Commercial Real Estate Purchase Agreements

What is it and why do I need one?

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.

When purchasing commercial property, your accounting team will go to great lengths to ensure that the financial aspect of the deal is handled in a thorough and accurate manner. This involves a close examination of the property's financial statements, tax records, and other financial documentation to ensure that the property has a strong financial standing and that the purchase price is fair and reasonable.

Your accounting team will also take steps to verify that the property is in compliance with all financial regulations and laws, including tax laws and reporting requirements. Additionally, the team will work to negotiate favorable financing terms, including interest rates, loan terms, and payment schedules, to ensure that the property purchase is financially feasible and sustainable. They will also work with other departments and professionals, such as lawyers and real estate agents, to ensure that the purchase process is completed smoothly and efficiently.

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 to 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
• Hotels
• 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 focusing on as you draft an agreement.

Common terminologies used in a commercial real estate purchase agreement

Consideration

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.

Earnest Money

This is 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 from the sale price upon closing. If a buyer backs out of 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, in which case the  buyer is refunded the earnest money.

Determining the amount to put down as earnest money is a delicate matter. You need to show 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

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.

Closing date

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.

Closing Costs

These are expenses incurred during the closing of the sale, such as title insurance, attorney's fees, and property taxes. It's important for both parties to have a clear understanding of who will be responsible for paying the closing costs.

Closing Statement

This is a document that outlines all the financial transactions related to the sale of the property, including the purchase price, closing costs, and any other expenses. It's important to review the closing statement carefully to ensure that all the transactions are correct.

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.

Owner financing

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

Escrow refers to an arrangement arrived at 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, and 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.

Effective date

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.

Estoppel certificate

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, 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. 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 he/she may suddenly encounter after the purchase.

Title Report

This is a report that provides information about the ownership of the property and any liens or encumbrances on the title. The title report is important for both parties to review to ensure that the property can be transferred cleanly from the seller to the buyer.

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:

Recitals

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 and their details such as names, addresses, and contact information. This part also contains an elaborate description of the property transferring ownership, i.e., its 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.

Financing

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.

Contingencies

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.

1. 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.
2. The buyer is also expected to make a deposit in the form of earnest money or a down payment to cater for expenses and utilities that arise in the transaction process as agreed with the seller.
3. For buyers, perfect accounting is essential in determining the financial viability of the property they are considering. By having a complete and accurate record of the property's financial history, they can better understand the potential expenses, income, and cash flow. This information can also help buyers to make informed decisions about financing options and to negotiate better terms.

Expected Seller Duties

1. 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.
2. Make sure any necessary permits, licenses, and existing leases if applicable, are in good order.
3. Maintain the property in sale until ownership is transferred. In some events, the seller might be required to provide warranties long after closing.
4. Stellar bookkeeping practices demonstrate the value and profitability of the property you’re selling. Detailed financial records help to provide a clear picture of the property's financial performance and can help to attract potential buyers. Sellers can also use this information to negotiate favorable terms for the sale, including the sale price, closing costs, and financing options.

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 suitable terms and duties.

Glossary

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.

General clause

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.

Closing

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.

The purpose of the general clause is to set the tone and expectations for how financial matters should be handled during the commercial real estate purchase agreement. This clause can include provisions related to payment methods, allocation of expenses, and the reporting of financial transactions.

It’s important that both the buyer and seller understand the general clause and agree to the terms laid out before the purchase agreement is signed. This helps ensure that the financial aspect of the transaction runs smoothly, avoiding any potential disputes or misunderstandings in the future. The general clause sets a clear framework for financial accounting and sets expectations for both parties to meet their respective obligations in a timely and accurate manner.

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.

The Necessity Of Good Accounting

A commercial real estate purchase agreement can be voided or terminated under certain circumstances, one of which is poor bookkeeping. Poor bookkeeping can result in incorrect financial statements and inaccurate reports, which can negatively impact the due diligence process. If a potential buyer discovers that the seller's bookkeeping is in disarray, it can cause them to question the accuracy of the financial information provided and raise concerns about the true value of the property. This, in turn, can lead to a termination of the agreement or renegotiation of the terms.

Furthermore, poor bookkeeping can also impact the ability of the buyer to secure financing for the purchase. Lenders require accurate financial information to evaluate the risk associated with a loan. If the financial information provided is not accurate or reliable, the lender may choose not to approve the loan or may require additional collateral. This can result in the termination of the agreement or a delay in the closing process.

Therefore, it is important for both the buyer and the seller to maintain accurate and up-to-date bookkeeping records to avoid any potential issues that may arise during the transaction process.

Important Tips

Buying commercial real estate can be a pain point for many investors and businesses. The long-drawn negotiations, the terms and conditions, among many other issues and legal documents to sign. In this chapter, I want to share quick tips that can help make the process smoother.

• 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 are 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.

Essential Bookkeeping Advice

• Clearly define the financial goals and objectives of the purchase. Make sure you have a clear understanding of the expected income, expenses, and return on investment.
• Hire a reputable accountant or financial advisor to help with the financial analysis and decision-making process. They can assist in developing a pro forma financial statement that outlines the expected costs and revenue associated with the property.
• Carefully review the property's financial statements, including tax returns, operating statements, and balance sheets. Pay close attention to the property's operating expenses, which can significantly impact the financial return on investment.
• Review the lease agreements with current tenants to understand their financial obligations and the impact they have on the property's income.
• Consider obtaining a property appraisal to understand the market value of the property and to verify that the asking price is in line with market conditions.
• Take into account the property's financial liabilities, such as outstanding loans or mortgages, property taxes, and insurance premiums.
• Create a contingency plan in the event that the property's financial performance does not meet expectations. This may include negotiating with the seller or finding alternative sources of financing.
• Consider seeking out professional tax advice to understand the potential tax implications of the purchase and to determine the best structure for owning the property.
• Make sure you have a clear understanding of the payment terms and conditions, including the down payment, monthly payments, and any potential penalties for missed payments.
• Keep accurate and organized financial records throughout the purchase process. This will make it easier to track expenses, analyze financial performance, and comply with tax regulations.