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Planning to buy or finance Commercial or Industrial Real Estate? Shopping Center? Office Building? Restaurant/Banquet property? Parking Lot? Storefront? Gas Station? Manufacturing facility? Warehouse? Logistics Terminal? Medical Building? Nursing Home? Hotel/Motel? Pharmacy? Bank facility? Sports and Entertainment Arena? Other? A KEY to laying out capital in mercantile real estate is performing an adequate Due Diligence Investigation to ascertain you know all material facts to make a wise investment decision and to calculate your expected investment yield. The following checklists are designed to help you conduct a concentered and significant Due Diligence Investigation. Basic Due Diligence Concepts: Commercial Real Estate dealings are NOT similar to big home purchases. Caveat Emptor: Let the Buyer beware. Consumer shelter laws applicable to home purchases seldom implement to mercantile real estate transactions. The rule that a Buyer will have to examine, judge, and test for himself, applies to the buy of mercantile real estate. Due Diligence: “Such a measure of prudence, activity, or assiduity, as is proper to be expected from, and ordinarily exercised by, a reasonable and prudent [person] underneath the peculiar circumstances; not measured by any sheer standard, but depending upon the relative facts of the special case.” Black’s Law Dictionary; West Publishing Company. Contractual representations and warranties are NOT a alternate for Due Diligence. Breach of representations and warranties = Litigation, time and money. WHAT DILIGENCE IS DUE? The scope, intensity and focus of any due diligence investigation of mercantile or industrial real estate depends upon the goals intended to be attained of the party for whom the investigation is conducted. These goals intended to be attained may vary depending upon whether the investigation is conducted for the gain of (i) a Strategic Buyer (or long-term lessee); (ii) a Financial Buyer; (iii) a Developer; or (iv) a Lender. If you are a Seller, comprehend that to close the dealing your Buyer (and it is Lender) must address all issues material to it is goal to be attained – a great deal of of which require data only you, as Owner, may adequately provide. GENERAL OBJECTIVES: (i) A “Strategic Buyer” (or long-term lessee) is acquiring the property for it is own use and will have to verify that the property is suitable for that intended use. (ii) A “Financial Buyer” is acquiring the property for the expected return on investment generated by the property’s income stream, and must determine the amount, velocity and durability of the revenue stream. A sophisticated Financial Buyer will likely calculate it is yield based upon discounted cash-flows rather than the will have to less precise capitalization rate (“cap rate”), and will need adequate financial data to do so. (iii) A “Developer” is seeking to add value by altering the reputation or use of the property – ordinarily with a short-term to intermediate-term exit scheme to dispose of the property; although, a Developer might plan to hold the property long term as Financial Buyer after development or redevelopment. The Developer will have to focus on whether the planned modify is reputation or use may be accomplished in a cost-effective manner. A developer conducting due diligence will focus on issues involving market demand, access, use and finances. (iv) A “Lender” is seeking to establish two basic lending criteria: 1. “Ability to Repay” – The capacity of the property to generate sufficient revenue to repay the loan on a timely basis; and 2. “Sufficiency of Collateral” – The goal to be attained disposition value of the collateral in the event of a loan default, to make sure adequate funds to repay the loan, carrying costs and costs of collection in the event forced collection becomes necessary. The amount of diligent inquiry due to be expended (i.e. “Due Diligence”) to investigate any queer mercantile or industrial real estate project is the amount of inquiry required to answer each of the following questions to the extent applicable to the goals intended to be attained of the party conducting the investigation: I. THE PROPERTY: 1. Exactly what PROPERTY does Purchaser believe it is acquiring? (a) Land? (b) Building? (c) Fixtures? (d) Other Improvements? (e) Other Rights? (f) The entire fee title interest including all air rights and subterranean rights? (g) All development rights? 2. What is Purchaser’s planned use of the Property? 3. Does the physical condition of the Property permit use as planned? (a) Commercially adequate access to public streets and ways? (b) Sufficient parking? (c) Structural condition of improvements? (d) Environmental contamination? (i) Innocent Purchaser defense vs. exemption from liability (ii) All Appropriate Inquiry 4. Is there any legal restriction to Purchaser’s use of the Property as planned? (a) Zoning? (b) Private land use controls? (c) Americans with Disabilities Act? (d) Availability of licenses? (i) Liquor license? (ii) Entertainment license? (iii) Outdoor dining license? (iv) Drive through windows permitted? (e) Other impediments? 5. How much does Purchaser suppose to compensate for the property? 6. Is there any condition on or within the Property that is likely to increase Purchaser’s effective cost to acquire or use the Property? (a) Property owner’s assessments? (b) Real estate tax in line with value? (c) Special Assessment? (d) Required user fees for necessary amenities? (i) Drainage? (ii) Access? (iii) Parking? (iv) Other? 