A previous blog post addressed the importance of due diligence when purchasing commercial property before a contract is signed. This post addresses a buyer’s due diligence after the contract has been signed but prior to closing and taking title to the property.
As stated in the prior post, a buyer must perform due diligence to ensure that all material facts concerning the property are known. The extent and scope of the due diligence differs with each property and depends on the property and the ultimate goals of the buyer.
Once a contract to purchase commercial property is signed, the buyer will need to revisit the questions set forth in the prior blog post and conduct a more thorough investigation of those matters. In addition, the buyer must perform additional due diligence on the property prior to the expiration of the inspection period. Due diligence should examine the following:
- Are there any title concerns? A thorough review of the title commitment and all of the title exceptions referenced in Schedule B-2 of the title commitment is critical. Some title concerns may include mortgages, liens, judgments or assessments against the property, easements burdening the property, and restrictions and restrictive covenants against the property which may limit the proper uses of the property. Although the contract will provide a buyer with a period of time for title review, it is best if the contract is drafted so that the title review period coincides with the due diligence or inspection period to provide the buyer with the most flexibility.
- Are there any survey concerns? An ALTA survey showing all improvements as well as depicting all plottable title exceptions should be obtained and be reviewed in conjunction with the title commitment. This allows a buyer to determine if there are easements, encroachments or other matters, such as height restrictions, building setbacks and flood zones, that need to be addressed.
- Is there insurable access to the property? Many people believe that if there is a road to the property, access is not a concern. However, actual access to the property is much different than insurable access to the property. If there is not insurable access, you may encounter problems upon future development or financing of the property or ultimately a re-sale of the property.
- Do applicable zoning and land use classifications permit the current uses of the property and/or the buyer’s intended uses of the property if different from the current use? A zoning verification letter from the applicable municipality should be obtained to confirm the property’s zoning classification and pertinent zoning and code related matters. Certain county’s and municipalities may, in addition to confirming the current zoning classification, confirm whether the property is in compliance with the zoning classification. In addition, unrecorded land and zoning documents relating to the property should be obtained from the appropriate governmental authorities including the local government building department and planning and zoning department. Such documents may include zoning approvals, site plans, governmental permits and approvals, development agreements and development orders. Meetings with local governmental building officials could also prove useful and provide additional information relating to the property.
- Are there any environmental concerns relating to the property? To answer this question, a Phase I environmental assessment should be obtained. Depending on the results of the Phase I report, a Phase II environmental assessment may be required. Do not assume that because the property has never been used as a gas station, dry cleaning business or other type of business that has a higher likelihood of contamination that there are no environmental concerns with the property. The adjacent properties should also be examined to determine potential contamination from neighboring properties.
- Are there code enforcement liens, open or expired permits, unsatisfied development or easement obligations, unpaid municipal liens for such things as water, electricity, sewer, gas or other utilities that may create potential legal liability on a successor owner? Some code enforcement liens may attach to all property owned by that property owner and is not limited to the property that is in violation of the code. This is referred to as “cross attaching.” If the seller owns property with a cross attaching super priority code enforcement lien against one parcel and you purchase another parcel from the seller, the property may be subject to the lien. If there are open or expired permits on the property, this could result in the denial of new building permits until the open or expired permits are closed which may include inspections by local governmental officials.
- Are there any major issues with the improvements on the property including any buildings and their components such as the roof, electrical, plumbing, fire sprinklers, elevator, HVAC, etc? Physical inspections should completed so an evaluation of the condition of the improvements and any repairs that may be required can be done.
- Are there tenants? If so, each lease should be carefully reviewed to determine the landlord and tenant obligations, if the tenant has a right to purchase or relocate, if tenant has exclusivity, if tenant paid a deposit or advance rents, and the status of the leases. Tenant estoppel letters should be obtained as well as a rent roll for the property.
- Is an on-going business being purchased in addition to or with the real property? If so, the business will have its own due diligence matters that must investigated, which matters are beyond the scope of this article. Some real property related concerns to consider are: what type of business or related licenses are required, is a liquor license required, is outdoor dining permitted, is music permitted, and is a drive-through permitted?
- How will the buyer take title to the property? This should be determined before closing on the property to avoid incurring additional costs post closing, such as additional documentary stamp tax and related costs.
The above list is not exhaustive but illustrates the depth of due diligence that is required by a buyer concerning commercial real property. Yes, buyers may spend thousands of dollars on due diligence investigations and ultimately elect to terminate the contract. However, that is the purpose of due diligence — so a buyer can fully evaluate the property and the risks and costs involved should the property be acquired.