You have agreed to the terms of the loan or the purchase price. Now the really treacherous part of the journey begins: meeting all the requirements of the lender, seller or buyer.
Having been a lender, borrower, equity investor, buyer, seller, and primary owner of commercial real estate, I am amazed at how often a simple misunderstanding bogs down or even collapses a mortgage or acquisition deal. These problems appear after the handshake, after the crucial elements have been negotiated. Sometimes it is the writing of a document or the list of what is and is not included or allowed. Sometimes it’s qualification requirements or the timing of payments. These are almost always issues that can be resolved if both parties discuss it and, more importantly, listen.
Experience helps. Companies that don’t routinely invest in real estate are the most likely to stumble because they basically don’t understand it. They “don’t understand” why a document is needed or how the information should be used. Without that understanding, the documents and information may be incorrect or misleading, if not simply incorrect. Some general ways to prevent this are:
o Discover and report as much of a property’s history as possible early on to avoid last-minute discoveries. For example, say where you rented dry cleaning in a shopping center even though it closed or moved 10 years ago. An on-site dry cleaner always raises red flags for buyers or lenders who may end up owning the groundwater contamination. Old dry cleaners are especially scary because they operated before there were strict regulations on the chemicals used and their disposal. One of my loans was close to closing when we found out that the dry cleaner had moved from its original location about 12 years earlier. The old space was now under the newly expanded supermarket. Sections of the store’s sales floor had to be cordoned off so the environmental engineer could drill for soil samples. Finally, several months after the originally scheduled date and at considerable additional expense to the borrower, the loan closed.
o Ask why a document is needed. An owner of a well-located shopping center originally developed by his family 50 years earlier arranged new financing to upgrade the center and raise capital. As the loan closing date approached, the owner submitted the required “certified rental list” signed by the CFO. It’s just that he overstated the center’s rental income compared to the operating states. It turned out that the borrower was honestly listing all of the tenants and their rental agreement, except that not all of the tenants were actually paying their rent. Some of the long-term tenants were not collected rent while the center was disrupted by construction. The CFO did not realize that by certifying the income list he was certifying the income earned. Ultimately, the loan was closed but with the amount reduced to allow sufficient coverage from actual income.
o Question and verify the information you receive and do your own file search if you are the buyer. As the head of acquisitions for a company, the seller provided me with data on a property showing that a primary tenant paid their share of real estate taxes in addition to the base rent. But, the lease said that this expense was excluded. A review of the tenant’s file showed that the taxes were being collected and paid by the (temporarily) unaware tenant. But, we were buying the lease as written, not the income from a mistake. The seller reduced the price.
Even companies that routinely market and finance real estate need outside help, including:
o Experienced legal counsel to advise you on the application, loan commitment, purchase agreement, creation of a separate ownership entity, and other legal documents. What are the standard terms for some lenders could be an issue for individual borrowers depending on their partnership structure, other financial relationships, and jurisdiction. For example, a borrower made us give up the right to guarantee the loan.
o Environmental and structural engineers to officially report on the property and provide inside information. Lenders will generally require property condition and environmental reports, so try to use vendors acceptable to them. But get inspectors started during negotiations so they can alert you to potential deal-changing issues. In an acquisition, the price may be significantly affected or the transaction may be cancelled.
o As an owner, whether lending or selling, gather all your information before the start of the transaction. Make sure tenant files are up to date and all accounting is up to date. Let your followers know what is happening. A smart buyer will interview them. Also, you will need them to provide impediments and SNDAs. A couple of uncooperative tenants can close a deal.
Whichever side of the table is yours, and whatever the size of the transaction, make sure your team is on board and fully engaged from top to bottom. The president must be ready to sign documents promptly, just as the assistant property manager must promptly answer questions about the building team. When everything is ready, you should feel a great rush, a rush of satisfaction, that is!
Part II of this article discusses the nitty-gritty of the transaction, in particular, the due diligence checklist. (Oh boy!)
