Interest rates are up, transaction volume is down, and on the deals that are getting done, buyers and lenders are scrutinizing every aspect of the underwriting process. You know what they are going to ask. The due diligence checklist for commercial real estate may vary slightly depending on the asset type, lender requirements, sophistication of the buyer, or geographic location of the property. But with respect to the hard asset, lenders and/or buyers will require an appraisal, a Phase I Environmental Site Assessment (Phase I), a Property Condition Assessment (PCA), and potentially a seismic risk assessment or zoning report.
Most sellers, who’ve already conducted a Phase I and a PCA when they acquired or refinanced the property, will just accept that the buyer will be conducting their own due diligence for the transaction. Those reports, purchased by the buyer, will find every issue at your property whether you know about it or not. Investing in predisposition due diligence allows you, the seller, to drive the narrative.
Scrutinizing the asset before you list it for sale informs your pricing strategy and allows you to identify deficiencies prior to listing and correct them on your own terms. You’ll be in a stronger position for negotiation and less likely to have your deal derailed by unforeseen issues. Consider the following four strategies to gather the property data you need to take the upper hand.
Know Your Market: After the frenzied market of 2021 and early 2022, you may have an inflated idea of your property’s value. Today, the buyer pool is smaller and multiple offer scenarios much less common. Ordering an appraisal before you list your property will ensure that your asking price reflects the current market. If you don’t want to spring for a full appraisal, even a condensed valuation report can help you set your price appropriately.
Know Your Financing: In the past, buyers might push for a re-trade based on findings in the due diligence process: a leaking roof, outdated HVAC system, or other deficiency in the physical condition of the property. Recently, however, buyers have begun to request price reductions due to the cost of financing. Before you list, find out if your existing financing is assumable. If your buyer can assume financing at a lower-than-market rate, you can avoid this scenario.
Know Your Property Condition: The cost of a pre-disposition PCA is well worth it for the negotiating power it provides a seller. The PCA will identify and quantify deferred maintenance and deficiencies with accurate repair costs. Buyers typically will ascribe the highest repair or replacement cost estimate possible for any required deficiencies. It is this delta between their cost estimate and the cost estimate in your pre-disposition PCA where the most value is captured. If you have net-leased assets, a PCA can also enable you to recover costs of deferred maintenance for which your tenants are liable at the end of the lease term. We recently performed PCAs for the owner of a portfolio of 100+ fast-food restaurants across the United States. The owner used the report to collect $4.5 million from the tenant for deferred maintenance that they should have completed during their tenancy.
Know Your Environmental Liability: As with PCAs, a Phase II Environmental Site Assessment (Phase II) allows you to identify and quantify issues before your buyer does, giving you a leg up in negotiation. We recently performed a Phase II remedial investigation for the seller of a property that had a former dry cleaner on site with known contamination. This issue greatly reduced the number of potential buyers willing to even consider the site, and the buyers that were interested were requesting massive price reductions–none of them less than $2 million—to offset their estimated cost of remediating dry cleaner-related contamination. Our investigation took three months and cost approximately $110,000. However, our remedial cost estimate was only $800,000 and it included a detailed path to closure—saving the seller $1.2 million.
Investing in pre-disposition due diligence greatly reduces the likelihood that a buyer will find grounds to renegotiate the contract price or demand costly repairs or remediation. Relative to the size of the deal, these reports cost little and pay for themselves by protecting your profits and minimizing frustration and delays.