Commercial property demand rising but pitfalls await the unwary
When vacancies are tight, prices for commercial property are usually higher, but don’t be tempted to quickly close a deal without conducting proper due diligence.
Economic growth in recent years has increased the demand for commercial property but a limited supply has contributed to the tightening of vacancies.
When vacancies are tight, it may be tempting to take on higher risk investments. Due diligence is essential in assessing the risks associated with a property and making informed decisions about whether the investment is worth the risk.
Due diligence involves researching and reviewing relevant documents, including financial records and contracts to identify risks, liabilities or issues that could affect the value or success of an investment.
Reviewing a property’s financial statements helps to verify the accuracy of the financial information and assess the property’s income-generating potential.
Covering the following key areas during due diligence can help to minimise those risks.
Submit offers ‘subject to due diligence’
Putting an offer in subject to due diligence means the offer is conditional on the completion of a satisfactory due diligence process by the buyer.
This allows the buyer time to investigate and verify important information related to the property before committing to the purchase.
Beware of auction pressure
Don’t be pressured by an agent to go unconditional without the due diligence clause—even if there is an upcoming auction.
One of the biggest mistakes an investor can make is go to an auction without covering all the necessary due diligence.
If you are successful at the auction, you are trapped by the contract. Plus, you often overpay for an asset you have set your sights on.
For example, purchasing a property with sub-4 per cent yields when you could have purchased similar assets for 5.5–6 per cent net elsewhere. To quantify, that’s a 37.5–50 per cent difference in price.
Check lease agreements
It helps to ensure that a potential property is generating the expected income and that the expenses associated with the property are accurate and consistent with the terms of the lease agreement.
It is essential to also review the specific terms of any lease associated with the property, as certain lease terms can severely impact the value of the property, your ability to make improvements or changes to the property, and your ability to generate income from it.
For example, if a lease is due to expire, it may fall upon you to acquire new tenants.
This takes time and money.
Knowing that the lease terms are consistent with what you were expecting or not expecting affords you the opportunity to negotiate where needed.
The importance of engaging a lawyer who specialises in lease review of commercial properties cannot be underestimated.
Rental receipts under the microscope
Make sure you view all rental receipts and bills and match them against the lease.
Reviewing the rental receipts can provide valuable information about the property’s rental history, including the amount of rent charged, payment frequency, late fees and other charges.
A thorough review will help identify any issues with tenants, for example, complaints or disputes that can affect the property’s value or future income potential.
