Comprehensive Guide to Due Diligence and Building Review in Commercial Real Estate Transactions

Generally, a due diligence period is the time afforded a purchaser or lessee to enter and upon the site to study, examine and inspect all aspects of the property. This time is also commonly referred to as the “feasibility period”, “study period” or “investigative period”.

There are several due diligence exercises that may be run over the building deal before the Heads of Agreement (HOA) is signed.

These can include: 

• Financial due diligence
• IP due diligence
• Commercial due diligence
• IT due diligence
• HR due diligence
• Regulatory due diligence
• Environmental due diligence

This course will discuss different types of due diligence but essentially focuses on ‘’Internal focussed due diligence and building review” which covers most of the due diligence types outlined above, but most importantly, commercial and financial due diligence.  The regulatory due diligence will be discussed a little later when complying with the Landlord requirements of fit out and occupation.

So, what are the differences between commercial and financial due diligence?  

Well, commercial due diligence provides a full overview of the target's internal and external environment, unlike financial due diligence which focuses solely on the financial health of a company.  

Let’s go and find out more about who’s engaged and involved in due diligence and certification when nearing final negotiations and Heads of Agreement.

Why Do Clients Conduct Commercial Due Diligence?

For any number of reasons, and there are different types of due diligence. 

The focus of due diligence is to review the commercial real estate deal that the prospective tenant, the Tenant Reps client, has shortlisted and is looking to further analyze before moving into the Heads of Agreement phase.

The process of due diligence can include checking, double-checking, and confirming any important information that was used to determine whether the property is a good, average, or bad deal.   

Due diligence can be broken up into three main specialized parts: physical, financial, and legal.

 

Who Assists in Due Diligence?

Let’s look at the engagement of the professional technical consultants that will help the client organization with their due diligence and general obligations.  

These consultants will come onboard at different times during the strategy, property procurement and fit out phases,

These technical consultants and professional advisors are required to support the leasing decision and will consist of technical consultants (from a varied array of disciplines), workspace planners (who will provide test accommodation fits) building services engineers (who will assess the performance capabilities of accommodation options), structural engineers (who will assess design loadings), project managers (who will plan the fit out construction program), and cost estimators (who will determine the project budgets).          

These advisors will provide essential due diligence support and inputs into modelling the various leasing options. 

 As with other advisors, the inputs of these professional advisors need to be managed. At the deal stage the required input is limited but essential. 

Once the leasing deal is done this team of professionals will become far more intensely involved in implementing the construction and fit out project – ready for the relocation.

 

Risks to the Client Organization if Not Practicing Due Diligence

Negotiating major lease transactions cannot be taken lightly. The overall potential financial commitment can cripple an unsuspecting company, particularly if the in-house team is not familiar with all the intricacies of long-term leasing obligations. 

The multidisciplinary skills required to assess accommodation options are often not well understood, properly briefed nor well managed. 

The challenges of lease negotiations are often underestimated and having professional technical consultants, who understand the organization's expectations and objectives will provide the best deal outcome for the client organization.

 

Scope of Work for Professional Technical Consultants

The client organization needs to hire different professional technical consultants at different stages in the project.

The Tenant Representative is one of the first consultants onboarded, closely followed, or perhaps preceded by the Quantity Surveyor and Designer.  This could be dependent on whether the client has been discussing options of staying put and refurbing before engaging with their Tenant Rep to source the market and conduct the stay vs go analysis.

The Tenant Representative is one of the first consultants onboarded, closely followed, or perhaps preceded by the Quantity Surveyor and Designer.  This could be dependent on whether the client has been discussing options of staying put and refurbing before engaging with their Tenant Rep to source the market and conduct the stay vs go analysis.

When onboarding what are some of the things that the client organization may put in their scope of work for these professional technical consultants.   Let’s see!

Some of the requirements consistent with due diligence and building review are highlighted in green! 

 

SCOPE OF WORK - General Obligations

The Consultants shall include for the following general scope of services items:   

