What is a Commercial Property Purchase Agreement?
A commercial property purchase agreement is a legally binding contract between the buyer and seller in a commercial real estate deal. It is similar to a residential purchase agreement with the exception that commercial property deals tend to be more complex, with additional terms and contingencies added to the basic agreement. It provides a framework of protection for both buyer and seller and outlines the obligations of both parties and what is expected of them to close the deal. In a commercial property purchase agreement, the buyer is typically the purchaser of commercial real estate and typically refers to "the buyer" as the "Purchaser." The seller of commercial real estate is typically referred to as the "Seller." The Seller may be an individual, a corporation, a limited liability company, a partnership, or any other legal entity that may sell real estate . The purpose of a commercial property purchase agreement is to provide detailed terms for the sale of the property. It is not only important for the necessary legalities of the deal, but it is also crucial in establishing a trust between the two parties. The agreement offers detailed descriptions of the property and its location and outlines the rights of the Purchaser and Seller. The goal is to prevent either party from pulling out of the deal without the consent of the other. It is important that both parties have an understanding of the agreement before signing the document so that they are able to uphold their part of the deal. Before the agreement is signed, a Buyer has ample time to review all the terms. However, once the terms are agreed upon and the contract is signed by both parties, the contract is considered legally binding.
The Essential Components of a Commercial Property Purchase Agreement
The success of a commercial property transaction oftentimes rides on the purchase agreement and its contents. A standard commercial property purchase agreement contains several key components. First, the agreement will include a description of the property. This typically includes the address of the property, and the County Tax/Parcel ID Number. The description may also include a legal description such as a metes and bounds description or perhaps the reference to the property’s plat on file with the County. Second, the purchase agreement will disclose the purchase price of the property. The purchase price is typically formulated with any earnest deposits to be made by the purchaser up front, a portion of the purchase price that becomes due prior to closing, and the remaining purchase price that is to be paid at closing. Aside from the purchase price, the purchase agreement may also contain financing contingencies if the purchaser was not able to obtain financing for the purchase of the property. Third, the agreement will include a closing date. The closing date is a definitive point in time that is the date of the actual transfer of ownership of the property from the seller to the purchaser. The closing date is oftentimes prior to the day to be recorded in the land records. For example, the closing date may be March 8, 2014, but the deed to be recorded in the land records may be dated March 10, 2014. The closing date may or may not be the same day as the date of settlement of the loan, or a day that has been agreed upon between the parties. The parties’ counsel will oftentimes agree in advance on a series of dates, including the closing date, the date of settlement, and the date for recording the deed in the land records. Aside from the closing date, other key dates in the purchase agreement are the inspection period date, a drop-dead date for contingencies to be satisfied, and recent updates to the Virginia Code allow for the buyer to request a due diligence period. If requested, this period may be a reasonable length of time for the purchaser to review both the physical and financial aspects of the property they are purchasing. The due diligence period is typically set at a time that allows the purchaser to obtain satisfactory financing for the purchase of the property prior to closing. Again, aside from the purchase agreement, the seller and the purchaser will also look to state statutes and local ordinances that may apply to the real property being purchased. These statutes and ordinances will also dictate how to properly convey the property to the purchaser.
Negotiating a Purchase Agreement
Negotiating the terms of a commercial property purchase agreement can be an important part of the buying process. Buyers who haggled for pricing may have to do the same when discussing contingencies and deadlines. Sellers who agreed to a lower set price may insist on other inclusions or provisions in the contract.
No one wants to spend a large sum of money purchasing a commercial property only to realize just after closing that the property is structurally unsound, subject to state or county liens or otherwise unenforceable. For this reason, contingencies are often added to purchase agreements such as:
Contingencies satisfy both seller and buyer by ensuring that certain actions occur, including the buyer successfully securing financing. This is often done even after an extensive inspection and to some degree banks have taken notice of this and decided not to lend on properties with conditions present that would previously not have been a deterrent.
