Reducing Risk When Purchasing New Commercial Buildings

Jan. 9, 2006
The following issues warrant consideration when acquiring new facilities

Many buyers think that purchasing a new building poses no significant risk with respect to construction defects. This is not the case. Further research should be conducted to augment the property walk-through condition assessment.

New buildings are defined here as either newly constructed or those that have undergone substantial core, shell, and MEP system renovation within the past 2 years. However, most of the due diligence techniques discussed apply to all buildings, regardless of whether they are new or not.

New buildings usually have not been thoroughly “road-tested” under full-load occupancy. Or, they may not have experienced extended usage or the stress and strain associated with repeated cycles of seasonal climatic changes. They also lack a sufficient period of elapsed time, which typically exposes latent defects that generally become apparent with extended use, operation, settlement, and shrinkage. Following are issues that warrant consideration by the acquisition due-diligence team.

Identify the Project Development Team
Have the seller provide contact information for the designer-of-record, construction manager/general contractor (CM/GC), and the owner’s rep, if any. This should be followed by interviewing these key construction team members to discuss any pertinent design or construction phase issues. Further research of individual team member experience with the particular asset type, type of construction, and project’s scope also provides insight into understanding the team member’s strengths and weaknesses with respect to the asset.

Development Strategy and Building Delivery Method
Often, a significant indicator of design and construction quality is the development strategy. Was the building constructed to be flipped upon completion, was it intended to be a long-term hold, or was the building a build-to-suit? Was the building delivery method a design-build, GMP, lump sum, or cost plus? Was there an “arms-length” relationship between the developer and the CM/GC? Did either the developer or GC self-perform any of the trades and, therefore, have unfettered control?

The development strategy may provide insight into the developer’s motivation to implement certain value-engineering/cost-reduction opportunities. Also, the building delivery method often impacts construction quality and workmanship with respect to the quality control exercised during the construction and the propensity of the developer to initiate unilaterally approved changes to the drawings and specifications.

Design Agreements, Construction Agreements, Change Orders, and Waivers of Lien
An effort should be made to obtain copies of the design and construction agreements. The design agreement will define the designer’s role, if any, during the construction phase; obtain copies of all site-visit reports and progress photos.

Determine if certain traditional design agreements are missing or if designs of certain systems are “carved-out.” This may flag vendor-designed systems (HVAC, control systems, sprinklers, energy management, and smoke- and fire-alarm systems). If vendor-designed, the design professional responsible should be clearly identified. Often, vendor-designed systems provide substantial leeway with respect to material and equipment selections, execution of details, etc. Sometimes, there is a tendency to incorporate materials and equipment that are readily available but considered “secondary market.” Incorporation of such components or systems should be a red flag to potential purchasers. Also of concern is the use of proprietary materials, components, and systems that tie an owner to a specific vendor for service contracts, maintenance, and supplies.

Many times, the scope of work depicted in the drawings and specifications will be modified by exclusions, clarifications, or alternatives provided in the construction agreement. The construction agreement will also outline warranty and bonding requirements.

As a quality control check, copies of all change orders (adds and deducts) should also be obtained, along with evidence that each change order was approved by the appropriate designer-of-record. Also obtain a complete schedule of all accepted value-engineering items.

Final waivers of lien should be obtained from the CM/GC and subcontractors to verify that all subcontracts were closed and the vendors paid.

Construction Documents, As-Builts, Shop Drawings, Etc.
A complete set (prints and files) of the construction drawings, specifications, and informational sketches should be obtained, along with the sealed and certified as-built survey (foundation and site plan) and drawings.

It should be noted whether the as-built drawings were updated by the CM/GC, subcontractor, or appropriate designer-of-record. If updated by the contractors, the drawings should be reviewed by the appropriate designer-of-record and accepted. Further research should divulge whether the as-built drawings were updated as construction progressed, which is a much better practice than updating the drawings at the end of the project.

Shop drawings and submittals should also be obtained. These documents - more than the construction drawings, specifications, and as-builts - tell the real story regarding the manner in which the building was constructed and what materials were used.

Government Agency Approvals/Development Agreements
It is important to determine whether there were any Zoning Board Approval (ZBA) variances obtained, and whether there are any development or current-use restrictions that may have been imposed by the ZBA as a condition to grant the variances. Copies of the approved site plan, the ZBA’s written decision, and the variances granted should be obtained.

Planning board approvals should also be examined. Restrictions may have been imposed on signage, colors, design, parking, operation hours, use of space, etc., as well as utility maintenance requirements.

With respect to the Certificate of Occupancy, make sure you understand exactly what has been issued for the building. Is it a partial or temporary? Does it expire? Most importantly, is the use (or uses) permitted?

Technical Studies/Construction Inspection/Testing Reports
Obtain copies of all pre-design technical studies, construction inspections, and testing reports. In lieu of receiving a voluminous amount of documents, a statement from the testing firm attesting to compliance may suffice for certain testing items such as concrete, steel, etc. Additionally, the close-out testing reports for the HVAC system balancing, fire- and life-safety testing, and security systems - to name but a few - are important documents to review and have on file.

Guarantees and Warranties
All guarantees and warranties should be provided in a bound and indexed notebook, complete with a table of contents. Each section should include the responsible subcontractor or vendor; the guarantee/warranty, complete with start and end dates; contact information; and any correspondence regarding giving notice or the exercising by ownership of any warranties or guarantees. Make sure all specialty and vendor-designed systems are included.