• Perform the services to meet the requirements of the Design Brief, the Program, and the Project Budget in the stages as set out in the scope of works outlined in this document
• Attend all meetings as reasonably required by the Project Manager
• Lead, act and co-ordinate as Lead Design Consultant, and assist, so far as reasonably required, the Project Manager and all other specialist design consultants engaged on the project
• Nominate a single point for day-to-day communications
• Liaise with specialist design consultants in relation to their individual outputs, coordinate and incorporate their information, as required. Provide recommendations into the selection of specialist design consultants, as required to undertake the design works
• Assist the Project Manager to draft and issue Request for Tender for secondary design consultants
• Review regulatory and authority requirements to facilitate compliance
• Assist the Project Manager as required in the management of the design sign off at milestone stages
• Advise on buildability and safety in design issues, and apply best practice quality assurance methodologies
• Assist with information requests related to change management through provision of documentation established per design phase
• Preparation of presentation materials and other project definition materials including requesting alternatives be identified and suitability assessed
• Assist Project Manager to establish and input into a project design change register for interior design scope and report on the register at regular design meetings
• Assist in the preparation of monthly and progress reports for the PCG. This is to include a statement of status of relevant works, any risks, and corrective actions to be taken
• Take all reasonable steps so that all Consultant's documentation including drawings, specifications and schedules are coordinated and audited for consistency with the endorsed/approved documentation for each stage
• Establish and manage a Project Design Program inclusive of key inputs for all disciplines and stakeholder engagement plan in consultation with the Project Manager
• Assist with cost estimate advice on recommended/specified specialist design, material, fittings, and fixtures as an input to the Quantity Surveyors reports and presentations – dependent per stage of completion
• Assist the Project Manager to establish and monitor a Request for Information register noting date received, response, and status
• Provide Safety in Design inputs at each milestone stage, managed by the Project Manager
• Assist the Project Manager in relation to establishment and input into a Design Change Register which captures agreed design changes associated with per phase value engineering process
• The Consultant shall not assign, delegate, transfer, pass on or require any other consultant to fulfil or provide any of the Consultant’s obligations, services, or duties, without the written approval of the Project Manager

 

Reviewing the HOA - Due Diligence Examples Required of the Consultant Team

Let’s now think about what the project team may want the professional technical consultants to input on the impending HOA. 

Who will be asked for input before the negotiations start on preferred options

 

Who are the core consultants in this example?

• Interior Designer/Architect
• Services Engineer (Incl. Mechanical, Electrical, Data/Communications, Fire, Hydraulics, Security, Audio Visual)
• Fit out Project Manager
• IT Project Manager
• Private Certifier (BCA/NCC/Building Approvals)
• Quantity Surveyor
• Graphics/Wayfinding Signage

 

What may the subject of the email be?

 

Building - HOA Highlights

 

What does the Project Director want their help on?

 

Review of the items in the Heads of Agreement.  So, the Project Director sends an email to them all, asking for feedback.   

The first thing the Project Director tells them is that they are all being provided a redacted copy of the preferred premises binding HOA and that the Project Director wants each of the core consultants to review and provide any comments, risks or concerns they foresee to the project before the HOA are finalised.

 

Example of some key highlights for design and construction

• Item 1A:  Option to surrender Lv1: drop dead date amended to Date, Month. We need to determine if Lv1 is unnecessary by Day, Date, Month so that we can draft and issue the Notice if required.
• Item 7:  Lease commencement: we can occupy from the Day of Month Year. Contractor access for due diligence – as of now.
• Item 9:  Contractor access for fit out works: once the lease is signed and other criteria, e.g. approvals, insurances etc have been submitted. We are reviewing materiality of the air con and electricity costs incurred during the project to determine if they should be booked to the project or general property budget.
• Item 10:  Tenant occupation: we must ensure the exit of Location is no later than Day Month (including the decanting/decom works). If this is at risk, it must be raised in advance as it will impact our arrangement to assign Location to Landlord at Day Month Year.
• Item 23:  Plant/Equipment: please advise if we’ll be installing any plant and/or equipment outside of the area we lease?
• Item 44:  Backup power: please advise how much is required so we can review against available supply?
• Item 45: Environmental initiatives: Please review as these may / will impact fit out design.

 

The time for helping the client is before the lease is binding and the client has confidence that the office accommodation meets the financial, quality, performance requirements of the organization.  

 Let’s next look at each of the roles that these professional technical consultants may play.

 

Role of Building Surveyor (Certifier)

Let’s look at the Building Surveyor/Certifier and what type of review they will do for the client.

They will ensure that a building design complies with all necessary legislation as per the building approval and ensure that building codes are being followed during construction and eventually will issue a Certificate which allows the building to be legally occupied.  This could be called an Occupancy Permit or Occupancy Certificate.

 

The Building Surveyor is tasked with ensuring building code compliance is achieved during the design and construction phase of a project (considering safety, health, amenity, and sustainability) management and compliant solution.

 

The Building Surveyor will liaise with the entire design team (engineers, project managers, designer, client, quantity surveyor, builder, etc.) to ensure the documentation and construction provide a risk management and compliant solution.

 

Why do clients need to get them involved from the commencement of concept drawings, which could be whilst negotiations are underway after preferred options are determined?  

