Episode 139 - Mastering Due Diligence in Commercial Real Estate Deals: A Comprehensive Guide

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This is this massive big empty spot for everyone's contact information because you'll soon realize that there's like 30 people and email addresses on this transaction and you're gonna forget 29 of them, maybe even your own. What is up and welcome back to how to invest in commercial real estate. And we are pumped for today's show. There we are. Here we go. There's a, there's a little bit of something, a little attitude out of Brian finally. Um So we've been busy, we've been chasing a ton of deals. A lot of these, uh you know, shoping center deals were, you know, we're finding bargains, I guess if you will. So a lot of these deals are not moving as fast as, you know, traditional hot market where somebody's got a dozen offers and you can just log in your offer, you know, when the final call is and then, you know, they're gonna pick somebody from right then or, you know, at that date or shortly after right now, we're buying stuff where if we're buying it, it's probably hurting a little bit. You know what I mean? Because we think we're at the bottom of the market and that's why we're buying. So anyway, we've got opportunities coming. Um I know we have shopping centers two right, one outside of Chicago, one at Saint Louis.

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Super excited about both of those. Um Those will probably launch in what a month maybe within Chicago, we're gonna have out by the middle of March. So yeah, within a month, about a month and then um last week we had just launched the bur learning experience development. Um So we'll see how that went. We're super excited about that deal. That is another learning experience we're developing. Um construction on that one will probably take 8 to 10 months and then we've built in, you know, like a year um to sell it. So super excited about that deal. Another deal on Burleson, it's almost right next door to our last site in Burleson. So we think we'll, we'll do good there. Yeah. Uh and those are, are they ask about the Starbucks uh development in Jacksonville? Uh We don't quite know exactly when that's gonna close, but it's, it's pretty much any day. I think we're just waiting on one document from Starbucks. Yeah, it should be, it should be closing very fast and our final permit is like 30 days away from pick up anyway.

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So we're kind of in the approach like, you know, any time of the next month, but it could be very, very fast. So a lot going on any update on the gas station. Uh, yeah, it's a, it's a big trade. Right. And we're doing a sale east back on a lot of different sites. So, definitely taking longer to negotiate. Um, crazy thing happened to one of the 16 sites. Um, so we're having to do something funny with that, but honestly, I've been saying it for weeks, we're about to sign the contract. But if anything, it's a testament to, to show how much goes into these deals, right? Like we're not just, you don't just sign the contract, right? Like you have uh we're writing a lease, we're writing all of these things. Um It takes a long time to negotiate every single point and um we're thorough and, and they're thorough. So it's a good segue to our subject today. Yeah, which is um what's the title, Joel? What's the show? So, it's about due diligence. And uh I've gotten asked uh from a few investors like, hey, can we see your due diligence checklist? Uh You know, you want to buy real estate and you, you, you send an lo I out but all this stuff needs to happen before you actually close on that property.

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And how do I know if I'm not missing anything? And so today, we thought because we have several shopping centers in the works and we're gonna be going through this type of due diligence with them. We thought we'd just run through this checklist and then try to again, make it available. I think we used to have it on our website. Uh But we'll make it again available if you would like the copy of this checklist, you can email us. So, so as the listeners are gonna see or here, there's a lot of things on this list. What's our typical due diligence period after the LO I? Uh After, so after the LO I, you typically spend 7 to 14 days negotiating A PS A that's kind of for free and in good faith, take advantage of that, take advantage of that. Um After you sign the PS A, we typically get 30 to 40 days of due diligence. Most always 30 after the PS A is signed after the PS A is signed. And typically after that 30 to 40 days, you get another 30 days to close because the idea is, is there are certain things that you're not gonna want to do and not gonna want to spend money on uh until you're sure you're gonna buy that deal and your money doesn't go non-refundable until after the DD period. So you kind of use that period to say, OK, are we sure we want to buy this?