It is important to understand the type of guarantees and warranties presented by the seller. Are they issued by the contractor or the manufacturer/vendor? Is it necessary to have a warranty provided by the manufacturer and another provided by the installing contractor? Are they for labor and materials, or for materials only? Special attention should be given to the assignability of the warranties upon transfer of the property’s title. Many warranties are not automatically assignable to a new owner; some require a transfer fee and/or a re-inspection fee. Sometimes, a manufacturer’s re-inspection will note repair work performed by a non-authorized contractor, which would void the warranty.

Labor and Material Payment/Performance/Maintenance Bonds
Obtain copies of all provided bonds as well as the respective consents of the surety for final release of retainage. Having copies of the bonds and the Consents of Surety may assist in the resolution of claims made by a subcontractor for non-payment and also non-performance of a contractor on any warranty work. Many bonds provide for 1 to 2 years of coverage beyond final payment.

Certificates of Completion for Designers-of-Record and Contractors
Obtain Certificates of Substantial Completion and Final Completion from all designers-of-record in the form of AIA Document G704. Receipt of these documents, or the lack thereof, provides insight into the project’s quality control and contract administration procedures. The wording of each certificate should divulge the designer’s role in quality control, and whether such designer conducted periodic site visits during construction or provided contract administration services. Furthermore, be aware that the date of substantial completion may represent the start date for various warranties and guarantees. For certain trades or systems, warranty or guarantee start dates are not contingent upon substantial completion, but on the completion or installation of the system or component.

Statements of Acceptance
If the asset has a major tenant, anchor, or hotel operating entity, most probably the design and construction were required to meet certain standards. Such requirements will be detailed in the lease or operating agreement, and they may require the tenant or end-users to provide a certificate of acceptance upon completion of the work. Sometimes, a certificate of acceptance is not always required - and if required, it may not have been provided. It is important to review all such agreements and letters of final acceptance to make sure there are no open issues or landlord requirements that could survive the property’s transfer.

Often the municipality may be required to accept developer-constructed improvements, such as roads, traffic signaling, sewage lift stations, etc. Such improvements need to be constructed in compliance with local or state requirements, since the municipality usually assumes the responsibility for maintenance.

There are also many specialized systems where, if possible, it would be advantageous to obtain the manufacturer’s written acceptance of the work due to exacting preparation requirements or the requirement of skilled or specially trained installers.

Start-Up/Preventive Maintenance/Procedural Manuals, Etc.
Obtain all start-up, preventive maintenance programs, and procedure and protocol manuals for MEP and specialty systems. Such manuals are usually custom-prepared for complex projects and systems.

Start-up training is usually provided by the manufacturer or installer for MEP equipment, security systems, etc. If this has not been provided to the seller’s maintenance staff, make sure such training will be made available to the new building management staff.

For some systems, the typical manufacturer’s manual alone may not suffice. Without a thorough turnover of these systems’ operating knowledge, a new building management/engineering staff may resort to entirely bypassing the systems, operating them manually, or not utilizing them to their full capacity.

In addition to obtaining operation/maintenance manuals, make sure all the basics are completed, such as the identification of all circuit breakers, the tagging of all plumbing shut-off valves, the passwords for specialty systems, etc.

Interview Building Service Providers and the Building Engineer
Obtain a schedule of all building service providers and copies of their service agreements. Inquire whether or not there are any pending or outstanding repairs, improvements, or code-mandated proposals. Sometimes the original construction subcontract includes a cost-free service period. If a building system is still within the warranty period, a separate agreement may not exist. This is common with conveying systems.

The schedule should be complete with contact names and information for the individual’s office, cell phone, and pager. The acquisition team should phone-interview each company. More often than not, service firms are usually able to provide the repair history and identify chronic defects or problematic systems. Such problems may also be flagged in the service firm’s invoicing records, which should also be examined.

Attic Stock
Many building specifications contain the provision for “attic stock,” which are extra supplies or replacement components for certain building systems. Attic stock is usually provided where a replacement or repair is required of a component or system that is critical, difficult to obtain, requires long lead time in ordering, or where a match (aesthetic or a particular use) might be difficult to realize. It is important to have ownership provide an inventory of the attic stock and verify the quantity, condition, identification, and storage location. At a minimum, the manufacturer, contact number, model number, or specification should be provided for each item. A schedule and identifier for all paint and coating finishes should also be obtained. Note: Reduced inventory may be indicative of undisclosed or chronic deficiencies.

Direct and Indirect Cost Information
Actual construction cost information is not ordinarily provided or readily available. However, if such information can be obtained, it could potentially save the purchaser thousands of dollars in subsequent professional fees for tax engineering services. Substantial tax benefits are often available by conducting a construction cost segregation study to realize accelerated depreciation or by bringing a tax certiorari proceeding against the municipality in order to receive a lower valuation and corresponding reduction in real estate taxes. Such tax engineering services often utilize actual construction cost data, if available. If this data is not available, additional professional fees are incurred to develop such data through cost estimating services.

George Wilson is vice president of facility assessment at White Plains, NY-based Inspection & Valuation (IVI) Intl. Inc. (

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