Investing in shopping centers can offer substantial returns, but ensuring your investment is in capable hands is critical. One of the most important indicators of an experienced and competent sponsor is their approach to due diligence—a comprehensive examination of the property’s financial, legal, and physical condition.
Due diligence is particularly complex for shopping centers due to shared spaces, diverse tenant mixes, and the operational dependencies on tenant performance. An effective sponsor will conduct meticulous due diligence to uncover risks, ensure compliance, and align a property's performance with investment goals. As an investor, knowing what to expect from your sponsor's due diligence process helps you gauge their expertise and the security of your capital.
In this guide, we'll outline the essential components of due diligence, including regular due diligence (focused on financial and legal reviews) and physical due diligence (covering structural, mechanical, and environmental inspections). By the end, you'll have a clear understanding of what an experienced sponsor should be doing to protect and grow your investment.
In commercial real estate, due diligence is the process of verifying the property’s condition, performance, and compliance with regulations to ensure it meets your investment criteria.
Imagine you're about to purchase a sophisticated, high-performance machine worth millions of dollars. Would you simply trust the seller's word about its condition? Of course not. You'd want a team of expert mechanics to:
Due diligence for shopping centers works similarly. You're not just looking at the surface-level appearance, but diving deep to understand:
As an investor, ensuring that your sponsor conducts the correct due diligence processes can protect you from investing in a project that may have costly surprises, hidden liabilities, and potential financial losses.
Due diligence is especially critical for shopping centers because they involve shared spaces, diverse tenants, and often large capital expenditures for maintenance or upgrades.
Due diligence is crucial for landlords in three distinct areas:
For shopping centers, this process is critical because of their complexity. Issues like tenant turnover, maintenance of shared spaces, and compliance with accessibility laws can significantly impact returns.
There are two overarching categories that any due diligence practice falls into: “regular” due diligence and physical due diligence. These pillars complement one another to give you a comprehensive picture of the property’s condition, financial viability, and long-term potential. We will explore the components of both categories below.
Standard due diligence focuses on understanding the property's financial performance and ensuring it meets all legal requirements. This involves verifying the documentation and income streams associated with the property. For shopping center investors, this process helps confirm the property's value and identify any risks that could impact its performance.
Leases are the lifeblood of a shopping center because they dictate rental income, tenant obligations, and operational flexibility. Carefully reviewing each tenant’s lease agreements helps you understand:
Suppose an anchor tenant—the property’s largest revenue source—has an early termination clause that could leave a significant vacancy. Identifying this risk allows you to renegotiate the price or plan for alternative leasing strategies.
A thorough review of the property’s income and expenses helps confirm the Net Operating Income (NOI) and overall financial health of the investment. Key tasks include:
If the seller reports low operating expenses, but your analysis reveals deferred maintenance or rising taxes, this could impact future cash flow and investment returns.
Shopping centers rely on strong local demand and competitive positioning. A market analysis provides context for how the property fits into the surrounding area:
If nearby centers are newer or better maintained, you may need to budget for upgrades to keep tenants and customers engaged.
Verify the property meets all local, state, and federal requirements to avoid fines or operational setbacks:
Discovering zoning issues, such as unapproved land uses, after closing could lead to costly legal battles or force you to stop certain operations.
Physical due diligence dives into the tangible aspects of the property, uncovering maintenance needs, structural issues, and environmental risks. Shopping centers often involve shared infrastructure—such as parking lots, roofs, HVAC systems, and landscaping—that can be expensive to repair or replace.
A thorough walkthrough is the first step to identifying visible issues. Structural elements to inspect include:
Deferred maintenance in any of these areas impacts tenant satisfaction and could result in safety hazards and liabilities for you as the property owner.
The mechanical systems of a shopping center must be in good condition to ensure tenants can operate effectively. Focus on:
A failing HVAC system or outdated electrical infrastructure could prevent tenants from operating efficiently, leading to frustration and potential vacancies.
Ensure the property meets safety and accessibility requirements:
Environmental issues can have serious financial and legal implications. The land beneath shopping centers may have previously hosted businesses that left behind hazardous materials, such as gas stations and auto repair shops, which can remain even after those businesses close. Even properties that look clean on the surface can harbor hidden risks, and environmental cleanup can be expensive and legally complex.
If contamination is discovered, you can negotiate a price reduction, request the seller handle remediation, purchase environmental insurance, or decide to walk away if the risks outweigh the reward. The baseline assessment for evaluating the ecological health of a property during the physical due diligence phase is typically an Environmental Site Assessment (ESA).
An Environmental Site Assessment (ESA) is a formal evaluation that identifies potential or existing environmental contamination on a property.
Conducting an ESA identifies risks such as:
Incorporating ESAs into your due diligence process ensures you’re fully aware of environmental liabilities before finalizing your investment. By uncovering potential hazards early, you protect yourself from costly surprises and can decide whether to proceed, renegotiate, or move on to a better opportunity.
Due diligence is a cornerstone of prosperous shopping center investing, and it is critical to work with a sponsor who prioritizes this process. An experienced sponsor will conduct thorough evaluations of a property’s financial, legal, and physical condition, ensuring the investment is sound and aligned with your goals.
Understanding the critical elements of due diligence—such as lease reviews, compliance checks, property inspections, and environmental assessments—enables you to assess a sponsor’s expertise and commitment to safeguarding your capital. By familiarizing yourself with these practices, you’ll be better equipped to select a sponsor who demonstrates transparency, professionalism, and attention to detail.
Choosing a sponsor with a strong due diligence process provides confidence in their ability to mitigate risks and maximize the property’s potential. Your knowledge of what to expect ensures you’re making an informed decision, laying the groundwork for a successful and rewarding investment partnership.
Due diligence is the best tool for evaluating a sponsor's expertise and competence. By understanding how a sponsor approaches regular due diligence—verifying financial and legal details—and physical due diligence—assessing the property’s condition—you can gauge whether they have the skills and processes needed to protect and grow your investment.
Shopping centers are complex assets, and a sponsor who prioritizes comprehensive due diligence demonstrates their ability to mitigate risks and make informed decisions. This ensures that your capital is not only protected but also positioned to deliver sustainable, long-term value. As an investor, knowing what to expect from a sponsor’s due diligence process empowers you to evaluate their suitability and ensure their strategy aligns with your financial goals.
To further strengthen your ability to assess sponsors and their processes, explore other key concepts in commercial real estate investing, such as:
The more knowledgeable you are about these topics, the better equipped you’ll be to make informed decisions, ask the right questions, and partner with the right sponsor. Remember, informed investors make confident decisions, and confidence leads to stronger, more rewarding investment outcomes.