Property problems: Commercial investment needs careful work

Q: After all the publicity about residential property I have decided to look at putting some surplus funds into commercial property. I understand that the returns can be greater, but so are the risks. What should I do to minimise them?

A: The first consideration for anyone looking to enter into a property transaction is to "see a property lawyer first". An experienced property lawyer will have the necessary expertise to guide you through the legal aspects of the transaction from before you sign the contract, and up to and after settlement of your purchase. Quality legal advice at an early stage will help to identify potential problems with the property. It is essential that you undertake a robust "due diligence" investigation of commercial property.

This means checking all aspects of it to establish the "truth" or otherwise of what the vendor has said and whether it is suitable as an investment.

The old common law phrase of caveat emptor (let the buyer beware) applies. It is quite simply a matter of managing the risk. The primary purpose of due diligence is to identify matters that may adversely affect the value of the property.

Your lawyer will check copies of the title documentation held by Land Information New Zealand to ensure there are no defects in the legal rights recorded. Legal rights such as rights of way, service easements and restrictive covenants can have a significant impact on the value of the property.

Your lawyer should also help get all relevant information held by the local authority by ordering and checking a Land Information Memorandum (Lim) report.

This should disclose any adverse material held by councils, including restrictions on use of the property, code compliance, Building Act issues and the like.

A prudent purchaser should also obtain a valuation and an engineer's report on structural matters and building services.

Usually your bank will require a satisfactory valuation as a minimum condition for any loan finance.

The engineer's report should reveal any problems with the building's structure and building services such as lifts, air-conditioning and the like. The report should also guide you on maintenance issues.

It is vital that you and your legal adviser also check the leases for commercial premises as the form and content of a lease will affect the property's value. For example, you should look at the length of the tenancies, the solvency of the tenants (you can run credit checks if you are concerned), and whether the lease is documented in a standard agreement or is a more informal exchange of letters.

In addition to checking the lease, it is worthwhile to talk directly with the existing tenants if at all possible. Ask the tenants how they feel about the building and what they consider are its strengths and weaknesses.

Remember it is the tenants' rental that will service your funding requirements and provide you with the return on your investment.

Other matters to be addressed will include the form and content of the agreement for sale and purchase, financing, ownership structure, and taxation issues. It is well worthwhile getting accountancy/tax advice on all aspects of the proposed purchase, including cash flow projections.

If you buy more commercial property you are likely to want to take on some of the due diligence yourself, such as checking the terms of the lease. However, until you are experienced it pays to get professional advice.

The important point to remember is that a prudent buyer will undertake a rigorous process of checks using a range of professional advisers before committing to an unconditional purchase.