A typical commercial real property can be described as a property used for commercial purposes by business or commercial tenants. The selling process of commercial real estate is largely identical to that of residential property. A seller’s objective is to provide the information the buyer needs for investigation, make the deal tight while allowing the buyer to have the necessary contingencies, complete the sale, and walk away from the property without any lingering exposure to liability. Here are the five steps:
1. Letter of Intent (Accepting an Offer)
When a potential buyer makes an offer, they will typically do so by sending a letter of intent. The Letter of Intent will list key sales terms, such as the purchase price, approximate closing date, and the conditions that have to be satisfied before the closing, etc. While the Letter of Intent gives you an idea as to the outline of the deal, it is not a binding contract for anyone yet. It should specifically state that. The significance of the Letter of Intent is that it confirms both parties’ mutual interests in making the deal happen, as well as key terms such as the purchase price. After the seller signs the Letter of Intent, attorneys on both sides will prepare and negotiate an actual purchase and sales contract.
2. Purchase and Sale Agreement (Attorney Review)
The attorney for the buyer and seller will now work on an actual contract to buy and sell and will fill in any gaps in the deal while also negotiating terms that were not included in the Letter of Intent. Commercial real estate transactions have a lot more complexities than residential transactions and the contract will necessarily reflect such complexities, but the idea is the same in any real estate transaction: the buyer will inspect and investigate the property, obtain the necessary financing, and then close. The contract will address the tensions between the buyer and the seller, and a good contract will find the right balance.
3. Due Diligence Period (Inspection Contingency)
The commercial real estate contract typically includes a 30-60 day period of due diligence where the buyer will review the economics of the property, physical condition, the leases and the cash flow they generate, and other information about the property to ensure that the property is a good investment. A seller typically has to turn over a list of documents and information as due diligence materials. At the end of the due diligence period, if the buyer isn’t satisfied with what they find, they have a right to terminate the contract with the earnest money returned to them.
Two key due diligence materials are the leases and rent roll. Considering the fact that the life blood of commercial real estate are the commercial leases and the cash flow they generate, having a good and thorough documentation on this is very important. Information and documents on other expenses such as utilities and common area expenses are also typically requested by the buyer.
4. Financing Contingency
The contract remains contingent until the buyer secures a loan for the purchase. This is the last hurdle before a closing. If the buyer cannot secure a loan during this period of time, the buyer can still cancel the transaction and receive their full earnest money. For this reason, many sellers would like to make sure that they know enough about the prospective buyer’s finances and some sort of proof of funds or pre-approval letter from lenders before they accept the offer in order to minimize the risk of the buyer not being able to obtain financing.
Once the buyer successfully obtains a loan, closing will be confirmed. Typically, the closing will occur at a title company. The title company provides closing services such as receiving the funds from the buyer’s lender, wiring payoff funds to the seller’s mortgage lender, and handling recording deeds and other important closing documents. On the closing day, the seller will receive the sales proceeds, sign a deed that transfers the legal ownership of the property to the buyer, and the buyer pays the full purchase price in combination of earnest money, loan, and/or their own funds. In addition, the seller will prepare assignment of leases so that the buyer will now become the landlord in the lease documents.
The COVID-19 pandemic pushed the industry to go remote and many closings now occur remotely. The seller’s side can especially go completely remote with a little bit of advance planning (such as pre-signing the deed as the original deed is required for recording with the county recorder’s office).
If you are in need of an attorney for your real estate transactions, contact Mauck & Baker at 312-726-1243.