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And then you go through the final kind of some of the final things you lock in your loan uh and you get ready to close. So could that first period be one of the times when maybe you find out that there's a problem with the roof and maybe you need to retrain or negotiate or something or, yeah, that's a fact finding mission um or at least a fact mission up until this point. And we've talked about it. You've got to be underwriting so many properties so fast and slinging so many offers. You kind of just have to believe everything they say and they're offering memorandum, right? And our due diligence period is our kind of free timeline to say. I don't believe anything. Let me, let me, let me re verify kind of all of this own information, but with my own data trying to find something wrong, I guess that that's the purpose of this. And like with anything we do in life on the show and in real estate, if you're gonna have success, you gotta have a plan, you gotta have, you gotta have a list, right? Like it's, it's, it's a list, it's a, there's a lot of shit on this, right? So it's, it's easier to go through a transaction like this with the list on the front page of the list is this massive big empty spot for everyone's contact information because you'll soon realize that there's like 30 people and email addresses on this transaction and you're gonna forget 29 of them, maybe even your own, right?

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So it's crucial, crucial, crucial that we stay organized. Yeah, and, and by by organized, you mean who needs to be on all these emails. Uh Some, some may need to be on some, some need to be on another, but you're going to have seller, you're gonna have Seller's attorney, you're gonna have buyer, you're gonna have buyer's attorney, you're gonna have uh your title representation. Uh You're gonna have their title representation, brokers on both sides. Internal team members verifying information on lease sales tenants. Eventually your lender will have to be on a bunch of the correspondence. So getting all of those names and addresses on your checklist that at least you can always refer back and say, OK, who needs to be copied on this information. All right. OK. So then the first thing is you, you submit an lo I they accept it and then you work on A PS A together. Uh maybe the buyer does it sometimes, maybe the seller does it sometimes, but once it's, it's drafted, you hand over to the attorneys and you say, OK, is there any changes that need made? Like Braden said, that takes about 7 to 10 days, typically, maybe 14 days depending on how, you know, rigorous you're gonna, you know, negotiate that. So this really starts as soon as you get a, an executed purchase and sale agreement because that's really when the clock starts.

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And typically, like we said, you're gonna have 3040 days to do uh all of this and then another 20 to 30 days to close. So once you get that, that signed executed agreement. You gotta go to work on finding out everything you need to know that about that property. And so you don't start on any of those. We don't start on any of these until we have that signed PS A. Yeah, number number one is, is the purchase agreement. So the only thing I'll say in the purchase agreement is the only option you have is, hey, are you, are you prepping the PS A or am I prepping the PS A? If you get that choice, I'm, I'm picking my doc every single time. Like if I can prep the documents, they're in my favor. I know what they say. My attorney wrote them. Option A go with that every single time. Obviously, if I'm a seller, I can just force you to use my PS A because if, if you don't use my PS A pound sand, go buy somebody else's property. And that's typically industry standard. I would say seller preps the PS A. But if you're a buyer, like we've, we've prepped P SAS and we're the buyer and it's nice. It's real nice. Yeah. OK. So now we've got the signed agreement. What happens first?

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Uh Some of these things don't have to be in this exact order, but we'll kind of roll through them. Yeah, the, the first thing is you have a title company and you send that executed purchase and sale agreement to the title company because in most contracts I know our contract, we have a, a receipt of, of title and that's just verifying, hey, there's a third party that's received this executed document by both the buyer and the seller and, and we're starting the transaction as of now and then they get into the nitty gritty on, on the first several and a lot of the, the nuanced title stuff that you just don't have to be an expert in because you're using a title company and an attorney who picks the title company, seller or buyer. Um You know, I would say market is probably seller again, but I've got a compelling argument for buyer picking title because the buyer is the one getting the title insurance, right? Which is the biggest cost of title. And um you know, I, I think there's an argument to be had for that when you don't agree, you use two separate title companies, which is perfectly fine.

