Must dos when purchasing a commercial building

I provide Location Advice to owners and occupants of manufacturing and warehouse buildings in Southern California. Today's post will deal with that "all important" must do list when purchasing a parcel of commercial real estate.

We will assume that you have made a decision to buy and have followed the  suggestions of a previous post on buying an industrial building. We will also assume that you have considered your financing source and have consumed the post on financing a commercial building.

You have agreed upon business points and have signed a letter of intent...now what? Hopefully, your location advisor will assist you though the process and will not just wait for escrow to close and the commission fee to arrive!

Generally and simplistically, here are the things you "must do".

Sign the Purchase and Sale Agreement: Also known as the PSA, deposit receipt, contract for purchase, escrow instructions, etc. I prefer the AIR Standard Offer, Agreement and Escrow Instructions for the Purchase of Real Estate. This document  is widely used in the state of California and contains succinct points on due diligence, financing, representations, warranties, remedies, deposits, liquidated damages, etc. Your contract should contain adequate time frames for you to secure financing and check out the building...structural (roof), environmental, title, operating systems (HVAC, plumbing, electrical, loading doors, fire sprinkler system), underlying liens, underlying financing, leases, etc. I generally ask for 30-45 days for "non-loan" approvals and 45-60 days for loan approval. The times are run concurrently from the opening of escrow (when both parties sign the PSA). Two items of note in the AIR PSA: Paragraph 7.1 obligates you as the buyer to use the services of the buyer's broker for a period of one year from the reference date...not big deal if you close...maybe a big deal if you don't. Paragraph 18.1 obligates the seller to pay a commission if contingencies are waived and you don't buy the building. I would suggest modifying or eliminating both of these paragraphs.

Open Escrow: You or your location advisor should deliver a signed copy of the PSA and any deposits to the escrow company listed in the PSA. As a buyer, you have some say in the title and escrow officer choice. I enjoy using a private escrow company because I get personalized service. My escrow company of choice is Heritage Escrow in Irvine, California. Janet Tilbury is extraordinary and my choice if you want to get the transaction closed with no brain damage.  Janet's phone number is 949.930.8501.

Order the Title Report (prelim) and the NHD: Your escrow officer accomplishes this for you. Once again, you get some say in the title company selected even though the seller pays for a standard owner policy. It is generally a good idea to have a real estate attorney review your prelim especially if the building you are buying is a condo, a PUD, or has an association. Any financing against the property will be removed at the close unless you are assuming the loan.

Review the NHD: The seller will provide you with a Natural Disclosure Statement which will tell you if the building is in a flood plain, seismic area, etc.

Conduct the necessary inspections, receive the reports and review and approve them: I would suggest engaging a company such as All West, Marc Cunningham to conduct a Property Condition Assessment (PCA). the PCA will review all of the building systems...HVAC, electrical, roof, foundation, plumbing, seismic, plumbing, elevators, sprinkler system, etc. and generate a report with any needed repairs and a capital expense schedule for the first five to ten years of ownership. Additionally, you or your lender will order a Phase I Environmental report which reviews the enviro history of the site and the previous uses. All West can also do the enviro but I would suggest routing this through the lender as some companies are not on the lender's accepted list and any loan made on the property will be subject to the environmental health of the building. The lender will also order an appraisal and any loan will be subject to a satisfactory appraisal at the agreed value.

Achieve a financing commitment: Make sure to build the appraisal and enviro approvals into the loan approval so that the time frame negotiated for loan approval includes receipt, review and approval, of the necessary enviro and appraisal reports. If you are seeking an SBA loan, there are actually three approvals...the bank, the CDC, and the SBA. I would suggest not waiving any loan contingency until ALL of these approvals are received.

Waive contingencies: You will receive a PCA with recommended repairs, you will receive a loan commitment. I would suggest approaching the seller on accomplishing some major repairs depending upon the other points of the transaction. Once all are received and approved and you are satisfied with the seller participation (if any), you can waive contingencies. Understand that once you waive, your contingencies you will have liquidated damages if you fail to close because you default. Generally, your liquidated damages amount will be equal to your deposit.

Close the escrow: The fun part! Now you own a building, congratulations!

Financing a Commercial Building Purchase

I provide Location Advice for owners and for occupants of industrial buildings in Southern California. I recently authored a post entitled The Buying Motivation. I would encourage you to read this post before you consider purchasing a location as there are some factors to consider prior to making a large investment such as this. We will now assume that your company meets the criteria necessary to consider buying a building and must now figure out how to finance it. There are several ways to finance the purchase of a location...conventional, private party, seller financing or SBA financing. This post will discuss SBA financing in great detail as this form of financing is used by a large percentage of buyers who purchase commercial real estate in Southern California. I have enlisted the help of my friend and colleague, Mark Rozelle of Rozelle Financial to assist me in the explanation. You can contact Mark directly, by clicking on his name or company name. You will be redirected to Mark's email address and company website. Discussed will be a history of SBA financing, types of SBA financing, eligibility requirements, business qualifications for SBA financing, and the process of obtaining SBA financing for the purchase of a location.

