An Overview
Commercial real estate purchases are typically complicated transactions that involve negotiations between parties, potentially supported by lawyers, brokers, accountants and lenders. In the course of a commercial real estate purchase and sale, a purchase and sale agreement will be entered into. Commercial real estate purchase and sale agreements contain common definitions and terms which can be confusing to a novice. Buyers, sellers and brokers, especially in the case of the sale by a trust or estate, should be familiar with some of the basic common terms.
Commercial real estate purchase and sale agreements set forth the terms of the sale of real property in such instances as the purchase and sale of income-producing property, non-income producing property, undeveloped land, residential or mixed-use property, or industrial or warehouse property.
There are many common elements in any commercial real estate purchase and sale agreement. Among these common elements, the agreement must set forth a description of the real estate being conveyed; a purchase price (which is often broken down into portions for the deposit and the balance upon closing); contingencies that must be satisfied prior to closing; provisions for a transfer of title; apportionments to be made such as real estate taxes, assessments and other expenditures common to all real estate transactions; conditions to closing; representations and warranties of each party and similar provisions that protect the interests of both the buyer and the seller.
As noted above, the commercial real estate purchase and sale agreement is not dissimilar to the typical residential real estate purchase and sale agreement that an attorney may employ for the sale of a family or vacation home or a condo unit. A commercial real estate transaction is usually more detailed, however, in that it involves extensive negotiation , as well as the input of various professionals or advisors on behalf of the parties, such as a real estate broker, attorney, accountant, tax advisor, lender and environmental specialist. There is also the added complexity of potential tax consequences, transfer tax issues, and zoning, environmental or municipal requirements that may need to be met in advance of or at closing.
In a commercial real estate transaction, the purchase and sale agreement must also contain provisions that address the practical aspects of the sale and purchase of the property in order for the transaction to proceed smoothly. Often a party may be interested in leasing the property back to the seller after the closing. There may be additional provisions for setting forth post-closing obligations. Again, this is where negotiating the language of the purchase and sale agreement is critical and each transaction must be carefully evaluated.
It should be noted that a commercial real estate purchase and sale is not the only way to convey title from one party to another. Beyond a traditional purchase and sale, an alternative transaction may involve a purchase by a family trust of property owned by the decedent. The key here is that the same or similar provisions that one would find in a commercial real estate purchase and sale agreement can also be found in an estate plan and trust document, which, if properly drafted prior to the death of the client, may afford for the most efficient and tax effective means of conveyancing title to real estate held in the name of the client to either the successor trustee or beneficiary.
Whether the transaction is a traditional commercial real estate purchase and sale or the transfer of title to real estate owned by a trust or estate, the provisions of the purchase and sale agreement or the trust or estate plan must be carefully drafted by counsel.
Important Elements of the Agreement
The contract for sale is a buildable document, with multiple facets and attributes. The contract will be like an outline for what will be a much more detailed and exhaustive document, the deed, at closing. Under most circumstances, and regardless of whether it is being prepared by a buyer’s lawyer or a buyer or seller acting as its own lawyer, a contract will include at least the following: • Description of the property, including, if it is a commercial condominium or apartment, the unit number; • List of items included in the sale (Some items, like the refrigerator, are assumed as included, unless provided otherwise. Other items, such as wall mirrors, are not included unless specified in the agreement); • Price of the property; • Deposit required; • Closing date; and • Time limit to perform inspections, including for radon, timber, estoppel certificates, existing tenants if the property is occupied, zoning, environmental impact assessment if the site is improved, etc. (a buyer would want to reserve the right to cancel the contract and have its deposit promptly refunded if it discovers a legal or regulatory condition that renders the property unsatisfactory, or if the seller cannot deliver title free of any liens, encumbrances or other title defects).
Due Diligence in Commercial Real Estate Transactions
Due diligence is a key part of the purchase and sale process for commercial real property. Its purpose is to identify any issues that could affect the desirability and value of the property and give buyers the opportunity to decide whether or not they want to go forward with the transaction. While due diligence requirements can vary from transaction to transaction, they typically include a physical inspection of the property, environmental assessments and financial evaluations. Depending on the type of real property, other due diligence may include zoning, title review and surveys. Inspections are typically performed in every commercial real estate transaction. For instance, general building inspections assess the integrity of the structure and mechanical systems. Environmental assessments can include Phase 1 and Phase 2 Environmental Assessments. The Phase 1 involves a survey of the property to detect any issues. If an issue is found with the Phase 1, a Phase 2 is typically required. Phase 2 involves a detailed investigation, such as sampling the ground water. Environmental due diligence is especially important when acquiring commercial property, since the buyer may be responsible for environmental cleanup regardless if the contamination was released or disposed by the purchaser.