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I've, I've not really had an issue with that at all. Title companies get paid for a fee. And again, the majority of that fee is title insurance for the buyer. Um So I don't know. Yeah, I, I would say that the buyer has the right. I, I believe uh in Oklahoma to decide, OK, where is the earnest money gonna be held? Um So, but it doesn't really matter which title company you use if the seller demands on using a title company, let's say in Kansas and you know I'm in Oklahoma. I'm gonna have a closing company, title company here in Tulsa. They're gonna handle the transaction from my side just to make sure all these title documents that we're getting are in line. They're normal customary and she's gonna, he or she's gonna be advising me on where we are with the title uh commitment. And is it, is it clean title? Is there anything I need to worry about all that stuff? What I look for in a title company is great communication, right? Keep me updated and don't drop the ball. And then if we schedule a closing like 60 days from now, like let's be ready to close 60 days from now. You know what I mean? If you can do that as a title company, I love you. Ok. And so, uh, as you'll see on this list, a lot of different uh, title, uh, things on here.

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But, uh, basically they're gonna produce, uh a, a title commitment. Basically just saying, hey, we, we, we got a commitment to for a good clean title for this transaction. Um You see on here a current tax statement that's part of it. Um There'll be some required documents and required exceptions to what the title is, is giving you. You know, what kind of warranty are they giving on that title? Uh The next big one is the survey, um, and this can be negotiated on who pays for this. It may be that they have, uh, an alta survey, alta is kind of like the top tier of surveys. If they have that one then and it's recent, you don't need a new survey. Yeah, within, like, within a year ish, you know, within a year probably. And a lot of people prep that, like you're saying to go out to market ready with that so they can cut down the time requirements because in your PS A you'll have uh time requirements after receipt of survey and after receipt of the initial title commitment, you have like 20 days after each of those to kind of review and provide comments like they're saying here and you can have AAA title. That's not a survey, that's not, not that old, just recertified, that'll be cheaper.

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What's the survey? Tell you where the utility lines are, where the boundary lines are, where the building is, parking easements, anything negative negative easements or encroachments that you may have to worry about. Uh maybe they're going to expand the road in the future and you're gonna lose part of your parking lot and they have the, where do they have the right to do that? Just, just generally things like that. All the bullshit that's filed on the court at the courthouse about that piece of property is supposed to be captured on an alta survey. And alta surveys are, you know, range in price from how busy they are and where you are in the country but a couple, I, I don't know what a couple of 1000 bucks less probably. And so then you get down to title policy endorsements and, uh, these are just kind of extra coverages that you can get on a title policy. And typically your lender is gonna dictate a lot of those. Um, and, uh, and, and they just list them here. You can go over with your title company. Hey, what endorsements do I need? We're not experts in that. They, they typically tell us uh what's necessary for any given transaction. Uh But they handle all of that. Yeah, title insurance is just like I have you ever known anybody that's had a title insurance claim?

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They do happen uh but it's a little bit of a racket. Everybody's taking their piece to both provide the title policy, provide the insurance for the title policy, provide the review for the title. And so those are all fees that you, you know, you will pay for or the seller will pay for. And what I'll say is that we, we typically just say, hey, what is customer in the market that we're buying in? And let's just all agree that we're not gonna fight that, we're gonna just follow the customary rules. So if seller is, you know, used, used to paying this cost, they pay it. If the buyer is used to paying this cost, they pay it and they kind of split it up that way. And then we each usually split the closing fee or the closing costs. So, gosh, that was boring. Um, that has nothing to do with real estate. And if you want to know nothing about that, just like go to a title company, hire an attorney, they will take care of all of that. You don't have to worry about it. They'll copy you on the email and it's done. All right. So, yeah, we'll get into some more, more relevant, exciting issues with the due diligence. So the next section is property information. And so uh Braden, why don't you roll through uh some of these that we need to make sure we get, yeah, we gotta get the leases. This is our contractual revenue.