7. Any encroachments onto the Property, or from the Property onto other lands? 8. Are there any encumbrances on the Property that will not be cleared at Closing? (a) Easements? (b) Covenants Running with the Land? (c) Liens or other financial servitudes? (d) Leases? 9. Leases? (a) Security Deposits? (b) Options to Extend Term? (c) Options to Purchase? (d) Rights of First Refusal? (e) Rights of First Offer? (f) Maintenance Obligations? (g) Duty on Landlord to provide utilities? (h) Real estate tax or CAM escrows? (i) Delinquent rent? (j) Pre-Paid rent? (k) Tenant mix/use controls? (l) Tenant exclusives? (m) Tenant parking requirements? (n) Automatic subordination of Lease to future mortgages? (o) Other material Lease terms? 10. New Construction? (a) Availability of construction permits? (b) Utilities? (c) NPDES (National Pollutant Discharge Elimination System) Permit? (i) Phase 2 effective March 2003 – Permit required if world is bothered on one acre or more of land. (ii) If applicable, Storm Water Pollution Prevention Plan (SWPPP) is required. II. THE SELLER: 1. Who is the Seller? (a) Individual? (b) Trust? (c) Partnership? (d) Corporation? (e) Limited Liability Company? (f) Other legally existent entity? 2. If other than natural person, does Seller validly subsist and is Seller in good standing? 3. Does the Seller own the Property? 4. Does Seller have authority to convey the Property? (a) Board of Director Approvals? (b) Shareholder or Member approval? (c) Other consents? (d) If alien person or entity, are any special requirements applicable? (i) Qualification to do business in jurisdiction of Property? (ii) Federal Tax Withholding? (iii) US Patriot Act compliance? 5. Who has authority to bind Seller? 6. Are sale proceeds sufficient to recompense off all liens? III. THE PURCHASER: 1. Who is the Purchaser? 2. What is the Purchaser/Grantee’s precise legal name? 3. If Purchaser/Grantee is an entity, has it been validly formulated and is it in good standing? (a) Articles or Incorporation – Articles of Organization (b) Certificate of Good Standing 4. Is Purchaser/Grantee authorized to own and operate the Property and, if applicable, finance acquisition of the Property? (a) Board of Director Approvals? (b) Shareholder or Member approval? (c) If alien person or entity, are any special necessaries applicable? (i) Qualification to do business in jurisdiction of the Property? (ii) US Patriot Act compliance? (iii) Bank Secrecy Act/Anti-Money Laundering compliance? 5. Who is authorized to bind the Purchaser/Grantee? IV. PURCHASER FINANCING: A. BUSINESS TERMS OF THE LOAN: What loan terms have the Purchaser, as Borrower, and it is Lender consorted to? (a) What is the amount of the loan? (b) What is the interest rate? (c) What are the repayment terms? (d) What is the collateral? (i) Commercial real estate only? (ii) Real estate and personal property together? (e) First lien? A junior lien? (f) Is it a single advance loan? (g) A multiple advance loan? (h) A construction loan? (i) If it is a multiple advance loan, may the indispensable be re-borrowed once repaid prior to maturity of the loan; making it, in effect, a revolving line of credit? (j) Are there reserve requirements? (i) Interest reserves? (ii) Repair reserves? (iii) Real estate tax reserves? (iv) Insurance reserves? (v) Environmental remediation reserves? (vi) Other reserves? (k) Are there requisites for Borrower to open business operating accounts with the Lender? If so, is the Borrower obligated to maintain minimum compensating balances? (l) Is the Borrower required to pledge business accounts as further and added collateral? (m) Are there early repayment fees or yield maintenance necessaries (each at times referred to as “pre-payment penalties”)? (n) Are there repayment blackout periods for the duration of which Borrower is not permitted to repay the loan? (o) Is there a Loan Commitment fee or “good faith deposit” due upon Borrower’s acceptance of the Loan Commitment? (p) Is there a loan funding fee or loan brokerage fee or other loan fee due Lender or a loan broker at closing? (q) What are the Borrower’s expense reimbursement indebtednesses to Lender? When are they due? What is the Borrower’s obligation to remunerate Lender’s expenditures if the loan does not close? B. DOCUMENTING THE COMMERCIAL REAL ESTATE LOAN Does Purchaser have all data necessary to comply with the Lender’s loan closing requirements? Not all loan documentation necessaries may be known at the outset of a transaction, though most mercantile real estate loan documentation necessaries are reasonably typical. Some required info may be received only from the Seller. Production of that data to Purchaser for deliverance to it is lender must be required in the buy contract. As guidance to what a mercantile real estate lender may require, the following sets forth a typical Closing Checklist for a loan secured by mercantile real estate. Commercial Real Estate Loan Closing Checklist 1. Promissory Note 2. Personal Guaranties (which may be full, partial, secured, unsecured, payment guaranties, collection guaranties or a potpourri of other types of warrants as may be required by Lender). 