Commercial Real Estate Due Diligence: What to Check

The seller has signed your offer. Your earnest money is in escrow. It feels like the hard part is over.

It isn’t. The next few weeks matter more than anything that came before. This is your due diligence period, and it’s your one chance to find out what you’re really buying while you can still walk away.

In four decades of commercial real estate, I’ve seen more buyers get hurt in this stage than in any other. Not because they found a problem, but because they didn’t look hard enough to find it. A leaking roof, a tenant who’s about to leave, a zoning issue that blocks your plans. These things don’t show up on a sales flyer.

Here’s what I check on every deal, in the order I check it, and what to do when something turns up.

What Due Diligence Is, and Why the Clock Matters

Due diligence is the period after your offer is accepted when you investigate the property before you’re locked in. Your purchase contract sets how long it lasts, often 30 to 60 days on a small commercial property. During that time, you can usually cancel and get your earnest money back.

Once the period ends, that deposit is typically at risk. So the deadline is the most important date in your contract. Put it on your calendar the day you sign.

A few things to settle before the clock starts:

Ask for enough time. Inspections, environmental reports and surveys can take weeks to schedule. I’d rather ask for 45 days and finish early than ask for 21 and run out. Set this up in your letter of intent so it’s agreed before the contract is drafted.
Get the seller’s documents fast. Your contract should require the seller to deliver their records within a few days. If the seller takes three weeks, you lose three weeks.
Know how to extend. Some contracts allow an extension, sometimes for an extra deposit. Know your options before you need them.

If you’re still working out your offer terms, my post on making offers and negotiating deals covers how to set this up.

Step 1: Verify the Money

Before you made your offer, you worked from the seller’s numbers. Now you check them against the records. Ask the seller for:

The current rent roll, showing every tenant, rent, lease dates and deposit.
Operating statements for the last 12 months (often called a T-12) and the last two or three years.
Tax returns or Schedule E for the property, if the seller will provide them.
Utility bills, property tax bills and the insurance policy.
Service contracts for things like landscaping, trash, elevators and snow removal.
Bank deposit records, so you can see the rent actually came in.

Then compare. Does the rent roll match the deposits? Do the expenses on the statement match the actual bills? If the seller says taxes are $18,000 a year but the tax bill says $24,000, you’ve found a $6,000 hole in the income.

Also ask your county assessor whether the sale will trigger a reassessment. In many areas, property taxes reset based on what you pay. The seller’s tax bill may not be yours.

My post on how to read a property’s numbers [LINK TO ADD] walks through the rent roll and operating statement line by line, with the red flags to watch for.

Step 2: Read Every Lease, and Confirm It with the Tenant

In commercial real estate, the leases are the property. A building’s value comes from its income, and the income comes from the leases. Read every one of them, including every amendment.

As you read, note:

When each lease ends, and whether the tenant has renewal options.
Rent increases built into the lease, and when they happen.
Who pays what. Taxes, insurance, maintenance and common area costs. My posts on commercial rental rates and expenses and the triple net lease explain the differences.
Special rights. Early termination, a right to buy the building, or a promise that no competing business can lease space nearby. These rights stay with the property after you buy it.
Free rent or allowances the seller promised but hasn’t delivered yet. If they’re still owed, you’ll owe them.

Then get a tenant estoppel certificate from each tenant. It’s a short signed form where the tenant confirms their rent, lease dates and deposit, and states whether the landlord is in default. If the seller says the rent is $2,500 a month and the tenant signs a form saying $2,200, you want to know that now. Make delivery of signed estoppels a requirement in your contract.

Finally, look at the tenants themselves. Is the business doing well? Are they paying on time? A tenant with three years left on a lease isn’t worth much if they’re about to close their doors. A walk-through during business hours tells you a lot.

Step 3: Inspect the Building

On a commercial building, hire an inspector who does commercial work. Many buyers order a property condition assessment. It’s a report on the building’s major systems, how much life each one has left, and what repairs to expect in the next several years.

The big-ticket items I always want answers on:

Roof. How old is it, has it leaked, and is there a warranty? A flat commercial roof is one of the most expensive things you’ll ever replace.
HVAC. The age and condition of every unit. A strip center can have a separate rooftop unit for each tenant, and each one wears out on its own schedule.
Parking lot. Cracks, potholes, drainage and striping. Repaving a lot is a major expense, and a pothole is a liability.
Plumbing, electrical and fire safety. Including sprinklers and fire alarms, which have their own inspection rules.
Structure and drainage. Foundation cracks, water pooling near the building, signs of past water damage.
Accessibility. Ramps, parking spaces, restrooms and entrances that meet the Americans with Disabilities Act. Fixing these after you own the building is on you.

Ask the seller for maintenance records and any past inspection reports. Then walk every unit, including the vacant ones and the space tenants use for storage. Problems hide in the rooms nobody shows you.

When the report comes back, get repair estimates for anything major. A number on paper is far more useful in a negotiation than “the roof looks old.”