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This is, this is the, this is everything right. Um Multifamily, you may have 400 leases. I I see a lot of people just pick some arbitrary percentage. Hey, I'll audit 50% of the leases. I'll audit 80% of the leases. If they're on their shit, they're gonna read every lease and just double check it. But in retail typically you would, I mean, um multi-tenant uh retail would you, you'd read every lease, every read every lease, every amendment and brief that onto a one pager that we can tie to a three year forecasted cash flow statement. And that's our biggest goal. Yeah, this is a big one guys. The, the leases will have all of the risks and the nuances associated with the cash flow. And so you can't take the seller's word for it on this. You have to say, OK, what is the tenant actually responsible to pay? And are they being billed, what they're supposed to pay or more than they're supposed to be paying? And so then once you get all that down, then we'll, we'll cover it a little bit later. You're gonna have what's called an s it's snd A Yeah, for what? Uh for the uh, oh, the tenant estoppel, sorry, the tenant estoppel. And basically that's gonna have the tenant guarantee, uh that the, the lease is in effect that they have no issues with the lease that they don't owe any money to the landlord.

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The landlord doesn't owe them any money. And so that way you take that risk out of it. Yeah, so there's companies out there that do this kind of stuff for you. I would use them as a good double check, you know, if you want to, I would not use them as a, I don't want to read lease tool. Somebody on your team needs to read these leases. Somebody, somebody does. All right, we're gonna keep going because there's a lot of points here, copy of all service contracts and warranties. Uh If there are any obligations, uh with service contracts at the property, you want to know those, most of the time you can cancel those, uh as the new owner. There's only a few exceptions. Um All, yeah, we build it into the PS A that they have to cancel all the service contracts, all environmental and engineering assessments, investigations and reports. Um You know what you're basically doing there is asking the seller, hey, what, what have you done? What do you know about the property? Do you have any reports you can let us have that you've, you've received over the years because that'll make your job easier when evaluating the property. Uh zoning leather. It just basically says that the property is in compliance with the survey and that there's no uh issues with the zoning versus how the property is being used.

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It's not like it's zoned agricultural and you've got a retail deal on there and you might have a problem in the future. And I gotta be honest guys, I'm not, I'm not getting a lot of this from most people like zoning letters. I don't know if I've ever gotten a zoning letter. Um I mean, yeah, we have on some out parcel stuff, I guess it would be important. So a lot of this is just case, case specific um certificates of occupancy. A lot of the times you don't really care that's for new construction. If you're, if you're, you know, buying, you wanna make sure they've got their certificate. I think the next one on the on page. Number two is inspection reports and certificates. I'm not sure if it's covered elsewhere, we were talking about it before the show. You want to make sure that you are inspecting, uh, all of the issues that might cost you, uh, cap X dollars capital, you know, expenditure dollars. And so you need to have roof inspected the HV. AC inspected the parking lot, inspected the structure and we even do the plumbing. We get, we get someone to scope the plumbing because we've had an issue with the sewer pipes underneath that are damaged. So that's, that's the key. Right. And I made a joke about that earlier. People inspect things that they've gotten burned on before in a 40 year old building.

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And they were like my God, I didn't even think to inspect that. We, we had a deal in Arkansas and, and you know, a gray water pipe just like freaking collapse into the ground. There's just no pipe, you shove a camera in there, just dirt. What happened to the pipe? No idea. It was an older center. So it was probably, you know, just corroded away. Yeah. So now, now we inspect that. So you're going through there thinking, what can I inspect? What do I want to make sure is fine and right, because a lot of this stuff doesn't directly tie to income, but it ties to, am I gonna have to pay to repair that during my ownership period? That's what, that's what you're trying to figure out. And, uh, a lot of times you, especially if you're in market, you can get a roofer up there and they'll give you an assessment for free because they want your business to fix leaks in the event that you have them. Same with HV AC. Uh And so these things shouldn't be expensive. Um, if you go to an actual third party and contract out an official report, uh sometimes those can be a few $1000 but it's not, it's not so cost prohibitive that you shouldn't be doing some of these inspections, especially if you're new to buying real estate.

