After looking at the commercial properties in your area, you’ve finally found one that seems to meet your investment criteria. It’s in a great location, the price is right, and you’re already thinking about putting in an offer.
But before you take the plunge, you should ask some tough questions. The key to success with any investment property is in the details, so gather all the information you can about your potential investment.
Here are nine not-so-obvious questions you’ll want to ask before making an offer on a commercial property.
1. Are There Tenants in Place?
Even though the commercial market has experienced a significant slowdown, it’s likely that any commercial property you’re buying already has a few tenants in place. Request the rent roll and copies of the current leases from your broker. These documents will tell you who the lessees are, when their leases expire, the terms of those leases (including allowed rent increases), how much rent they pay, and how much they may contribute to common expenses.
2. Can I See a Pro Forma?
A pro forma is a complete accounting of all the income and expenses of a commercial property, so this is vital information. Once you receive copies of the leases, make sure all the rents and fees detailed in the leases add up to the amount of income indicated in the pro forma. If they don’t, ask the broker for clarification.
The expenses should include everything the owner pays to maintain and market the property, from trash removal, routine building maintenance, and landscaping to professional property management. Collectively, this is just the cost of doing business—similar to how a seller generally has to pay real estate commission.
Combining the income and the expenses should get you a net operating income (NOI), which is what you can expect to pocket each month from the property. Whether you’re planning to buy and hold or resell in a year or two, the NOI allows you to calculate your return on investment (ROI)—making it arguably the single-most important factor in any commercial property decision.
3. What Other Projects Are Planned for the Area?
Future developments can have a massive impact—positive or negative—on your future profitability. For example, a new highway being built nearby could bring in the commuter crowd, or cut you off from the neighborhood, depending on the placement. An influx of new construction in your area could boost customer traffic and increase your profitability, or it could dilute demand and siphon business away from you. Buying a commercial property is a lot riskier than investing in an REIT.
Look into commercial building permits that have been recently filed for projects near you and talk to your broker about any new developments in the area, including rumors and possibilities they’ve heard about. Then conduct a careful analysis of the impacts these new projects could have on your property.
4. Is There a Ground Lease?
Many commercial properties have a ground lease, which means you’ll pay rent on the ground under the property you buy. There are pros and cons to a ground lease. On the plus side, it can make a commercial property much more affordable since you’re not paying to own the land under the building. On the other hand, you won’t benefit from appreciation on that land either.
Additionally, the terms of your ground lease are extremely important—make sure you comb through the lease carefully to find out if it’s renewable and what kind of rent increases are allowed.
5. What Is the Developer’s Track Record?
Don’t underestimate the importance of the developer to a project’s overall profitability. Newer developers can tank a project, even if the property is in a prime location, simply through mistakes of inexperience. Look into the agent’s experience with previous developments in the same sector.
If it’s thin or spotty, be careful in your analysis.
6. Is Your Intended Use Allowed Under Zoning Rules?
Zoning is as important as location in any analysis of a commercial acquisition. Determine, with the assistance of your broker, whether zoning rules allow for your intended use. If not, this complicates your purchase. You could put in an offer that’s contingent on receiving a variance or a rezoning, but you can’t count on receiving either. And the variance or rezoning application processes can be long and complicated.
7. Is the Title Free and Clear?
When you’re doing your due diligence, make sure you receive a full title report. This report will detail any liens, claims, restrictions, covenants, or other encumbrances that could complicate your purchase. You’ll want a full Ownership and Encumbrance report before you make your offer.
8. What Are the Exact Property Lines?
Getting a property survey is pretty standard, whether you’re selling a home or buying an office building. You’d be surprised how many times an actual survey disagrees with the property lines as described. Make sure the seller has a survey done (you may have to request one) to confirm the actual property lines and that you’re going to receive the property you think you’re supposed to. If your property encroaches onto a neighboring lot, even by just a tiny bit, it could introduce serious legal complications down the line.
9. Does the Property Have Any Environmental Issues?
To make sure there are no environmental problems that will need to be remediated—which can be a very costly and lengthy process—have a Phase I environmental assessment done. If that doesn’t uncover any issues, you’re in the clear. If it indicates the presence of potential issues, you’ll need a Phase II environmental assessment, which is an in-depth environmental study that closely analyzes the property’s soil, water, and air.
If major contamination is found, you’ll need to have a serious conversation with the seller about liability issues and remediation. This could give you significant leverage in the negotiation—the kind of leverage that can get contingencies removed from a contract or lead to a huge price reduction.
Luke Babich is the co-founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers, and investors make smarter financial decisions.
Babich is a licensed real estate agent in Missouri, and his research and insights have been featured on BiggerPockets, Inman, the LA Times, and other media.
He received a bachelor’s degree with honors in political science from Stanford University.
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