Step 4: Check for Environmental Problems

This is the step residential buyers skip, and it’s the one that can cost the most. If a property is contaminated, the owner can be held responsible for the cleanup, even if a previous owner caused it. That can mean you.

The standard first step is a Phase I Environmental Site Assessment. An environmental consultant reviews the property’s history, government records and neighboring uses, and walks the site. Most lenders require one on a commercial loan, and it helps protect you if contamination is found later.

Pay close attention if the property is, or ever was, near a gas station, dry cleaner, auto repair shop or manufacturing site. If the Phase I finds a concern, the consultant may recommend a Phase II, which tests the soil or groundwater. That costs more and takes longer, which is one more reason to ask for enough due diligence time up front.

On older buildings, also ask about asbestos, lead paint and mold.

Step 5: Title, Survey and Zoning

These checks answer a simple question: can you own and use this property the way you plan to?

Title. Your title company issues a title commitment that lists anything recorded against the property: liens, easements, unpaid taxes, restrictions. Read the list of exceptions, not just the cover page. An easement that lets the utility company run a line across your parking lot may be fine. One that blocks the spot where you planned to add a building is not.

Survey. A commercial survey shows the property lines, buildings, parking, easements and any encroachments, such as a neighbor’s fence or sign sitting on your land. Lenders and title companies often require one. Compare it against what you think you’re buying.

Zoning. Confirm that the current use is allowed and that your plans are too. Ask the city for a zoning letter, and ask whether there are any open code violations or permits. Check the parking count, too. If a new tenant needs more parking than the zoning allows, you may not be able to lease to them.

This is also a good time to look past the property line. What’s planned nearby? A new road or a big competitor down the street can change your numbers. My post on the 9 keys for finding the best location covers what to look for.

Build Your Due Diligence Team

You don’t have to do all of this yourself, and you shouldn’t. On a first commercial deal, I’d want these people lined up before the contract is signed, so nobody’s waiting on a callback while the clock runs:

A real estate attorney who handles commercial deals, to review the contract, leases, title and survey.
A commercial building inspector for the property condition assessment.
An environmental consultant for the Phase I.
A title company and surveyor.
Your lender, who will order an appraisal and may have their own list of requirements. See my post on commercial real estate lenders for what they look for.
An insurance agent, to quote coverage before you close, not after.
An accountant, to review the financials and talk through the tax side of the purchase.

These reports cost money, and it’s money you won’t get back if you walk away. I’ve never once regretted paying for an inspection. I’ve seen plenty of buyers regret skipping one.

When You Find a Problem

You will find something. Every building has issues. The question is whether the issue changes the deal, and that usually comes down to the cost. You have four choices:

Ask for a lower price. Bring the repair estimate. “The roof needs $60,000 of work in the next two years” is hard to argue with.
Ask for a credit at closing. The price stays the same, but the seller gives you money at closing toward the repair. Sometimes this is easier for a seller to accept.
Ask the seller to fix it before closing. This works for smaller items. On big repairs, I’d rather take the money and control the work myself, so I know it’s done right.
Walk away. If the problem is too big, or the seller won’t budge, cancel before your deadline and get your deposit back. Losing the money you spent on reports hurts. Owning the wrong building hurts much more.

If the appraisal comes in low, that’s a negotiating point too. My post on overcoming a low appraisal covers your options.

Whatever you decide, put it in writing as a contract amendment before the deadline passes. A seller’s verbal promise to fix the roof is worth nothing once your deposit is at risk.

If You’re Coming from Residential

If you’ve bought houses or duplexes, you’ve done a home inspection and a title search. Commercial due diligence builds on that, but it goes much further:

The leases matter as much as the building. On a house, you’re buying a structure. On a commercial property, you’re buying an income stream, and it lives in the leases.
The environmental review is a must. It’s rarely part of a house purchase. On commercial property, it’s standard, and your lender will likely require it.
Fewer protections for the buyer. In many states, commercial sellers have fewer disclosure duties than residential sellers. Assume nothing is disclosed unless you find it.
More people involved. You’ll be coordinating an attorney, inspectors, a consultant, a surveyor and a lender on one deadline.

None of this is out of reach for a residential investor. It just takes more planning. My book From Residential to Commercial: Making the Leap covers the shift in more detail.

The Bottom Line

Commercial real estate due diligence comes down to five checks, done before your deadline:

Verify the money against real records.
Read every lease and get tenant estoppels.
Inspect the building and price out the big repairs.
Order a Phase I environmental report.
Review title, survey and zoning.

Rushing through this stage is one of the common mistakes I see new investors make. Take your time, use your team, and don’t be afraid to walk away. Once everything checks out, you’re ready for closing the deal. If any term here is new to you, my glossary explains it in plain English.

If you’re buying your first commercial property, my book Buying Your First Commercial Property walks you through the whole process, from finding the deal to closing it.

Get My Free Deal Analysis Checklist

Due diligence goes faster when you’ve already done your homework on the numbers. My free Deal Analysis Checklist lists the documents to request, the figures to check and the questions to ask before you make an offer. Keep it handy for every deal you look at.