Deal Issue? Now What?

Last week I reviewed the the steps in purchasing commercial real estate. Whether you’re buying to house your company’s operation or simply to enjoy the rent a parcel of commercial real estate produces, the steps are essentially the same. The possible exception could be the financing portion - which some investors abandon in favor of deploying large sums of cash into the buy.  

Today, I will complete the orbit and describe some challenges that can occur and some suggestions on how to overcome them.  

From last week: 

“Due diligence. Also referred to as a “contingency period”. Ranging from as few as 15 days to as long as 90 - a ton must occur during this time frame. Financing must be secured, title exceptions approved, inspection of the building - roof, electrical, HVAC, etc. accomplished, vesting documents drawn, financial aspects of the tenancy - if any - analyzed, and environmental health diagnosed. Whew! Within each of the main categories of approval - there are checkpoints which guide toward the end. Financing, for example, involves - credit of the buyer, the tenant, an appraisal, an enviro report, and lender concurrence. There’s a lot to be done in a short time. What if something isn’t approved? That, dear readers, is a subject for another column.” 

So, here goes.  

Generally, purchase and sale agreements include a mechanism for solving issues that arise in a deal. Specifically, the most widely used contract is published by the Association of Commercial Real Estate - AIR. Clearly defined within paragraph 9 are the various categories of approval items - inspection, title, tenancy, other agreements, environmental, material change, governmental approvals, and financing. Within the boiler plate language are roadmaps for resolution. If your contract is not the standard AIR form - results may differ. As always, it’s wise to seek legal counsel before engaging. But within the document - typically, offered are three choices - cancel, accept, or fix. A fourth creeps in which is a buyer and seller compromise.  

Indulge me as we walk through some quick examples.  

Let’s say a building inspector discovers the HVAC units are past their useful life. From experience - this is quite common. So, here’s what happens. The buyer objects to the condition of the cooling systems by disapproving a portion of the physical inspection contingency. You may be wondering. Wait, I thought the buyer was buying the building “as-is, where-is, with no seller warranties”. She is. But that refers to relying upon her inspection to alert her to any fixes necessary. Confusing? Yes, it is. Sure. A seller may simply refuse to repair or replace the units and cancel the escrow but cannot do so immediately. You see, here’s where the “mechanism” takes place. Buyer objects. Seller has 10 days to respond - yes, no, or maybe. A no vote on the recall - ooops, sorry. Wrong issue. If seller refuses, buyer can cancel the deal within another ten days, opt to continue and purchase with the faulty units, or accept a compromise - the “maybe” offered by the seller.  

Financing is trickier. You see, if the buyer is unsuccessful in their pursuit of a loan by the date specified - generally, the seller can walk away. Therefore, it’s imperative to be quite transparent with the seller during the loan approval process. Because prior to the financing condition date - there may be some leverage. If an appraisal comes back less than the contract price - which causes a lender to renege on the amount - it’s recommended to level with the seller. Sure. You or the seller can cancel, additional dollars can be added to adjust for the delta - accept, an appeal can be made to the lender - buyer fix, purchase price can be reduced - seller fix, or a compromise between buyer and seller can be struck whereby buyer adds some dough, seller reduces the price - and voila! 

I’ve witnessed these go every way you can imagine over my decades in the business. One certainty - there must be issues. It’s a thing. The next deal I close without one will be the first. But, fair warning. In today’s overheated industrial market, I’d not plan on a seller being terribly receptive to what’s referred to as a “re-trade.” Chances are there is a line of suitors waiting for the chosen buyer to blink.  

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.