Commercial real estate transactions involve significant capital and long-term commitments. Unlike residential purchases, where standardized forms and inspections are the norm, commercial deals require a more thorough and customized approach to investigation. In North Carolina, the due diligence period is a critical phase of any commercial real estate transaction — it is the buyer's opportunity to investigate the property, verify the seller's representations, and identify any issues that could affect the value or intended use of the property.
What Due Diligence Means in Commercial Real Estate
Due diligence is the process of investigating and evaluating a property before finalizing a purchase. In North Carolina commercial transactions, the due diligence period is typically negotiated between the parties and set forth in the purchase contract. During this period, the buyer has the right to conduct inspections, review documents, and assess any risks associated with the property.
Unlike the residential context, where standard form contracts from the North Carolina Association of Realtors provide a built-in due diligence framework, commercial contracts are typically custom-drafted. The scope, duration, and cost of the due diligence period are all negotiable. Buyers should ensure that the contract provides adequate time and access to conduct a thorough investigation.
Environmental Assessments
Environmental contamination is one of the most significant risks in commercial real estate. A Phase I Environmental Site Assessment (ESA) is a standard component of due diligence. The Phase I ESA evaluates the property's history, current and past uses, and surrounding land uses to identify recognized environmental conditions — potential sources of contamination that could affect the property.
If the Phase I assessment identifies concerns, a Phase II ESA may be necessary. Phase II involves actual sampling and testing of soil, groundwater, or building materials. In North Carolina, the Department of Environmental Quality (NCDEQ) maintains records of contaminated sites, underground storage tanks, and brownfield properties that should be reviewed during due diligence. Failure to identify environmental issues before closing can result in substantial remediation costs and potential liability under state and federal environmental laws.
Title Search and Title Insurance
A thorough title search is essential in any commercial real estate transaction. The title search examines the chain of ownership and identifies any liens, encumbrances, easements, or restrictions that affect the property. In North Carolina, title searches are typically performed by an attorney who examines records at the county Register of Deeds office.
Common title issues in commercial transactions include outstanding mortgages or judgment liens, tax liens, utility easements that restrict development, and restrictive covenants that limit how the property can be used. Title insurance protects the buyer against losses arising from defects in title that were not discovered during the search. Both owner's and lender's title insurance policies are standard in commercial closings.
Zoning and Land Use
Before purchasing commercial property, the buyer must verify that the property's current zoning designation permits the buyer's intended use. Zoning regulations vary by municipality and county in North Carolina, and the rules can be complex. A property may be zoned for commercial use but restricted to certain types of commercial activity.
Buyers should also investigate whether any special use permits, variances, or conditional use permits have been issued for the property, and whether those approvals will transfer to a new owner. If the buyer's intended use requires a zoning change, the buyer should assess the likelihood of obtaining approval before committing to the purchase.
Survey
A current survey of the property is important for identifying boundary lines, encroachments, easements, setback requirements, and any discrepancies between the legal description and the actual physical condition of the property. In North Carolina, an ALTA/NSPS Land Title Survey is the standard for commercial transactions. This type of survey meets the requirements of both the American Land Title Association and the National Society of Professional Surveyors.
Survey issues can have significant consequences. An encroachment by a neighboring structure, for example, could require legal action to resolve or could limit the buyer's ability to develop or expand the property. Identifying these issues during due diligence allows the buyer to negotiate a resolution or reconsider the purchase.
Financial Review
For income-producing properties, financial due diligence is as important as physical inspections. The buyer should review the property's financial records, including rent rolls, operating statements, tax returns, and expense reports for at least the prior three years. This analysis helps the buyer verify the seller's income representations and assess the property's true financial performance.
Buyers should also review current and projected capital expenditures, property tax assessments, and insurance costs. Understanding the property's financial history and outlook is essential for determining whether the purchase price is justified and for securing financing.
Lease Review for Tenanted Properties
If the property is leased to one or more tenants, the buyer should carefully review all existing leases. Key items to examine include the lease term and renewal options, rental rates and escalation provisions, tenant improvement allowances, maintenance and repair obligations, and any tenant options to purchase or rights of first refusal.
The buyer should also obtain estoppel certificates from tenants to confirm the terms of their leases and verify that the landlord is not in default. Subordination, non-disturbance, and attornment (SNDA) agreements may also be required by the buyer's lender. In North Carolina, lease obligations run with the land, meaning the buyer will be bound by the terms of existing leases upon taking ownership.
NC-Specific Requirements and Timeline
North Carolina law does not prescribe a specific due diligence period for commercial transactions — the timeline is determined by the parties' contract. However, most commercial deals in the state provide for a due diligence period of 30 to 90 days, depending on the complexity of the transaction and the size of the property. More complex transactions — those involving multiple parcels, environmental concerns, or extensive tenant leases — may require longer periods.
During the due diligence period, the buyer typically deposits earnest money that becomes non-refundable after the period expires, subject to the terms of the contract. North Carolina follows the "buyer beware" principle in commercial transactions, making thorough due diligence essential. Unlike residential transactions, there is no statutory right to terminate based on the results of inspections unless the contract provides for it.
Working with an experienced real estate attorney during the due diligence process helps ensure that potential issues are identified, properly evaluated, and addressed before closing. The cost of thorough due diligence is a prudent investment that protects the buyer's interests in what is often one of the largest financial commitments a business will make.