December 4, 2022
Commercial Property

As the business environment becomes increasingly uncertain, it is more important than ever to re-learn the behaviours that maximise returns and efficiency despite recession. We are now strongly advising our landlord and seller clients to carry out commercial property due diligence process on their own assets: investigating their own commercial properties as if they were a prospective tenant or a prospective buyer and thereby finding out all the issues which will come up after a deal is initially agreed. Just as a property sells better after a lick of paint, it also sells better if the seller has addressed any legal, commercial and tax issues in advance and has its documentation and records in good order.

So you think you know your own property…

You may think you know your building but the breadth and depth of issues to have covered off is considerable. This is where commercial property due diligence comes in.

Even property companies who have dedicated asset managers for each commercial property rarely achieve full mastery of all the issues that come up during a thorough sale or investment process. This is because the list of issues to be covered even on a simple property sale is both very broad and detailed. The following give you some idea of all the legal, technical, tax, environmental, construction and commercial issues that can come up when selling a commercial property:

If the property is subject to one or more leases, that is an additional and very significant aspect to ensure that things are in order. A buyer will also want to know that the tenants have registered and deregistered everything properly – things that can sometimes be omitted by the Landlord’s advisers in the day to day operation of a portfolio. A buyer will also want to know the tenants pay on time and are not facing financial difficulties. The simple act of organising that information by carrying out your own commercial property due diligence investigation in advance can make a huge difference.

Planning those thorny grey areas through commercial property due diligence

In fact, the most intractable problems can be the grey areas between accountants, tax advisers, structural engineers. We once waited some months for a German professor to analyse the quality of the concrete used to make the columns in the underground car park. It also gets a bit problematic if the accountants’ records of rents received do not match up with the legal documentation, either because rent reviews have not been properly recorded or signed off if a third party has been paying the rent. Financial statements should be thoroughly reviewed to ensure they align with legal records and rent reviews.

If the property is held offshore or has intra-group financing, this may also change the target sale structure and the tax consequences so a thorough understanding of the issues and possible sale structures is best established before a property is marketed to ensure the agent’s information is correct. Evaluating the risks involved and understanding the implications for business transactions can also prevent potential complications during the sale.

Just being organised…

Selecting a good online dataroom and organising it carefully and thoroughly will not only make a sale or investment proceed much faster, it will also build up trust with the buyer or investor and can hugely reduce the legal fees for both buyer and seller. Here some issues that happen too often:

  • the buyer’s advisers are given an unstructured dataroom 
  • there are documents in the wrong place
  • documents are incorrectly labelled
  • documents are missing or 
  • documents are added to the dataroom at the last minute 

The result of these organisational issues is to cause considerable extra work for all the professional advisers, adding to the time for the buyer or investor to carry out the commercial property due diligence and possibly even causing mistrust.

Why seller’s commercial property due diligence saves money

By preparing online datarooms, finding any missing documents and solving any problems before an actual buyer/tenant sees them, it can save:

  • Pro-longed contract negotiations. Problematic title issues can cause lengthy discussions over how to deal with it in a sale contract. It can then cause price reductions, money to be held back in escrow and indemnities. 
  • Price re-negotiations.
    • If the agents’ investment memorandum contains inaccurate or misleading information about the income or the length or quality of the leases, that can be used to reduce the price.
    • Unresolved items are usually the target of attempts to reduce the price, particularly if it impacts income or running costs.
  • Conditions Precedent. This produces a delay between exchange and completion. In an extreme case, it can even produce considerable uncertainty about whether or not a deal will actually complete and if so, at what price.
  • Even indemnities, which do not actually cause a price reduction on the day of completion, may still force a seller to keep a provision in its accounts for some years. A thorough shareholder value analysis can provide insights into the financial impact of certain indemnities.

Professional fees will be much lower for solving the problem in advance compared to discussing how to handle it in a sale contract and then solving the problem after the contract is signed. Effective risk management can minimise these unforeseen costs and ensure a smoother transaction process.

Why commercial property due diligence can save your deal

Property Investors have a variety of different approaches and internal calculations when assessing a deal. However, one issue that crops up is that many institutions do not have the internal capacity to actively manage a property but they will pay top prices. In other words, they will beat off the other bidders but they will also walk away if they are presented with too many problems.

Once the initial bidding is closed, the winner is announced and the other bidders depart from the process, a property can get a bad reputation if the announced sale falls through. To know in advance if a legal issue or a tax issue will block a sale is very important. It can even be the case that time must be taken before going to market to improve the holding structure or get necessary consents.

For property owners, carrying out preliminary commercial property due diligence on their own assets can be a fast and value-for-money way of greatly reducing risk and uncertainty in the near future. Engaging with reliable business partners can also help streamline this process, paving the way for successful mergers and acquisitions.

How we can help you

James was a partner in a commercial law firm and then worked in-house at one of the largest property companies in Europe where he led commercial property transactions worth over EUR 1.4BN, both as share deals and asset deals, including shopping centres, office buildings and international portfolios. Get in contact with James here.