Commercial Real Estate Purchase Agreements
A commercial real estate purchase agreement also shortened for CRE purchase agreement or sometimes combined to one contract known as Commercial Purchase and Sale Agreement (PSA) is a legal document used in the transfer of commercial property in real estate between a buyer and a seller in exchange for a consideration (often monetary or through other means such as trade). It outlines in detail the property being purchased, terms and conditions, any inspections to be carried out, how the transfer will be financed, the parties involved, and their duties.
A commercial real estate purchase agreement is preceded by a letter of intent. Sometimes buyers will jump right into the commercial real estate purchase agreement, but it is always good document interest in commercial property first through an LOI.Upon drafting the purchase agreement, buyers are often required to make a deposit referred to as earnest money. This constitutes a certain percentage of the contract price (commonly ranging between 2-5%). Earnest money is refundable in the event of a valid dispute during the due diligence process before closing.
Examples of commercial real estate property that will require a purchase agreement during their sale are:
- Office spaces
- Industrial units, e.g., warehouses
- Apartments of four units or more
- Retail spaces
Check out this 12 minute guide by Tyler Cauble on how to purchase your first piece of Commercial Real Estate to gain a better understanding of what aspects of the purchase you should be focus on as you draft an agreement.
Common terminologies used in a commercial real estate purchase agreement
This is a benefit or anything of value that is given or expected in a valid contract. In a commercial real estate purchase agreement, consideration is what is expected in exchange for the real estate property. This usually comes in the form of money or in some cases, a share in future profits from the use/rental of commercial property.
Letter of Intent
A letter of intent is a formal declaration of an offer to get into a legally binding agreement between parties. It drafts out basic terms before arriving at serious negotiations to close on a deal. If you are considering the purchase of a highly-sought-after property, drafting your letter of intent at the soonest possible time is advisable.
This a deposit made by a buyer to relay their commitment to completing the transaction. It is usually a percentage of the property’s sale price, commonly ranging between 2-5%. Earnest money is deducted off the sale price upon closing. If a buyer backs out on the agreement, they forfeit earnest money to the seller who is compensated for damages unless the reason to back out is due to a breach in contingencies, then the buyer is refunded the earnest money.
Determining the amount to put down as earnest money is a delicate matter. You need to show to the seller that you are serious about trying to acquire the property he/she is selling. At the same time, you need to safeguard your financial position in case you find reasons not to push through with the purchase of the property. Check out this 2 minute video from The Commercial Real Estate Show to get some insight on determining an amount to put down.
Contingencies set out conditions assuming risks that may arise before the closing of a purchase agreement. Specifics such as expectations from all parties, timelines and cost estimates can all be part of a contract's contingencies.
This refers to the date when the property deed from the seller and the purchase price from the buyer exchanges hand. This signifies the successful end of the transaction and usually comes between 1-3 months after the signing of the purchase agreement/contract.Sometimes the buyer might not have the purchase price in cash. It may be in the form of a mortgage commitment letter in the case of third party financing.
Third-party financing happens when a buyer of real estate property purchases the property through the help of another party, usually a lending institution. For example, through a mortgage that is paid over a period of time.
When a buyer cannot get into a third-party financing agreement with a lender and does not have all the purchase price up front, they can reach an arrangement with the seller to pay them in installments.
Escrow refers to an arrangement arrived by both the seller and buyer in the commercial sale of real estate where they appoint a third party to hold an account for them. The third party is referred to as an escrow agent who should be neutral to both parties, e.g. an attorney. Check out this short video by the Investor Trading Academy to get a better understanding of what an escrow account is.
An escrow holds earnest money, down payment, property title, documents such as inspection certificates. At the point of agreeing to an escrow, both the buyer and the seller should agree on the terms and conditions to be fulfilled before the release of items held in escrow. This protects both of them from being shortchanged by either party.
This is the date both parties in a commercial real estate sale sign the purchase agreement, i.e. the contract binding them to the terms laid out.
This is a signed document from one party in a rental property ascertaining that there is a lease in effect, its validity, if the lease is in any default whatsoever, indicates the extent to which rent has been paid, by how much and if there is any amount paid in the form of a security deposit. The Commercial Real Estate Show features a short 1-minute video to help you understand the importance of a tenant estoppel certificate before you acquire commercial property.
