Minimizing Your Risks in the Purchase Contract for a CRE Investment

Most investors leave the review of their property purchase contract to their attorneys.  However, having an understanding about what to look for and what questions to ask can pay off immeasurably-not only in dollars and cents but in time and emotional well-being.   Typically your real estate lawyer receives a “term sheet” from the brokers, detailing in broad strokes the agreement reached between you and the seller of the property.

Match the Purchase Contract to the Term Sheet
The first thing every lawyer will do is to compare the terms of the contract with those of the term sheet provided by the brokers.  This exercise will reflect the “meeting of the minds” between you and the seller and whether in fact, the seller’s attorney drafted what you believed to be the agreement in the contract.  Although verbal agreements can change subsequent to further negotiations, once you sign the purchase contract, you are obligated under law to comply with its terms and conditions.

Generally, the more flexibility  your attorney can write into the purchase contract, the better. The following contingencies are typical to include on the buy-side:

*Financing-especially these days it is vital that a well-drafted contingency be written detailing the buyer’s exit strategy should the financing anticipated fall through.  Otherwise, you risk loosing the deposit you put
down for the property.  In the event the seller is not willing to accept a financing contingency, an alternative can be offering to “leave some money on the table” just not the total deposit placed on the property.  Typically anywhere from 2%-10% can be negotiated in exchange of keeping the contingency in the contract and accommodating the seller’s concern of tying up the property without guarantee of closing.

*Consider negotiating your loan commitment terms early and broadly so that you decrease the potential of surprises at closing.

*Title Search- is the next paramount contingency that needs to be carefully addressed.  If the term sheet is silent as to any title violations, it is critical to draft a contingency allowing you to exit the contract should you and the seller fail to successfully negotiate any uncovered title violations. At times identifying the lineage of prior owners of a property can be challenging and can further complicate conducting a title search which offers you as the buyer notice of any potential claims.  (See:  Title Issues In Negotiating A Deal).

*Consider negotiating to keep an amount in escrow in the event a title issue is uncovered and needs to be resolved or alternatively, negotiate a discount off the purchase price to address an unforeseen title issue.  Typically, a provision can be drafted with the seller agreeing to pay up to half (1/2) of one-percent of the purchase price and the buyer paying the difference to resolve the title issue.

*Building Code Violations-are also important to write in as contingencies in the purchase contract should these be discovered  during the title search.  These too will need to be successfully negotiated between you and the seller in order to consummate the purchase.

*Environmental Inspection-is another vital contingency to ensure is written broadly in the contract in order to allow you as the buyer to get out of the deal should you uncover circumstances that would thwart your objective for the property or prove to be costly to eradicate.

*Engineering and Structural Reports-similarly need to be written broadly into the contract as these have the potential of having the similar devastating consequences as the environmental inspection results.

*Zoning-your ability to use the property for the purpose you plan is the foundation of making a successful investment. Consider retaining an attorney with zoning expertise in addition to your real estate attorney to ensure the property is zoned is for the purpose you plan for.

Careful Attention to Purchase Contract Provisions
Once having matched the term sheet to the purchase contract, and taking note of major contingencies to closing on the deal, the following provisions need to be carefully reviewed to ensure your protection AT and AFTER closing:

* Representations & Warranties-to the extent the transaction is not an “as is” purchase deal, careful review and
inclusion of any unforeseen circumstances need to be covered.  Although most deals will be “as is” any representations that are made by the seller need to be checked and a exit strategy detailed should the representations prove invalid.

*Review of all the leases and status of the leases needs to take place.  Check for non-payment or conflict of interest circumstances in your review to ensure you will  not experience challenges with your tenants once you take control of the property

*Request the Rent, Security and Payroll, if applicable, schedules for your review.

*Request service and maintenance contracts for the property past and for any on-going work.

*Ensure there are no legal or tax proceedings either against the seller or being pursued by the seller on behalf of the property.

*Request a pay-off letter from the seller of the existing mortgage on the property so that you know exactly what is owed, how much you want and need to finance, and whether an assignment of the loan is possible.

*Ascertain whether you will obtain a “warranty deed” for the property.

*Consult a CPA and determine what is the best legal entity in which to “hold” your property for tax and management purposes.

*If you are purchasing the property with more than one partner, consider creating two separate entities to allow for flexibility in the future, should one or more partners decide to exit the partnership and want to pursue a tax advantaged exchange of the property-or section 1031 exchange.

*In New York City it is wise to calculate anywhere from 8%-10% of the purchase price to account for closing costs involved in acquiring a commercial property.

[Data Source: Interview with Panel Expert, Thomas E. Kass-Commercial Real Estate Attorney.]