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Yeah. And most roofers and asphalt companies is another really big one I like. Um, they use Google Maps these days and like a quick drive by the property to see the condition maybe, but a lot of this stuff is quick and easy for them as well and they're giving you big round numbers. Ok. Next uh in this section is a copy of all operating statements and info for the past three years. This is, goes to the point that we're gonna have to try to build uh a budget. Uh You know, we're gonna, if we're gonna syndicate this, we have to be able to say this is what we think the no I is gonna be and these are the returns and so what we wanna see is their operating statements for the last two or three years. So we can verify what exact income they're bringing in, what are the utilities, what is the common area maintenance, the, the lawn care costs and just, just build this model using their expenses and their income and then verifying all of that against the leases, you know, who should be paying for what, how much the rent should be and just make it just kind of a double checking while you're building your model on that. The lender is gonna ask for all of this crap too, right? We're not, we're not saying anything that the lender isn't also going to ask for it.

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Is the lender gonna ask us to provide it to him or? Hell, yeah. Ok. Yeah. And if, if you don't, they'll probably hire it. It'll be twice as much as you could have got it for and, and for what, you know, because they use some national firm or whatever it was like, and then when you're on the front end of all of this stuff and you give the bank, hey, here's all my inspections, property looks good. Here's what I found and that checks out. Then they love you. Like, man, they're, they're putting together a deal here. They know what they're talking about. That presents. Well, um, the last one in that section is the environmental and so you'll wanna do a phase one, or if they've done a recent phase one, you can use theirs as long as it's not more than a year old, but really important just to make sure there are no issues. We've had issues at a couple of our properties and it can be expensive to remediate. And so the phase one is that first step and looking to see if there's any hazardous chemicals, any oil tanks underneath the ground, anything like that, that may need to be remediated before you close. Ok. Uh, the next is a section for closing documents. So I don't want to spend too much time on this because the title company will really uh work on this for you.

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A special warranty deed. They'll do the bill of sale, they'll do, um, they'll do an assignment of leases. So, you know, the seller has got to assign all those leases to you in a sense, he's giving up all rights under those leases and he's assigning those rights to you and that makes you the enforcer of those leases after you close here guys. I, you can literally get assigned a lease. That's as in six months, the landlord will have to pay 10 at $50,000. If they paid the rent the previous month, that could just be in there, right? So if you don't read your leases and you, you assign yourself as the new landlord to all of these leases, you could be really hosed if you miss something. Yeah, for sure. Uh I'm gonna see here. If there's anything else I wanna mention, um, the closing statement, they'll prepare a closing statement, your title company will and that'll show all the debits and credit. So who's paying for what and how much everything costs, what the attorneys, legal fees were? All the third party reports that you, you purchased all that's gonna be on the closing statement, it's gonna net out and it's gonna say, ok, cash from buyer, this is how much you have to bring.

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You know, you have your loan, you'll have your earnest money and then you'll have the net cash you need to bring and then you'll see potentially on the seller side. Sometimes they send you both is how much the seller is getting at closing after they pay off whatever debt they have and all their expenses. But you gotta re review that too, right? Haven't we found some mistakes on those before? For sure. I have yet to receive a closing statement. That was right. Oh Really? Yeah. OK. So you gotta look closely at those, you gotta look closely and a lot of times you'll close and, and you'll still forget shit, right? Like you do post closing agreements at closing that says if I missed a bill or if a tenant accidentally paid you, if, if you buy or sell. So I wanna stop on this. Like if you buy or sell something from an asshole, you're unnecessarily exposing yourself because there's a lot of things that go past the transaction in a sense and if you just cannot stand to talk to that person or they're a scumbag. I would just not, not buy it just don't, don't do the deal unless you absolutely have to. Yeah, it can be tough after the fact to get any resolution if, if you don't have it locked down beforehand. Ok, a couple things more on the closing documents, you have the tenant estoppel we talked about, this is basically saying that the tenant's certifying that the lease is accurate, that his rent is accurate and that his cam and all the charges that he pays are accurate and that neither the landlord or the tenant owe each other anything.

