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The Commercial Real Estate Due Diligence Process – Part 1

If you do not know how to ask the right question, you discover nothing. – W. Edwards Deming

The Function of Due Diligence is to Discover and Verify!
The purpose of a thorough due diligence process is that when the time comes to present your deal to investors and lenders, you will be armed with the level of information and knowledge regarding the property required to determine the foundation of a good investment.

Due diligence has many aspects, encompassing both the relatively tangible and the completely intangible. Let’s begin with the following.

Environmental Due Diligence
As applied to commercial real estate transactions, this typically includes Phase I and Phase II environmental site assessments. In the US, these are often undertaken to avoid liability under the Comprehensive Environmental Response, Compensation, and Liability Act, commonly referred to as the “Superfund law.”

The purpose of an Environmental Phase One Assessment: to determine the environmental status of a property or facility as it relates to a real estate property transaction. This kind project follows standards which include those published by ASTM.

Regarding Environmental Phase Two Assessments/Subsurface Investigations: these projects include, but are not limited to, sampling and subsurface drilling , asbestos and lead sampling., ground penetrating radar, and monitoring well installation and sampling.

Technical Due Diligence
Caveat emptor is in important legal principle underlying all property transactions: the party acquiring the property is legally obliged to discover and verify as much about it as possible. This means is that the most comprehensive and painstaking technical due diligence is indispensable.

Similar in terms of process to a building survey, the term technical ‘due diligence’ has become increasingly common in describing the process of gathering information regarding the physical characteristic of a property risk assessment tool. The process involves research, analysis and discovery.

An engineering or property condition assessment (PCA) typically includes a review of building systems in order to evaluate deferred maintenance items that can materially affect the operation and value of a property.

In the course of such an assessment, micro-cameras, scopes or other devices may be required to scrutinize (behind the walls or underground) the condition of HVAC ducts, plumbing, vertical transportation, electricity, windows and walls.

The information these assessments provide can be critical in identifying major defects and opportunities for improvement, in verifying and confirming the quality of the building and the land it stands on (thus ensuring the suitability of the property for its intended use), and for negotiating the price of a property. Finally, in order to provide a level of protection for institutional investors, these assessments are required as part of securitized lending commercial mortgage-backed securities.

Due diligence is an incredibly complex matter, so we are far from having exhausted the subject. We will continue our discussion in subsequent blog posts.

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