Commercial real estate deals can be challenging to execute as an active investor because there are so many moving pieces you need to align and manage throughout the process.
Many investors utilize checklists to help control the chaos and ensure essential items don’t slip through the cracks. While every active real estate investor tends to develop their own process and checklist for completing real estate transactions over time, it’s helpful to utilize a foundational commercial real estate transaction checklist to get started or at least use as a reference to improve an existing checklist.
Below is a commercial real estate transaction checklist (complete with a due diligence checklist) that you can use and customize to improve your property acquisition process.
Overview of the Commercial Real Estate Transaction Checklist
Table of Contents
Step #1: Identify Assets of Interest
The first step in any commercial real estate transaction is to identify properties that are of interest to you. The best practice is to have a set of filters that you broadly run properties through to see if they align with your commercial real estate investment goals.
As you know, there are many types of commercial real estate properties and asset classes, each with unique risks, advantages, and operating characteristics. By establishing what type of property type and asset class you’re targeting, you can streamline your search and identify multiple commercial properties that could be a good fit for your next purchase.
The broad criteria you can use as filters in this step include, but are not limited to:
- Property Type
- Property Class
- Location (Market + Neighborhood)
- Price Point
- Size (Square Feet, Units, etc.)
- Value-add Opportunities
Once you have a handful of properties that meet your broad criteria, you can move to Step 2 where you will evaluate each property more closely.
Step #2: Screen Assets of Interest
With a handful of properties on the table that meet your broad criteria, you can spend a bit more time exploring each one. You can start to do some rough math to estimate where the cash flow might land and look into important non-financial components such as the property history, zoning, and whether it sits in a special flood hazard area.
The second phase of screening should help you refine your list of potential properties from a handful to just a few. The remaining few are then sent to the next step, where you underwrite the property and establish a valuation.
Step #3: Complete the Underwriting and Valuation for Assets of Interest
Once you have a commercial real estate property that fulfills your primary and secondary criteria, it’s time to determine if the property is the deal you think it and, if so, how much you’re willing to pay for it.
To do this, spend time underwriting the property by plugging in key estimates and financial information such as the estimated:
- Rental Revenue
- Other Income
- Operating Expenses
- Net Operating Income
- Purchase Price
- Payment(s) for Debt Service
- Renovation Costs
- After Repair Value (ARV)
Many investors develop their own approaches and models to underwriting properties. Generally speaking, your underwriting should consist of a model that accounts for all of these major financials along with any other financial nuances you see in the property, that will help you evaluate the risk and/or opportunity of the investment in the short term and long term (or however long you plan on holding the property—which should also be factored in when underwriting).
If you underwrite the property and decide it’s not a good deal, stop here and return to step one to search for more properties that might be a good fit.
If you underwrite the property, decide it’s a good deal, and have a firm idea of what purchase price and renovation costs you need to secure and rent the property, it’s time to start thinking about financing in the next step.
Step #4: Put Together Your Financing
In a typical commercial real estate transaction, investors fund the purchase of the property using a capital stack which is a combination of loans and equity sourced from various parties.
There’s a plethora of ways you can secure and structure financing for a deal, so it’s important to determine where you’re going to source the funds and how you will pay those funds back. Using your underwriting numbers and projections, create a selling memorandum and begin sharing it with investors and lenders to get the right pieces in place.
Additionally, while qualifying for a commercial real estate loan is different than qualifying for a residential loan, commercial lenders often ask for general documentation from each sponsor to gauge the level of experience coming into the deal. These documents can include the last couple of years of tax returns, K-1s, personal financial statements, driver’s license, and a list of commercial real estate experience for each partner.
Note that lining up funding and solidifying terms with lenders doesn’t always happen in an organized and sequential manner. It’s possible to still be finalizing these things after you have made an offer. The important thing is to get started on them as soon as you can and feel confident you’ll be able to get the deal done before you proceed to make an offer.
Step #5: Submit an Offer
When you have a deal and feel confident you’ll be able to secure all of the funds needed to close on the property, it’s time to make an offer.
5A. Create and Submit a Letter of Intent (LOI)
The first step is to submit a Letter of Intent (LOI) that outlines the primary details of your offer including, but not limited to:
- Names and contact information for both parties (buyer and seller), as well as the broker(s)
- Proposed purchase price
- Proposed deposit amount, if any, and whether it will be held in escrow, for how long, and under what terms
- Due diligence period (usually expressed as a certain number of days ranging from 30–90 days)
- Financing overview (e.g. an explanation of how the buyer intends to finance the transaction)
- Expected closing date and closing conditions (this usually includes a list of items)
- Additional information that may be helpful to the seller
- Clause of Confidentiality
- The expiration date of the LOI
The major benefits of LOIs are that they’re cheap to create and help you negotiate key terms with the seller before a formal sale contract or sale agreement is created which are legal documents that are naturally more expensive.
