You have just signed the contract to buy a commercial property. You are now in the “Due Diligence” period, sometimes called “inspection period”, and have 30 to 45 days until you close. So what now? Should you order a Property Condition Assessment (PCA)? What are the benefits of doing so? How do you maximize the benefits of conducting a PCA?
We believe there are 5 main benefits to conducting a PCA:
- Gain a Technical Understanding of the Property. The results of a PCA helps you understand how the property functions and make a more informed purchasing decision. If there are particular features of the property that are of importance, this is your chance to evaluate them in detail. Often, potential sellers are reluctant to let potential buyers into tenant spaces or behind closed doors. The PCA allows you to more fully evaluate the risks associated the property. This will also allow you to further understand the technical aspects of the property, especially as it relates to future use. You may discover conditions that will make you decide to walk away from the deal. Its best to learn as much as you can while you can.
- Identification of Physical Deficiencies. A good PCA should list all the problems, both big and small, associated with a property. Many property owners are under the mistaken belief that buildings require little maintenance, and they defer maintenance to spend 100% of the cash generated by the property elsewhere. The result is properties that are in poor condition. Over time problems resulting from deferred maintenance can compound, so that smaller, easy to repair problems become major problems that will be very expensive to correct. The fact is that commercial buildings, especially larger ones, require almost constant maintenance. An owner should put roughly 20% of the revenue generated from a property back into immediate maintenance or into a fund for future maintenance and capital expenditures. A failure to fund ongoing maintenance will show in the condition of the property. Additionally, a PCA may reveal design or construction problems, including structural issues, code violations, poor material quality, bad workmanship, and inadequately designed systems. These can all shorten the life of a property and be very costly to remediate.
- Estimation of Costs. A good PCA will estimate how much it’s going to cost to fix all of the problems identified and lay out expectations for near term capital outlays. This may be the most important part of the PCA. These costs should be part of your calculations for the returns you expect to get from the property. You also need to be prepared for the current and future expense and capital outlays.
- Power to Negotiate Terms. You wouldn’t pay full price for a used car with bald tires, a leaking engine, and torn up seats, and you shouldn’t pay full price for a building in poor condition. The PCA can be used to leverage contract terms to get a lower price from the seller or other concessions, which may be one of the greatest benefits. We’ve seen buyers negotiate huge discounts based on the results of our PCA. We’ve also seen sellers agree to make substantial repairs of problems identified by our PCA before or after closing in order to keep the deal from falling through. Your ability to negotiate is stronger if your PCA provider has professional authority backed by technical expertise and credentials.
- Mitigation of Exposure to Future Liability: The inspection may identify potential health or safety hazards that could expose you to huge liabilities later, but just as importantly if the inspection does not identify a particular hazard that causes injury later, your PCA becomes an excellent prophylactic against liability–evidence that the alleged hazard was not reasonably foreseeable (even the expert didn’t see it) and therefore you are not legally liable for any resulting injury. In effect, you have an expert witness already on your side if something bad happens in the future.
Now that you’ve decided to perform a PCA, how do you maximize the benefits you get from the assessment?
- Follow up with identified issues. A PCA may just be a starting point for your technical due diligence. Other investigations may be warranted based on the findings of the PCA in order to look deeper into issues uncovered from this initial inspection. Many buyers add additional investigations into Radon, Mold, Termites, and ADA Compliance. We also recommend that you perform a Phase I Environmental Site Assessment or an alternative form of environmental due diligence as well. The environmental risks associated with commercial properties can be significant, and you should at least understand your exposure.
- Use highly qualified inspectors. We recommend someone with an engineering degree and plenty of experience with constructing, maintaining, and inspecting commercial properties. The mistake many buyers make is using a home inspector to conduct a PCA for a commercial property. Most commercial properties are much more complicated than residential properties and have many systems and features not normally found in residential construction. Although home inspectors may be qualified to inspect simple single-family residences, they often don’t have the education and experience to provide cost information for repair and replacement of commercial systems. They also won’t have the authoritative opinion of a degreed engineer that will be needed to convince sellers to lower their prices when expensive issues with the property are uncovered. There are countless potential pitfalls that may be encountered when buying commercial property. You may have only done this a few times (or maybe it’s your first time), but a good inspector will have done it hundreds of times and can point out potential problems you never would have thought about or realized were an issue.
- Don’t skimp on the PCA and additional inspections. Even though the price tag may seem high at face value, these assessments very often pay for themselves, sometimes many times over. Would you pay $10,000 to uncover $1,000,000 worth of deficiencies at the property that will be corrected by the seller or discounted in the contract price?
To sum up the main purpose of a PCA in a single sentence would be to answer the question, “What’s wrong with the property and how much will it cost to fix it?” A quality PCA can be a tool you use to make a more informed purchasing decision, refine future cash flow projections, negotiate a more favorable contract price, or obtain concessions from the seller. The information you get from a quality PCA may be the difference between a winning and losing commercial transaction.