The Complete Guide to Commercial Property Due Diligence

Table of Contents

1. What is due diligence in commercial property?
2. Why is due diligence so important when buying commercial property?
3. How to do due diligence as a commercial property buyer
4. When should all of your due diligence be done by?
5. How can Arver Law help?

It is not unusual to see a buyer jump on a commercial property that looks like a great deal, only to discover later that the income, the building or the zoning was not what they expected.

Commercial property carries more risk than residential property. The price is higher, the contracts are more complex, and in NSW there is no cooling-off period. Whether you are buying a shop, office, warehouse, industrial site or a leased investment, thorough due diligence is what protects your money.

This guide explains what commercial property due diligence involves, what to check, and when to do it.

What is due diligence in commercial property?

Due diligence is the process of investigating a property’s legal, physical, planning and financial position before you commit to buying it.

In commercial property, that goes well beyond the condition of the building. You are also checking whether the property can be used for what you intend, whether the building is compliant, and, if it is leased, whether the income is as secure as it appears.

The law places the responsibility on the buyer to do their homework before entering into the contract.

Why is due diligence so important when buying commercial property?

Failing to do proper due diligence can mean buying a property with structural defects, an outstanding fire safety order, contamination, a tenant in arrears, or zoning that does not allow your intended use. Knowing this before you commit lets you walk away, or use it to negotiate a better price or terms.

The stakes are higher than in a residential purchase because the statutory cooling-off period in NSW applies only to residential property. Once you exchange on a commercial contract, you are bound. If you discover a problem before settlement and no longer want to proceed, you risk losing your deposit (usually 10%) and may be liable for the vendor’s losses. Or worse, you may have to pay the full price for a property that does not meet your needs.

Beware of special conditions

Commercial contracts often contain long lists of special conditions, and many of them are written to protect the vendor.

Almost every commercial contract we review contains a clause stating that the buyer has relied on their own enquiries and not on any statement by the vendor, the agent or the vendor’s solicitor. Information memoranda and marketing materials usually carry similar disclaimers.

For example, if the agent tells you the building has 40 car spaces, a fully leased tenancy schedule or approval for 24-hour trading, and you later find this is wrong, these clauses make it much harder to bring a claim against the vendor.

Do not rely on the agent’s statements or the marketing material. Verify every fact that matters to you, and ask your solicitor to include anything important as a warranty in the contract.

Other special conditions to watch for include clauses that make you accept the property “as is”, accept existing compliance issues, take on the vendor’s obligations under the leases, or limit your right to make requisitions or claim compensation.

How to do due diligence as a commercial property buyer

Now that you understand why due diligence matters, how do you actually do it? Here is a commercial property due diligence checklist you can follow:

• Get your contract reviewed by a property lawyer
• Check the zoning, permitted use and planning approvals
• Get a building condition and compliance report
• Review the leases and tenancy information (if the property is leased)
• Investigate environmental and contamination risks
• Obtain strata reports for commercial strata lots
• Obtain a survey report
• Apply for a building information certificate from the council
• Make enquiries with Transport for NSW, utility providers and other authorities
• Check the financial and tax position, including GST, land tax and outgoings

As a bare minimum, you should always have the contract reviewed, confirm the zoning allows your intended use, and get a building report. If the property is leased, a review of the leases is just as essential.

Get your contract reviewed by a property lawyer

Commercial contracts are longer and more complex than residential ones, and they often come with an information memorandum, tenancy schedule and pages of special conditions.

With so much money involved, it is wise to have a property lawyer review the contract and any letter of offer or heads of agreement before you sign. This is the most important part of your due diligence.

Your property lawyer will help you:

• Explain the special conditions and any clauses that shift risk onto you
• Conduct title searches to identify easements, covenants, caveats and mortgages
• Identify registered and unregistered leases, licences and options affecting the property
• Check the sewer diagram and any service infrastructure on the land
• Review the section 10.7 planning certificate
• Confirm the GST treatment and how adjustments will be made at settlement
• Obtain land tax, council rates and water certificates, so you do not inherit the vendor’s unpaid land tax or rates (unpaid land tax can be a charge on the land)
• Negotiate a due diligence period, conditions or warranties where needed

The contract of sale contains crucial information that will help you identify any deal breakers.

Check the zoning, permitted use and planning approvals

Before you buy, confirm that the property can lawfully be used for what you intend. A property may be zoned for commercial use but still not permit your particular business, trading hours or level of activity.

Your checks should include:

• The zoning and planning controls in the section 10.7 planning certificate attached to the contract
• The development consents and occupation certificates for the current buildings and use
• Whether your intended use needs a new development application or a change of use approval
• Any heritage, flooding, bushfire or acid sulfate soil affectations
• Council or state government proposals that may affect the property, such as road widening or rezoning

If you plan to redevelop, subdivide or extend the building, speak to a town planner before you exchange. The value of a commercial property often depends on what it can be used for in the future.

Get a building condition and compliance report

A building condition report assesses the structure and condition of the property so you can avoid costly surprises. For commercial buildings, it should also cover compliance, because the cost of bringing a building up to standard can be significant. No building is perfect, and the findings can help you negotiate the price.