Contingencies can be added to any part of the contract. For example, inspection provisions may specify that the buyer has met with a bank officer or secured a loan from any private institution. Similarly, purchase agreements often include the obligation to provide any legal easements for the property in writing. If any of these events do not occur within a specified period, the sale is generally invalidated without penalty, though sellers can agree to take up the issue directly with the buyer.
Most property inspection clauses are intended to protect the buyer. Purchasers who realize too late that the property has non-visible defects may wish to sue the seller for damages, given the fact that many such defects would reduce the value of the building or require months of work and loss of potential revenue while repairs were made. Not all buyers expect that the property be perfect, and some expect to settle on properties without any contingencies at all, as discussed above.
Inspecting the property before signing the purchase agreement allows buyers to renegotiate the terms, if necessary. If the buyer then chooses to back out of the sale altogether, it could prove to be a strong defense against potential litigation. By including such clauses in the contract, sellers can protect against this situation while simultaneously covering themselves against possible lawsuits if the buyer later decides that the property is not suitable.
Unless the buyer has a significant amount of cash available, financing will be necessary. Many buyers choose to leave this up to the bank. Others prefer to address financing terms directly in the purchase agreement.
There are several potential contingencies related to financing that can be added, including the buyer’s ability to secure financing at a specified interest rate. While buyers may lobby for a lower rate, sellers may wish to specify a higher rate of interest (or at least one that is close to today’s standards) to protect against changing economic conditions.
Legal Considerations and Due Diligence
Beyond inspecting the property for structural and mechanical issues, it’s incumbent upon the buyer to conduct due diligence of the legal aspects of the property. For instance, certain purchases are contingent upon a zoning variance for a home occupation; if the city won’t issue the variance then the transaction is dead. Likewise, due diligence should also determine that the property isn’t in foreclosure, has liens or judgment encumbrances, easement issues, or environmental concerns. A good commercial real estate purchase agreement will make the transaction contingent upon title clearance in the hands of a reputable attorney or title company. This initial step will generally set into motion any and all due diligence necessary for the transaction. In other words, if a property is owned by an LLC and you want to buy it in your name or another LLC, title plans and it’s possible to do so. The same goes for any number of property features that you believe may be of concern. In fact, if such predicates to agreement have not already been addressed, doing so within the purchase agreement is vital. Suffice it to say, due diligence should be quantified and all contingencies should take full advantage of the period of time afforded by applicable state law. Some states, like New York, give only 10 days to perform due diligence while others allow for 30 days. In addition to title, other due diligence should include (but is not limited to): flood zone map review, environmental surveys (Phase I standard practice), requests for special permits (permits for signage, liquor, health care), inspections (certified commercial property inspector for structural, environmental, and lead smoke issues), factors affecting property value (economic, social, political, community incentives such as re-zoning), property condition disclosure statements (state or federal law may dictate or compel certain disclosures via statute or regulation), local government (zoning codes, development, redevelopment, site plan review standards), market analysis (profitability of location), and brokerage valuation.
Common Mistakes and How to Avoid Them
One of the most common mistakes made by buyers when entering into a commercial property purchase agreement is failure to read the contract carefully. The purchase agreement is your entree — a detailed roadmap of the obligations, rights, time limits and contingencies involved in the transaction. Other than an agreement for lease, it is the most important piece of documentation for commercial real estate and cannot be taken lightly. It establishes the framework for the purchase and sale transaction, and any alteration made to the purchase agreement can substantially impact the outcome for the buyer.
Bearing this in mind, fail to pay close attention to "boilerplate" clauses, language included in most commercial property purchase agreements. For example, since a purchase and sale agreement contains a provision that the agreement envisions a fully integrated and complete contract, many parties sign an agreement without realizing that there are any omitted obligations, terms or conditions. There may be a commitment to provide documents, such as plans or surveys, but they may not be a prerequisite to closing. As such, the buyer may lock itself into a contract where providing documents to the seller or even granting access to the subject property are optional. Failure to be extra-ordinarily careful will have you unintentionally signing away important rights.
