BUYER BEWARE – Purchasing commercial or residential investment property requires a significant financial commitment. Diligent investigation before signing contracts (or committing to the purchase) can save a buyer unwanted surprise and potential financial hardship later on. Therefore, it is essential that a buyer closely examine the property and scrutinize the risks and benefits of the potential investment. Below are several steps that every buyer should take before purchasing an investment property. A buyer should request at least thirty (30) days to complete the due diligence after all information has been received from the seller.
Know the general market conditions, as well as your target market:
- Is now a good time to invest in real estate? Is it a sellers’ market or a buyers’ market? Is your intent to flip the property or hold it for income generation and appreciation in value?
- Is the investment in a good location? Is it close to jobs, shops, parking and transportation? Is the neighborhood safe with a low crime rate?
- A buyer should consult with a realtor specializing in commercial property in your target market.
Perform an income and expense analysis:
- Performing an income and expense analysis helps a buyer understand the costs, cash flow, return on investment (ROI), debt service costs and potential increase in future revenue generation.
- A buyer should consult with a mortgage broker to confirm current financing interest rates and loan types suitable for your potential investment purchase to more accurately predict cash flow
Perform a thorough physical inspection of the property:
A thorough physical inspection of the property is essential to determine the soundness of your investment; it is important to get access to as much of the property including leased space as possible.
This investigation should include:
- Engineer’s inspection of the property including its boiler(s), roof, floor, foundation, plumbing, mechanical and electrical systems, as well as a search for and testing of any underground oil tanks, asbestos and lead paint.
- Environmental inspection
Obtain proof of all expenses including real estate taxes, utility bills and insurance:
- Obtaining a copy of the property’s real estate tax history is strongly advisable. Real estate taxes represent a major expense that accompanies property ownership. Determine if any tax abatements or tax grievance applications are pending.
- It is advisable that prospective purchasers examine at least one year’s worth of monthly oil, gas, electric, water and sewer bills.
- Review the property’s current insurance policy information, including all riders, risk assessments and claims history. Usually the owner will have to request a risk assessment and a claims history for the property, but obtaining these documents can reveal some critical information.
Determine the nature of the tenancies:
- Does the property have commercial or residential tenants? Are they ren controlled, rent stabilized or free market? Are the commercial leases triple-net? Are the leases expiring soon and/or are there options to renew and/or options to purchase the property? Are the rents below market? Is there better use for the property?
- Rent stabilized property owners must file annual registration statements with the Division of Housing and Community Renewal (DHCR) and must provide tenants with a copy of the registration. Failure to register may render property owners ineligible for rent increases, disallow them to submit tax grievances or subject them to penalties. Request a copy of all DHCR filings for the subject property directly from DHCR to confirm all registrations are current and accurate and that there are no past or pending rent overcharge claims. You will need to obtain an authorization from the owner for said records.
- Compare the DHCR registrations with the current and historical rent roll (which should include the unit mix information, security deposit listing, the rent arrears schedule) and the existing leases with any renewals or modifications through the Emergency Tenant Protection Act, Section 8 or the Department of Social Services.
- Examining the fair market value and rent rolls of similar properties provides additional insight into the upward revenue potential of your investment.
Visit the local municipality’s building department (in person or online):
- The local municipality’s building department houses important records about your potential investment property. Documents such as the certificates of occupancy, certificates of completion, open permits, violations, property survey etc. may be found in these files.
- These documents contain critical information about the property, including the legal use and occupancy of the premises, a history of construction performed on the premises, a record of any outstanding violations on the property, the dimensions of the property, filed plans and floor layouts and a litany of other useful information.
- You should also check into the zoning to make sure the property’s use is currently in compliance with the zoning code.
- Check for current boiler, elevator, oil tank permits with the appropriate agencies.
Review a copy of the property’s service contracts and confirm employees’ status:
- Service contracts govern matters such as elevator maintenance, trash carting, parking lot maintenance, boiler maintenance, oil supply, plowing and snow/ice removal, landscaping, laundry facilities, extermination, union agreements, commission agreements, etc. Although some of these contracts may be cancelled on 30 days notice, the terms of these contracts should be reviewed closely before purchase.
- Confirm status of employees (if any) as union or nonunion or if any employee contracts have been signed or if the employment is at will.
Review property’s deed, survey and recent report and/or appraisals:
- The owner may provide you with the current deed to the property which will confirm the current owner and a legal description of the property.
- A survey (as built) will show the property boundaries and whether there were any encroachments when the survey was done.
- The owner may also have a recent appraisal report to estimate value as of a certain date, and may have other reports done by engineers, architects or environmental companies.
Examine the personal property (furniture, fixtures and equipment) which may be included in the sale:
- In large multi-family properties, the owner of the building also owns the major appliances inside the apartments such as stoves and refrigerators, and possibly air conditioners.
- If commercial property investments, confirm what personal property the tenant owns and what the landlord owns.
Obtain a title report and survey from a reputable title agency:
- The presence of mortgages, liens or judgments secured against the property can greatly impact the value of an investment property as well as your ability to close on the property. Depending on the terms of the purchase agreement, the buyer may take the property subject to these debts, so it is critical that a buyer is aware of these debts. Ordering and reviewing a title report and survey are usually done with the assistance of an attorney.
James G. Dibbini, Esq