in?
- What amount of new construction in your asset type is in the pipeline?

Question: Do you want to own Property in this Market? If yes, go on to:

Step #2:

Financial Due Diligence:

- Request at least three years worth of monthly Profit and Loss Statements and as many Rent Rolls as you can get your hands on.
- Sit down with your property manager and build a detailed expense projection based on their experience in this market.
- Plug your income/vacancy/expected rent estimates in from your market Due Diligence step above.
- Get estimates of loan costs and projected payments from your mortgage broker.
- Create your Investor's Proforma for 3-5 years out.

Question: What will it take for you to hit your ROI numbers at this price? Is this even possible? If yes, go on to:

Step #3:

Tenant Due Diligence:

(this is especially important in Industrial, Office and Retail Properties).

- What is the strength of your current tenants and their existing leases?
- You will need to do a thorough analysis of your tenet's underlying business strength.
- This gives you an estimate of their ability to continue to pay you rent.
- Perform a complete analysis of existing Leases with Estoppel Letters to verify the contents of the Leases.

Question: Are the Leases - and the businesses behind them - solid enough and safe enough to continue?

If so, go on to:

Step #4:

Physical Due Diligence:

- Perform a walk-through of every unit and every square foot of the building(s).
- Create an estimate of all repairs needed and costs associated with those repairs.
- What amount of money, time and effort will it take to put the Property in the condition that allows you to hit your Rent and Occupancy numbers?

Question: Will you be able to hit your ROI numbers with these repair expenses included in your Proforma?.

NOTE: Physical Due Diligence is always saved until last for one simple reason.

It doesn't matter what the building looks like if it can't pass the first three steps of Due Diligence. A great looking building in a lousy market, or one that doesn't reach your ROI hurdles, or one that has unsafe short-term leases is still a bad investment ... no matter how pretty it is when you drive by.

When you approach your Due Diligence process using these four steps - in this order - you will have a clear understanding of the property's current state AND exactly what you will need to do to make it a profitable investment.

Due Diligence assembles the puzzle pieces of the Deal. And since you are still in the Due Diligence period, if you find the risk is too high, you can walk away.
About the Author
Learn the Insider Secrets of Commercial Property Investment from Monte Lee-Wen who has personally purchased over $150M in Commercial Real Estate. CLICK THIS LINK NOW to start your Commercial Real Estate Investing Education with his 14 page FREE Report "35 Reasons You Should Invest in Commercial Real Estate".
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