“Is This the Right Property for Me?”
You’ve found a fantastic property for your new business. By all appearances, your business plan has met its location. Other buyers are also looking at the property, your realtor is eager to get your offer in, and you don’t want to lose the opportunity. At the same time, you are uncertain about signing a contract.
Many clients have come to me in this position. The good news is, with a properly communicated and agreed upon due diligence period, a contract can be quickly drafted, protecting your right to be first in line to purchase, while you continue to confirm the property’s suitability. With properly drafted due diligence terms, you are protected by the right to back out if certain deal-breakers are found.
Experienced real estate investors and developers typically look at numerous criteria before even making an offer. For these buyers, due diligence is focused on those details that are outside of their expertise and control, such as environmental investigations and zoning approvals. By comparison, entrepreneurs and investors without any such real estate experience may be up against more constraints than they realize when signing a contract. To help them out, here are eight suggested inquiries for preliminarily vetting properties.
Eight Inquiries for Vetting Properties
A buyer is responsible for confirming deal-breaking criteria prior to deadlines. While much of due diligence is performed once a buyer is under contract, preliminary inquiries can be made around the time of making an offer, subject to your negotiation strategy and timing.
1 – Zoning: How do you want to use the Property?
Paramount to any real estate acquisition is the question: “how do you want to use the property?” Define your primary use and all related uses (i.e. store with some classes, offices with limited wholesaling, bed & breakfast with weddings). Compare all proposed uses to those which are allowed under local zoning ordinances. In most New Jersey municipalities, zoning ordinances are online, and the zoning officer will provide guidance. I have access to many ordinances and often review them for clients.
If your use is allowed as a right, the property is more suitable. If not, you will need to understand the process, likelihood, and cost of obtaining zoning approval. If appropriate, your contract should protect your right to back out if you cannot get necessary zoning approvals. When receiving preliminary zoning opinions, you should rely upon the written statements of the zoning officer or on objective, knowledgeable professional, such as a land use attorney or a licensed professional planner, when interpreting zoning and the historic and proposed use of a property. Keep in mind, zoning changes from time to time.
2 – Site Constraints
If you plan to build new or modified improvements, restrictions and setbacks may or may not be deal breakers. Keep in mind that resources such as wetlands, streams, steep slopes, impervious surfaces, flood hazard areas, and preservation easements (without limitation) may prohibit certain improvements or require permits and approvals which take time and are uncertain. Ultimately, professional surveys and inventories are necessary to confirm site constraints. However, a seller or township may have some data on hand, and review of state sponsored digital mapping provides preliminary information. Check out New Jersey’s GEOWEB.
3 – UCC: Can you get a certificate of occupancy for the proposed use?
Zoning Code and the Uniform Construction Code are two, very separate considerations that are often overseen by different municipal officers. Construction requirements vary based upon the use of the building and current code. For example, a buyer might overlook that a fire suppression system will be required based upon a change or expansion of use. Such a costly investment might make an otherwise ideal property unaffordable. Talk to the construction official and/or hire an experienced architect or engineer to advise accordingly.
4 – Taxes: Any Surprises with the Tax Assessment?
These records are just a start and are not a substitute for reviewing a tax assessor’s file. Keep in mind that fair market value and assessed value typically diverge. If you are looking to obtain or maintain a reduced assessment, confirm your assumptions with preliminary inquiries, and include proper representations and contingencies in the contract. Before closing, at a minimum, a buyer should become familiar with the tax assessor’s valuation and assessment, including whether the valuation reflects the current improvements and fair market value, whether the property is assessed at a reduced rate subject to conditions, whether roll-back taxes might apply, whether the assessment was recently appealed with a negotiated assessment subject to conditions, and whether any special assessments have been applied and remain unpaid.
5 – Title: Possession is not really 9/10ths of the Law!
Carefully review a Seller’s disclosure and any available title documents for restrictions such as easements, licenses, or general references to the rights of others to use the property. Specifically ask about known easements, both on the target property as well as any serving the target property. Utility easements, shared driveways, shared private roads, site distance easements, preservation easements, conservation easements, bridge maintenance easements, county rights of way, agricultural licenses, hunting clubs, deed restrictions, association rules and regulations…. Get the idea? Title is often ordered weeks or months into a transaction, making a buyer’s preliminary inquiries even more important.
6 – Environmental History
Many desirable properties have a known history with environmental closures but are now considered remediated with proper closure documents. Request that a seller disclose any known environmental history and provide documentation before or soon after contracting. Review the documentation with your attorney to confirm it is complete.
State and federal law allow a Seller to obtain certain protections for current or past releases provided investigations are conducted and recommendations timely followed. These investigations also serve the practical purpose of determining whether a property is “environmentally suspicious” in lay terms. Although these investigations are typically conducted once a buyer is under contract, identifying whether a property has environmental releases or permits on file is a preliminary step available to buyers. The New Jersey Department of Environmental Protection has a data miner of identified sites, but search criteria are tricky. Review of historic aerial photography may also reveal some interesting property history.
Keep in mind other issues related to the physical condition of the property, such as asbestos, water quality, and similar issues. While these investigations may be made while under contract, communicating deal breakers early in the transaction may save time and money.
7 – Choice of Entity
Most lawyers want to see their clients purchase investment or business real estate in a limited liability entity that is different from the operational, business entity. If desired, your contract can be drafted to allow assignment to such a business entity prior to closing. However, understanding the proper business structuring of your deal early on, upon the coordinated advice of your attorney and accountant, will facilitate the lending and contracting process.
8 – Financing: Charting a Course
When it comes to business and real estate investment lending, especially for entrepreneurs new to a business, your lender and its many requirements are often a driving force in the transaction. Different loan products come with differing requirements for due diligence, ownership structuring, documentation, etc. I often relate the lending process to “jumping through hoops” because borrowers need to be prepared to promptly work through detailed lending checklists in coordination with their attorneys and title company. Sometimes the process feels more like a dog agility course than mere hoop jumping, with tunnels, balancing beams, and technical requirements that quickly cause delays. Prior to diving in headfirst, have a general sense of realistic financing options/programs and their respective requirements.
Surround Yourself with “Good People”
The above suggestions are not a substitute for legal counseling specific to your business plan and target property. Other criteria likely require preliminary and contractual inquiries, such as tenants, past permits and approvals, etc. To be successful, surround yourself with a qualified team of successful and objective professionals. The above inquiries are not exhaustive and are offered merely to help purchasers rule out obvious unrealistic expectations and properties. If deal-breaking, unresolvable constraints can quickly be identified, moving on to a different property saves everyone involved both time and money. That said, many profitable business plans are executed despite constraints via planning/zoning/environmental applications, construction fit-out, waiting out environmental closures, obtaining easements, and so forth. Navigating these decisions is where your team of professionals and a properly drafted contract come into play.