Other pitfalls can arise from assuming that you are entitled to the return on the deposit in the event of a breach of the obligations in the agreement. Some purchase agreements provide for the forfeiture of the deposit in the event of a buyer’s default , although any changes to this standard must be expressly set out in the contract.
Another common pitfall is assuming that you are automatically entitled to any deposits made by the seller to third parties retained for work on the subject property. Sometimes, these amounts have been fully paid by the seller. However, if you do not expressly require the return of such deposits in the agreement, you may end up with an unpleasant surprise at the closing.
One of the potentially most contentious issues that can arise between the parties are the risks associated with "realty taxes" for the subject property. Since commercial real estate transactions usually involve an extensive negotiations process, sometimes critical details can get overlooked with respect to the final terms. The seller may lease back the subject property from the buyer for a period of time (for example, to give the seller time to relocate its business or to provide it with some sort of rental income). During the negotiation process, it is important to verify whether the buyer or the seller will be responsible for paying the realty taxes on the subject property while the seller is the tenant. If the seller is to be responsible for all taxes, the buy/seller should specify that such taxes are to be prorated since the seller will only occupy the subject property for part of the year.
The Importance of Real Estate Attorneys
Whether a buyer is new to the commercial real estate market or an experienced property investor, it is always important to have a real estate attorney review the purchase agreement. The experienced attorney will find issues that can mean the difference to the success or failure of the deal. The buyer deserves to know all potential problems upfront before committing to the deal. For example, the buyer may be unaware of a pending zoning change that can make future property use completely unfeasible.
An attorney will not only advise the buyer with regard to the language in the purchase agreement, but will also provide guidance through the many nuances and corners of the deal that are not expressly addressed in the purchase agreement. For example, within a multifamily deal, the buyer might not understand how a tenant’s notice to vacate affects rent receipts, etc.
An experienced attorney will be able to point out potential issues that could cause the buyer to miss critical deadlines, such as obtaining financing and conducting inspections and due diligence. An attorney will understand the different superstitions of each lender and the importance of certain lender requirements, which vary by type of loan.
The attorney will also work with the buyer’s team, including brokers, financiers, accountants, including ones experienced in real estate taxation, etc. A buyer can save thousands (and sometimes millions depending on the size of the deal) of dollars by understanding the intricacies of a deal. In addition, an attorney can advise the buyer if there is a better financial structure for the deal.
Closing the Deal
Once all the terms and contingencies have been agreed to and the contract is signed, the next steps include transferring funds, exchanging documents, and recording the deed. Some contracts will require the purchaser to deliver a deposit or earnest money along with a signed contract. This money is held in escrow until closing. If the deal falls through for reasons outside of the purchaser’s control, the deposit is returned to the purchaser. However, if the deal falls through due to the purchaser’s decisions or actions, the seller may keep the earnest money. The next step is usually an inspection period. During this time, the purchaser will have a chance to inspect the property. For raw land, the buyer may want to perform soil and other tests. If the deal is for improved space, the condition of the roof, HVAC, plumbing , and electrical systems as well as other items are often tested. These inspections help the purchaser to determine the value of the property prior to closing. If the purchaser identifies issues with the property during the inspection, it can be a good opportunity for negotiation regarding potential repairs and price adjustments. The seller could either agree to fix any items found in the inspection, lower the purchase price, or give a credit at closing to allow the purchaser to make repairs. After the parties reach agreement on these issues, the last step required of the purchaser is to bring the funds needed to close and sign the closing documents. The closing will typically happen when all parties are in agreement on the conditions of the deal. Most commercial deals close within 90 to 120 days from contract formation. Once the parties have completed these steps, the deed is recorded and the property is transferred.
