Today I focus my work on the process of closing commercial real estate transactions. After all, I’m writing this post before Labor Day weekend, so it turned out to be premonitory.
Whether you depend on the rent generated or the utility gained by your business as an investor or an occupant, you go through a similar process to become a homeowner. Let’s dive in, will you?
Research is conducted, a candidate for purchase is selected and negotiation begins. Once the terms of the purchase have been settled between the buyer and the seller, a contact, the purchase and sale contract, is established. This part is relatively easy. Now the fun begins. The buyer and seller must now complete the transaction. What happens after the documents are signed is the subject of this column.
Buy and sell agreements, whether standard or exclusive, provide a roadmap on how to proceed. The price, funding, if applicable, due diligence period, receiver of escrow, title company, deposits to be opened, deposits once contingencies are raised and the closing period are all carefully defined.
Price. Fairly simple but generally a combination of cash and debt. The seller – unless a loan is granted – receives the full proceeds, less closing costs once the deed is registered. Can this amount differ from what is agreed? Yes. See “due diligence”.
Funding. A lot of the deals we see these days are funded but not subject to lender approval. Confusing? Yes. But this seller’s market, in which we are stuck, has produced this wrinkle. A seller may say, “Sure, mister buyer, go get a loan. But, failure to qualify will not allow you to cancel. Plus, if your lender is late – a hard taco. “
In a more conventional approach, a buyer seeks the loan proceeds to couple with their infusion of money to make the purchase. If she can’t get a loan, she leaves and her deposit is refunded.
Escrow. Usually in California, an escrow holder is a clearinghouse to accept the deal and conduct the symphony – also known as the execution of the deal. Deposits, documents, and closing instructions are all neatly folded into the job of an escrow holder.
Title. Most securities companies also have an escrow service, but frequently the two functions are separate. Your title agent will produce a preliminary title report at the start of your transaction. This uncovers items such as loans the seller must have repaid, easements, liens, status of property tax payments, legal description, and other “exceptions.” A commitment to insure a blank title will be issued. In the event of a problem, after closing, you are covered.
Deposits to open escrow. In trade agreements, there is no real standard. This is what the buyer and seller negotiate. However, these typically cost around 3% of the purchase price. If the buyer chooses not to make the purchase and before a contingency waiver, in most cases the deposit is returned.
Due diligence. Also called the “emergency period”, it ranges from 15 days to 90 days, and a ton of work has to be done during this period. Funding should be secured, title exceptions approved, building inspection (roof, electrical, HVAC, etc.) performed, acquisition documents drawn up, financial aspects of the lease – if applicable – analyzed and diagnosed environmental health. Phew! In each of the major approval categories, there are checkpoints that guide us through.
Financing, for example, involves buyer’s, tenant’s credit, appraisal, environmental report, and lender’s agreement. There is a lot to be done in a short period of time. What if something is not approved? That, dear readers, is a topic for another column.
Deposits once contingencies are lifted. You have crossed the gauntlet of contingencies and are at full speed. Now you are going to add some “skin” in the form of an increased amount of money to the escrow. By the way, deposits are generally applicable on purchase. But, once you nod your head, the deposits are non-refundable. Can you still back off? Sure. But not for free.
Closing. A cacophony of chords completes the transaction. Similar to a family reunion group photo, everyone must look at the camera and smile before the image can be captured. The lender finances the loan, the buyer adds additional dollars, the deeds of grant are filed and recorded, and the monies are distributed. The seller gets his, the buyer gets the title, the lender gets a trust deed, and the agents get their fees. Boom!
Allen C. Buchanan, SIOR, is Principal at Lee & Associates Commercial Real Estate Services in Orange. He can be reached at [email protected] or at 714.564.7104.