1. A Phase One Environmental Assessment gives the buyer a survey of the environmental condition and history of the property. The report is intended to identify problems, such as underground storage tanks and hazardous materials. Engineers do a review of historical documents, regulatory databases and they physically inspect the site. It is important for the buyer to initiate work on the Phase One report early in the due diligence process so that the environmental consultant has enough time to complete the project and, if problems are disclosed, there is adequate time to follow up with further studies and tests. It is important to note that a Phase One report typically does not include specific inspections for asbestos, lead (paint or in plumbing), radon, delineation of wetlands or review of environmental compliance. If these problems potentially exist on the property, the buyer should discuss incorporating coverage of those issues into the environmental consultant's scope of work for the Phase One report.
2. A Phase Two Environmental Report is typically done as a follow up to a Phase One report and involves physical inspections and testing of the property, such as core samples, ground water testing, typically focusing on the specific issues of concern identified in the Phase One report. If the presence of regulated hazardous materials contamination is confirmed by the Phase Two report, further reporting, monitoring, investigation and/or remediation may be necessary, based upon the extent and magnitude of that contamination. If additional investigation and remediation activities cannot be completed prior to closing, the parties may need to negotiate an environmental agreement which establishes an escrow to cover the anticipated costs of such work and contains an appropriate environmental indemnity which will survive closing.
3. If Asbestos is present on the property, it is advisable to engage a consultant to prepare an asbestos survey and report. Asbestos can be found in a number of building products used in older construction, including pipe insulation, plaster, floor tiles, mastic and roofing materials. There are several important issues related to asbestos: (i) identifying whether asbestos is present, (ii) identifying the form of the asbestos, and (iii) determining whether abatement, encapsulation or removal will be necessary for the buyer's planned use of the property. In the end, the buyer needs to determine the monetary and schedule effects if asbestos is present, so that those effects can be factored into the buyer's purchase decision. It is important to note that required asbestos abatement work may temporarily affect the owner's ability to use part or all of the building during the remediation work.
4. If Underground Storage Tanks ("USTs") or aboveground storage tanks ("ASTs") are located on the property, there may be affirmative reporting, removal or closure obligations for the property owner related to those tanks. USTs and ASTs are also often the source of hazardous materials contamination. If USTs or ASTs have been removed from the property, the buyer will want to ascertain that proper site closure procedures were followed and completed in connection with the tank removal.
5. The buyer's environmental consultant can also typically be used to determine whether there is Lead Paint present on the property. Lead paint is most problematic in residential settings (i.e., multifamily housing) where child safety is a concern and where federal law requires disclosure to tenants and buyers in residences built prior to 1978. Lead paint can also be problematic in industrial settings, since it can significantly affect how repainting and refurbishing activities are conducted. For example, sandblasting and removal of old lead paint often will require significant precautions in order to avoid lead contamination problems.
6. It appears that Mold and Mildew has developed into an important issue. Over the past few years there have been a growing number of lawsuits and insurance claims across the country related to the level of mold and mildew in buildings and its adverse effect on health and habitability. This is the main reason that contractor's insurance premiums have gone through the roof for condominium projects. See Actual Mold and Mildew Case Law by this Attorney.
7. It should be determined whether the existing use of the property requires any Environmental Operating Permits or triggers any reporting obligations related to air or water quality. This issue is important regardless of whether the buyer will continue the existing use. The buyer should obtain copies of all existing environmental permits, plans and reports and check with the applicable enforcement agencies to determine whether there are existing or past violations or nonconformance issues related to the property. The buyer should also determine prospectively what, if any, environmental permits and/or reports will be required in connection with the buyer's intended use of the property. It is usually good practice to contact the applicable air and water quality agencies with jurisdiction over the property to determine procedures and timing for obtaining and/or transferring any necessary permits. To the extent that the buyer is depending upon existing permits for its intended future use, the buyer needs to make sure that the purchase agreement is contingent upon such transfer and obligates the seller to cooperate in the transfer of such permits to the buyer. Furthermore, the buyer needs to confirm that the desired permits can be transferred to the buyer upon closing.
