Purchasing Property? 7 Steps for Due Diligence
Wednesday, December 15, 2010
Posted by: Joy Ingram
By Steve Barnes, CHC Client Advocate, The Neenan Company
At some point, most CHCs realize they need to buy property on which to build a clinic. For the purposes of this article, I’m going to assume that the size of the property, budget and the timing for acquisition have already been worked through.
Still, a number of significant issues and details need to be thought through before committing to purchasing land. That process is commonly known as a “Due Diligence” process. My goal is to help CHCs become aware of and work through those issues involved in a typical Due Diligence for land.
First, it is important to understand the “usable” square footage of the property that you are considering. This is defined as the amount of land remaining after you have determined: how much land the city, county or state might require for street widening, utilities or expansion; how much of the property might be unusable due to grade issues (where the land is too steep) or water issues (bogs, marshes, etc.); land required for any easements or right of ways through the property that you cannot build upon; configuration of the land, which has a significant impact on how much building square footage can be obtained; storm detention, landscaping and green area requirements.
After you’ve determined the property is the size you require, it is important to know that it has the proper zoning and/or planning designations for the use your clinic requires. If not, then it is critical to understand what it will take to get the property rezoned or the changes in the planning designation accomplished. This is a grey area that typically requires expertise from a consultant who does this type of work in your area on a regular basis. The consequences of not completely understanding the chances of getting this work done can be costly in terms of dollars and time wasted.
Title issues can be one of the biggest nightmares for property owners. It is important to obtain a title commitment or a title binder from a title insurance company. That document will spell out any exceptions to the title that would limit the use of the property and would need to be cleared before a loan could be obtained. All sorts of strange property issues can pop up in these documents, and at times the property is determined to be unsuitable.
Off-site development costs can be a huge item. These are the costs that will be incurred by a landowner who wishes to build on their own property but will be required to pay before they are able to get a building permit or a certificate of occupancy. Many times the local municipality will have declared that the street running adjacent to a piece of property will need to be widened or a new intersection is needed, and the land owner will be required to pay for a portion of those improvements. These can be very costly, but costs are fairly easy to determine by speaking with the local municipality about the property. Additionally, there may be utilities (water, sewer, electrical or gas) that are available but are a distance from the building site. The cost of the utility extension is typically borne by the property owner unless an arrangement with the utility provider is made. These extensions can be very expensive, so understanding what utilities are available at the site is absolutely critical.
Soils testing will need to be completed to understand the type of structural foundation required for the given soils-bearing capacity. Contact a local soils engineer, and then have the information evaluated by an architect or structural engineer to determine the impact on the building costs. The budget impact can be as high as thirteen dollars per square foot of the building, and these costs will create no higher valuation for the building.
Environmental testing is another critical area to understand, something that in the past had little bearing on property purchases. It is important to know whether any particular type of testing needs to be done to comply with any special funding (grants, financing, etc.), and that information needs to be passed on to the environmental testing consultant. The first test done is typically a Phase 1 environmental audit. If the property is tested with no issues, or only minor issues, a phase 1 is typically acceptable. However, if there are any findings and the recommendation for a Phase 2 study is made, there could be much bigger issues. A Phase 1 audit is not too costly, but a Phase 2 can be more expensive and takes more time. The results from a Phase 2 audit will spell out what remediation would be required to make the property comply with environmental laws. At that time, getting a cost for that remediation is critical. That type of work requires special certification and compliance, and only professional firms that meet these demands should be considered.
A highly subjective topic is an evaluation of what the impact on the property valuation would be. When you borrow money for the building project, it will most likely be based on an appraised value that has been determined by an MAI appraiser. The ways in which the ultimate building project could be valued on that particular property can vary widely. A discussion with a real estate broker or an appraiser could save you a considerable amount of equity dollars when you are negotiating the terms of your loan.
CFOs often ask about spending the money required for due diligence. These tests and requirements are not inexpensive; however, the cost of finding out issues that limit the ability to build or increase construction costs can be into the millions of dollars. You don’t want to find these things out after you’ve closed on the land. It is risky, and the result could be that the property has to be resold, often at a loss, due to the cost impacts.
However, often times the land owners will have some of this information already collected and available for you to inspect. It is important to verify this information so you are not misled.
The building process is a complex and challenging experience. Most good design build or architectural firms are capable of assisting and guiding you through this endeavor. Going through the proper due diligence on the property before signing a contract can make that experience a much more positive one.