An estoppel certificate in a Commercial real estate purchase agreement is mostly applicable when a buyer is interested in a commercial property that is already occupied by tenants. So the tenants (upon request from the seller/landlord) are the ones to sign the estoppel certificate. This certificate helps the buyer be assured that the property is free from any encumbrances that the he/she may suddenly encounter after the purchase.
What are the contents of a Commercial Real Estate Purchase Agreement?
Most states provide a guide on the sale and purchase of real estate property. Within the confines of these guidelines, buyers and sellers (with the help of an attorney) can customize their own agreement that is most suitable for their sale. Therefore, while there is no right way to have the outline of the agreement, be sure not to miss out on some of the following:
The first pages of a commercial real estate purchase agreement contain recitals. These usually begin with the preface – Whereas. Recitals outline all the major parties in the agreement, their details such as names, addresses, and contact information. This part also contains an elaborate description of the property transferring ownership, i.e., it’s address, location, title/deed to the property, if the title is in the legal ownership of the seller, if it has any lien attached to it, etc.
This section should clearly state the consideration, which is the total cost expected from the buyer, payment form i.e. if it will be through cash, third party financing, owner financing or any other agreeable mode.
Amount paid as earnest money should also be included, any down payment made and who pays for any ongoing expenses that may arise. This guide does not cover how to secure financing for commercial real estate. However, if this is something of interest to you, check out this short video guide from Bigger Pockets on what you can do to ensure your commercial real estate loan gets approved.
Depending on the complexity of the transaction, this section may be the bulkiest in a commercial real estate purchase agreement. It outlines all the conditions to be met by the parties involved before closing. These conditions may touch on financing, inspection/any applicable assessments and approvals. All these conditions should have a sequenced schedule and timelines to avoid omission.
Expected Buyer Duties
- The primary and expected duty of the buyer is to settle the consideration agreed upon in full.
- Due diligence - The buyer is expected to do his homework carefully on the property before closing. The principle of caveat emptor- “buyer beware” applies in that a buyer cannot seek redress for observations they failed to make when buying a property.
- The buyer is also expected to make a deposit in the form of earnest money, down payment to cater for expenses and utilities that arise in the transaction process as agreed with the seller.
Expected Seller Duties
- A seller is expected to give full disclosure of the property being sold i.e he should not purport it to be what it is not.
- Make sure any necessary permits, licenses and existing leases if applicable, are in good order.
- Maintain the property in sale until ownership is transferred. In some events, the seller might be required to provide warranties long after closing.
As mentioned earlier, the sale of commercial property varies from state to state. Hence the commercial real estate purchase agreement differs from transaction to transaction. It is your duty as a buyer to negotiate for suitable terms and duties.
This section contains all the applicable documents in use during the transaction. Most of these may be in the custody of an escrow agent if there is one. These include property title, mortgage commitment, estoppel certificate, inspection certificates, warranties, promissory notes, receipts of payments made etc.
In this section, it is common to find the legal clause outlining the implication of default or withdrawal of any party in the transaction, the recourse to be pursued, course of action if there are to be any changes permitted in the agreement or any other miscellaneous conditions.
If the transaction involved third parties such as brokers, the extent of their association can be outlined here if not documented elsewhere.
Here you will find the identity, date and signature section for the parties involved in the transaction. If the consideration is to be settled in tranches, then the agreed payment schedule will also be outlined in this section as well as any other costs e.g. insurance, attorney/brokerage/escrow agent fees and miscellaneous costs that may need to be paid on closing.
Can a commercial real estate purchase agreement be voided/terminated?
Earlier on in this guide, we mentioned that a commercial real estate purchase agreement is a legally binding document. However, does that mean that the agreement cannot be terminated? The answer to this is no. Under most state laws, a commercial real estate purchase agreement can be terminated if the seller does not make full disclosure on the state of the property being sold. This includes such things as the material used, any prevailing defects, etc.
Buying commercial real estate can be a pain point to many investors and business. The long drawn negotiations, the terms and condition among many other issues and legal documents to sign. In this chapter, I want to share quick tips that can help make the process smother.
- Always make sure the property is well described
- Due diligence is your friend in such deals. You’ll always unearth an issue that wasn’t disclosed
- Pay extra attention to any transfer taxes, both local and state
- estoppel certificates from the tenants is very important
- Go through any obligation placed on you and make sure they are not unreasonable, a lawyer will greatly help with this
- If you feel there is a lingering issue, do not close the deal till you address it.