8. The presence of Wetland Conditions can have a significant effect on the operation and development potential of a property. As a result, it is important to check with the applicable municipality to determine whether any portion of the property is considered wetlands or shoreline. Wetlands and certain uplands located near navigable waters are under federal jurisdiction (U.S. Army Corps of Engineers) under section 404 of the Clean Water Act, 33 U.S.C. § 1344, and there may be significant restrictions on the use or development of land in those areas. In addition, there are significant regulatory hurdles related to filling, cutting, or relocating wetlands areas. It is important to remember that wetlands are not always "wet" or obvious to the casual observer. Generally, the analysis of what constitutes a wetland is focused on vegetation and wildlife characteristics, rather than the presence of surface water.
9. Shorelines and Watersheds. In addition to the wetlands issue, certain states and municipalities also have special regulations that pertain to property located near certain bodies of water or within certain watersheds. For example, in South Carolina, land within a certain distance of the ocean is subject to overlay regulation by the South Carolina Coastal Council. Similarly, land within the Lake Tahoe watershed (both in California and Nevada) is subject to overlay regulation by the Tahoe Regional Planning Agency. Buyers should assume that any construction activities on or near water (e.g., docks, boat ramps, rip rap) may be prohibited or subject to substantial regulation. Similarly, land that drains into certain watersheds may be subject to substantial water quality restrictions that can significantly limit construction activities (e.g., excavation) during certain times of the year. For example, in many parts of California there are restrictions on grading and excavation during the winter rainy season.
10. Flood Zones. Buyers should check with the local planning agency to determine whether any portion of the property is located in a designated flood zone. Flood zone designation can adversely affect the development potential, applicable building standards and the availability of financing, as well as insurance requirements and costs.
11. Endangered Species. In some areas of the country, the presence of endangered or potentially endangered plants and animals may significantly restrict the development potential and value of a property. Typically, initial inquiries on this subject can be made at the local planning agency to determine whether there are species of concern in the area. If there is the potential for the presence of such species or habitat on the property, the buyer should consider retaining an appropriate consultant to examine the property for the presence of the species and/or habitat in question. While the endangered species issue is typically related to undeveloped properties, it can also affect fully-developed properties. For example, in one instance, the owner of a high rise urban office building ran into endangered species hurdles related to building signage caused by the presence of falcon nests in the crooks of some of the existing letters on the exterior of the building.
12. Seismic Safety Zones. Some states in seismically active areas of the country (e.g., California) maintain seismic safety zone maps, similar to flood zone maps. Typically, seismic safety zones run in strips along known fault lines, often extending a set distance outboard of each side of the fault. If applicable, the buyer should determine whether any portion of the property is located in a seismic safety zone, as such designation can adversely affect the development potential, applicable building standards, availability of financing and insurance requirements for the property.
13. Water Rights. The buyer should determine the scope and nature of any water rights related to the property. Like seismic safety zones, water rights tend to be an issue only in certain parts of the country, particularly in the arid portions of the western states. If a property is fully serviced by water and sewer utility service, water rights for usage typically will not be an issue for the buyer. Water rights can take several forms, but the two most common are the right to appropriate water for use and the right to access and use water for recreational purposes (e.g., deeded lake access). If important water rights for the property have been separated from the fee interest or come from an off-site source, the buyer will want to make sure that the purchase agreement adequately addresses the transfer of necessary rights to the buyer at closing. For example, if subsurface water rights are held by a third party, the buyer will need to make sure that an adequate source of water is available for the buyer's intended use of the property. Similarly, if the property relies on an easement for access to recreational water facilities, the buyer will want to make sure that the access easement is covered by title insurance.