5B. Sign a Sale Agreement
Using the agreed-upon terms from the LOI, the commercial real estate broker and legal counsel supporting the transaction will write a formal sale agreement that both parties sign. Once this agreement is signed, the property is under contract. This is when the critical stage of due diligence begins.
5C. Enter Escrow
Usually, when a sale agreement is made, the prospective buyers need to make a deposit on the property. This deposit is submitted to an escrow account that is held and managed by a third-party escrow agent. When this account is opened and the deposit is submitted, the escrow agent begins working on all necessary documentation for a successful sale transaction. This can include gathering signing authority for the legal entities involved (e.g. an LLC or LLP).
Step #6: Commercial Real Estate Due Diligence Checklist
During the earlier steps, the property was scrutinized and evaluated based on estimates and market knowledge. However, now that the property is under contract, the seller is required to provide official documentation that includes real numbers from the property, and you—as the buyer—have the ability to bring in a variety of experts to fully inspect and evaluate the property to ensure it’s the deal you think it is.
Thus, the official due diligence period is underway, and there’s a lot to work through. Let’s break it down into some helpful sub-steps:
6A. Organize Your Documentation
With a wave of documents headed your way, it’s helpful to create a shared project folder on a cloud storage platform such as Dropbox. The cloud component of this makes it easy for your team to pull different documents when they need them, and you can set permissions on that folder to ensure only people on your team can access them.
The files can include a variety of documents from property surveys, leases, appraisals, code violations, natural hazard disclosure, governmental notices, photographs, easements, encumbrances, title reports, tax bills, environmental reports, soil reports, zoning documents, previous site plans, receipts, copies of all material correspondence relating to the property, records of any discussions with any governing authorities, and other testing reports and civil documents relating to the property.
To stay organized, rename the files with a clear naming convention as you receive them. Using the property address, document name, and date or version in the naming convention can make it easy for you and others to reference and pull the right documents when needed.
6B. Review All Documents and Financials
As you receive documents about the property, review them closely and start piecing together the facts and details about how the property has been performing and what outstanding issues may be lingering.
A few big things to pay particular attention to include:
- Ensure the property is making the amount of revenue the sellers claimed it makes with the current tenants
- Analyze costs by reviewing rent roll, expenditures, property taxes, utilities, insurance (and any other expenses)
- Look for any environmental issues or hazardous materials that may have been a problem in the past
- Review the property and outline what capital expenditure items will be needed in the next few years
Use your review to confirm the property is what you think it is, identify ways you can run it more efficiently, and price out renovations that will allow you to increase rents.
6C. Inspect the Property
A proper inspection is one of the most critical components of the due diligence process. Many real estate investors have been saved from bad deals by a good inspection. Inversely, many real estate investors have been burned by a poor inspection.
Ensure you have a reliable professional to conduct a thorough inspection of the property. During the day they are inspecting the property, try to get other team members on the property as well, such as your general contractor, architect (if applicable), property manager, and landscaper, so that they can all get a quality first-hand look at the building as well.
Scrutinize the property closely and take note of everything you find. This will be important for your own notes as well as negotiation power with the seller.
6D. Hire Experts for Evaluations and Reports
If you have uncovered major problems during your documentation review or property inspection, it may not be worth moving on to this stage. After all, if the numbers don’t make sense or you’ve found a massive issue in the inspection that will cost too much to repair, there’s no sense in spending more money on a bad deal.
On the other hand, if everything still looks good after your document review and property inspection, it’s usually time to bring in experts for the next level of evaluations and reports. The experts you bring in will depend on where the property is located, what you want to learn, and what you want to do with the property. Generally, these are some good experts to bring in and reports to have done.
Phase 1 Environmental Report (ESA)
The Phase 1 Environmental Report, also known as the “ESA,” is an environmental site assessment that evaluates the property’s current and past usage to identify whether or not there are issues such as polluted soils and waterways, asbestos, or lead-based paint.
If any issues are identified in the ESA, they need to be remedied before tenancy because they present significant health risks. Failing to identify and address issues on the ESA can present substantial legal issues down the road.
Geotechnical engineers evaluate your property by drilling boreholes and running tests on the soil throughout the lot. These site consultants provide you with details on the:
- Types of soils found
- Compaction, strength, and density of the soil
- Existence of rock and its probable location
- Remedies to any prospective site troubles
When evaluating a commercial real estate purchase, you want to ensure the ground the building sits on will support the building itself and your goals for a long period of time. Purchasing or building a property on poor ground can cause significant damage.
Boundary Survey or ALTA Survey
Boundary surveys and ALTA surveys are similar in nature but different in detail. A boundary survey locates and displays the boundary lines between two parcels of land, whereas an ALTA survey is much more comprehensive showing improvements, easements, and other details about the parcel.