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Uh And that's important because sometimes special deals are cut, you know, and like, oh, you know, if you renew in five years, I'll give you three months free rent. Well, if that's in writing somewhere, but not in the lease, the tenant estoppel will cover you there because they'll, if they cert that that lease is all there is and in full effect, and they don't mention this other three months of free rent that he thinks he's entitled to. Well, he loses that ability because you're relying on that tenant estoppel and him guaranteeing that this is the situation. And if he doesn't mention any obligation outside of that, then that's what you get to use. Um ok, and sometimes the tenants won't sign, you won't be able to get all the estoppel before the closing. And so that the seller may say, hey, I'll, I'll guarantee the lease is, is all there is and it's not as good as a tenant estoppel, but it is something that is legally binding on them that if they misrepresented that uh and or they missed something and the tenant comes with a claim later, then you could take that and go and sue the seller for that because he guaranteed that lease. All right, the snd A is the next point and that's essentially the exact same thing for the lender.

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It basically just says the lender is lending on this property and you are the tenant, you have this lease and if the buyer defaults, you still have to pay your rent to, to me and I'm allowed to do that and they just sign it again. You don't have to get it from every tenant every single time, but most of the time you're getting it from most of the tenants. Ok? The next section is really easy because your lender will take care of all of this and it's always better to, to have some type of relationship with your lender. So there's some trust there because a lot of these documents have a lot of pages to them and you wanna make sure the lender isn't being adverse in, in all these documents to you on how uh how they're gonna kind of, you know, dictate the loan and the payback terms and all that. But you can see here, you're gonna have a loan agreement and a promissory note, you're gonna have to probably personally guarantee it if it's a local bank you'll have the mortgage, you know. And so all of these will be given to the title company and you'll show up at the day of closing and you'll have all these documents. If you want to read those before the closing day, you should do that because there's not enough time at the closing table to read half of the documents you're gonna sign.

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Yeah. And I'd almost go as far as to say on your first deal if you're, you know, buying multimillion dollar property that, you know, from a local bank or even a non, non recourse lender, whatever, having your attorney review those loan documents is helpful maybe the first time or two because it helps you understand what a lot of these big banking terms mean and the repercussions of some of them once you have a general understanding for the, the, you know, the mortgage and the promissory note and the security agreement and all of that stuff. Yeah. Later on. Do you have to have an attorney read it? Now, do you still want to read it? Probably? Ok. Yeah, I mean, I think that's probably all that we're, uh, really gonna cover. There's a few, you know, other closing documents like getting keys, uh, you know, for all the, the units, uh, and things like that, wiring instructions, where are you sending the money to? But all that's pretty basic and uh you can, you can all read that for yourselves. So, uh there's a little bit of post closing, but mostly the title company will work on that. Um And so you'll get the final documents in the mail sometime after you close.

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Uh But the, the, the key is we wanted to provide at least a baseline document for people that are looking to get into commercial real estate that can at least guide them through the process. This isn't gonna be perfect. Uh But it will at least uh cover many of the areas you need to know. And if you have questions, you can just hit us up, obviously, you can hit your lender up for the loan stuff, you can hit your title company for most of the stuff. Uh And then, you know, most of the other information comes from the listing broker uh through the seller. So what else do you think we need to cover? I think that's a pretty good list. Obviously, there's, you know, genre specific like raw land is gonna be different than multifamily, that's gonna be different than a big office complex in Chicago. So a good point, there's very nuanced uh checklist for uh multifamily versus let's say, you know, self storage. So uh get, get to know what kind of property you're doing and, and some of the specifics of, of due diligence. List for that type of commercial property? Yeah, if you would like a copy of this, is it, what are the email info info at the criterion fund or invest at the criterion fund?

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Ok. If you would like a copy of this checklist or if you have questions, email us at invest at the criterion fund.com. Yep. All right. And we will see you guys next time on how to invest in commercial real estate. Thanks guys.