14. Oil, Gas, Mineral, and Timber Rights. It is important to determine whether the property to be acquired excludes mineral, oil or gas rights or is subject to third-party timber rights. To the extent that the mineral, oil and gas rights have been severed from the fee ownership, it is critical to determine to what extent, if any, those severed rights affect the use of the property by the buyer. For example, surface rights may accompany oil and gas rights. However, because of the dynamics of oil and gas deposits, in combination with lateral extraction technologies, it is often possible to extract oil and gas from under a property without entering onto the surface of that property or otherwise disturbing the occupant of the property. On the other hand, timber, sand and gravel rights would all include surface use of the property and may be more likely to have a significant effect on the use and value of the property.
15. FAA Restrictions. Properties located within a few miles of an airport are often subject to significant FAA restrictions as to height and use, particularly if a property is located within a takeoff or approach path for a runway. For example, high occupancy uses (e.g., theaters, stadiums) and residential uses are typically not permitted within a certain distance of an airport in these areas. In addition, many properties located near airports are subject to overlay height restrictions that may be more stringent than the height restrictions established in the applicable zoning code.
16. Noise Restrictions. If a property is located near a major freeway, railroad line, airport or other major noise generating use, there may be use restrictions and/or additional construction requirements related to sound mitigation. Local planning agencies will typically be able to assist the buyer in locating relevant sound contour maps related to the noise generating source. These sound counter maps indicate the relative decibel level by contour. Often, there will be significant requirements and/or restrictions on portions of a property that are within certain zones on the sound counter map.
Code Compliance And Physical Condition
1. Code Compliance. The buyer should confirm that the existing use of the property complies with applicable zoning, building and life safety codes. This includes checking with the applicable jurisdictions as to applicable zoning for the property. It often is useful to review both planning department and building department files and records for the property. These files may contain important information related to the property, such as conditions for use permits or records of past building code violations. If the current use of the property does not comply with the current zoning, it may still be permitted but have significant restrictions. When zoning for a property changes, existing uses and structures which do not comply with the new code requirements are usually "grandfathered" in as nonconforming uses or noncomplying structures. However, these codes usually place significant restrictions on any expansion of the nonconforming use or additions to existing noncomplying structures and often will not permit reconstruction of a nonconforming use or noncomplying structure after casualty damage. While improvements are typically considered code compliant if the improvements complied with the codes that were in effect at the time of construction, this is not the same as complying with current code requirements, which are often more stringent. In addition, renovations to existing buildings often can trigger code compliance requirements that are more restrictive. Life safety and handicap access upgrades triggered by renovations to a structure can be expensive (e.g., adding sprinklers, providing handicap accessible bathrooms and/or elevators) and add significant amounts to the total project costs.
2. Structural Inspection. If there are existing improvements on the property, the buyer should consider having a qualified engineer or building inspector determine the condition of those improvements and identify any potential problem areas, such as deferred maintenance and necessary repairs. The buyer will want to determine the cost and schedule effects of any necessary repairs to the property. If work is being performed on the improvements prior to closing, the buyer should obtain copies of any design or construction contracts and determine whether the seller's rights under those contracts are assignable to the buyer. The buyer should also determine whether the contractor(s) have been and are being paid and whether proper lien waivers have been (or will be) obtained by the seller for work performed prior to closing and that it obtains adequate protection from any mechanic liens related to pre-closing work on the property.
3. Handicap Accessibility. In addition to the physical inspection, it is important to determine whether existing improvements on the property comply with applicable handicap accessibility requirements, including the Americans with Disabilities Act ("ADA"). It is important to remember that a change in use or construction of additional improvements may trigger significant additional handicap accessibility compliance requirements. For example, under the ADA, "public accommodations" (i.e., retail, restaurants and other businesses generally open to the public) have more stringent standards than other commercial facilities. Consequently, an existing commercial building may be in compliance for its existing use, but not for a new use which constitutes a public accommodation under the ADA.
4. Site Improvements & Drainage. Depending on the nature of the property, the buyer should consider inspecting the nonbuilding site improvements (e.g., drainage system, retaining walls) both as to condition and design, paying particular attention to potential drainage and subsidence issues (e.g., ponding water, storm water control and/or soil erosion).