History of SBA Financing: Mark explained that small businesses have been given a huge boost by the federal government through the Small Business Administration’s SBA loan programs.  These loans are almost always the best choice for a business owner when he/she wants to buy a commercial building, buy another business or capitalize the business with long term working capital.  In the most recent government fiscal year over $30 billion in SBA loans were approved.  These loans were split almost equally between the two SBA loan programs known by their government code section:  504 and 7(a). SBA loans are designed to help businesses be more successful.  By requiring smaller down payments to purchase real estate, they leave more cash to be invested into a business.  By offering lower interest rates, they help a company’s cash flow.  By financing business acquisitions when banks shy away, they keep small businesses active and growing. By providing permanent working capital they help businesses keep up with growth opportunities. The program is very efficient and tightly regulated to make sure that every tax payer dollar used by the program goes to help a company that needs it.

Types of SBA Financing: Mark identified the SBA as the only source of commercial real estate loans that require as little as 10% down.  Non-SBA loans usually require 25% down. When buying real estate, borrowers can also finance the tenant improvements and renovation of the building at up to 90% of the appraised value. The most important requirement to keep in mind is that the buyer’s business must occupy 51% of the building. Special purpose properties can only be financed to 85%.

Most real estate buyers prefer the SBA 504 loan program. This program provides for very low and long term fixed rates.  In this program a bank provides a 50% loan in first position and the SBA provides a direct loan in second position for 40% through a non-profit agency called a CDC.  The SBA loan is a 20 year fixed rate loan.  Bonds are sold every month to fund these loans, and the price on those bonds determines the rate.  Recently rates have been below 4.5%. The first TD loan differs in terms from one bank to another with the best rates generally tracking slightly above the SBA. The SBA has a prepayment penalty that declines over the first ten years, and bank loans often have penalties for the first five years or longer.

Alternatively, the SBA 7(a) program can be used to purchase real estate. With this program a bank provides a 90% loan and the SBA gives the bank insurance against a default.  These loans are generally adjustable, but a few banks offer fixed rate 7(a) loans. The loan fees are quite a bit higher and a lien may be required on your residence or other property. A prepay penalty that disappears after three years may make these loans the best choice for buyers anticipating a short term hold.

SBA 7(a) loans can be used to refinance certain real estate loans and other business debts.  Some rules apply to make sure the limited SBA funds are not used up on refinances. The loans being refinanced must have unreasonable terms, such as a balloon due soon or extremely high interest rates. 

Eligibility Requirements: According to Mark the SBA has a large rulebook that defines which companies can borrower through the SBA program.  These rules make sure that companies are not too large, too speculative, too passive or morally questionable.  This rulebook is available on line. You may access the rulebook by clicking here.  Since it is a PDF document, you can do key word searches for topics of interest.

Most businesses are eligible, but here is a list of some of the businesses that cannot borrow through the SBA:  non-profits, lenders, life insurance companies, foreign businesses, religious institutions, political institutions, businesses that exclude individuals and highly speculative businesses.  Many franchises are eligible, but some are not. Most individuals are eligible, but the following are not:  those who have neither US citizenship nor permanent residency status, those with liquid resources that are too great (generally more than the cost of the building for real estate loans), those who have defaulted on government loans previously and those with certain criminal convictions.  Mark can speak confidentially with you about your situation and advise about your personal eligibility.

Business Qualifications for SBA Financing: Mark continued by stating that businesses must be small to qualify.  There are two different standards for this determination.  For 504 loans businesses must have a net worth below $15 million and a two-year average after tax profit of under $5,000,000.  Some exceptions apply to these levels.  For 7(a) loans and as an alternative measure for 504 loans, the government has established a separate definition of small for each type of business based on either the number of employees or gross revenues.  In general, companies exceed the definition of small when they have a dominant market share in their industry.  The government doesn’t want to promote monopolies.  Very few businesses that seek SBA loans exceed the size standards. You can contact Mark to discuss your situation and confirm your company’s eligibility.

The Process: Mark cautioned that SBA real estate loans generally require a 45 to 60 day escrow, but if tenant improvements are extensive, more time may be needed.  These loans can also be used to build a new building, in which case the escrow cannot close till the construction drawings are complete and approved. There are several approvals and third party reports such as environmental and appraisal must be completed prior to funding.

Please visit the Rozelle Financial website for additional information or to apply for an SBA loan. You can also reach Mark by phone at 714.710.9400 or email mark@rozellefinancial.com.