Due Diligence for Commercial Real Estate: More Complex than Residential

Due diligence in real estate is a reality that no one would ignore. In the residential real estate segment, the home buyer undertakes the due diligence or verification of real estate, based on titles and other documents and evaluates the pros and cons of investing in the property. In commercial real estate, however, one is not as emotionally driven, as compared to investing in a home. The quest for commercial spaces is mostly driven by return on investment (RoI).

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When it comes to the lease model in commercial realty, things may be even more casual. As the occupier is not the legal owner of the premises in such cases, one may not be much bothered about the nitty-gritty of the project and unit. As per records, there are lesser number of litigations related to transactions in commercial properties, as compared to residential properties.

Also read: Land purchase due diligence checklist

Common problems in buying / leasing commercial real estate

However, big-ticket-size litigations related to commercial space purchase is much higher, in terms of value. There have been many instances of under-reporting of facts and mis-selling of commercial properties. For example:

Rakesh Parashar made a leasing commitment for a commercial space at Noida Expressway. It was a nine-year lock-in-deal and the owner offered upfront discount for one year. Parashar thought he made a good deal. However, his confidence was shattered when he came to know that the office space remained vacant for more than a year and the owner, reeling under pressure to EMI, had earlier offered a three-year rent discount. This made Parashar feel cheated.
Surinder Pahwa bought a restaurant on outright sale, on the ground floor of a mall in Panchkula. Within one-and-a-half years, as maintenance shifted to the association, he was told that the restaurant would only be allowed at the top floor food court. He is now into a legal battle with the association, while the builder, who is also a party in the case, never appeared in the court.
When Rashmi Yashi was offered a lease for a coffee shop at the ground floor of a mall in Gurgaon, it appeared to be a good deal at decent price. However, she was never told that two leading coffee chains would also open their franchise on the same floor. This soured the deal for her, as her coffee shop could lose footfalls.

There have been cases too, where property agents have concealed market realities and represented only the seller’s perspective. In some cases, buyers have spent significant money on stores in malls, only to realise later that other units in the mall were being sold at throwaway prices. Such cases only suggest that a commercial space occupier should be more vigilant before making a purchase or lease commitment.

See also: Lease vs sale of commercial real estate: Which is a better option?

Due diligence for commercial realty transactions

There are a few challenges that are unique to commercial properties. Due diligence of commercial spaces is more complex than residential properties. This is because, for a house, a home buyer needs to cross check the legal title, sanctions and fiscal liability on the unit for sale. For commercial properties, a buyer has additional task of looking for opportunity cost and to optimise the RoI. Factors like rental potential, competing businesses, parking spaces and business possibility, among others, play an important role.

Ashish Narain Agarwal, founder and CEO, PropertyPistol.com believes that authentication is a crucial process for purchasing or investing in a property, as it helps to get a fair deal. This could be a time-consuming process, depending on the nature of transaction. “There could also be several parameters that a buyer or investor needs to take into consideration before the deal. Hence, it is advisable to hire a third party who has the required expertise and experience in conducting such due diligence,” says Agarwal.

Amit Goenka, MD and CEO at Nisus Finance, believes whether sale or lease, proper due diligence needs to be done by a lawyer or property consultant who will check the title, permissions, area statement, applicable licenses and put a public notice if needed.

See also: Fractional ownership of real estate India: Will it change the commercial property market?

Disclosure norms for commercial real estate transactions

There is no law in the country that categorically defines the custodian of due diligence in the property market, with commercial property being no exception. The Indian commercial property market does not have the concept of disclosure norms where the seller needs to disclose everything relevant and defined by the law.

In developed countries, it is mandatory to disclose detailed due diligence before the contract is signed to buy a commercial property. The rules should be mentioned in the contract for sale and the buyer must follow the timelines for everything. This also compels the seller to deliver required documents on an expeditious basis. This gives buyers an edge in negotiations, to ensure a fair and accurate property valuation, considering all the risks involved.

Also read: Commercial vs residential: Which rental income is more attractive?

Checklist for buying or leasing commercial spaces

As transactions related to commercial properties are more complex than residential units, buyers must prepare a due diligence checklist, marking each item of concern and whether it has been addressed. This checklist should serve to evaluating risks against rewards, irrespective of the investor type and investment objectives. The checklist is as much for evaluating one’s own purpose and finances as for evaluating cost and benefit for legal safety.

Some of the key checklists are:

Land title
Legal status
Purchase objectives
Investment goals
Leasing potential
Tenant leases
Lease payment history
Valuation report
Encumbrance certificate
Zoning regulations
Tax certificates
Financial records and operating statements

Due diligence is not only required, to reduce and mitigate financial uncertainties in high-value transactions but also required to know your limited/restricted rights in the given commercial space in shared buildings. Moreover, it is one’s livelihood in question, when it comes to investing a large amount in buying commercial spaces or in leasing.

(The writer is CEO, Track2Realty)

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Ravi Sinha

Ravi Sinha is a journalist with nearly two decades of cross-discipline media exposure. He is the CEO of real estate think-tank group Track2Realty. He has been writing extensively on the real estate sector for nearly a decade. Evaluation of real estate brand performance is his expertise and he has immense insight into consumers’ psychograph in the property market.

Twitter: https://twitter.com/ravitrack2media