5. Roads. The buyer should check whether the property has adequate access from public streets. If new or additional access is required, speak with the applicable public works department to determine if additional access is possible and the procedure, cost and lead time for establishing the necessary access. It may also be worthwhile to consult with the applicable local and/or state agency to determine whether there are planned road improvements, which may affect the property. Projected road improvements or realignments could significantly enhance or diminish the desirability of the property. For example, installation of a median strip on a road often limits or eliminates access by left turns.
6. Railroads. If applicable, check with railroad(s) regarding access to sidings and mainlines located on or near the property. Contact the applicable railroad to determine whether there are existing access and trackage agreements and whether those agreements are assignable in connection with a transfer of the property. Determine whether existing stubs and sidings are sufficient and, if not, the cost, process and lead times for constructing additional sidings or stubs to the property.
7. Circulation/Parking/Loading. It is important to determine whether the property has sufficient parking (auto and truck) for the buyer's intended use. Similarly, the buyer should determine whether the property has sufficient truck loading facilities and check for any user specific concerns (e.g., dock high loading turning radii for trucks) and whether the vehicular circulation on the property is adequate for the intended use.
8. Public Transit. The servicing of a property by public transit can have a significant effect on the value and desirability of a property for certain uses. For example, proximity to a lightrail station is often an asset for an office development. Consequently, the buyer should determine how the site is presently serviced by existing public transit and whether there are significant plans for changes in public transit that may effect the site.
9. Utilities. The buyer should check with the applicable utility providers to determine whether the property has adequate service levels available and determine the procedures for entering into provider agreements with the appropriate utility providers. It is important to determine whether development of the property may be affected by any utility-related moratoria or allocation programs, particularly with respect to water and sewer. If inadequate service exists or new service is required, the buyer should determine availability, timing and costs of upgrading the existing utility service.
10. Wells. As part of its due diligence inspections, the buyer should determine whether there are any wells (water, oil, gas or monitoring) located on the property. In many states, the presence of certain types of wells must be disclosed by the seller prior to closing. Operating wells may require permits and inoperative wells may require sealing and/or regulatory closure. If there are or have been oil and gas wells on the property, there may be soil and/or water contamination in connection with the operation of those wells. If water for a site is provided by an on site well, quality/potability and quantity (i.e., gallons per hour) need to be determined. In some instances the output of the well may limit the permitted development of the property. Community wells are common in agricultural areas like Washington State, and a Developer/Builder would be well advised to have a good Well and Maintenance Agreement.
11. Crime Statistics. Depending on the buyer's intended use for the property, it may be worthwhile to check crime statistics for the neighborhood. This may be particularly important when the buyer is not familiar with the area in which the property is located. For example, the relative safety of a neighborhood can be a significant factor for a hotel, restaurant or retail operation. Most cities and counties compile annual crime statistics that list the number and type of crimes, as well as the precincts in which the crimes occurred.
12. Leases and Contracts. The buyer should require the seller to promptly provide copies of all leases, licenses and contracts that affect the property. If there are leases on the property, the buyer should also require the seller to provide estoppel certificates (e.g., no defaults, no prepaid rent, status of security deposits and the like) from each of the tenants prior to closing and have the seller provide a current rent roll for the property. Where rental property is involved, the buyer should make sure that the purchase agreement places appropriate restrictions on the seller's ability to enter into new leases or to modify or terminate existing leases. Issues of concern to the buyer related to existing leases include the rent structure, duration, renewal rights, expansion rights, termination rights, free rent, security deposits, TI allowance obligations, rights of first refusal, exclusive use rights and options to purchase. If there are service contracts on the property (e.g., HVAC maintenance, snow removal, landscaping and the like), the buyer should review these contracts to determine whether they can be canceled at or prior to closing and/or be assigned to the buyer (if desired).
