In commercial real estate, the difference between a wealth-building investment and a capital-draining mistake isn’t discovered at closing—it’s revealed during due diligence.
This guide breaks down what thorough, experience-driven due diligence looks like and why it should be your first real investment in any deal. Whether you’re acquiring your first property or evaluating your fiftieth, the ability to uncover risk, validate returns, and pressure-test assumptions is where deals are won or lost.
Why Due Diligence is Essential in Commercial Real Estate
Due diligence serves as your last line of defense before capital commitment. Generally speaking, in commercial real estate, Sellers do not have to make any warranties to the condition of their property, or the accuracy of the information they share. Skipping or rushing this process can lead to:
- Unexpected Repair or Replacement Costs: Hidden maintenance issues can drain cash flow and require significant capital infusions after closing. Account for all potential repairs and replacements for the first few years of your hold in your reserves at purchase. Furthermore, if your property is cash-flowing, consider building a reserve balance.
- Title and Zoning Restrictions: Property use limitations can undermine your entire investment thesis and development potential. Verify the potential uses with a zoning study and thoroughly review any recorded or deeded use restrictions.
- Environmental Hazards: Contamination can create legal liabilities and remediation expenses that wipe out returns. The downside in this situation can be infinite and tied to an owner even after selling a property, so do not take environmental risks lightly.
- Problematic Financing Structures: Unfavorable loan terms can restrict cash flow and limit exit options. Furthermore, loan covenants tied to overly aggressive or inaccurate projections can jeopardize the entire project if the business plan encounters setbacks.
- Lease Agreement Complications: Tenant terms may contain hidden provisions that restrict landlord rights or limit income growth.
A rigorous due diligence process helps identify these risks early, confirm assumptions, and negotiate better terms before committing capital.
The 4 Pillars of Comprehensive Due Diligence
1) Financial Due Diligence
Every investment has a story, and financial due diligence helps ensure that the story is based on facts, not just projections. Understanding a property’s true financial performance ensures the investment aligns with your objectives. Key areas to review include:
- Historical Financials
- Analyze multiple years of profit/loss statements
- Review rent rolls and operating expenses
- Verify income against bank statements
- Identify expense trends and anomalies
- Lease Agreements
- Examine all lease terms and amendments
- Understand tenant responsibilities and landlord obligations
- Verify renewal options and escalation clauses
- Assess the tenant’s financial strength
- Require seller to provide estoppels for all active leases
- Market Rent Comps
- Compare current rents to market standards to identify under-market leases and growth potential.
- Evaluate rental history and concession patterns to project realistic rent growth based on market data.
- Debt Structure
The debt structure evaluation is important because different lenders (banks, credit unions, life insurance, etc.) have different preferred loan structures that can vary widely. You will want to structure your debt to meet your investment goals- Bank Debt: when you need flexible terms, bank debt is the best, although it usually costs more than other sources. Banks are more negotiable on terms thus can work within your investment goals, but generally require personal guarantees.
- Credit Unions: due to tax savings resulting from their structure, credit unions can provide lower rates than banks, but usually are slightly more challenging to work with and more rigid.
- Life Insurance: life insurance companies are very rigid in their structure, but can provide very attractive terms. These are best for longer term holds as they generally have defeasance or yield maintenance as prepay fees, creating exposure to interest rate movements in the case you want to sell before the loan matures.
You want to align interest rate, interest-only term, amortization schedule, performance draws, prepayment penalty structure and any other loan terms that affect your underwriting and business plan.
2) Physical Due Diligence
A property’s condition directly impacts long-term returns, especially in value-add strategies. Your physical diligence process should include:
- Third-Party Professional Inspections: Engage qualified engineers for structural, mechanical, electrical, and plumbing systems review. These inspections identify immediate needs and long-term capital requirements.
Pro Tip: Two of the largest potential expenses for commercial properties are HVAC and roof repairs/replacements. Have both inspected by professionals and request reports on useful life and any near and mid term preventative maintenance/repairs are needed.
- Environmental Studies:
- Phase I Environmental Site Assessment: This is a study of historic uses, current visible use, and neighboring property uses to identify potential environmental contamination and risks.
- Phase II Environmental Site Assessment when required by Phase 1: This is a further study of the site’s condition, requiring soil and groundwater testing to measure potential contamination types and levels.
