Last week I reviewed the steps in buying commercial real estate. Whether you’re buying to house your company’s operation or simply to enjoy the rent a parcel produces, the steps are essentially the same.
The possible exception could be the financing portion, which some investors abandon in favor of deploying large sums of cash into the buy.
Today, I will complete the orbit and describe some deal challenges that can occur and some suggestions on how to overcome them.
From last week:
Due diligence, also referred to as a contingency period, ranges from as few as 15 days to as long as 90, and a ton of work must occur during this time frame. Financing must be secured, title exceptions approved, inspection of the building – roof, electrical, HVAC, etc. accomplished, vesting documents drawn, financial aspects of the tenancy – if any – analyzed, and environmental health diagnosed.
Whew! Within each of the main categories of approval, there are checkpoints which guide toward the end. Financing, for example, involves credit of the buyer, the tenant, an appraisal, an enviro report and lender concurrence. There’s a lot to be done in a short time. What if something isn’t approved?
That, dear readers, is a subject for today’s column.
So, here it goes.
Generally, purchase and sale agreements include a mechanism for solving issues that arise in a deal.
The most widely used contract is published by the Association of Commercial Real Estate, or AIR. Clearly defined within paragraph nine are the various categories of approval items — inspection, title, tenancy, other agreements, environmental, material change, governmental approvals and financing. Within the boiler plate language are roadmaps for resolution.
If your contract is not the standard AIR form, results may differ. As always, it’s wise to seek legal counsel before engaging. But within the document, typically there are three choices – cancel, accept or fix. A fourth can creep in, which is a buyer-seller compromise.
Indulge me as we walk through some quick examples.
Let’s say a building inspector discovers the HVAC units are past their useful life. From experience, I can say this scenario is quite common. So, here’s what happens.
The buyer objects to the condition of the cooling systems by disapproving a portion of the physical inspection contingency. You may be wondering, wait, I thought the buyer was buying the building “as-is, where-is, with no seller warranties.” She is, but she’s also relying on her inspection to alert her to any fixes necessary. Confusing? Yes, it is.
Sure, a seller may simply refuse to repair or replace the units and cancel the escrow, but they cannot do so immediately. You see, here’s where the “mechanism” takes place. The buyer objects; the seller has 10 days to respond — yes, no or maybe. A no vote on the recall – ooops, sorry. Wrong issue. If the seller refuses, the buyer can cancel the deal within another 10 days, opt to continue and buy with the faulty units, or accept a compromise — the “maybe” offered by the seller.
Financing is trickier.
You see, if the buyer is unsuccessful in their pursuit of a loan by the date specified, generally, the seller can walk away. Therefore, it’s imperative to be quite transparent with the seller during the loan approval process. Because prior to the financing condition date, there may be some leverage.
If an appraisal comes back less than the contract price – which causes a lender to renege on the amount – it’s recommended to level with the seller.
Yes, you or the seller can cancel, additional dollars can be added to adjust for the delta – accept, an appeal can be made to the lender – buyer fix, purchase price can be reduced – seller fix, or a compromise between buyer and seller can be struck whereby buyer adds some dough, seller reduces the price – and voila!
I’ve witnessed these go every way you can imagine over my decades in the business. One certainty – there will always be issues. It’s a thing.
The next deal I close without one will be the first. But, fair warning. In today’s overheated industrial market, I’d not plan on a seller being terribly receptive to what’s referred to as a “re-trade.” Chances are there is a line of suitors waiting for the chosen buyer to blink.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at firstname.lastname@example.org or 714.564.7104.
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