Written by: John Hynes
When Capital Rivers Commercial (CRC) represents a growing commercial tenant, we act as their developer. Although development and brokerage are intertwined, this article focuses on the development side of our business. The development manager covers the ins and outs of the commercial real estate due diligence process as part of their many responsibilities. The ultimate goal is to facilitate growth for our client.
Representing a Growing Commercial Tenant
When working with a growing commercial tenant, we oversee the process from A to Z. We begin by scouring areas that our client would like to be a part of. Once we determine a location, we purchase property/properties the client wants to operate their business in. This requires a lengthy and in depth process that requires many steps. From start to finish the process can take years. Simplified, the steps include:
- Site selection
- Letter of intent negotiated and eventually mutually agreed upon by both parties
- Purchase and Sale agreement (PSA) negotiated and eventually mutually agreed upon by both parties
- Seller provides mandatory disclosures and other due diligence materials
- We order Phase 1 and other reports as necessary
- Lender approval
Commercial Real Estate Due Diligence Process: Site Selection and Contract Negotiations
Once we have selected a property, we connect with the seller or seller’s agent to begin the process. Timed to coincide, we present it to our client to receive approval for the site.
Because there are many steps, negotiating a reasonable timeline for commercial real estate due diligence is essential. The PSA clearly outlines the buyer’s timeline to do any and all investigation into the property to determine the property is suitable for Capital Rivers, the lender, and our development client. Once the PSA has been signed, due diligence begins.
Performing due diligence is an important task that involves many stakeholders, inspectors and environmental consultants, state and local government agencies, pre-sale contractors and more.
Mandatory Disclosures and other Due Diligence Materials
The due diligence period isn’t just a single checklist: it’s important to note there are a number of balls in the air at the same time. The development manager works with the client to ensure the due diligence period progresses smoothly. The seller or the seller’s agent provide us with the following:
- Property Information Sheet
- Mandatory disclosures
- Material facts known by the seller
Many times patience is key because not everything works on a forward-paced timeline.
Phase 1 Environmental Site Assessment
When purchasing a piece of property or a building, a Phase 1 Environmental Site Assessment (ESA) is required. This review is done by a third party. Capital Rivers typically uses Intertek, a nationally-known environmental testing company that does top of the line work.
The ESA includes an on-site visit and inspection where they look at the following:
- Current and past conditions and uses of the property and adjacent properties
- Historical record of any environmental problems with the property
- Current analysis of the soil
- Review of state and federal records of the property
- If there are issues that are visible, the inspectors may require drilling into the soil or foundation to look for bigger issues (Phase 2)
Once the report is complete Intertek provides a certified letter and signature. This signed letter satisfies the requirements of the lender.
If there are recognized environmental conditions, further action may be required with additional recommendations. Frequently if issues exist, they may impact the use of the property. For example, if the building is a dry cleaner and it is processing the cleaning on site, there may be contaminated fluid. The fluid could cause environmental problems. Another example would be a gas station near the property that the buyer is purchasing. There could be issues with the ESA if gasoline or oil have leaked onto the proposed property.
The environmental and property condition reports are often expensive and very detailed. In fact, typically the reports are hundreds of pages long. The Phase 1 report usually takes 2-4 weeks to prepare, depending on how busy Intertek is. This timeline can be expedited if the buyer is willing to pay additional charges.
Property Condition Assessment
In addition to a Phase 1 inspection, a property condition assessment (PCA) will also be conducted. The PCA is also a part of the review the lender requests to confirm or deny the buyer’s request. At this point if the buyer or the lender decline the purchase, the buyer is required to turn over all inspection documents to the seller. Moving forward, the seller is required to add them to the documents they provide the next potential buyer.
The lender has certain requirements it wants to confirm in order to lend money to purchase this property. The lender’s questions include:
- Is the property compliant with local regulations?
- Is the seller the sole owner? Have you ensured there are no tax liens or judgments against the property?
- Confirm property conditions match the descriptions on the title and survey
- Will the property need to be rezoned based on your plans?
- Is it ADA compliant?
- Is there asbestos?
- Is there any underground storage?
- In terms of the building: how old is the roof, the AC, the parking lot, etc.
The lease that is presented to the lender/future buyer drives values for commercial property. The property must be appraised before the lender will approve the loan. The lender wants to be certain this property is worth what the buyer is borrowing capital for. In addition to appraising the property, the development manager looks over any current leases. To avoid any legal issues after the purchase of the property, a Tenant Estoppel Certificate is required by the lender. This signed agreement ensures the lender has accurate information on the terms of the existing lease(s) and any potential claims against the Seller.
After all due diligence has been completed and both lender and CRC are satisfied, we waive contingencies and move towards closing. After close, Capital Rivers is the owner of this property and we can begin construction for our client.
Capital Rivers facilitates growth for our commercial real estate clients. We make sure everything stays on track and conversations are happening in a timely manner. Failing to do the appropriate due diligence could result in the client losing out on the property or could extend the development process by months or even years.
Capital Rivers Commercial Philosophy
We understand commercial real estate is complicated. To help our clients maximize their efforts with franchise investment opportunities, Capital Rivers Commercial in Sacramento operates in a collaborative environment. All of our brokers specialize in a specific sector of commercial real estate, but we work together to share industry expertise and market knowledge. This approach allows us to have many resources available when working on a project. The variety of expertise developed in our careers prior to and at Capital Rivers benefits the real estate brokers when working with franchisees and franchisors.
At Capital Rivers Commercial, we blend leading technology with old-school work ethic. We love discussing commercial real estate, especially when it comes to franchisees and franchisors. If you are interested in learning more, sign up for our email blast or contact us today.