Harbor City Real Estate Advisors, LLC - Investor Learning Center

510 Live Oak Drive
Mount Pleasant, SC 29464

843.805.8011 tel
843.805.8012 fax

HARBOR CITY INVESTOR LEARNING CENTER

MESSAGE FROM BROKER/TOC
A. MEASURING AND COMPARING INVESTMENTS
B. REAL ESTATE FINANCE
C. PURCHASE AND SALE ISSUES
D. LEASE LINGO AND LEASE NEGOTIATION ISSUES
E. REAL ESTATE TAX ISSUES

C. PURCHASE AND SALE ISSUES

1. Aside From the Purchase Price, What Are the Most Commonly Negotiated Issues in a Commercial Purchase Contract?
In the residential context, it is very common to make use of standardized form contracts. This is almost never the case with commercial purchase contracts. Instead, contract terms vary widely in their length, scope, and favoritism toward the buyer or seller. Commercial purchase contracts are sometimes intensely negotiated by the parties and their respective attorneys. Below is a summary of key issues that often are the subject of negotiation:

Earnest Money. The purchaser will typically try to “tie up” the property with a relatively small deposit. Especially during strong market conditions, a seller may demand a more substantial earnest money deposit so as to confirm that the purchaser is serious about the property.
Inspection Period and Liquidated Damages. A sophisticated purchaser will typically attempt to limit its liability in the event that it becomes necessary to cancel the transaction. While this practice is not customary in residential transactions, it is very common in commercial transactions. Thus, a commercial purchaser will almost always attempt to include contract clauses that: (i) give the purchaser a right to receive a refund of the earnest money in the event that the purchaser terminates the contract during a designated “inspection period” or “due diligence period”; (ii) confirms the agreement of the parties that, in the event of a termination by the purchaser after the inspection period has expired, the earnest money deposit shall serve as “liquidated damages”, with the purchaser having no further liability for damages.
Length of Inspection Period. A purchaser typically tries to negotiate a long inspection period (perhaps 90 days, 120 days, or longer with rights to further extend the inspection period), whereas the seller will desire to limit the length of the inspection period (a 30 day inspection period is considered short by commercial standards).
Special Contingencies. A purchaser may attempt to add a clause that conditions its obligation to close upon the occurrence of certain events that may not be completely within the purchaser’s control. A common example is a special contingency that releases the purchaser from its obligation to close in the event that a necessary rezoning application or site plan is not approved by governmental authorities.
Representations and Warranties. A purchaser will attempt to get the seller to make certain affirmative statements regarding the property. In contrast, the ideal seller contract includes an “as is” clause whereby the purchaser agrees that the seller has made no representations or warranties regarding the property.

2. What Is Meant by the Phrase “Due Diligence”? What Are the Key Elements of an Investor’s Due Diligence Investigations of a Potential Investment?
“Due Diligence” is a phrase that generally refers to a party’s investigation of a property. Purchasers, lenders and tenants all engage in various forms of due diligence. Since we are focusing on the investor perspective, below is a summary of key types of due diligence investigations that a purchaser might pursue in connection with a potential investment:

Title Review. It is critical that an investor promptly engage an attorney to conduct a title review as soon as possible after a property is put under contract. The attorney will often need significant “lead time” to coordinate the work of a title abstractor and surveyor. The results of the title search and survey are typically summarized in a “title commitment”, which is a commitment by a title insurance underwriter to issue a title insurance policy to the investor (and its lender), subject to the “exceptions” (e.g. easements, covenants, deed restrictions) to title set forth in the title commitment, and subject to the satisfaction of the “requirements (e.g. termination of the seller’s existing mortgage) set forth in the title commitment. This process is critical, as the title search may reveal defects in title that make the property undesirable as an investment.
Survey. A property survey is typically ordered in conjunction with the title search. There are different standards for the quality of the survey and it is important to distinguish an “ALTA” survey (required by some lenders) from other surveys. Among other distinctions, an ALTA survey requires that the surveyor actually review the title exception documents listed in a title commitment and either: (a) plot the exception on the survey; (b) indicate that the exception does not actually apply to the property; or (c) indicate that the exception does apply to the property but that the exception cannot be precisely located on the survey.
Lease Review. An investor (or his attorney) needs to review the terms of the property’s leases for the following purposes, among others: (a) confirm the net operating income that the lease with generate; (b) confirm the length of the lease term and the existence of any renewal options; (c) confirm if the tenant has any ability to terminate the lease early; and (d) confirm that the other legal terms of the lease are acceptable to both the investor and the investor’s lender.
Tenant Estoppel Certificates. It is customary for a purchaser to request an estoppel certificate from each of the property’s tenants. An estoppel certificate is an affirmative written statement by the tenant that, among other things, confirms the key terms of the lease and confirms that the tenant does not have any claims or offsets against the current landlord. A lender will often require that the estoppel certificate be addressed to the lender and that the lender’s preferred form of estoppel certificate be used.
Zoning. Inquiry should be made with the city or county authorities to confirm that the zoning of the property is consistent with the intended use. If the zoning needs to be changed, the purchase contract should specifically address that issue and provide a mechanism for the parties to pursue rezoning of the property, ideally prior to closing.
Environmental Review. It may be appropriate to order a Phase I environmental report to confirm that the property (or neighboring properties) are not contaminated by hazardous substances. For smaller investments, some investors elect not to incur this cost if they otherwise feel confident about the environmental condition of the property and if a Phase I report is not required by their lender. An “environmental screen” is a environmental review that is less expensive (and less thorough) than a Phase I report. Some lenders are willing to accept an “environmental screen” instead of a Phase I report for smaller investments.
Appraisal. Where a purchase is to be leveraged with borrowed funds, lenders almost universally require an appraisal of the property. Since an appraisal is a “lead time” item (some appraisers have a backlog of a month or more to generate an appraisal), it should be ordered as early as possible. Often, a lender will require that the appraisal be ordered directly by the lender, using one of their approved appraisers.
Special Issues for New Construction. Where land is being purchased for development, several additional investigations become necessary. These include: (a) preparation and government approval of plans and specifications; (b) analysis of construction costs; (c) confirmation of the availability of utilities; (d) soil compaction tests; and (e) confirmation of ability to obtain building permits.