What to Expect When Buying Commercial Real Estate

Purchasing commercial real estate is a significant investment that requires careful planning and attention to detail. From the initial property search to closing, each step in the process is crucial for ensuring a successful transaction. This guide will walk you through what to expect in each stage of buying commercial real estate.

Stage 1: Searching for Properties and Touring

Searching for properties and conducting tours are fundamental steps in finding the right commercial real estate investment. This stage involves identifying properties that meet your criteria and physically inspecting them to assess their suitability. Here’s what to expect:

Searching Properties

Define Your Requirements:
- Location: Determine the geographical area where you want to invest. Consider factors such as proximity to clients, suppliers, and transportation hubs.
- Property Type: Decide on the type of commercial property you need—office space, retail, industrial, multifamily, etc.
- Budget: Set a clear budget that includes not only the purchase price but also potential renovation costs and operational expenses.
- Size and Layout: Identify the necessary square footage and preferred layout to support your business operations.
Work with a Commercial Real Estate Broker:
- A commercial broker can provide access to listings that are not available to the general public and residential brokers. They can also help negotiate favorable terms and guide you through the complicated purchasing process.
Online Listings and Marketplaces:
- Utilize online platforms and databases to search for properties. Keep in mind that a lot of properties are not available to the general public and residential brokers.
Networking:
- Attend industry events, join commercial real estate groups, and leverage professional networks to discover off-market opportunities. Working with a broker that is well connected in the industry is crucial.

Touring Properties

Schedule Tours:
- Once you have a list of potential properties, schedule tours to see them in person. Coordinating with the property owners or brokers to arrange a convenient time for the visit is essential.
Prepare a Checklist:
- Before touring, prepare a checklist of what to look for during the visit. Key points to consider include:
  - Building Condition: Assess the overall condition of the property, including the structure, roofing, HVAC systems, plumbing, and electrical systems.
  - Interior and Exterior: Evaluate the aesthetics and functionality of both the interior and exterior spaces.
  - Accessibility: Check for adequate parking, ADA compliance, and ease of access for employees and clients.
  - Amenities and Facilities: Note the availability of necessary amenities such as restrooms, kitchen areas, loading docks, and storage spaces.
Take Notes and Photos:
- Document each property visit with detailed notes and photographs. This will help you remember key details and compare properties later.
Ask Questions:
- Engage with the property owner or broker during the tour. Ask about the property’s history, any recent renovations or repairs, current tenants if applicable, zoning compliance or variances, and any known issues or future developments in the area.
Evaluate Surroundings:
- Assess the surrounding neighborhood or business district. Consider factors such as safety, local amenities, traffic patterns, and potential for future growth or development.
Consider Future Needs:
- Think long-term about your business’s growth and how the property can accommodate future expansion or changes in operations.

Touring properties is a critical step in the decision-making process, allowing you to visualize how each property meets your needs and fits within your investment strategy. Taking the time to conduct thorough tours ensures that you make an informed choice and find a property that aligns with your goals.

Stage 2: Offers and Negotiations

Once you’ve found the property you want to purchase, it is time to make an offer and start negotiating. The brokers, clients, and complexity of the transaction will determine which documents will be used. For straightforward transactions, the forms provided by state REALTOR boards can be used, but more often than not a Request For Proposal (RFP) will start the process.

Signing Authority: If you are purchasing in a company name, make sure you have articles of incorporation along with a current operating agreement clarifying who can sign documents for the company.

Submit Offer: Submit an initial offer with terms or use a Request for Proposal/Letter of Intent for the seller to provide terms.

Negotiate: In most situations the RFP/LOI will be redlined, meaning terms that you would like to be different will be struck through and replaced with new terms. This will continue to happen until all parties agree. This is different from the offer/counteroffer process used for residential sales.

Sign PSA: Once the terms are agreed to, a Purchase and Sale Agreement will be written up by an attorney for all parties to sign.

Stage 3: Due Diligence

Now that the PSA has been signed, it is time to start working on removing all those contingencies to the contract and get to the closing table. The due diligence period is oftentimes several months long and may be longer depending on the complexity.

Earnest Money

Earnest money is a deposit made by the buyer to demonstrate their commitment to purchasing the property. This amount, typically a percentage of the purchase price (1% – 10%), is delivered within days of the PSA being signed and held in escrow until closing. It shows the seller that you are serious about the purchase and provides some security against the potential risk of the buyer backing out without cause. If the sale goes through, the earnest money is applied toward the purchase price as a credit to the buyer. If the deal falls through due to contingencies outlined in the contract, the earnest money may be refunded to the buyer or released to the seller.

