Third Party Reports for Due Diligence

Commercial Real Estate Toolkit

Third Party Reports for Due Diligence

When purchasing commercial real estate, the buyer is usually afforded a due diligence period.  During this time, the buyer is given the right and opportunity to review documents, perform inspections, and commission third party reports to determine if the property is a suitable investment.  While negotiating the purchase and sale agreement, a buyer should plan ahead by obtaining bids and time frames from consultants who perform this type of work.  The buyer, at a minimum, should consider obtaining the following types of third party reports for due diligence:

• An ALTA/NSPS Land Title Survey. An ALTA Survey is a graphical presentation of the real property, showing the boundary lines, improvements, easements, encroachments, and other matters that may affect title to the real estate. Is the building sitting on top of a utility easement where a contractor may need to dig? A buyer can find that out with an ALTA survey. An ALTA survey helps a buyer better understand what it is buying.  In addition, obtaining an ALTA survey will allow the title company to issue “extended coverage” making the owner’s policy of title insurance more robust.
• A Property Condition Assessment also known as a “PCA”. A PCA includes a physical inspection of the building by an expert, a report detailing the existing condition of the various components of the building and a capital replacement budget for the next 10 years.  A PCA helps the buyer identify deficiencies that need to be addressed in the short, medium and long term.  At a minimum, it will help the buyer understand what costs it will likely incur in the future. Often, a PCA will pay for itself when it reveals deferred maintenance the buyer can use to support a request for a price reduction.   

• A Phase I Environmental Site Assessment. This report is prepared by an environmental consultant. It includes a tour of the property, interviews with the existing owner and occupants, and a review of various public record sources and databases used for reporting environmental and other information.  A buyer can expect that all commercial lenders will require a Phase I before funding the loan. If the Phase I identifies recognized environmental conditions (known as RECs), such as underground storage tanks (which often leak), or historical uses or releases of hazardous materials, the consultant may recommend a Phase II Environmental Site Assessment. A Phase II usually includes taking soil and ground water samples and testing for substances that are hazardous to human health. These reports can help prevent the buyer from incurring unanticipated environmental cleanup costs. If the buyer determines the property is contaminated during due diligence, the buyer can require the seller to pay for the cost of cleaning up the property or terminate the contract.
• A Zoning Report. This report is prepared by a consultant with expertise in zoning matters. The consultant will request a zoning verification letter from the local municipality and will usually submit a public records request to determine whether there are any existing code violations at the property. In addition, the consultant will review the zoning map, zoning code and an ALTA survey of the property and determine whether the property and improvements comply with the existing zoning laws from a bulk, density and permitted use standpoint. 

The list above is not exhaustive.  The doctrine of caveat emptor always applies when buying commercial real estate. A buyer can reduce the risk of making a bad investment by obtaining and carefully reviewing the foregoing third party reports before the due diligence period expires.