Commercial real estate transactions are often complex and usually require more time to close than residential real estate transactions. The differences between a residential and commercial real estate purchase include the responsibilities of the buyer and seller. In a residential real estate transaction, the agents and lenders are subject to the Real Estate Settlement Procedures Act (RESPA). This act requires certain information to be disclosed by parties, agents, and lenders. Generally, this results in standardized forms, all focused on full disclosure of relevant information to the purchaser. However, many of the rules pertaining to residential real estate do not apply in commercial real estate. Therefore, it is important for the parties in a commercial real estate transaction to be diligent in the purchase process. The basic commercial real estate purchase process can be broken down into five broad steps. These steps represent fundamental and different sections of the transaction, although some overlap does exist.
Letter of Intent: After deciding to commit to a commercial real estate purchase, the first step is often a letter of intent. The letter of intent serves as notice to a seller, or potential seller, of a desire to commence transaction. Although letters of intent are designed to be non-binding, it is important to remain aware of the following common problems:
- Creating a binding notice—a letter of intent, if poorly drafted, may bind the parties to a transaction, even though its purpose was only to be informative or demonstrate intent.
- Option letter—a letter of intent should strive for brevity and simplicity. When the letter contains many requirements, or outlines very broad concerns, the letter can be interpreted by a court as nothing more than an opinion.
Escrow: While escrow can be routine for residential transactions, commercial real estate is different. Each transaction is unique to the parties and the escrow document should be drafted according to the specific needs of each party:
- Agreement—an escrow agent in commercial transactions must have specific duties delineated and assigned by the parties to the transaction.
- Release of escrow—a commercial real estate transaction typically requires written statements from both buyer and seller prior to release of funds, and a provision within the purchase agreement stating how and when these letters will be written.
- Absence of escrow—commercial transactions may not always require an escrow upfront. If the purchaser has sufficient credit or assets, the seller or lender may agree to establish an escrow only if the purchaser defaults on an obligation.
Signing Authority: Prior to the sale or purchase, the parties must be authorized to transact the deal. In residential real estate, it is usually easy to ascertain, but can be much more difficult when dealing with corporations and business entities.
- Named corporations—although a human being is conducting the transaction, the named party of the transaction will be the corporation or legally recognized entity. Frequently, the person authorized to conduct the transaction will be an officer of the entity, but it is important to ensure that both parties are represented by the appropriate individuals prior to proceeding with a transaction.
Due Diligence and Title and Closing Documents: Although these two areas are separate parts of the transaction, the steps involved are closely related. In residential real estate, due diligence is the responsibility of the seller through required disclosure documents and inspections from licensed agencies. In commercial real estate, this requirement is solely on the purchaser. The due diligence function can be accomplished by the purchaser individually, or by designated agents who may have expertise in a specific area. Whether conducted personally, or by a designated individual, it is important to ensure a thorough inspection and evaluation of every material aspect.
- Purchases subject to existing finances—unlike residential transactions where a typical sale will pay off the existing loan with proceeds going to the seller, commercial real estate can often maintain existing loans, transferring responsibility to the new owner after the transaction. Purchasers need to know what liens or financing restrictions exist on a property prior to making an informed offer.
- Options to purchase—commercial real estate is frequently subject to rights of purchase. Diligent research to ensure another entity or individual does not have an existing legal right to be a first purchaser or subsequent right to purchase at any time is required.
- Environmental matters—encumbrances on commercial properties is significantly more expansive than in residential real estate, with environmental regulations usually the most significant of all. Many states impose strict liability for environmental violations. Purchasing a property with existing violations due to lack of diligence in inspection could subject the purchaser to penalties.
- Closing process—when negotiating the final closing documents, focus on the essential terms and conditions important to each side of the deal, and ensure those considerations are properly accounted for explicitly in the language of the final purchase agreement.