Unless you have been living under a rock, you know that we are still in a recession. Unemployment is still up, debt is out of hand, and commercial real estate values have not bottomed out.
It is a difficult market because while values continue to decline, the availability and cost of financing is more challenging than ever. With that said, there are real opportunities in commercial real estate for investors with liquid assets available.
But now, more than ever, investors must be sure to understand what they are buying and how to reduce risk in the purchase process. In particular, keep in mind these best practices:
1. Pair up the right property with investment goals. Most professionals get a dozen emails a day from people claiming that they can provide a “list” of the best commercial properties in town. But chances are good that this “list” will not help investors. If they understand their market thoroughly, they may be able to find a great property on their own. However, it is almost always better to retain the services of a commercial broker or other professional who understands the market and an investor’s specific goals.
And remember that the old adage “if it seems too good to be true, it probably is” holds true more than ever for commercial property purchases in a depressed market. Sellers know that they need to make properties visually presentable, so prospective buyers must be willing to look deeper than the new paint job on what may be a crumbling structure.
2. Use complete, professionally prepared contracts. Many buyers lean toward using a short, “off-the-shelf” contract for its simplicity, but a purchase may be hundreds of thousands of dollars and a thorough contract should not be sacrificed just to keep the deal “simple.” Any purchase contract must consider the broad range of issues that arise in a commercial real estate transaction, but sales in difficult times must be even more detailed to avoid issues down the road.
A well-written contract will also require tenant estoppels, subordination agreements, lease assignments and bills of sale where appropriate. A clearly written contract will detail the responsibilities of each party, specify timelines and, most importantly, provide a clear exit strategy if things go badly.
3. Perform due diligence. Buyers often fear the cost of a thorough due diligence investigation. They think, “What if I spend a lot of money and find something horrible and the deal fails because of this? I will have wasted all that money.”
While inspections can be spendy, they can help an investor avoid closing on a property requiring thousands of dollars of repairs or remediation. An attorney or broker should provide a due diligence checklist that includes inspections of the roof, parking area, foundations and HVAC systems. Also, analyze ADA compliance and existing tenant leases.
Be sure to order a title report, get a new survey, double-check zoning ordinances and, after review, follow the advice of professional advisers. Be thorough and object to any title matter that may be a problem. No one wants to find out later about that easement that runs right through the middle of the building. Sometimes, all one needs to do is ask and the seller or title company will remove an exception to title.
Another buyer nightmare involves hazardous materials. A new owner does not want to be left with contaminated property wondering where things went wrong. Phase I and, if necessary, Phase II environmental reports prepared by experienced environmental engineers can reveal environmental contamination, and a buyer can always require that a seller “hold back” money to be retained in escrow if the closing date needs to be firm because of a seller’s financing issues.
Be sure to walk and inspect the property and building. If there is a discolored stain on the dirt or a dripping transformer, do not brush it off as inconsequential. We may be able to afford a little ketchup on our shirts, but we know for sure we cannot afford even a little toxic spill on our land.
4. Be ready to close. When the closing date approaches, nothing should come as a surprise. Be sure that all property and documentation “ducks” are lined up well in advance. Ensure the lender is really ready to go and that all ancillary closing documents are deposited in escrow, including any amendments, title affidavits and other title-related documents.
A good title officer will be invaluable in this aspect of the transaction. Again, an attorney or broker should provide a closing checklist.
Buying commercial property at any time can be complex and tedious. But to be fully protected, particularly in a down market, a strategy of detailed due diligence in partnerships with experienced professional advisers will ensure a successful transaction.