Before you engage an inspector, ask the vendor for any previous building reports, maintenance records and service contracts. Older reports can show how well the building has been maintained.

A commercial building report can identify issues such as:

• Roof leaks, water ingress and drainage problems
• Structural cracking, concrete cancer and movement
• Termite and other pest damage (a pest inspection is still worthwhile for many commercial buildings)
• Rising damp and deteriorating floors
• The condition and remaining life of plant and equipment, such as lifts, air conditioning, fire systems and switchboards
• Asbestos and other hazardous materials
• Electrical, fire and safety hazards

Compliance checks should include:

• The current annual fire safety statement and whether the fire safety measures are maintained
• Any council or Fire and Rescue NSW orders or notices
• Combustible cladding
• The asbestos register, which most workplaces built before 31 December 2003 must have
• Accessibility and National Construction Code compliance, particularly if you plan to change the use or fit out the premises
• For office space of 1,000 square metres or more, the Building Energy Efficiency Certificate required when the space is sold or leased

It is recommended that you have your reports before you exchange contracts, or during a due diligence period negotiated in the contract. Once you are bound, the cost of fixing any defects is generally yours, not the vendor’s.

Can I do the building inspection myself?

It can be tempting to save money by walking through the property yourself. But commercial buildings have complex structures, services and compliance requirements, and a qualified building consultant will spot issues that most buyers cannot.

For larger or older buildings, you may also need specialist reports from a structural engineer, fire safety consultant, mechanical services engineer or hazardous materials assessor.

Avoid relying on reports provided by the vendor or agent

In commercial sales, vendors often provide building, fire safety or environmental reports in a data room. These can be useful as a starting point, but be careful about relying on them.

The reports were commissioned by the vendor, may be out of date, and almost always say they cannot be relied on by anyone else. Combined with the “no reliance” clauses in the contract, this means you may have no one to claim against if the report missed something.

If you want to use a vendor’s report, ask the consultant for a reliance letter addressed to you, or ask them to update the report for you. Otherwise, commission your own.

Example: the vendor’s report missed a compliance problem

A buyer purchased a small industrial unit and relied on the building report in the vendor’s data room. The report noted that the building was in good condition but did not cover fire safety.

A few months after settlement, the council inspected the premises and issued a fire safety order requiring new fire separation and an upgraded sprinkler system. The buyer’s own consultant later found that the fire safety measures had not been properly maintained for years.

Because the contract contained a no-reliance clause and the report was addressed only to the vendor, the buyer had to pay for the upgrade works themselves.

Review the leases and tenancy information

If you are buying a leased property, much of its value comes from the rental income. When you buy, you generally step into the vendor’s shoes as landlord and take on its obligations under the leases.

Ask the vendor for copies of every lease, variation, licence and side agreement, along with a tenancy schedule. Your solicitor should check:

• The rent, outgoings and how the rent is reviewed
• The lease term, options to renew and expiry dates
• Any rent arrears, disputes or default notices
• Incentives such as rent-free periods, rent reductions or fit-out contributions that have not been disclosed in the headline rent
• Whether the Retail Leases Act 1994 (NSW) applies, and whether the landlord has complied with it
• Make-good obligations, landlord repair obligations and any promised works
• Security deposits and bank guarantees, and how they will be transferred to you at settlement
• Whether any tenant has a first right of refusal or option to buy the property

If the property is being sold with vacant possession, make sure the contract requires the vendor to end any leases or licences and that no one has a right to stay.

Investigate environmental and contamination risks

Contamination is one of the most expensive risks in commercial property, particularly for industrial land and sites that have been used as service stations, dry cleaners, workshops or factories. In some cases, the owner can be required to pay for remediation even if they did not cause the contamination.

Your checks may include:

• The section 10.7 planning certificate for any contamination notations
• A search of the NSW Environment Protection Authority’s public records of contaminated land notices and environment protection licences
• A review of the property’s past uses
• A preliminary (Phase 1) environmental site assessment, and further testing if the assessment recommends it
• Any underground fuel tanks, which carry their own compliance requirements

If contamination is found, you can negotiate a lower price, ask the vendor to remediate before settlement, or seek an indemnity in the contract.

Obtain strata reports for commercial strata lots

Many offices, warehouses and retail units are strata lots. When buying one, request a strata report, which should cover:

• The owners corporation’s financial records and budgets
• The balance of the administrative and capital works funds
• Current and proposed levies, including any special levies
• By-laws that restrict how the lot can be used, such as trading hours, signage or deliveries
• Building defects, pending repairs and any defect claims against the builder
• Disputes between owners and any court or tribunal proceedings
• Insurance, including whether it covers the whole building

Review the minutes of recent owners corporation and strata committee meetings. They often show issues that are not obvious on inspection, such as recurring leaks, fire safety upgrades or plans for major works that will be funded by special levies.

There are typically two funds you will contribute to:

• Administrative fund: used for recurring expenses such as cleaning, insurance, utilities and maintenance of common areas.
• Capital works fund: used for major repairs and replacements, such as roofing, lifts, painting and structural works.

Should I get a building report for a commercial strata lot?