1. Title Insurance Commitment. Commonly, the initial step in the title review process is the issuance of a title insurance commitment, or preliminary title report, depending on the state where the property is located. This initial document provides documentation of the current state of title for the property and includes the precise legal description of the property. The title commitment/report can be a vital indicator of title problems (e.g., some or all of the property is not owned by the seller). The commitment/report also provides the buyer with a list of all current exceptions to title on the property such as unpaid taxes, easements, options to purchase, mortgages, judgment liens, liens, restrictions, equitable servitudes and other significant encumbrances and may contain information regarding appurtenant benefits to the property, such as access easements. It is usually prudent for the buyer to obtain copies, where available, of any item which is listed as an exception to title in the commitment/report, particularly any items which will remain on title after closing (e.g., easements, CC&Rs and/or equitable servitudes).
2. ALTA/ACSM Survey. In connection with obtaining an ALTA ("American Land Title Association") owner's policy of title insurance, the title insurance company will require an ALTA/ American Congress on Surveying and Mapping Land Title survey of the property ("ALTA Survey"). An ALTA survey is a comprehensive survey of the existing, as built, state of the property, which locates the parcel boundaries, existing improvements, adjacent infrastructure, and recorded and apparent unrecorded easements and interests. ALTA surveys often are one of the most useful documents in the due diligence process, especially when they include one or more of the optional levels of detail available. First, with the physical survey, the buyer can review and confirm that it matches the property the buyer intends to purchase. It is often quite difficult from the legal description in the purchase agreement (particularly metes and bounds descriptions) for nonsurveyors to determine the precise location of the property. Second, an ALTA survey provides the buyer with the precise location of utility and other easements and physical encumbrances which are described in the exception schedules in the title commitment, as well as illustrating the precise location of physical improvements located on the property. Once again, since it is often difficult to determine the location of utility easements based on the metes and bounds descriptions in the public records, the ALTA survey is quite useful in disclosing potential issues or problems with the property (e.g., a utility easement running across an area where buyer wishes to construct improvements, encroachments onto or from adjacent properties). Finally, an ALTA survey may disclose physical encroachments that are not indicated in the title commitment. These can include boundary fences that do not correspond with the true boundary, potential prescriptive easements and physical encroachments of improvements onto or from the property in question. Obtaining an ALTA survey should be initiated early enough in the due diligence process so that there is adequate time to address any title problems disclosed in the survey prior to the end of the due diligence period or closing.
3. Easements, REAs & CC&Rs. The buyer should make sure to carefully review any easements, reciprocal easement agreements ("REAs") covenants, conditions and restrictions ("CC&Rs"), or similar encumbrances that may affect use of the property. As this type of encumbrance will continue to burden the property, it is important that the buyer determine, prior to committing to close, whether it can live with these applicable encumbrances. Significant restrictions typically affect multi-parcel developments such as office or industrial parks with shared facilities. Buyers should be cautious of provisions in any REA or CC&R that permit further restrictions to be placed on the use of the property in question (e.g., relocation of access roads, right of master developer to grant further easements on common areas, and the like) or expansions of the existing use of the property. See Example CC&R's. Written view covenants are very important if you want to avoid litigation later.
4. Title Insurance Endorsements. During the title review process the buyer should check with the title insurer as to the availability of endorsements for the property. Typically, individual buyers will have standard title insurance endorsements that they require in connection with any purchase. It is good practice to explicitly require the issuance of these required endorsements as conditions to closing in the purchase agreement. Examples of commonly-sought endorsements include: (i) a zoning endorsement insuring that the present use of the property complies with applicable zoning laws; (ii) a contiguity endorsement that insures that the parcels comprising the property are contiguous; (iii) a survey accuracy endorsement; (iv) a location endorsement insuring that the legal description matches the address for the property; and (v) a specific access endorsement insuring the property has access from a public right-of-way. Depending on the context of the transaction, there may be other endorsements that are desirable or appropriate. For example, if the property being purchased is undeveloped, many buyers will require what is commonly referred to as a "Sear's" endorsement. Although the policy limits on title insurance are typically based on the purchase price or fair market value of the property, a Sear's endorsement provides the buyer with the ability to increase the policy limits of the title insurance coverage in connection with the construction of improvements on the property and eliminates the risk that the title insurer will impose additional exceptions on a reissuance of a policy with higher limits after completion of construction.
