Investing in commercial real estate sounds complicated, but don’t let that put you off. There are only a few minor differences between the closing processes for commercial and residential properties. In both situations, you will start with a purchase agreement and then inspect and research the property. However, the level of due diligence required from buyer and lender differs when buying and selling commercial property.
If you are considering buying or selling commercial real estate, it is essential to understand the process and terms involved. In this article, we will outline some of the key points to remember when entering into this type of transaction.
What is commercial real estate?
Commercial real estate refers to properties used for commercial activities rather than residential. These properties are rented for professional purposes and generate regular income. Residential buildings used for profit are also considered commercial real estate.
Commercial real estate is a broad term and covers a wide range of businesses. It can range from a large shopping center to a simple convenience store. Here are some broad categories of commercial real estate:
● Office space
● Shopping centers
● Multi-family rentals
● Hotels and resorts
The office space is further divided into three classes. Class A includes buildings with high physical quality and structure. Class B buildings are old compared to Class A, but their value can be increased by restoration. Finally, class C buildings are the least competitive and require maintenance.
1. Execute the purchase contract
The first step in a commercial real estate transaction should be the creation of a purchase and sale agreement. The agreement must be carefully negotiated and evaluated on behalf of each party. This is only possible if an independent lawyer is hired to represent each party.
The execution of purchase and sale agreements answers many questions that could arise after the conclusion of the agreement, as well as the settlement of possible legal disputes. The purchase agreement also initiates the creation of a preliminary title report and the opening of an escrow account. Any charges that could prevent the buyer from acquiring the property are disclosed in this report.
2. Escrow Account
Escrow agents monitor escrow accounts and release assets or money only when specific contractual requirements have been met. Escrow checks are also involved in residential property purchases. Yet they are stricter when buying commercial property due to the high financial numbers and complicated transactions involved. Usually, commercial properties need money from multiple sources, which requires more due diligence and a lot of paperwork. Escrow accounts can be a useful way to manage payment risk in commercial real estate leases. These include:
● Acts as a source of security against unpaid rent.
● Secures payment for development and maintenance.
● Provides exemptions and other permissions such as change of use and development approvals.
3. Due Diligence
A standard contract for the purchase and sale of commercial real estate provides time for the buyer to perform additional due diligence on the property. Before the sale is finalized, a buyer inspects the commercial real estate. This process includes assessing building conditions, performing environmental due diligence, and checking other records such as utility bills and taxes. The objective of due diligence is to confirm that the property is in good physical condition. Some due diligence procedures include:
● Ask the property manager about the maintenance and repair history performed on the property.
● Check light switches, tiles and raceways for damage.
● Collaborate with structural engineers to ensure the building is suitable for business.
● Determined the scope of renovations required and completed the process of budgeting for them.
● Review documentation to ensure there are no significant issues.
Investors should have a high level of confidence that the property is in good working order when the due diligence process is complete. The sale price may have to be renegotiated if damage is found. The investor can withdraw if the problem is serious enough.
4. Title Deeds
Title insurance protects buyers and sellers against losses resulting from inaccurate title deeds. You may need to make adjustments or discover inconsistencies like old leases for tenants who no longer live in the property. All must be removed from the property’s chain of ownership.
The chain of title has often come under scrutiny in recent years. It is essential to fully protect yourself whether you are buying or selling real estate, especially high value commercial property. It is also necessary to ensure that your title policy completely covers you from any problems that may arise in the future.
5. Keep a set of books and records
You should receive a complete set of property books and records. These include copies of tenant leases, property financial accounts and any work performed. Using this data, it is possible to assess the financial performance and physical condition of the property.
6. Remove contingencies
Inspections often bring to light defects in the asset or problems with financial records, which the buyer will use to negotiate a lower price. For example, if a buyer discovers that a tenant is not paying their rent on time, they can request an amendment to account for the possibility that the tenant continues to be a problem. Commercial buyers can claim credits for issues with the physical condition of the building. You can negotiate to remove these contingencies.
If you’re looking to invest in commercial real estate, don’t be put off by the complexity of the process. A standard purchase and sale agreement will provide time for the buyer to perform additional due diligence on the property before the sale is finalized. This includes professional inspections by architects, engineers and environmental consultants. They will assess building conditions and check for any environmental hazards.
They may also perform audits of accounts payable records or other documents such as utility bills and taxes. These inspections aim to ensure that everything is in order before signing any document related to the transaction. If any issues are found during these checks, they can be resolved to avoid delays.