Because often for new workplaces, the layout and leasing plans (which are often signed off by the leasing agent) may not comply. An example is when a tenancy is subdivided – this impacts egress travel distances, fire hydrant and fire hose reel layouts. These are not issues typically considered by the Tenant Rep or Leasing Agents representing the Landlord– hence it is critical for a Building Surveyor to be involved early in the design phase.

 

DID YOU KNOW

Did you know that the building surveying industry was privatized to take the strain off the municipal system and allow building control processes to be managed whilst ensuring that development was not hindered.

 

Role of the Quantity Surveyor

It is essential therefore to have the correct information to assess the true impact of relocating to the preferred premises.   Quantity Surveyors bring the client back to earth if they get too motivated and influenced by the rental rates, landlord incentives, location and even the views from the tenant floors, when they should be focussing on their business strategy.

 

A critical part of the assessment is the Quantity Surveyor’s Due Diligence Report. This report aims to provide the prospective tenant with a cost impact report of choosing one tenancy over another.

 

So, what are the issues that are assessed in preparing a QS Due Diligence Report?

Usually the client (potential tenant) will have a broad outline brief (Accommodation brief) of the accommodation requirements that have been provided to the leasing agent (Tenant Rep) and the project team (this can include architect, building services consultant, accessibility consultant, sustainability consultant and quantity surveyor). 

This brief may include:

• Desired location
• Grade of building (e.g., Premium A Grade etc.)
• Net Lettable Area required
• Density of work points (1:10 or 1:14 etc.)
• Sustainability requirements (Wells Rating, NABERS Rating, Green Star rating)
• Accessibility (Number and speed of lifts, DDA, Inter tenancy Stairs, End of Trip Facilities, Public Transport etc.)
• Type of Fit Out (Open Plan, Enclosed Individual Offices, Activity Based Working, Fixed Work Points, Co-Share etc)

In addition to the other professional consultants that will help the client with due diligence of their new premises, the work of the Quantity Surveyor is to help the client understand costs and reveal hidden costs.  - Lceted

In addition to the other professional consultants that will help the client with due diligence of their new premises, the work of the Quantity Surveyor is to help the client understand costs and reveal hidden costs.  - Lceted

The Quantity Surveyor helps in many ways:

• Keeping the client real to what is required.
• Reminding the client as required to stick to the business plan.  They will also do sanity checks with the client to review how realistic the premises are in alignment with the business goals. 
• Analysing the existing market, and any changes and the company's position within it.
• Reminding the client to look at the complete breakdown of the gross lease and all the costs they are responsible for.

This will help in negotiating and dropping any costs that do not fulfill business needs and perhaps are just ‘’wants’’.

 

Role of the Mechanical Engineer

Let’s look at the role of the Mechanical Engineer.   What type of review will they do for the client?

This consultant will review the indoor air quality performance as this is crucial upfront when planning and negotiations are underway.

Prospective tenants often neglect the office accommodation indoor air quality performance discussions during the initial lease negotiations and find themselves in a bind once the deal is done as it is unlikely that there will be any concessions agreed to by the landlord to fix any issues.  

The Mechanical Services Engineer will make sure that the client understands the performance of building services, and in particular the air-conditioning, which should be a key criterion in the building selection and lease finalisation.

What about another consultant type that the Project team will consult during this due diligence and building review period. - and whom the IT Manager will work closely with?  

The Technical Services Engineer

 

Role of The Technical Services Engineer

What is the role of the Technical Services Engineer?  

They are the professional, technical consultant teams that look after Electrical, Data/Communications.

Technical services engineers are responsible for assisting customers on their systems and network issues, providing them the best technical solutions.   The technical services engineers review the base building design specifications in detail and certify that these standards will meet the client accommodation and design density requirements. Then, make sure that the relevant building performance specification as agreed with the landlord is noted as a material component of the lease agreement and that suitable remedies are available if these standards are consistently or regularly breached.

What about another consultant type that the Project team will consult during this due diligence and building review period?  This role is whom the Property Manager and Executive Leadership team have been working closely with during test fits of the preferred and secondary options.

           

Role of the Interior Designer/Architect

A test fit allows for the design plan to be ultimately completed, tested, and vetted through all parties.   The Designer will do the test fit which is a study of the guidelines and restrictions of the building which are relevant to the construction, design, and operation of the office.

 

They will be involved in many phases prior to preferred premises being selected and have a big part in ensuring that the design layout is approved by the landlord.  Since we have just been talking about what the service engineers do for the client during due diligence and building review, let’s use one example of the due diligence that both parties, the interior designer and that the base building design engineers will work together on.  

 

What would they do together?  

