Throughout the United States, developers are acquiring vacant commercial buildings in the aftermath of the Great Recession. Although most of these are retail buildings, some are office or industrial structures. Vacant buildings often are pre-entitled for the developer’s intended use and can deliver impressive returns after refurbishment. Much depends on timing and price, of course, but in some instances proper due diligence can make the difference between a cash cow and an albatross. Vacant buildings present unique due diligence issues that cannot be vetted adequately with a generic feasibility checklist.
The following are examples of the types of critical issues that due diligence can reveal:
Environmental contamination. Physical inspection may reveal high concentrations of airborne contaminants or lead in a building’s water. Often, this is due to the prolonged shutdown of the structure’s heating, ventilation, and air conditioning or plumbing systems. Consultants experienced with vacant buildings know how to interpret these results, retest, and compare readings after the building systems have been operated for appropriate periods under appropriate conditions. Engineers and environmental attorneys experienced with these matters can explain such findings to lenders and investors, keeping the deal on track.
Entitlement issues. To what extent can the building be remodeled without triggering discretionary governmental approval requirements? If the building is in a shopping center, office park, or industrial park, do the governance documents permit the proposed refurbishment and use? Do other entities have approval rights? How can a developer avoid paying ransom to a holdout? Did the building vacancy terminate valuable rights that otherwise would have continued to run with the land? If so, can these rights be reinstated? A skilled due diligence team will identity these types of entitlement parameters early in the process.
Bankruptcy complications. Is the building’s owner, a prior owner, or a prior tenant insolvent or in bankruptcy? If so, how likely is it that the building — or an interest in it — is or will be part of a debtor estate? Did the vacancy constitute a default under the existing mortgage or convert it from nonrecourse to full recourse? Is there an opportunity to amend and assume that loan on favorable nonrecourse terms? Timely due diligence can answer these questions — and may result in substantial savings for the purchaser.
Access issues. Will the city require upgrades to the entire path of travel from the street to the building entrances, to comply with the Americans with Disabilities Act? If so, how much of that path is on property owned by third parties? Will the city entertain an alternate path of travel? Likewise, are existing truck routes and docks compatible with the trucks and routing system of the proposed end user? Are those truck routes dependent on easements that are about to expire? An experienced land use team knows how to handle all of these challenges.
Security. Has the property been secured and fenced? Has the owner allowed prescriptive easement rights to accrue over the parking lot or access ways? Such rights can restrict the developer’s ability to reconfigure the hardscape and, in some instances, materially impair the intended end use.
Other questions. Why, exactly, did the prior operator vacate? If the prior use was the same as the developer’s intended end use, this will be a critical question. Would the developer be best served if its identity (or that of its proposed end user) is not disclosed? Would competitors seek to delay or stop the reuse project? How and to what extent can anonymity be maintained while a potential purchaser seeks permits? Skilled legal counsel will know how to draft effective confidentiality agreements specific to this scenario.
Does the developer intend to lease the building by a lease assignment or sublease from the vacated tenant? If so, did the vacancy constitute a default under the lease? Does the landlord have a recapture right? An experienced team can offer advice about the best way to open a dialogue with the landlord to assure cooperation rather than resistance.
A Positive Outcome
Experienced due diligence teams ask the right questions and add value by resolving issues that the less experienced might see as deal-killing impediments. The result for developers looking to acquire vacant commercial properties can be creative solutions and, ultimately, successful projects.