Step by Step: Commercial Real Estate Due Diligence [With Checklist]

So, if that’s true, then conducting your due diligence before you buy the site is crucial to your success as an investor.

But what if you’ve never been through the process before?

Here’s my step by step guide on commercial real estate due diligence with a checklist for you to download at the end.

1. Organize The Files

Once the contract is fully executed and finalized, we organize it into a project folder on Google Drive and send a fully executed copy to our real estate attorney and any partners involved in the project.

The sellers will have a number of files that we require they turnover within a specified number of business days after the execution of the contract - typically 5 to 10 business days. These files can include:

• Property surveys
• Leases
• Appraisals
• Governmental notices
• Photographs
• Easements
• Encumbrances
• Title reports, commitments, and policies
• Recent tax bills
• Environmental reports and related correspondence
• Soil reports
• Zoning documents
• As-built construction documents
• Previous site plans
• Copies of all material correspondence relating to the Property
• Records of any discussions with the City of Nashville or other governing authorities
• And all other testing reports and civil documents relating to the Property or the development thereof that are in Seller's possession or are otherwise available to Seller

As you can tell, having these files readily accessible through the Cloud is critical when working with multiple team members and partners since everyone can add to and view the folder at any time necessary.

Be sure to thoroughly investigate each of these files to ensure that you fully understand what is involved with the property you’re buying.

2. Explore Financing Options

If you haven’t discussed the project with your lenders prior to going under contract, open up the conversation with them immediately.

The more time you have to work with your lender on the project and get them comfortable, especially if it’s unique or a heavy lift, the better off you’ll be when it comes to closing.

Lenders will typically require the following from each of the partners:

• 2-3 years of tax returns and K-1s (if any)
• A personal financial statement
• A copy of driver's licenses
• Your track record

I also send them a CRS tax report on the project, an overview of my plans for the site, an abbreviated version of my underwriting, and an abbreviated version of my offering memorandum.

Now, if you’re raising capital for the project, it’s unlikely that you’re going to have your offering memorandum compiled the same day that you put the property under contract.

I typically open up the conversation with potential lenders to test the waters and see if this project is inline with what they’re interested in at this stage. If so, I get high level terms that can help me finalize my underwriting before I come back to them with my full request on the project.

3. Review The Operations

Begin reviewing any and all contracts and documents related to the property after receiving them from the owners, including but not limited to:

If you’re buying a property based on the income that it produces (like on a cap rate), then you’ll want to double-check to make sure that the property is actually making the money as advertised.

At this point in the due diligence period, I’ll loop in my property management firm to help dive into the leases, rent roll, and operating expenses. They’ll also visit the site with me so that we can start putting together a list of capital expenditure items that may need to be addressed in the next few years.

If possible, get your CPA or financial officer involved in the numbers, too. Fortunately, it’s fairly easy to “follow the numbers” if you have qualified professionals on your side so that you know how truly profitable (or unprofitable) the site is.

When you’re able, you’ll want to open up discussions with the current tenants to see what they like and don’t like about the property, what their wish list might be, and if they’re interested in renewing their lease terms. Of course, you’ll likely need to do this talking through the current owner or their property manager, considering how sensitive sales can be sometimes with tenants.

Your primary objective here should be to investigate how you could possibly run the property more efficiently. We’re able to significantly increase our property values, oftentimes without raising rents, simply by decreasing our operating expenses and therefore increasing our net on income.

Now would be a good time to see if you can get a better deal on landscaping, property management, save utility costs by installing LED lighting, and more.

4. Inspect the Property

You may even get to this before diving into the documents, but you’ll want to inspect the property.

And I don’t mean just a casual walkthrough - I mean the kind of inspection where you spend half the day onsite if the project is big enough. You need to be thorough in your inspection and get eyes on every possible nook and cranny to make sure you know what potential issues there may be onsite.

You’ll also want your team with you, which could include:

Now that I’ve worked on a number of projects from the brokerage, management, and ownership sides, I have a pretty good understanding of exactly what I need to look for when I’m on a site visit. However, I will still engage a property inspector if I find anything suspicious so that I have backup to my claims should I need to renegotiate with the seller.

When you’re on site, try to ask the business owners / employees and any customers what they like and don’t like about the property. You’ll be surprised at what they’ll share with you and it’ll certainly help with not only your understanding of the property, but also your tenant relations if you actually fix the issues they point out.