When a real estate deal stumbles, what fixes can be made? – Orange County Register
Last week I reviewed the steps in buying commercial property. Whether you are buying to house the running of your business or just enjoying the rental that a package generates, the steps are essentially the same.
A possible exception could be the financing portion, which some investors forego in order to invest larger sums in the purchase.
Today I’m going to complete the Orbit and outline some deal challenges that can arise and some suggestions on how to overcome them.
From last week:
Due diligence, also known as the contingency period, ranges from just 15 days to 90 days, and there is a lot of work to be done during that period. Funding needs to be secured, title exemptions approved, inspection of the building – roof, electrical, HVAC, etc. – carried out, deeds of ownership issued, financial aspects of the lease – if any – analyzed, and environmental status diagnosed.
Furious! Within each of the main categories of permit there are checkpoints that lead to the end. The financing includes, for example, a loan from the buyer, the tenant, an appraisal, an environmental report and the approval of the lender. There’s a lot to do in a short space of time. What if something is not approved?
That, dear readers, is the subject of today’s column.
So here it goes.
In general, sales and purchase contracts provide a mechanism for resolving problems that arise in a business.
The most widely used contract is published by the Association of Commercial Real Estate (AIR). Paragraph 9 clearly defines the different categories of permit items – inspection, title, lease, other arrangements, environment, material changes, government permits and funding. There are roadmaps for resolution within the boilerplate language.
If your contract does not conform to the standard AIR form, results may vary. As always, it is advisable to seek legal advice prior to employment. However, there are usually three options within the document – cancel, accept, or correct. A fourth can sneak in, which is a buyer-seller trade-off.
Pamper me as we go through some quick examples.
Let’s say a building inspector determines that the HVAC units have exceeded their useful life. From experience I can say that this scenario is quite common. So here is what happens.
The buyer objects to the condition of the cooling systems by declining part of the physical inspection need. You may be wondering, wait, I thought the buyer is buying the building “as it is, where it is, with no seller guarantees”. It is, but it also relies on its inspection to alert them of any necessary corrections. Confusing? Yes it is.
Sure, a seller can simply refuse to repair or replace the equipment and cancel the escrow, but they cannot do so immediately. You see, this is where the “mechanism” takes place. The buyer objects; The seller has 10 days to reply – yes, no or maybe. A no-vote to the callback – oops, sorry. Wrong problem. If the seller refuses, the buyer can cancel the deal within an additional 10 days, choose to proceed with the defective units, and accept a compromise – the seller’s “maybe”.
Financing is more difficult.
You see, if the buyer is unsuccessful in tracking a loan by the specified date, the seller can generally walk away. Hence, it is imperative to be fairly transparent with the seller during the loan approval process. This is because there may be leverage before the funding condition date.
If an appraisal comes back below the contract price – causing a lender to forego the amount – it is recommended that you catch up with the seller.
Yes, you or the seller can cancel, additional dollars can be added to make up the delta – accept, appeal to lender – buyer fixation, purchase price can be reduced – seller fixation or a compromise between buyer and seller can be struck, with buyers some batter adds, seller reduces the price – and voila!
I’ve seen these go in every imaginable direction over my decades in business. One thing is certain – there will always be problems. It is one thing.
The next deal I get without one will be the first. But fair warning. In today’s overheated industrial market, I wouldn’t plan for a seller to be terribly receptive to what is called “re-trade”. Chances are there are a number of admirers waiting for the chosen buyer to flash.
Allen C. Buchanan, SIOR, is a Principal at Lee & Associates Commercial Real Estate Services, Orange. He can be reached at [email protected] or 714.564.7104.