The owners corporation is responsible for maintaining the common property, which usually includes the structure of the building. A full building report would need to cover the whole building, which can be costly.

Start with the strata report and meeting minutes to see whether owners have raised defects or major works. You may still want a report on your own lot, especially the services, fit-out and anything you will be responsible for under the by-laws.

Obtain a survey report

Some commercial contracts include a survey report and others do not. A survey (sometimes called an identification or boundary survey) shows where the buildings sit in relation to the boundaries, and identifies encroachments, easements and services.

For commercial property, a survey can also confirm the building area and the number of car spaces, which often affect the rent and the value. If the lettable area in a lease or the marketing material is overstated, the income may be too.

A survey is especially useful if you plan to extend, redevelop or add structures such as loading docks, signage or fencing.

Apply for a building information certificate from the council

A building information certificate (previously called a building certificate) is issued by the local council and confirms the council’s position on the buildings on the property.

If the council issues the certificate, it generally cannot make an order to repair, demolish or alter the buildings covered, or take proceedings for unauthorised work, for 7 years. This is valuable protection for commercial buildings that have been altered, extended or fitted out over the years.

Without it, the council may issue orders to an owner to:

• Stop building work that does not comply with the law
• Repair or upgrade the building, including fire safety upgrades
• Demolish unauthorised or unsafe structures
• Stop using the premises for an unapproved purpose

The vendor is not required to provide a building information certificate. If you want one, ask for it as a condition of the contract or apply for it yourself (with the vendor’s consent) as early as possible.

Make enquiries with Transport for NSW, utility providers and other authorities

One part of due diligence that buyers often forget is checking whether government agencies or utility providers have an interest in the property.

These include Transport for NSW (formerly Roads and Maritime Services), which builds and maintains road infrastructure, Sydney Water, and energy network providers such as Jemena (gas) and Ausgrid or Endeavour Energy (electricity).

Sometimes these bodies have planned infrastructure projects that may require part of your land to be acquired, or that may affect access, parking or exposure to passing traffic. For a commercial property, a road widening or change to access can significantly affect its value.

You or your lawyer can make enquiries with these authorities to find out about any plans affecting the property.

Check the financial and tax position

Commercial property is an investment, and the numbers must stack up. Before you exchange, confirm:

• GST: whether the price includes GST or is “plus GST”, and whether the sale is a taxable supply, a going concern or under the margin scheme. Speak to your accountant early.
• Land tax: commercial property is not exempt from land tax, so factor it into your holding costs and check how it will be adjusted at settlement.
• Outgoings: council rates, water, strata levies, insurance and other costs, and how much the tenants pay back.
• Valuation and finance: commercial lenders usually lend a lower percentage of the value than for residential property and may need their own valuation. Make sure your finance is approved before you are bound.
• Stamp duty and buying entity: confirm the duty payable and that you are buying in the right name, such as a company, trust or SMSF.
• Foreign resident capital gains withholding: make sure the vendor will provide an ATO clearance certificate before settlement. Otherwise, you must withhold 15% of the price and pay it to the ATO.
• Foreign buyers: if you are a foreign person, check whether you need approval from the Foreign Investment Review Board (FIRB) before you exchange.

To learn more about stamp duty, GST and land tax, see our article on minimising transactional taxes [insert link].

When should all of your due diligence be done by?

We advise you to complete your due diligence before you exchange contracts. Because there is no cooling-off period for commercial property, exchange is the point of no return.

This is especially important at auction. If you are the successful bidder, you must sign the contract and pay the deposit on the day, with no conditions. Read our article on real estate deposit rules so you are prepared.

In a private treaty sale, tender or expression of interest campaign, you can often negotiate more time. Common options include:

• A due diligence period in the contract, allowing you to end the contract and recover your deposit if you are not satisfied
• A finance or approval condition, such as finance approval or development consent
• A call option, giving you an exclusive right to buy within a set period in return for an option fee

These must be negotiated before exchange and drafted carefully, so speak to your solicitor early.

Plan ahead and understand your circumstances

In a perfect world, all your due diligence would be done before you commit. In reality, that is not always possible.

For example, if you hear about an auction or tender closing in a few days, you may not have time to get every report. Commercial due diligence takes longer than residential. As a guide, allow:

• Several days to a week or more for a building condition report, depending on the size of the building
• Several weeks for a survey report or a Phase 1 environmental site assessment
• Several weeks or longer for a building information certificate
• Time for your lender’s valuation and credit approval

Always plan ahead, keep these timeframes in mind, and negotiate a due diligence period if you cannot finish your checks before exchange.

How can Arver Law help?

Completing your due diligence correctly and thoroughly can make all the difference in a commercial purchase. An experienced property lawyer can review the contract, leases and special conditions, negotiate a due diligence period and warranties, and help you engage independent building, environmental and strata consultants whose reports you can rely on.

We can also make enquiries with Transport for NSW, utility providers and other authorities, and obtain the certificates that may affect the property you are interested in.

If you would like peace of mind that you are covering all your bases, call us today on (02) 299327143 or book a free consultation so we can make sure your commercial property purchase goes smoothly