3. Loan Agreement (often integrated into the Promissory Note and/or Mortgage in lieu of being a discerned document) 4. Mortgage [sometimes expanded to be a Mortgage, Security Agreement and Fixture Filing] 5. Assignment of Rents and Leases 6. Security Agreement 7. Financing Statement (sometimes referred to as a “UCC-1″, or “Initial Filing”) 8. Evidence of Borrower’s Existence In Good Standing; including (a) Certified copy of organizational documents of borrowing entity (including Articles of Incorporation, if Borrower is a corporation; Articles of Organization and written Operating Agreement, if Borrower is a fixed liability company; Certified copy of trust agreement with all amendments, if Borrower is a land trust or other trust; etc.) (b) Certificate of Good Standing (if a corporation or LLC) or Certificate of Existence (if a fixed partnership) or Certificate of Qualification to Transact Business (if Borrower is an entity doing business in a State other than it is State of formation) 9. Evidence of Borrower’s Authority to Borrow; including (a) a Borrower’s Certificate; (b) Certified Resolutions (c) Incumbency Certificate 10. Satisfactory Commitment for Title Insurance (which will quintessentially require, for analysis by the Lender, copies of all documents of record appearing on Schedule B of the title dedication which are to stay after closing), with required mercantile title insurance endorsements, ofttimes including: (a) Affirmative Creditors Rights Endorsement (extending coverage over policy exclusion 7 and policy exclusions 3(a) and 3(d) as they relate to creditor’s rights matters) (b) ALTA 3.1 Zoning Endorsement modified to include parking (c) ALTA Comprehensive Endorsement 1 (d) Location Endorsement (street address) (e) Access Endorsement (vehicular access to public streets and ways) (f) Contiguity Endorsement (the insured land comprises a single parcel with no gaps or gores) (g) PIN Endorsement (insuring that the identified real estate tax permanent index numbers are the only applicable PIN numbers affecting the collateral and that they relate solely to the real property comprising the collateral) (h) Usury Endorsement (insuring that the loan does not violate any prohibitions versus exuberant interest charges) (i) other title insurance endorsements applicable to protect the intended use and value of the collateral, as may be determined upon review of the Commitment for Title Insurance and Survey or arising from the existence of particular issues pertaining to the dealing or the Borrower. 11. Current ALTA Survey (3 sets), [typically prepared in accordance with 2005 Minimum Standard Detail for ALTA/ACSM Land Title Surveys, certified to the lender, Buyer and the title insurer, including items 1 through 4, 6, 7(a), 7(b)(1), 8 through 11(a) and 14 from the Surveyor's "Optional Survey Responsibilities and Specifications" referred to as "Table A"]. 12. Current Rent Roll 13. Certified copy of all Leases (3 sets) 14. Lessee Estoppel Certificates 15. Lessee Subordination, Non-Disturbance and Attornment Agreements [sometimes referred to merely as "SNDAs"]. 16. UCC, Judgment, Pending Litigation, Bankruptcy and Tax Lien Search Report 17. Appraisal (must comply with Title XI of FIRREA (Financial Institutions Reform, Recovery and Enforcement Act of 1989, as amended) 18. Environmental Site Assessment Report (sometimes referred to as Environmental Phase I and/or Phase 2 Audit Reports) 19. Environmental Indemnity Agreement (signed by Borrower and guarantors) 20. Site Improvements Inspection Report 21. Evidence of Hazard Insurance naming Lender as the Mortgagee/Lender Loss Payee; and Liability Insurance naming Lender as an “additional insured” (sometimes listed as plainly “Acord 27 and Acord 25, respectively) 22. Legal Opinion of Borrower’s Attorney 23. Credit Underwriting documents, such as signed tax returns, property operating statements, etc. as may be specified by Lender 24. Compliance Agreement (sometimes likewise called an Errors and Omissions Agreement), whereby the Borrower agrees to correct, after closing, faults or omissions in loan documentation. It is utile to become intimate with the Lender’s loan documentation requisites as early in the dealing as practical. The necessaries will likely be set forth with a great deal of detail in the lender’s Loan Commitment – which is specifically much more elaborated than most loan commitments issued in residential transactions. Conducting the Due Diligence Investigation in a mercantile real estate dealing may be time consuming and highpriced in all events. If the loan requisites cannot be satisfied, it is better to make that determination for the duration of the contractual “due diligence period” – which specifically provides for a so-called “free out” – rather than at a later date when the earnest cash may be at danger of forfeiture or when other liability for failure to close may attach. CONCLUSION Conducting an effective due diligence investigation in a mercantile real estate dealing to discover all material facts and conditions affecting the Property and the dealing is of critical importance. Unlike proprietor occupied residential real estate, when a house may almost always be occupied as the purchaser’s home, mercantile real estate acquired for business use or for investment is impacted by a heap of components that may affect it is use and value. The existence of these components and their affect on a Purchaser’s capacity to use the Property for it is intended use and on the Purchaser’s projected investment yield may only be encountered through diligent investigation and attention to detail. The circumstances of each dealing will determine what degree of diligence is required. The level of diligence required beneath the circumstances is the diligence that is due. Exercise Due Diligence.
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