- Building Material Testing: This checks for hazardous material, such as asbestos, within the property.
Pro Tip: If a Phase II assessment is required, spend some time to re-evaluate if the investment is worth the potential risk of inheriting environmental liability. If contamination is found during your ownership and can’t be tied to an adjacent property or previous owner, you could be on the hook for cleaning up your and all neighboring properties for a very long time.
- Property Boundaries and Rights: ALTA surveys verify boundaries, identify easements, confirm access rights, and assess development potential. These legal aspects prevent costly disputes after closing and provide transparency regarding rights to the properties use. The survey is a depiction of the title, thus can be very useful to clarify easement locations and size.
- Capital Expenditure Planning: Prioritize immediate versus future repairs and create accurate budgets for identified issues. Develop implementation timelines and calculate ROI on potential upgrades.
- Placement in Market: It is important to clearly understand how a property fits within the immediate area – its traffic flows, customer and tenants journey in and out of the property, visibility, and adjacent uses. Be sure no external variables around the property create additional risk to the investment.
Interested in Alakai Capital’s investor-focused approach to commercial real estate? Explore our current investment opportunities or contact us to discuss how our thorough due diligence protects your capital.
3) Legal and Compliance Due Diligence
Legal factors play a crucial role in protecting investment returns and future value. Protecting your downside means reviewing all legal and regulatory exposures. To do this, be sure to:
- Title Review and Insurance: Conduct comprehensive title searches to clear all defects before closing. Secure appropriate title insurance coverage and address any unrecorded rights or claims. Use restrictions, development restrictions and access restrictions can be hidden in title. Have a professional review and provide title comments on your behalf (usually your attorney can do this), but make sure you understand all the items in the BII section of the title report.
- Loan Agreement Review: Understand all covenants and restrictions to verify favorable debt terms. Examine prepayment penalties and identify assumption opportunities to ensure financing aligns with investment strategy.
Pro Tip: Always confirm the loan agreements match the term sheet provided – although uncommon, we have caught loan documents that didn’t align with our term sheet.
- Litigation Risk Assessment: Research pending legal issues and review tenant complaints. Examine code violation history and assess potential insurance claims to quantify legal exposure. The title agent can pull a lien and open permit reports for the property.
- Tax and Insurance Verification: Confirm current tax assessments and identify reassessment risks. Verify insurance coverage adequacy and review premium trends to accurately project operating expenses. Understand the impact from property insurance, liability insurance, and flood insurance (inspect FEMA maps for flood zone qualification)
Pro Tip: In recent years many investors have been stung by not properly accounting for insurance increases. Between inflation in property values and in insurance premiums, it is not uncommon to see insurance increase 20%+ on acquisition. Be sure to understand in the leases if that is a reimbursable cost from tenants or a landlord expense.
You’re not just acquiring a building, you’re inheriting every legal obligation attached to it.
4) Development and Entitlement Due Diligence
For ground-up and value-add projects, additional evaluation is necessary. When acquiring land or repositioning property, you need clarity on what’s allowed—and what’s realistic. Consider:
- Construction Cost Validation: Obtain multiple contractor bids and verify current material and labor costs. Include appropriate contingencies and confirm project timeline feasibility. Industry standard contingencies are 5% for hard costs and 10% for soft costs on a construction project.
- Permitting and Approval Confirmation: Meet with local planning departments to verify zoning, Future Land Use (FLU), code requirements and allowable uses. It is important to have a clear understanding of realistic timelines for approvals.
- Engineering and Design Feasibility: Confirm structural integrity for renovations and verify utility capacity for intended use. Evaluate site limitations and plan construction logistics to prevent execution issues.
- Tenant Demand Verification: Secure pre-leasing agreements when possible and analyze absorption rates for similar properties. Verify rent projections with market data to ensure the completed project will achieve projected occupancy.
Pro Tip: Understanding a project’s entitlement and construction timeline is key. From the day you close on the acquisition, if you have debt, each day that the project is not complete with a tenant paying rent is a day that you’re paying debt service, taxes, insurance, and other holding costs. Include ample reserves in your budget to avoid future capital calls. Don’t get stuck under estimating the length and cost of time.
The earlier you confirm these assumptions, the better you can avoid cost overruns or stalled projects.