If you’re not planning on doing any foundational work, additions, or groundwork, an ALTA survey may not be necessary because surveys can show you precisely where your land meets your neighbors’ properties to support the addition or renovation of things like parking lots, fences, and landscaping. If you do plan to do more significant work, an ALTA survey may be best.
Lastly, even if you don’t plan on doing significant work that would require finer details of the land, it’s also possible that your lender, title company, or commercial real estate attorney may mandate an ALTA survey to validate the security of a project.
Traffic engineers study traffic flow to and from commercial property and adjacent communities. Traffic engineers are helpful to bring in to:
- Determine how much traffic passes the building each day (which you can then use for marketing the building)
- Identify bottlenecks and infrastructure challenges that may require additional work/cost such as stop signs, speed bumps, dividers, and other features.
6E. Consult with Architects and Engineers
This tends to be more relevant for development work or projects that involve significant renovations. However, it’s always worth considering if you want to bring in architects or engineers to evaluate the property and provide their expert opinion. Here are the general scopes of work each specialist covers:
- Architect: Primarily helps with designing properties, designing remodel plans, reworking floorplans, enhancing exterior design features, and creating renderings
- Civil Engineer: Primarily helps with utility plans, master grading and drainage plans, and water and wastewater plans
- Structural Engineer: Primarily helps assess the structural integrity of the building and identify any weak areas that need to be replaced or reinforced
When it comes to buying commercial real estate, these experts can provide a great deal of value that can save you from potential issues and legal problems. If you think there may be an issue with the property or see an opportunity for value-add, it’s likely worth bringing in the appropriate expert(s) to provide their opinion.
6F. Explore Local Regulations and Zoning
If you’re purchasing an existing structure, the building is likely already in compliance with local zoning. However, it’s always a good idea to double-check. Additionally, if you have different plans for the building, you will want to work with the local city to determine whether or not you will need to 1) change the zoning and 2) if the city is willing to work with you on re-zoning that particular area. Depending on the city, this can be a large undertaking so it’s important to know what (and who) you’re working with.
If your project is a ground-up development, you’ll need to ensure the city has signed off on all necessary zoning and entitlements.
When working through zoning and entitlement work, it’s always a good idea to get legal advice and have a licensed professional support the process to make sure nothing is missed.
6G. Confirm You’re Ready to Proceed
A lot happens during the due diligence process, and the outcomes can vary drastically. It’s possible that everything comes back crystal clean and ready to go. It’s also possible that a plethora of negative items come back and kill the deal. More often than not, things land somewhere in the middle and you need to decide what to do.
With this, always take time toward the end of the due diligence process to outline what you found, what it will cost to remedy any issues, and determine whether or not this is still a deal you want to take on. It can be disappointing and frustrating for both parties for a deal to be canceled after the due diligence process. However, if you’re the buyer and you have reservations about the property, it can be better to walk away now than get yourself into a mess.
Take this time seriously and decide what to do. If you still think the property will do what you want it to do, it’s time to begin the closing process.
Step #7: Get Insurance
With the due diligence phase behind you, all eyes are on closing the deal. Talk with your insurance broker to explore what insurance policies you need and how much they will cost.
Set up the insurance policies and gather all necessary documentation.
Step #8: Schedule an Appraisal
Schedule an independent appraisal to assess the current value of the property. An independent appraisal helps ensure you don’t overpay for a property while also helping protect your lender from not over-lending on a deal. Appraisals can sometimes throw a kink in the process if it comes in lower than what you anticipated. That being said, if it comes in low, you can use it as a bargaining tool with the seller in the next step.
Step #9: Negotiate and Resolve Any Issues
Throughout the entire process, you, your real estate attorneys, and your agent should be keeping track of issues that you may need to bring up with the seller. For example, if you found that the property needs a new roof, you may be able to ask the current property owners to fix it before closing or give you a credit toward closing costs to help cover it. Effectively, you—as the deal sponsor—should help identify which issues you want to bring up and try to negotiate with the seller, and then your attorney and/or agent should be the ones to do the actual negotiating.
Once you’ve reached common ground with the seller, it’s time to make final revisions to the contract and close.
Step #10: Close on the Property
With all the necessary checks and evaluations completed, it’s time to close the deal. Commercial real estate closings differ from state to state, so it’s important to understand what closing within your state looks like. Generally, a closing statement will be created that outlines all of the costs involved and the money that needs to be transferred between the buyer and seller.
Additionally, the following documents will generally need to be presented and signed:
- Bill of Sale
- FIRPTA Certificate
- Transferable Leases
- Notice to Tenants
- Transferable Service Contracts
- Tenant Estoppel Certificates
- Deed Transfer
As you can see, no matter what type of commercial building you’re purchasing, there are a lot of moving parts and it takes a team of real estate professionals with various specialties to complete a successful acquisition or sale.
Establishing and refining your own investor checklist for buying commercial space is a great way to help keep track of all the pieces and manage the process in real time.