SMALL DEAL DUE DILIGENCE
By: R. Kymn Harp
A misconception abounds in commercial real estate. I am partly to blame. I didn’t mean to add to this false belief, but I recognize that I have.
While writing articles and presenting seminars on due diligence for commercial real estate transactions, my colleagues and I who focus on due diligence as a topic of continuing education tend to overstate the case as it applies to any single transaction. We tend to make our hypothetical project or transaction so complex and so filled with due diligence potholes that we can sometimes obscure what really happens in most commercial real estate transactions. Our audience – whether they be readers or live seminar attendees – can understandably find their eyes glazing over and may conclude that the scenario being addressed has no connection to their life or their deals. They have never seen a project or transaction so convoluted or complex, and don’t expect that they ever will.
In truth – no one does. In practice, commercial real estate due diligence is not that hard. It is not that complex. It need not be that expensive.
I have been asked to discuss “small deal due diligence”. I generally try to avoid using the term “small deal” when describing commercial real estate projects or transactions, because to our clients no deal is small when it involves their money or business. To some, a $4,000,000 transaction may be described as small. To others a $1,000,000 transaction may seem large. The practical reality is that a great majority of all commercial real estate transactions involve dollar amounts of less than $5,000,000, with a huge percentage of those being less than $2,000,000 and a sizable number less than $800,000. The line of demarcation for deals is not between large and small dollar amounts. It is between typical and hyper-complex.
When presenting our hypotheticals in articles and seminars we sometimes do what law school professors do – we throw in everything plus the kitchen sink so we can discuss issues that might arise. It would be rare, indeed, to find even a small percentage of these concerns in any one transaction. Our hypotheticals are merely thought-devices. They allow us raise a wide variety of issues for consideration – most of which will not, in any one actual transaction, ever present itself.
I am reminded of a scene from a sitcom I saw years ago while my kids were growing up. A high school student confides to his teacher that he may drop out of school because he does not see the relevance of what he is learning. The teacher, somewhat surprisingly, confirms to the student that what he is sensing is correct. “Ninety percent of what you learn in school you will never use in real life. Only about ten percent of what you learn will make a difference. The problem is . . . you will never know which ten percent you need until you actually need it.”
So it goes with commercial real estate due diligence.
By definition, due diligence is a standard of conduct. It is the degree of diligence due under the circumstances of your particular transaction. It represents the level of inquiry necessary to confirm in the affirmative all important questions that must be answered “yes”, and to confirm in the negative, all important questions that must be answered “no”, for your project or transaction to succeed. In the typical project, this is not particularly difficult. You just need to know what you are looking for, and be able to recognize it when you see it.
A plastic surgeon once told me about an experience he had in medical school. One day the Chief of Surgery addressed his class and told them that, in truth, they could learn in about thirty minutes how to remove a patient’s appendix. In about six hours they could learn how perform a kidney transplant; and, in a week, could learn to perform a heart-lung transplant. When a medical student asked why, then, they had to go to medical school for four years, followed by five years of surgical residency, the Chief of Surgery explained simply that it will take that long to teach them what to do if something goes wrong.
Commercial real estate transactions are not so different – though the issues seldom involve urgent life or death decision-making.
Most commercial real estate transactions are not terribly complex. Most transactions do not present particularly troublesome or risky circumstances. An experienced commercial real estate attorney should be able to assess your risks and implement your transaction plan without breaking the bank.
The challenge is to recognize unexpected obstacles or issues, and to know how to handle them. Though they may seldom arise, they sometimes do. When they do, they must be handled in a timely and effective manner to avoid potentially catastrophic transaction consequences.
The point of this article is that “small” commercial real estate transactions take place every day. They are the rule rather than the exception.
Most commercial real estate practitioners – myself included – often handle commercial real estate transactions involving amounts in the $1,000,000 to $5,000,000 range, as well as smaller and larger amounts. Deals involving smaller dollar amounts tend to be less complex – though not always.
There is a saying among commercial real estate lawyers that “the only difference between a $5,000,000 deal and a $50,000,000 deal is one zero”. That is not entirely true, but close. Still, a typical commercial real estate transaction should not be mind-numbing and should not cost you an arm and a leg (or a kidney or a lung). I apologize for my part in creating an impression that it will.
Thanks for listening . . .