By Dale Eisenman
Most self-storage facility buyers know they should perform due diligence before closing a purchase transaction, but do they know what that really means? My old Black’s Law Dictionary defines “due” as reasonable, just, regular and sufficient. “Diligence” is defined as prudence, attentiveness and care. Used together, "due diligence" can be thought of as sufficient care and reasonable prudence. In other words, it’s that degree of care one generally exercises with respect to his concerns.
Commercial real estate transactions typically involve a period of time during which a buyer can exercise his due diligence to satisfy any concerns. This enables him to fully understand what’s being purchased, which serves his own interests and those of the seller. A thorough due-diligence process will provide both parties with factual information to minimize the risk of a “surprise” post closing, which could give rise to a claim.
Let’s assume Bob the Buyer has his eye on a self-storage facility in the Soccer Suburbs, which is being marketed by a self-storage broker. The broker's information package includes historical and projected financial information reflecting the performance of this income-producing property. Additionally, it includes a description of the facility’s unit mix, location, size, age, operating hours, etc.
Based on this information, Bob is interested and schedules a property tour. Afterward, he requests some updated financial and occupancy information, which he finds satisfactory. Bob then makes an offer to purchase the property and, after some negotiation, a written purchase agreement is signed by both parties that includes a provision for a due-diligence inspection period.
During that period, Bob or his representatives may review information supplied by the seller as well as conduct inspections as Bob sees fit. Typically, a buyer will be able to terminate the purchase agreement at no penalty for any reason whatsoever prior to the end of the inspection period. Commonly, once the due diligence is completed, any deposit becomes nonrefundable and an additional nonrefundable deposit may be required. The parties then proceed to close the transaction.
Accordingly, Bob wants to learn all that’s important to him during the due-diligence period, before his deposit becomes nonrefundable and he’s committed to close the transaction. What do you think he should know with a fair amount of certainty before committing to the buy? The list could be almost endless, but most reasonable buyers seek an acceptable degree of satisfaction and comfort to proceed to closing.
While the following is not meant to be all-encompassing (and may not even satisfy Bob), it can serve as guidance with regard to what’s likely to be accomplished during due diligence. The process falls into three broad categories: the physical property, financial documents and the local market. Bob may do more or less. It’s within his discretion to decide what qualifies as adequate information to move forward or terminate the purchase.
Here are some due-diligence considerations buyers should keep in mind when it comes to the physical property.
- Survey: Are there any encroachments, easements, setbacks, etc?
- Building plans: Secure and review the building’s plans to ensure the facility was built accordingly. Are they accurate and acceptable?
- Phase I environmental site report: Is the site free from environmental issues?
- Title report (insurance): Is the chain of title (ownership) clean? Are there any clouds or encumbrances?
- Structural report: Inspect the buildings, HVAC, doors, gates, security system, lights and roofs. Are any repairs needed?
- Certificate of occupancy and permits: Are all the appropriate documents available and in force? Are there any zoning issues? Is the business license up to date?
- Signage: Verify signage rights and opportunities. Can the signage continue or be expanded?
- Personal property: Inspect the golf cart, computers, furniture, etc., and any other property that will transfer with the sale. Is the condition as expected?
- Management: Interview current staff (with the seller’s permission), and understand management practices. Should any staff be retained?
Reviewing the facility’s financial records is a critical component of the due-diligence process. Buyers should be on the lookout for these key elements.
- Profit-and-loss statements: Verify and review all monthly revenue and expenses, tie bank deposits to reported revenue, and examine actual invoices and bills to support reported expenses. You should also match software reports to financial reports and understand the accounting used including capital expenditures. Are there any inconsistencies or issues?
- Occupancy: Verify the facility’s occupancy. Perform lock checks, review rental promotions and discounts, and consider occupancy trends and rental-rate sensitivity. Do they support your market assumptions?
- Rent roll: Evaluate all delinquencies and current rents. Are they as expected?
- Prepaid rents: Verify prepaid rents. Are they as expected and reported?
- Repairs and maintenance: Understand the facility’s expenses. Is there any deferred maintenance?
- Real estate tax: Examine the real estate tax history and estimate real estate tax post closing. Is it acceptable?
- Ancillary income: Review the facility’s tenant-insurance program, retail sales, late fees, administrative fees, etc. Can those be increased, maintained or reduced?
- Leases: Examine commercial leases including cell tower, if applicable. How do they impact income?
- Property insurance: Consider the existing policy and consult with an agent regarding a new policy. Will insurance premiums increase or decrease?
- Rental agreement: Verify all rental agreements are in force and cross check with the facility’s occupancy. Are there any problems?
- Service agreements: Review all third-party service agreements (software, HVAC, landscaping, etc.). Which agreements must be continued?
- Credit card processing: Can any improvements be made? Can you reduce any of these fees?
- Auctions: Understand the facility’s auction frequency, policy and process. What changes should be made?
- Appraisal: Review for accuracy and compare value to purchase price. Does the report provide support for the purchase?
The Local Market
A due-diligence process would not be complete without careful examination of the facility’s market. Keep these important considerations in mind.
- Competition: Visit competitors, review their rental rates, occupancy and physical plant. Is the facility properly positioned?
- Demographics: What is the number of households, income levels, dwelling types, growth, etc., in the market? Do the demographics support the projections?
- Location: Consider drive-bys, visibility, neighboring retail, traffic quality and quantity. Are there any changes or improvements needed?
- Reputation: Ask locals about storage in the market. What is the business reputation of the facility? How do the results impact marketing plans?
- Advertising: Review programs, promotions and ads. Can adjustments be made?
- Website. Explore and evaluate the business’ online offering. Does it need improvement?
- Telephone: Verify adequacy and transferability. Are tracking numbers in use?
I’m confident you will have thought of additional items I’ve overlooked. Keep in mind there are no hard and fast rules regarding what a buyer should or is entitled to consider; although, lenders may have specific requirements regarding documentation and third-party reports.
Purchase agreements often include very broad descriptions of what a buyer is permitted to inspect and consider as part of the buying process. It’s the buyer who has to be satisfied to move forward. The due-diligence process is his opportunity to exercise reasonable care and prudence to address his concerns. If Bob is satisfied after completing his due diligence, he’ll likely become Bob the Storage Owner.
Dale C. Eisenman is president and broker-in-charge of Midcoast Properties Inc., as well as a licensed real estate broker in Georgia, and North and South Carolina. In addition to being a professional pilot early in his career, he has practiced law, owned and operated several small businesses, and been an active commercial real estate investor for more than 20 years. He specializes in the self-storage industry as an investor and broker. To reach him, call 843.342.7650; e-mail email@example.com; visit www.midcoastproperties.com .