What Is Due Diligence and Why Is It Important?
If you’ve targeted a self storage property to purchase and things have progressed to the level of ‘serious’, by either the execution of a Purchase and Sale Agreement (PSA), you’ll be staring down the barrel of an intense process called “due diligence.” This period allows a reasonable investigation of a proposed investment deal to check out the investment’s worthiness. This process is not unique to self storage; it is part of all real estate transactions and can be quite involved for any commercial real estate purchase.
Essentially, it’s the buyer’s opportunity to exercise reasonable care and prudence with respect to three key components on the transaction; the condition of the physical self storage property, the financial records of the existing storage business, and the local market for the business.
Just like any other significant purchase you make, know what it is that you’re buying.
So, why is due diligence important?
That’s plain and simple; it’s just good business. Due diligence is a process to minimize risk and create a method for both buyer and self storage seller to clearly know the risks and rewards of the deal. In addition, it will be required of the purchaser by any third-party lender. During the due diligence process, an examination of the storage property might reveal an environmental issue, for example. If the remediation of this issue comes at a significant cost that the seller is unwilling to undertake, the buyer is then able to terminate the PSA at no penalty and regain the deposit prior to the end of the inspection period. In most instances, once the due diligence period is completed, any deposit money becomes nonrefundable and sometimes an additional nonrefundable deposit is required as the parties move toward closing.
Another critical component of the due diligence process is the ability to review the financial records of the self storage business. Sellers should be prepared to share profit-and-loss statements (P&Ls), monthly rent rolls, repairs and maintenance records, property tax records, service agreements and appraisals, among others. Everyone’s record-keeping systems are different, but access to this material is critical for purchasers to properly evaluate the business before deciding to move forward. Cooperation between both parties is key here. If due diligence can’t be completed within the time periods established in the Purchase and Sale Agreement (PSA), usually attorneys for each party must get involved to create addendums and extensions to the purchase agreement. The passage of unnecessary time kills transactions, and you certainly don’t want that to happen when you are trying to buy a self storage property. To avoid that happening during your deal, plan to work with your team to make sure due diligence material is ready to be shared and accessible to those who need it by the established deadlines.
The last type of due diligence involves getting an accurate assessment of the local market for the storage business you are looking to buy. Getting a handle on the competition, area demographics, and business development in the area all are largely a buyer’s concern. However, occasionally the process reveals that the seller may not have adjusted rates to suit the current market or didn’t take maximum advantage of potential revenue streams, which could change the value of the storage property.
The bottom line is that there are no hard and fast rules for what a buyer can or should consider when evaluating a self storage business. So look at everything you can! The PSA may include a broad description of what the buyer is permitted to inspect on site or a detailed list of items; so it is incumbent upon the buyer to be satisfied to move forward with the deal. A well-prepared seller will expedite the due diligence process and gain the fast track toward the closing proceeds. Then everyone wins!
We specialize in the self storage industry and our team has assisted with hundreds of transactions for both buyers and sellers in Pennsylvania, Maryland, Virginia, West Virginia, New York, New Jersey and the rest of the Mid-Atlantic and Northeast. We are the experts at navigating the ins and outs of closing the deal. If you are planning to buy a self storage property or sell your storage portfolio (or maybe just starting to think about it), let us put you on the right track toward a smooth settlement! Contact me, Rick Hansberry, at [email protected] and I will provide a complimentary sample of a due diligence document checklist to get you started in the right direction.