The Importance of Dates

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Today, dear readers, I’d like to talk about dates. No, not those that emerge from swiping right - where’s the challenge there, btw? Or, for those frothy products of palm fronds that find their way into a shake. But, those calendar creatures that presage the passage of time. You see, dates are quite important in a commercial real estate transaction. Indulge me, as I share a few examples.
 
Time is of the essence. A fancy legal way to let you know - hey, pay attention! I learned this the hard way early in my career. We negotiated a five year lease. My guy ultimately wanted to buy the building. Thus, we convinced the landlord to grant us an option. Well, the date for exercising said right - by notifying the owner in writing - came and went as did our opportunity. Ooops! Fortunately, the title holder was forgiving and allowed us a bit of grace - but not before a finger wagging letter was sent our way. Contained within most commercial real estate agreements are these words - “time is of the essence.” Governed are all the dates - commencement, expiration, notices, and extensions. Wise agents calendar the important ones lest they blink past. I’m penning this post three days late. Hopefully, my editor will allow some latitude.
 
Leases. Leases memorialize the terms and conditions of landlord and tenant understandings. Generally, a commencement date signals the start. Early possession may indicate an earlier date under in which the occupant is granted access. Expiration occurs at the end. Easy! Not so fast. Don’t forget rent increases that bump throughout the term - typically on the anniversary and by a preset or calculated amount. Then there are expense reconciliation dates. Expect these in February. As mentioned above - extension rights such as options to renew, extend, expand, contract, and ownership options such as rights of first offer, refusal, to buy come with dates. Fortunately, in the case of options to extend - you’re afforded a window - like no earlier than nine or later than six months from expiration. Approaching expiration - you’ll make a decision to stay or move. Staying might be for an additional term or month-to-month. Yes. Dates are involved.
 
Escrows. Purchasing commercial real estate is a rather involved dance defined by days on the docket. A signed purchase and sale agreement is delivered to a clearinghouse of documents and dollars - AKA an escrow holder. Date of the agreement, yep. Date of full execution, sure. Dates for deposits to be received, uh huh. Date for additional deposits, boom. Ok, got it. But, lurking within the boiler plate are dates under which contingencies are outlined. How much time will a buyer have to arrange financing, inspect the condition of the roof, visit the city and check on uses, review title for any exceptions - etc. And. When will these time stamps commence? Upon buyer and seller signing the contract, seller delivery of an important document, preliminary title commitment or the opening of escrow? Yes, yavol, oui, and si! As you may have gathered - a cacophony of calendar credits consists. And ALL of the dates are as important as your first one with your significant or as memorable as waiting in line on PCH. You may be wondering - how does an agent keep track? Many employ a critical date calendar produced by the escrow holder. Or, we group certain waivers together. Or, we simply write into the contract language that reads - “the later of 30 days from opening of escrow or five days from receipt.”
 
So, don’t date yourself by using a paper calendar or singing “Eye of the Tiger”. Simply, use a modern tool that can provide calendar alerts - like when it’s time to head to Laguna and wait in line for a shake.
 
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. 

True Down Payment Amount

As you’ve read here a number of times - purchasing commercial real estate is a great way to build generational wealth. It’s like a jelly of the month club. By that, I mean the gift that keeps on giving! Many who read this column founded an enterprise housed in a parcel of commercial real estate which they also own. So. The occupying company earns income through its business operation and pays rent for use of the building. Company value increases over time and the address appreciates. A double whammy! Southern California has countless entrepreneurial stories whereby a generation took a risk, formed a company, bought a location and succeeding family members benefited. I have the privilege of counseling these family owned and operated manufacturing and logistics businesses. 

Recently, a conversation occurred which I believed column worthy. Specifically, how much should be allocated for a down payment when considering a buy? The easy answer is 10% of the purchase price if leveraged through the Small Business Administration and 20-30% when financed conventionally. Boom. Done. See y’all next week. But, there is substantially more to the story of originating a loan. So please stay tuned for a minute more. 

In addition to the 10-30%, suggested would be to budget for the following: 

Appraisal. Regardless of your lender choice - SBA, bank, insurance company, or hard money - an appraisal will be completed. Contained within the bank’s underwriting - this confirms the price paid is in line with the market. Plan on $2500-$5000 for this review. 

Environmental. Lurking beneath the surface of your purchase could be a problem. These unseen issues are caused by something toxic deposited in the soil. A review of the previous occupants in the building, messy neighbors, and the smokestack down the street combined with a look at old aerial photos - forms what is known as a phase I environmental report. Generally, this does the trick and provides a clean bill of health. If recognized environment concerns - such as stained concrete or containers of waste - abound, a phase II will be employed. Soil borings are sampled and tested. Recommendations range from no further action to remediation. Have you ever witnessed a pile of dirt inside yellow tape next to a gas pump at your local station? No. It’s not an episode of CSI. Aeration is one way to get the bad stuff out of the soil. Plan on $2500 for a Phase I to ?? If remediation is required.

Legal. You’re going to want an attorney to review the purchase agreement, title commitment, and draw your LLC formation documents. Budget around $10,000. 

Escrow and title. Sure. Seller pays for a standard policy but any lender policies or extended coverage are yours to bear. Plus, you’ll pay 1/2 of the escrow fees. Another $10,000 but dependent upon deal size. 

Survey. Not always necessary unless you’re after an extended policy of title insurance. Unrecorded easements, abandoned driveways, and recorded leases are typically not covered with a standard policy. Utility locations, property lines, and underground pipes are clearly mapped as well. $5000 is reasonable. 

Loan points. In addition to the interest payments due over the term of your debt - you’ll pay a percentage of your loan amount to the bank. 1-2% is pretty typical. 

Cost segregation. One of the really cool things about owning commercial real estate is the depreciation which lowers your income tax burden. The improved portion of your parcel - the buildings - can be depreciated over 39 years on a straight line. 1/39th each year. But, other components of the improvements such as walls, doors, glass, and air conditioning have a shorter useful life and if properly segregated - can be written off sooner. Usually your CPA can help with this. She’ll want to be paid, though. $15,000 seems fair.

Once you become the owner, gather and total your receipts. Add all you spent to the 10-30% down payment. What results is the “true” investment into your buy. 

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.

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