Well, they will certify that the proposed fit out design layout does not breach the air-conditioning design, airflow, or temperature constraints of the base building.

 

Role of the Electrical Engineer

Let’s look at another consultant from the group of professional, technical consultants that will work for the client, let's choose the Electrical Engineer this time.  

What type of review will they do for the client? 

 

Due Diligence saves legal hassles and business disruptions later.  

DID YOU KNOW

In addition to the due diligence and technical reviews the client organization will do before leasing premises, there are a number of landlord requirements and building checks against local laws that need to occur before the fit out is signed off by the landlord and occupation certification is achieved.

Additionally, it is important not to assume that the landlord is up to date on local zoning laws and regulations, and when conducting due diligence, it is unsafe for the client organization to assume anything. 

 

It is smart for the client organization to conduct due diligence on their potential landlord’s compliance with local regulations, and they may use their other important professional consultants, the Real Estate Lawyer and/Building Certifier to do this.

 

There are some essential things that the client organization (incoming tenant) will check out and that the Landlord will also complete as part of their due diligence on the incoming tenant.  What are some of these?

 

Check out local zoning laws

Tenants should check out local zoning laws to determine what restrictions they have. 

All commercial real estate has local commercial property zoning requirements. Zoning laws determine the type of business that you can operate in a building. For instance, a warehouse is a commercial property zoned for industrial use.  

 

Background check on the landlord and property management team

Tenants should conduct a background check on the landlord and property management team.

 

Dependent on the market, and if the client organization is NOT using the professional services of a competent and duly experienced Tenant Representative, there may be the need, before signing the lease, to conduct a background check on the landlord and property management team. Tenants can do this by checking online reviews as well as news articles. This will help them to understand how the landlord and property management team have been performing and what other companies think about the landlord and the location.  

Tenants can contact the local agencies to confirm if the landlord is the actual owner of the space and is authorized to lease it out. This is necessary because some properties are in the foreclosure process. Properties in the foreclosure process do not belong to the landlord anymore.  

Now let’s look at some of the essential checks that the landlord will undertake as part of their due diligence on the incoming tenant.  These are just examples and not exhaustive, and just highlight that due diligence and building review can continue well beyond Heads of Agreement through to occupation of premises.   

What are some of the things the Landlord will require of the incoming tenant?

 

Tenants can contact the local agencies to confirm if the landlord is the actual owner of the space and is authorized to lease it out. This is necessary because some properties are in the foreclosure process. Properties in the foreclosure process do not belong to the landlord anymore.  

Now let’s look at some of the essential checks that the landlord will undertake as part of their due diligence on the incoming tenant.  These are just examples and not exhaustive, and just highlight that due diligence and building review can continue well beyond Heads of Agreement through to occupation of premises.  

 

What are some of the things the Landlord will require of the incoming tenant?

Building Owners’ Consent

In the interest of maintaining the high quality of the building, Consent is to be granted for Fit Out works or alterations by way of a License for Alterations or Agreement for Lease.

Workplace Health & Safety

The Tenant is to always comply with Workplace Health & Safety Act, appropriate Fire and Safety Act and the Building Code and all other relevant legislation and standards relevant to the city or country and will provide a list of contractors appointed to carry out the works.

Statutory Compliance Approvals

Building Approval / Construction certificates (building permits) prepared and issued by an independent Accredited Certifier including BCA compliance and Plumbing and drainage compliance.

Practical Completion Certificate

Upon completion of the works, an Independent Accredited Certifier shall certify that the fit out, inclusive of all services and equipment, conforms to Building Code, Standards, or other prescribed code.  

Certificate of Substantial Completion

At occupation phase there needs to be a review in accordance with the approved design documentation from the fit out design team; including a sprinkler verification; a final electrical inspection; a fire alarm verification; and a final inspection and sign-off from Building Certifier.

Fit Out Documentation

The Tenant must commission recognised design professionals (the “Fit out Designer”) to prepare designs and documentation for submission and approval. Written approval of the fit out works is required by the landlord to ensure that the: - proposals are in keeping with the building; the design is coordinated with other adjoining tenancies and common areas; interruptions to services and other tenants are minimised; and the design does not jeopardise the base building's green star rating.

There’s more to due diligence checks than you think, and it is essential that the client organization (tenant) engages skilled professionals to undertake due diligence checks.  Don’t forget when parties enter a lease, they are also agreeing to comply with the applicable laws and regulations. Whilst complying with the law seems obvious, some local laws and restrictions can take parties by surprise, especially if they are not familiar with local laws and zoning.  

There are many other due diligences and building review requirements and these can vary from building to building, fit out to fit out and country to country.