Peeling Back the Layers: Do I Need A Building Inspection For My Net Lease Acquisition?

Building Inspections Can Pave The Way For Successful Net Lease Investments

One of the top reasons that attract many investors to net lease investments is the ability to take advantage of the benefits of real estate ownership without the day-to-day management headaches that come with most properties. The net lease tenant is typically in charge of maintenance, repairs – and all related expenses. If the tenant bears all of the responsibility, an investor should be able to skip a common due diligence step of obtaining a commercial building inspection, right? Not so fast!

Much like when you buy a new house, a commercial building inspection is meant to assess the current condition and quality of the property. An inspection by a licensed professional will help identify any necessary repairs, as well as determine the remaining useful life of key structural components and equipment. Importantly, the inspection will incorporate those potential costs into the maintenance budget required during the life of the projected ownership. For example, the useful life of a roof is typically about 20-30 years. If you are buying a 15-year-old building, you would need to evaluate the condition of the existing roof to determine how many years of use are likely remaining to figure out when the cost of a roof replacement may impact your bottom line.

Who needs a commercial building inspection? First and foremost, anytime you are purchasing a NNN or NN property), if the property is NOT a brand new one (e.g., not built within the last ~3 - 5 years) you should always consider hiring a professional building inspector to assess the physical conditions of a building. The inspection report helps you to gather a clear picture of what it is you’re buying, as well as identify any potential problems that might surface down the road. Some key components for the inspection include the roof, gutters, structure, HVAC systems, electrical, plumbing, parking lot, building envelope and foundation.

A commercial building inspection is akin to doing a health checkup to see if there are building issues that should be addressed now, over the near horizon, or into the future. You wouldn’t buy a car without looking under the hood, and the same is true when buying a property. The building inspection process should be performed during the due diligence process timeframe that the property is in escrow and can be a driver of a go/no-go decision on completing the transaction and buying the property.

Here are some key reasons on how you will benefit from having a building inspection done…

Understand the as-is picture: The tenant and lease in existence today may not be the same throughout the hold period for that investment. You might buy a property that has an absolute net lease today, and 15 years down the road you might have a new tenant that will only agree to a NN. So, it is always prudent to assess the condition of a property, especially when acquiring properties that are 5+ years old.

Plan for a rainy day: A key benefit of a commercial building inspection is that it helps you plan for that rainy day. Will you need to pay for a new roof or HVAC upgrade in five, 10 or 15 years? Big capital expenditures during the hold period of the investment can impact annual yield and total investment returns. How do those costs change your financial analysis of a potential acquisition? Understanding potential future costs helps you to plan accordingly and allocate sufficient capital reserves to address these future maintenance requirements.

Improve your bargaining power: A buyer has the potential to use information gained in an inspection as a bargaining chip. Similar to buying a home, a buyer can negotiate with the seller to remedy an issue, such as fixing a roof leak or replacing an air conditioning unit, prior to the sale. Or a buyer might negotiate a reduced price if the buyer agrees to take responsibility for the repair.

Obtain a win-win outcome: In the net lease marketplace, we often talk about tenant credit and location as key elements in determining value and assessing cap rates. An important third part of that stool is the underlying quality of the real estate asset. Replacing a roof or HVAC system can easily come with a six-figure price tag. Depending on the lease structure, that expense could take a big bite out of an investor’s anticipated rate of return. As such, a commercial property inspection is an important part of looking at an investment opportunity from a 360°, holistic approach to realize an optimal outcome for that investment.

A seasoned broker will help guide you through the inspection process, know what to look for in the final report, and help you make the most of that information in your analysis and negotiations. To learn more about whether a NNN investment property is the right fit for your financial and lifestyle goals contact Andrew Vu at 415-539-1120 or andrew@tcpre.com for a complimentary strategy consultation.