Purchasing Commercial Real Estate
How much do you know about the process?
June 18, 2013
Some businesses purchase real estate to house their operations. Transactions to buy office buildings and warehouses are similar. Residential purchasers will recognize many similarities as well.
After the parties agree on a price, seller’s counsel will send a contract to buyer’s counsel and request a down payment. Buyer’s counsel should carefully review the contract. Depending on the language and nature of the property, negotiations can be extensive. In the contract, the buyer will request “representations” about current information (e.g., the presence of tenants) and “warranties” about future conditions (e.g., there will be no tenants at the time of closing). Parties will request covenants promising future action (e.g., the seller will remove tenants). (A purchaser may want to retain all or most tenants.) If the parties agree to convey business property along with the real estate, sales tax must be paid.
Upon signing, if the buyer has not already provided a down payment, the buyer must send one with the signed contract. The title company or seller’s counsel will hold it in escrow until closing. If the closing does not occur, under certain conditions, the down payment will be refunded.
Usually, the buyer will apply for a mortgage to finance the transaction. If approved, the bank will issue a commitment letter specifying the basic terms. If the seller has a mortgage with favorable terms, the lender may authorize the seller to assign it to the buyer. In that case, the buyer becomes responsible for the balance of monthly payments. This will reduce the buyer’s mortgage tax. Mortgage tax is paid on “new money” lent by the bank. For example, if the buyer needs $1 million in financing, and $250,000 remains due on the seller’s mortgage, if there is an assignment, the buyer will pay tax on only $750,000.
The bank will require the property to be appraised to determine the collateral’s value relative to the loan. Also, the bank will require the buyer to obtain liability and fire insurance.
Buyer’s counsel should retain a title company to investigate the seller’s title. The title report will reveal whether the seller owns the property and whether there are encumbrances on it—including open mortgages to be paid, liens to be removed, or ongoing litigation. The title company will require a survey to discover the location of any easements and encroachments. The buyer should always purchase title insurance.
As part of its due diligence, the buyer should be sure that there is sufficient access into and out of the property for its intended use. The buyer should hire an engineer and pest inspector to examine the premises. In some instances, buyers should commission an environmental survey to determine if there is any contamination. If the building has tenants and the buyer will become a landlord, buyer’s counsel should examine all of the leases. If the buyer discovers significant problems, it can decide not to close or request repairs or a price adjustment.
There are two types of closings: table closings and escrow closings. At a table closing, the parties sit around a table and execute documents. In an escrow closing, the parties submit closing instructions to the escrow agent and complete their respective obligations over a period of time.
Before a table closing, buyer’s counsel will try to get estimates of closing costs so the buyer can bring certified checks. Due to discrepancies and unanticipated expenses, the buyer should be prepared to write additional checks at closing, if necessary.
Usually, a title company representative (i.e., a closer) runs the table closing and requests a variety of affidavits and signatures. The buyer will execute a mortgage. It is advisable to find out ahead of time when the bank will wire the funds so lender’s counsel can disburse them. Not infrequently, the parties end up spending hours waiting for the wire to arrive. When it does arrive, lender’s counsel cuts a check for the seller and other necessary parties (e.g., real estate broker, loan broker, title company). Then, the seller executes the deed (and bill of sale) in favor of the buyer.
If the wire does not arrive within a reasonable amount of time, the title company holds the deed in escrow. After payment, the title closer ensures that the deed and relevant documents are filed and local taxes are paid.
Editor’s note: This column does not constitute legal advice.