We are constantly reading about legal challenges and issues in purchasing commercial real estate. These may be adjustment rules pertaining to VAT, company reorganisations, unusual rental contracts, etc. There is also much discussion of company-related challenges about incorrect deductibility, tenants who fail to pay in accordance with contracts, and so forth. However, not much is said about the technical condition of a property, which truly is quite odd, as what you are buying is ultimately a property.

Commercial real estate purchases are generally conducted by transferring ownership of shares in a real estate agency. The new owner will thus take over all obligations held by the real estate agency. Therefore, owning commercial real estate imposes major responsibilities as given in prevailing legislation, regulations, and any obligations on the property or the real estate agency. This may include registered obligations on the property, financial obligations of the real estate agency, or if the present owner is not up to date in terms of compliance with laws and regulations pertaining to the technical condition of the building. We are particularly concerned with the latter factor.

One aspect here is the extraordinary maintenance that the seller should complete. This is an apparent due diligence concern and requires thorough construction, HVAC, electrical, and fire safety expertise. A worse matter is non-compliance with statutory inspection routines, which may often involve safety in the building. Such non-compliance may result in severe costs to bring the property to a good state, which in the worst-case scenario may result in the current use of the property failing to satisfy legal requirements. For example, we have discovered premises registered for a different type of use than what they are used for, which may affect requirements for escape routes or fire resistance at the premises in the event of a fire. This may apply in cases such as when office spaces are modified to serve as common areas or when warehouses include materials with a fire load far exceeding the design specifications of the premises.

Furthermore, it is important to understand whether findings become an issue in negotiations if it should be determined whether the owner or the tenant holds liability or if they are already accounted for in the agreed purchase price. It is often a challenge to communicate the analysis in a manner understood by all parties, including those without technical expertise.

We feel it is an advantage to work across disciplines here, with both financial and technical analysis. If you understand the various value drivers for a property, it will also be easier to understand the character of the building. This involves understanding what a buyer will look for, how this affects the value of the property, and not least, what is required by law depending on when the building was constructed.

We sometimes hear about how some agencies write reports that are so comprehensive and full of complicated expert terminology that even their authors only barely understand them. In our view, this is counter-productive, as it is more likely to confuse the parties than assist them in completing the transaction. Because that’s what it’s actually supposed to do. In our world, it’s not about blame; it’s just facts. Then we can let the lawyers discuss who should be liable and who should pay.

Therefore, the seller’s due diligence should be the same as the buyer’s due diligence. There is no difference in extraordinary maintenance. A due diligence report should be neutral and objective so that it will be trustworthy every time. A buyer today is a seller tomorrow. Furthermore, it should be possible to use it in the governance of the building. The operations department should be able to follow the sections of the report and systematically resolve non-compliance issues.

No matter what, it’s a good rule of thumb to avoid unpleasant surprises by knowing what you’re investing in.

Bjarki Reyr