What does commercial due diligence mean?

Question

When you investigate a commercial property what aspects do you consider?  What is important to you when determining which properties to buy or not buy?

Darryl Dahlen · Answer

As someone who works in commercial finance, there are a lot of factors that one should consider if they need financing.
Just some of those include:
-Verification of historical financials. That means requiring audited financials.
-Looking at any leases in place with regards to term, exit clauses, and if they are N, NN, or NNN.
-Are there any environmental factors? Do you need to have a phase 1 done?
-Are there any market conditions with regards to saturation/absorption?
-Is the debt service ratio sufficient to cover debt?
-What is the NOI and does that number support the value?
-Is there a competent property management company in place? 
-Is there any deferred maintenance or immediate repairs needed?

I could go on, but I think that list covers a lot of the basic items one should think about (if they are applicable that is).

Dale Osborn · Answer

Bottom line does the property support itself from day one. If so then get into the due diligence portion. Any deferred maintenance on the property? Any major repairs needed? Condition of roofs, sewer lines, water lines, electrical lines & poles, curb appeal as to landscaping, exterior painting as well as interior painting. If you do not have to put too much back into the property - then go for it and the "cash flow"!

Account Closed · Answer

I agree Joel, I like to take a serious look at the potential a property has as well.  I don't look at buying a property though based on this potential, but it is very much a factor in deciding to move forward or not with a deal.

Joel Owens · Answer

I look at the land just as much as the improvement upon it.First having started out working with commercial developers before that market tanked you never look at land the same way again.

So not just the financials of what the property is but also what could it become?? (highest and best use with repositioning)

Maybe there are many apartments in the area but none that cater to senior living.By having demand and changing to senior or adult living with a light rehab and change you can then increase the rents.

Also if you have additional land you can build or add on later.

Who holds the loan on the property?? Local or national bank might not can take the hit.If it's a national bank,the fdic,or a CMBS security they can take a much greater loss on average.

Is the owner retiring?? Can they finance at below market rates??

You can go on and on.I like to look at it from as many angles as possible. I know most of the time the owners presented numbers are junk.

Darryl Dahlen · Answer

I agree with you about not trusting proformas. Almost without exception, the reality is a different story that the one that was presented.
We almost always request the past 3 years financials. Those can either be tax returns, audited financials from an accountant, or a combination of the two.
Getting YTD numbers verified can be a little more tricky since getting those numbers verified can take time and money, and in most cases because of time constraints, that isn't in the cards.

Account Closed · Answer

Darryl,  the financial statements are also one of the first things I review.  I put no trust whatsoever in proformas.  I also don't trust one year of financial history, I want to see several years so that I see trends and variances.  It is amazing sometimes what you can learn form financial statements.

I'm sure there are many other areas that should be reviewed as well as these that you have mentioned.  Anyone venturing into the commercial arena needs to understand what is they are investing in.  There is great potential for higher ROIs but there is greater risk especially for the unwary.

What does commercial due diligence mean?

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