Points Often Negotiated
There are a number of common negotiation points that arise in commercial real estate purchase and sale agreements. Much of the negotiation revolves around price. Typically, the seller will have a figure in mind on what it should get for the property, usually based on recent comparable sales of similar properties in the area. The buyer will want to pay the least amount possible. The ultimate price will depend on how much negotiating room the seller has and what the buyer believes the property is worth. The typical starting point in a commercial transaction is the listing price. The parties would then negotiate from there.
Other common negotiation points are the closing date and contingencies, which are various conditions that must be satisfied before the sale is complete. Buyers typically want some kind of contingency, such as being able to finance part of the purchase price with the help of investors. Sellers usually resist the idea of an open-ended deal and try to insist on strict time limits on any contingencies. In addition, the limiting of closing costs and improvements may also be issues subjects to negotiation.
Legal Considerations
The legal nuances of a commercial real estate purchase and sale contract are significant and should typically only be handled with the utmost attention by an experienced real estate attorney. Too often, the lawyers involved in the transaction, or worse yet the parties themselves, take this important document for granted; and they literally sign away potentially millions of dollars of their clients’ money on an ill-prepared purchase and sale agreement that is completely one-sided and/or not negotiated at all.
The victorious party in a deal where they have taken advantage of the other party through the purchase and sale contract may be laughing now; but, years later, after it has been found that their purchase and sale contract was fraudulently obtained or is otherwise unenforceable, that same victorious party may end up paying legal fees of hundreds of thousands of dollars to undo the great deal it thought it had . It can take years to shake off the damage a badly written real estate purchase and sale contract can do to a client, and that is if the transaction proves to be enforceable at all. It is much better (and cheaper) to pay the small investment for a strong and effective purchase and sale agreement in the beginning, than it is to pay the likely large final bill years down the road.
This is especially problematic for inexperienced or non-lawyer business persons and real estate developers who may end up believing the goods and services they are buying are a "done deal" when, in reality, the purchase and sale agreement they signed is incomplete, flawed or otherwise just plain false. Those real estate developers and business owners may have been duped using unscrupulous practice by the seller involved. The victims of such fraudulent conduct often have claims against the lawyers as well as the sellers and the related entities involved.
Concluding the Arrangement
Once the parties have negotiated and reached an agreement in principle on the material terms of the contract, the next step is to execute and date the contract. Upon execution, the parties are then usually required to deliver the executed contract to third parties, such as, lenders, title agents or escrow agents, under which the same becomes a binding contract to all the parties.
Note that, although the execution of the contract also implies acceptance of the contract as drafted, once executed, the parties to the contract are bound to perform under the contract provisions even if the contract has not yet been signed by others, such as, title agents or lenders. Most contracts, however, contain a condition precedent that the contract shall not be effective until executed and delivered to all parties. In such case, the delivery of the executed contract to all parties constitutes a precedent to the closing of the transaction.
Closing of a transaction typically occurs at a later date agreed to by the parties, or agreed to by the parties or title agent (on behalf of lender), following the completion of due diligence, receipt of approvals (if any) and satisfaction or waiver of conditions precedent. Closing consists of, among other things, the delivery by the seller of a vested marketable title to the property together with all of the necessary documentation and funds required to complete the closing.
The documents commonly delivered at closing by the seller include: a deed generally conveying the fee interest in the property subject to valid existing easements and restrictions; a bill of sale; an assignment of contracts; an assignment of leases; assignments of licenses; a recent survey of the property; an estoppel certificate for tenants; documents to evidence assumption of contracts; indemnification and hold harmless agreements; releases of liabilities for the seller; or any other document or certificate required under the contract.
The buyer shall deliver payment in a form acceptable to seller or its closing agent.
Possible Issues and Solutions
In all likelihood, the greatest challenge in the jurisdiction-centric, commercial real estate transaction process involves how to move the real estate in question from Point A to Point B with minimal disruption to the business operations of the buyer and seller. To make this happen, it is critical to set a reasonable timeline and provide early notice to other parties involved in the transaction. However, in some cases, it is common for buyers and sellers to receive notice from governmental authorities that an environmental or regulatory issue may affect the property during the transaction. Such notices can constitute a significant and iterative challenge to the buyer and seller.
To address potential issues presented by a governmental authority or an ongoing investigation or litigation, it is critical to be well-organized and communication-focused. By developing an early understanding of how to handle potential problems and getting a general idea of how such issues could affect the timing of the transaction , the buyer and seller may be able to prevent or minimize the potential for significant downtime during a sale transaction.
Add-on issues, such as whether certain environmental work should be performed prior to closing or whether certain actions need to be taken before the closing date, can also present significant challenges. In some cases, additional businesses that may be acquired by the buyer as part of the transaction can present unexpected challenges as well. To minimize the risks involved in a transaction of this kind, it is essential for interested parties to have a good understanding of potential problems and how to lance the procedural boils that can later spring up after the closing.
Despite the challenges that may be encountered during the commercial real estate transaction process, most sellers and buyers are able to balance their various needs through careful planning and considerate communication. For that reason, it is essential to understand what can arise and how to address the potential challenges that may impact the sales timeline.