There’s a lot to consider when preparing to buy a commercial property. A Prescott Valley man recently approached me as he was in the process of purchasing a roughly 22,000-square-foot office building in the Prescott area. The property had nine total office suites with three spaces currently vacant. He asked what sorts of things he needed to check out during the inspection period.
As a commercial broker, I can’t even begin to tell you how many prospective buyers overlook key concerns during their inspection (or “due diligence”) periods. For starters, it’s important to make sure to include a detailed list of property-related items to be provided to you by the seller within the first week or so following the acceptance of your offer.
These should include, at a minimum, copies of all tenant leases (including estoppel certificates from each tenant), detailed operating statements for the current year and at least one prior year (some lenders require three years), copies of all service contracts with current vendors, a list of any personal property to convey with the property (as well as a list of any leased equipment at the property belonging to third-parties, i.e., vending machines, copy machines and other office equipment, and so on), property tax bills for the past two years, property insurance bills, including a copy of the current policy and a three-year loss run from the insurance agent, a list of all capital expenditures for the past two to three years, including any applicable warranties, and copies of any governmental notices, zoning or building code violations, safety citations, etc.
Next, make sure to give yourself enough time to conduct a thorough inspection of the entire building, inside and out, including roofs, plumbing, electrical, HVAC, mechanical rooms and all occupied and vacant suites. The landlord will need to provide all tenants at the property with sufficient written notice of such an inspection. It is highly recommended that you bring along one or more licensed, bonded and insured professionals to assist with this inspection, unless you yourself are a general contractor or are otherwise well-versed in such things.
A few final thoughts, in no particular order: how long have the vacant suites been vacant, and what efforts have been made to re-lease these spaces? What are the new asking rents (or rents being asked at similar buildings in the area) as compared to the rental rates being paid by the other tenants? Can these spaces even be rented at the rents you will need to justify the purchase price? When do the remaining tenants’ leases expire, and have you allowed for a sufficient vacancy factor, even after the building is full? In your market that should probably be between 5 and 10 percent, which includes both physical and economic vacancy. Speaking of which, are you paying cash for the building or getting a new loan? If there will be a bank involved, you will probably want to speak with them before submitting your offer just to be sure you fully understand their underwriting requirements, both for you as the borrower, as well as for the real estate you are purchasing (they may even require certain additional items not mentioned above – you will need that list).
I have seen a few dozen transactions blow up over the years due to a lender who either wouldn’t finance the acquisition at all, or where the loan dollars being offered were far below what the buyer/borrower believed he could get at the time the offer was made. In most cases I would chalk this up to either unreasonable buyer expectations, or simply a lack of knowledge or experience on the part of the buyer or broker.
The bottom line here is that “let the buyer beware” couldn’t be more true than when buying a commercial or multifamily property. What you don’t know CAN hurt you, however if you go about it the right way with all “i’s” dotted and “t’s” crossed this could turn out to be a solid investment for you. QCBN
By Neil Sherman
Neil Sherman is the Designated Broker and Managing Director of Sperry Commercial in Phoenix, and can be reached at 602-566-7210 (direct). Please send all commercial or multifamily property-related questions to firstname.lastname@example.org