Physical Inspections

Physical inspections are a critical part of due diligence. These inspections help identify any potential issues with the property that could affect its value or your plans for its use. Common inspections include:

Structural inspection: Examines the building’s foundation, roof, walls, and other structural components.

Mechanical inspection: Reviews the heating, ventilation, air conditioning (HVAC) systems, plumbing, and electrical systems.

Pest inspection: Checks for signs of termites or other pest infestations.

It’s essential to hire qualified professionals to conduct these inspections and provide detailed reports on their findings.

Environmental Inspections

Environmental inspections assess whether the property has any contamination or environmental hazards that could affect its usability or value. Common environmental inspections include:

Phase I Environmental Site Assessment (ESA): Identifies potential or existing environmental contamination liabilities. Costs vary depending on the property but anticipate spending a couple thousand dollars for this inspection with a few weeks turnaround time.

Phase II ESA: Conducts further investigation if the Phase I ESA finds potential issues, often involving soil, water, and air testing. This inspection is more involved and will add another few weeks for turnaround time. If this is required, anticipate spending at least five thousand dollars for this inspection but they can be tens of thousands of dollars depending on what was found with the Phase I.

These inspections are crucial for ensuring that the property complies with environmental regulations and for avoiding costly remediation efforts in the future. It can also be a requirement from the lender to ensure there is no risk or liability to them. There are long-term consequences when it comes to environmental contamination so it is important you know what you are getting into.

Survey

An ALTA Survey provides a detailed map of the property, showing boundaries, structures, easements, and other important features. This information is crucial for:

Confirming property boundaries: Ensures there are no encroachments or boundary disputes.

Identifying easements and rights-of-way: Determines if there are any restrictions on property use or access.

A professional land surveyor should conduct the survey and provide a certified report that can be used for closing and future reference. This can also be a requirement from the lender and costs vary depending on the size and complexity of the property. Anticipate spending at least five thousand dollars.

Zoning

Zoning regulations dictate how a property can be used. Before purchasing, you must ensure that the property is zoned for your intended use, whether it’s for retail, office space, industrial use, or another purpose. You may need to:

Check with local zoning authorities: Verify the current zoning classification and any restrictions.

Investigate potential zoning changes: Understand the process for requesting a zoning change if the current classification does not meet your needs.

Zoning compliance is essential to avoid legal issues and ensure your business operations are viable on the property. It is also important to understand that any existing variances may not convey with the sale, meaning a rezone or new variance will be required before you can use the property as intended. Engineers and attorneys may need to be contracted to help with this and the costs can easily be in excess of ten thousand dollars.

Financing

Financing commercial real estate often involves more complex arrangements than residential properties. You may consider:

Traditional bank loans: Typically require a substantial down payment and have specific qualification criteria.

Small Business Administration (SBA) loans: Offer favorable terms for small businesses.

Private financing: May provide more flexible terms but often at higher interest rates.

Securing financing early in the process can help ensure a smooth transaction and provide clarity on your budget and purchasing power. You will also want to confirm the underwriting requirements for the loan product you’ll be using as this can add a significant amount of cost if they require certain inspections, surveys, or reports.

Insurance

Insurance is crucial for protecting your investment. Common types of insurance for commercial real estate include:

Property insurance: Covers damage to the building and its contents.

Liability insurance: Protects against legal claims for accidents or injuries that occur on the property.

Business interruption insurance: Covers lost income if the property becomes unusable due to a covered event.

Work with an insurance professional to tailor coverage to your specific needs and ensure comprehensive protection.

Additional Considerations

Not all product types are the same and there are additional due diligence items to consider depending on what you are buying.

Existing contracts: If you are buying a building with existing tenants and/or operations, you’ll need to get copies of all existing leases and service agreements. As the new owner, you will be assuming these liabilities and it is important to know what your obligations are.

Site plans: If you are buying undeveloped land or part of a parcel, you’ll want to review existing site plans or order your own to determine feasibility for your intended use.

Technical drawings: If you’ll be doing any development, you’ll also need drawings and renderings for the structure(s).

Stage 4: Closing

Closing is the final step in the commercial real estate transaction. During closing, all parties sign the necessary documents, and the property ownership is officially transferred. Key aspects of closing include:

Reviewing closing documents: Ensure all documents are accurate and complete, including the deed, bill of sale, and loan agreements.

Conducting a final walkthrough: Verify that the property is in the agreed-upon condition.

Transferring funds: The buyer provides the remaining balance of the purchase price, and the seller transfers the property title.

Once all documents are signed and funds are transferred, the transaction is complete, and you become the official owner of the property. Buying commercial real estate involves multiple steps and considerable due diligence. By understanding each stage of the process and working with experienced professionals, you can navigate the complexities and make a well-informed investment decision.