Part 3: How Professional Investors Turn Due Diligence Into Their Competitive Edge
Due diligence is often treated as a checkbox to reach closing. The best investors see it differently: as a window into the real dynamics of an investment—and a phase where real value is either confirmed, protected, or created.
When approached strategically, due diligence becomes a source of long-term advantage.
Look Beyond the Reported Facts
Third-party reports reveal facts. Strategic investors uncover context. By asking deeper questions, probing assumptions, and seeking second-order insights, you move from documenting a deal to understanding it at its core.
The consultants, engineers, and brokers supporting your diligence often know more than they initially report. Pressing thoughtfully uncovers nuances others miss and those nuances shape better deals.
Negotiation Power Comes from Knowledge
Deals are not won at listing price—they’re shaped during diligence. Whether adjusting price, securing credits, restructuring leases, or deciding to walk away, well-documented findings give you optionality. The earlier you surface risk, the more power you retain.
Relationships Built During Diligence Create Future Opportunity
Diligence is also where reputations are built. Consultants, brokers, and lenders observe how investors engage in the process. Demonstrating thoroughness, respect, and clarity builds credibility—and those relationships often lead to off-market opportunities, better service terms, and priority access down the line.
Why It Matters
A rigorous, curious, and structured due diligence process allows you to:
- Avoid capital-draining surprises post-close
- Find upside that spreadsheets alone can’t reveal
- Strengthen your negotiation leverage
- Build a professional ecosystem that compounds with each acquisition
Mastering diligence isn’t just about protecting downside—it’s about positioning yourself to capture opportunities others aren’t even seeing.
Part 4: Common Due Diligence Mistakes to Avoid
Many investors make critical errors during the due diligence process:
- Underestimating Capital Expenditures: Insufficient physical inspections lead to surprise repair costs that erode returns.
- Ignoring Lease Agreement: Details Special provisions and tenant options can significantly impact cash flow, allowed uses within the center, and exit timing.
- Skipping Environmental Assessments: Environmental issues discovered after closing can create unlimited liability and remediation costs.
- Rushing Financing Approvals: Misaligned loan terms can restrict cash flow and limit future flexibility.
- Overlooking Market Trends: Failure to understand supply-demand dynamics can lead to unrealistic rent projections.
Each of these can lead to delays, reduced returns, or blown business plans. The antidote is a disciplined process.
Ready to invest with confidence? Alakai Capital offers accredited investors and family offices access to our carefully vetted commercial real estate opportunities. Learn about our current investment offerings to see how our thorough due diligence protects and enhances your investment.
The Alakai Capital Due Diligence Philosophy
Our approach extends beyond checklistsit reflects our core investment principles:
- Assume Nothing, Verify Everything: We independently verify all seller-provided information through multiple sources. This skeptical approach has saved our investors millions in potential losses.
- Relationships Create Information Advantages: Our consultant network provides timely insights unavailable to most investors. These relationships have been carefully cultivated over years of partnership and represent a significant competitive advantage.
- Speed With Thoroughness: We move quickly without cutting corners, conducting comprehensive analysis while maintaining transaction momentum in competitive situations.The key is focused attention throughout the due diligence process and having a mapped out plan of execution.
- Find Opportunities Within Problems: Issues discovered during due diligence often become our greatest value-creation opportunities. Whether it be discoveries in title, creative negotiated loan terms, unknown capital improvements uncovered during inspections, we approach each singular decision from a holistic approach as to how it affects the overall investment goal.
Due Diligence as a Competitive Advantage
In commercial real estate, diligence is your first, and most important, filter. It’s how you protect capital, confirm opportunity, and build confidence in your investment.
A thoughtful, repeatable diligence process allows you to act with conviction, avoid preventable mistakes, and see deals others overlook. At Alakai Capital, our diligence process has been refined over 10 years of investing across 70+ transactions. If you’re an accredited investor or family office looking to invest alongside experienced operators with a rigorous, relationship-driven approach—we’d love to connect.
For accredited investors and family offices interested in commercial real estate investments backed by institutional-quality due diligence and entrepreneurial execution, we invite you to explore our current opportunities.
Nick Jones is the founder and CEO of Alakai Capital, with over 20 years of experience in commercial real estate management, investment, development, and brokerage.
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