5. Taxes and Assessments. In conjunction with the title review, the buyer should determine what real property taxes and assessments will apply to the property after closing. The buyer should pay particular attention to the presence of any special assessments or the property being located within a special assessment district. Issues with assessments often arise in the context of newly subdivided/platted property where significant public infrastructure has been or will be constructed. If the property being acquired is currently, or was recently, agricultural property that is (or has recently been) converted to a more intensive, non-agricultural use, there may be significant increases in the property taxes applicable to the property. A number of states have property tax provisions that encourage the preservation of agricultural property, sometimes referred to as "green acres" provisions. These provisions are typically structured so the preserved agricultural property is taxed at much lower agricultural rates rather than the higher non-agricultural rates applicable to adjacent properties and may defer installments of special assessments until the land is developed. Typically, green acres provisions will include significant restrictions on conversions of the property to non-agricultural uses or include substantial penalties and/or tax and assessment recapture provisions in the event that the land is taken out of agricultural use. Finally, the buyer should determine whether the sale of the property will trigger a reassessment of the property. This issue is of particular importance in states like California, where Proposition 13 has placed limits on annual increases in assessments, but requires a reassessment to market value when a property is sold or transferred. If the property is income-producing rental property, the buyer should determine whether there are any applicable state or local rental taxes, as some jurisdictions tax rental income (e.g., Florida and Arizona). Many leases in states with a rental tax will require the tenant to pay the rental tax in addition to base rent and additional rent. Failure to properly account for rental taxes may skew the projected pro forma for a property and may result in the buyer overvaluing the property.
1. Subdivision/Platting. It is important to confirm that the property being acquired constitutes a legal and separate parcel. This can often be determined by checking with the applicable jurisdiction and will generally be confirmed by a title commitment. Be cautious if subdivision or platting of the property is necessary to close the purchase transaction or to develop the property as intended. Depending on the nature of the subdivision and the state where the property is located, the subdivision or platting process may involve significant efforts (both time and money) to complete and may include unanticipated exactions or conditions of approval. Make sure to determine whether the property to be purchased is affected by any current or planned urban growth boundary ("UGB") or other growth control limits or moratoria that may adversely effect the buyer's intended use for the property.
2. Historic/Open Space Preservation. Check with the local planning department and any state or local historical agencies to determine whether the property is effected by any open space or historic preservation controls. If the property is in a potential historic district or area, there may be archeological testing requirements in connection with any excavation or grading on the property or there may be restrictions on alterations to structures in historic areas.
Required Approvals & Permits
1. Use Permits. If the proposed use is not expressly permitted under the applicable planning code or zoning regulations, the buyer should determine the procedure and schedule for obtaining any necessary use permits and/or variances. Municipalities sometimes will view a conditional or special use permit as an opportunity to require monetary exactions or land dedications (e.g., parks, open space) or to impose "social" conditions upon the property (e.g., hiring preference for local citizens, inclusionary housing). Consequently, it is important that the buyer understand both the costs and significant requirements that will attach to these permits.
2. Variances. If the buyer's proposed improvements do not comply with the applicable building or use restrictions (e.g., height, bulk, set backs), variances may be required. As variances are typically discretionary in nature, there may be conditions attached to their issuance. Beware that many municipalities require a unique hardship to justify the issuance of a variance.
3. Occupancy. The buyer should determine whether a new occupancy permit will be required. If so, this requirement may trigger an inspection of the property by the applicable municipality, which may in turn create a requirement to remediate any existing code violations prior to issuance of any new permit.
4. Business. The buyer should determine whether the applicable municipality will require a business or operation related permit or license. It is important for the buyer to make allowances for the lead time needed to obtain any business permits. Certain types of business-related permits (e.g., liquor licenses) may have significant application periods.
5. Signage. Some types of signage may be prohibited by law or require governmental permits. If there is existing signage on the property, the buyer should determine whether it will be able to replace that signage with its own or install additional signage, without requiring a new permit.