Investing in California commercial real estate requires extensive planning and research. A prospective buyer must consider potential legal, financial, structural, and environmental issues. This process of research and review is commonly known as “due diligence.” Since every real estate investment is unique, the precise due diligence process will be different each time. The following is a very general checklist, which may apply to a wide range of properties.
1. Investigate both the property and the seller
Due diligence for a commercial real estate investment is about more than the property itself. An investor should also look into the seller’s reputation and their track record for similar transactions. Even if the property is spotless, an investment might not be worth the risk of an unscrupulous seller.
2. Title and Survey
Inaccurate identification of a property is a common complication. An investor should obtain the full legal description of the property, to compare to official real estate records.
They should also obtain a title commitment, in which a title company identifies potential title defects. The title company will also require the most recent ALTA/NSPS land survey. To the greatest extent possible, an investor should also conduct their own title search and review the survey themselves.
3. Zoning and Land Use
Non-compliance with zoning regulations can lead to significant liabilities for a new property owner. An investor should investigate current compliance and obtain copies of all permits, licenses, and certificates of occupancy affecting the property. They should research past code violations, and determine whether any proceedings for code violations are still pending.
Investors should also review the property’s compliance with the provisions of the Americans with Disabilities Act (ADA) regarding accessibility.
4. Property Value
An investor might need an appraisal of the property for multiple purposes. The title insurance underwriter may need it, as well as any lenders or other investors contributing to the purchase price. A market-value appraisal is also useful when investigating property tax issues.
5. Environmental Concerns
If a property is contaminated with certain pollutants, federal and state law may require one or more environmental site assessments. Investors should determine whether any such assessments have taken place and obtain copies of the reports. Other environmental concerns may include mold remediation, underground storage tanks, or asbestos.
The adage about “location, location, location” also applies to environmental concerns. If a commercial property is located in a flood plain, that will affect insurance. Fire hazards are a concern for properties throughout California, as are earthquakes.
Restrictive covenants, easements, and other encumbrances on real property often “run with the land” in California, meaning that a buyer is subject to the same restrictions after the sale has closed. Many encumbrances are easily identifiable in county real property records, but some may require a more careful search.
Investors should identify all leases and guaranties in effect during the due diligence period, and should determine which leases would carry over after the sale. They should also obtain an accounting of all security deposits currently held by the seller for the tenants.
8. Income and Expenses
The seller should provide financial statements, rent rolls, and other documents demonstrating income and expenses associated with the property. Rent is perhaps the most common form of income. Expenses may include:
– Common area maintenance
– Service contracts
– Insurance premiums
Unpaid property taxes can lead to liens on a property, followed by foreclosure. Confirming that all taxes are up-to-date is crucial.
More Blog Posts:
What Disclosures Must a California Real Estate Investor Make When Selling an Apartment Building? Titles and Deeds, July 19, 2018
Restrictive Covenants and California Real Estate, Titles and Deeds, July 16, 2018
Easements and California Real Estate, Titles and Deeds, June 29, 2018