Commercial Real Estate Purchase Agreement Do’s and Don’ts
By Ben Hammond
Whether you are purchasing commercial property as an investment or to address the needs of your business, there are at least 5 “do’s” and 5 “don’ts” you are going to want to consider when negotiating the Purchase Agreement. The Purchase Agreement in many cases can follow a letter of intent, but letters of intent are most times non-binding. Careful attention must be paid to the terms and conditions of the Purchase Agreement as the details can greatly impact your risks and liability in the transaction.
Do #1: Make sure the property is properly described.
While this sounds obvious, many times errors are made by using tax property descriptions or old legal descriptions that don’t actually reflect the property being sold. This can lead to boundary disputes, zoning problems or worse when you go to sell the property.
Do #2: Allow for enough time for due diligence.
In today’s world of national and international investors and 1031 exchanges the timelines for “clean” deals can be extremely short. Twenty-one days may not be a sufficient amount of time to review the title work, obtain a Phase I environmental assessment, physically inspect the site, review any applicable tenant lease and understand the local zoning ordinances.
Most deals are sold as having no issues. However, I have yet to be involved in a deal where there wasn’t one issue to address, review or consider. Every transaction is unique and you really don’t have a full grasp until you start the due diligence process. Make sure you have enough time.
Do #3: Consider the condition of the property when you agree on the price in the Purchase Agreement.
In older developments immediate upgrades might be necessary, such as a new parking lot, HVAC, signage, etc. These points may be areas of negotiation after the Purchase Agreement is signed and that should be considered on the front end.
Do #4: Understand the transfer taxes, local taxes, and fees in the jurisdiction where the property is located.
Each state has a different set of rules and this must be carefully considered.
Do #5: Get estoppel certificates from the tenants.
While this step is common place for national tenants, you need to remember that some national tenants charge $500 or more for these certificates. That cost should be addressed in the Purchase Agreement. Also, some national tenants will have up to 21 days to provide an estoppel certificate which could delay closing. It is tempting to avoid requiring estoppel certificates from smaller tenants, such as in a strip mall or shopping center, but this is the best way to confirm if the seller/landlord has lived up to its end of the existing lease and find out if the landlord is obligated to perform any work on the property.
Don’t #1: Don’t tie up the property for a long period of time without the earnest money deposit “going hard”, or becoming non-refundable.
There is a real cost to a seller in terms of waiting for a buyer to investigate the property for 1-2 years and then pull out of the deal. Consider triggering timelines every six months or less when milestones are achieved in the due diligence process, such as a successful zoning variance, acceptable environmental report, etc.
Don’t #2: Don’t agree to ridiculous warranties, guarantees and representations.
From time to time I see a Purchase Agreement that goes overboard. It asks the seller to warranty, guarantee and represent a host of items that it simply has no way to verify. One way to soften these stringent requirements is to add language that the representations and warranties are “to the knowledge of the Seller”.
Don’t #3: Don’t skip having a lawyer look over the Purchase Agreement.
There is a temptation to justify skipping this step by saying “the deal is only XXXX dollars”, “this is a simple, clean deal”, or “lawyers just slow down the process and cost too much”. I’ve heard all of these and more. While true that some lawyers have reputations as “deal killers”, most who practice in this area attempt to clarify ambiguities so there are no surprises at or after the closing. Like most things in life, an ounce of prevention is worth a pound of cure, and I’ve seen that hold true more so in Purchase Agreements that many other areas of the law.
Don’t #4: Don’t get stuck with unknown fees if there is a termination.
Typically if the buyer breaches the agreement, the seller’s damage is the recovery of the earnest money deposit. However, if the seller breaches, many agreements are silent as to what recovery is available. Some form agreements provide for attorney fees to be awarded to any prevailing party in a subsequent lawsuit. Others will allow a buyer to recover its actual costs (including due diligence and legal) incurred in pursuing the transaction. If the buyer has incurred costs for an ALTA survey, Phase 1, Phase 2, property inspections, zoning reports, attorneys’ fees, zoning variance applications, etc. the costs can run up quickly. If the buyer insists on this type of a provision, setting a max dollar amount for such recovery provides clarity and caps the risk to the seller.
Don’t #5: Don’t close until you are ready.
Many times there are loose ends to tie up, such as a repair that is scheduled, landscaping that needs to be planted, a release of a construction lien that is in the process of being paid, etc. As you approach the closing date, there will be pressure from the brokers and others to close and address “minor” concerns after the fact. Sometimes these concerns can be addressed by putting some closing funds in escrow for a specific purpose. However, as a general rule, once you close, you have to expect silence and no assistance from the other party. While the Purchase Agreement may require the seller to take some action post-closing, these matters frequently become the buyer’s problem once the seller receives its money and signed closing papers. Avoid the temptation to close before you have addressed all foreseeable concerns.
A significant portion of Ben Hammond’s practice involves commercial and residential real estate transactions, business law, and commercial litigation. You can contact Ben with questions at (616) 458-3600.