Buying a commercial property is a complex process. Your entire business operation hinges on your ability to obtain a good deal, and the most crucial aspect of achieving this goal is understanding the contract tied to the sale. For first-time buyers, there are a lot of unfamiliar terms riddled throughout the document. So, we've put together some of the most common terms found in a purchase agreement that every buyer should know to complete a successful transaction.
- Due Diligence
Due diligence is a legal term transferred into daily jargon resulting in a muddled definition. Due diligence is explicitly a purchaser examining a property before the transaction closes. There are different ways this examination is articulated in the purchase offer, but most include an assessment of the building, an environmental report, a title search, a survey, and a thorough review of the expenditures of the property. These financial obligations are usually fees for repairs, utility bills, taxes, and other maintenance. If a buyer fails to perform sufficient due diligence, there is a risk of getting stuck with an unattractive deal.
Purchase agreements will often find the term "easement" through when talking about commercial property. An easement gives the owner access to part of a neighbor's property. For example, using the private path or sharing a sewer line. Easements are also there to allow a landowner the right to access their property by crossing another's land under some circumstances. Easements are complicated by design because they are there to protect you and your neighbor. However, it's essential to understand what is an isn't expected of you.
Encroachment is on the same plane as easement because it has to do with neighbors. Any structure that uses the neighbor's property without permission is considered an encroachment. A "structure" could be anything from shrubbery to a fence post extending past a property line. These terms are outlined during the due diligence process when addressing the property line. Comprehension of this section will save you from potential lawsuits.
- Building Condition Assessment
Another term tucked under the due diligence umbrella is "Building Condition Assessment." It refers to an inspection of the property to identify any needs for repairs and to summarize the buildings overall condition. The assessment dives into structural components, the roof, walls, windows, and addresses any mechanical concerns like plumbing and electrical systems. The entire process is designed to give the buyer an opportunity to discuss major repair work and protects the seller from being held accountable after the deal has closed.
A blanket term, encumbrance covers a wide range of claims that are made on the property by someone other than the title holder. We've talked about some of the types of encumbrances already. For example, easement and encroachment both fall under encumbrance. Additionally, so does the lease, lien, mortgage, or restrictive covenant. All of these could result in legal difficulty for the property owner and in some instances make it difficult or impossible to transfer the title at the end of a sale. When you buy a commercial property, you want to understand any financial or non-financial, personal or non-personal implications you might face as the owner.
- Environmental Site Assessment
At one point in time, the U.S. government started having difficulties with highly contaminated properties. As a result, legislation was passed that makes a party responsible for maintaining the property and cleaning up any issues. The answer was the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA, commonly known as Superfund). By participating in an Environmental Site Assessment, you are hiring a professional trained to meet specific criteria to assess the property's environmental impact. The investigation covers the current and past use of the commercial property. By participating in this inspection, you are obtaining a certain level of protection in a situation where you might be charged with causing environmental damage and facing costly cleanups.
A survey is a comprehensive description of the legal address, the dimensions, the location of additional structures, additional structure's dimensions, and any easements or encroachments. Most buyers will complete their surveys of the property during the due diligence phase. However, this can become costly. As a result, many individuals purchase title insurance instead to protect themselves in case of any legal issues.
- Title Search
An examination of public records to confirm legal ownership. The query's results determine what legal claims are on the property. The title search is performed by a title company or a commercial real estate attorney. Their responsibility will include thorough research of the vested owner, liens or other judgments, loans on the property, and taxes due. The benefits of the title search give the buyer a preliminary report outlining areas of concerns. Fortunately, most issues are easily solved. However, some problems might take too long to rectify and may jeopardize the buyer's loan.
- Net Operating Income (NOI)
A calculation of your gross rental income minus your expenses, and it's a term that is central to your deal. The expenses don't include the mortgage or depreciation. They reflect only the money that it takes to maintain the property. If your property value increases, so does the NOI, and decreases as the value goes down. Being aware of the commercial property NOI will provide the buyer the opportunity to make money on the property when or if they decide to sell.
- Building Classifications
When it comes to commercial properties, there are three different classifications: A, B, and C. Class "A" buildings are newer constructions with modern amenities and available in premium locations. Buildings found in this classification often attract the highest rental rates. Commercial buildings that are less than four stories tall with an average amount of amenities tend to fall under the "B" classification. It's possible this building might have once been a class "A," but due to wear-n-tear, it was downgraded. Class "C" buildings are more than 20 years old and in need of major repairs. The locations of these buildings aren't as desirable, but rent is usually much lower. Understanding the classification of the building will help ensure you’re asking price is fair.
The best deals are done with the help of a commercial real estate attorney. At Rochford Law, we can help you effectively handle your project. Contact us today to learn more about how we can help you on your commercial real estate venture.
If you would like to learn about commercial real estate contracts, download our latest ebook on The Essentials of Commercial Real Estate Purchase and Sales Contract.