Authored By: Ryan A. Featherstone, Esq. firstname.lastname@example.org
Does the following sound familiar? You’ve been selling residential real estate for years, and you suddenly get a hot lead on a commercial property and you have the perfect buyer for it. Or perhaps client calls and says he wants you to show him some commercial property. You think to yourself, “I haven’t done commercial real estate deals before, but how different could it be?” Answer: Very!
The distinctions between commercial real estate and residential real estate transactions are abundant, and go well beyond the scope of a blog article. The below is meant to only highlight some of the more common differences and issues that may arise in commercial transactions versus residential transactions. My recommendation is to always bring on an experienced commercial agent to work with you on the deal, or alternatively refer the matter to the commercial agent and take the referral fee.
Valuation challenges: Locating “comps” can be more difficult in commercial deals due to the uniqueness of many commercial properties as well as the differing uses by the commercial businesses/tenants. Residential properties are much more uniform, with some exceptions, and the use is always consistent, i.e. it is a residence. There are also different approaches to appraising commercial property: e.g. “CAP” rates, income versus cost versus sales approach. The use of appraisers in determining value “pre-contract” is much more common in commercial deals.
Zoning complexities: Residential usage is a given in residential zoning districts. However, this is not as certain in commercial property deals, where specific usage and intent of the client must be verified as an allowed use within the district. As with residential property, there may be times when a certain usage or property attribute would violate current zoning laws. A review of the zoning history is needed to determine if you have a “legally non-conforming” (i.e. “grandfathered”) use or property attribute (e.g. setbacks or base flood elevation), and to determine how a sale (or buyer’s intended plans thereafter) may affect such grandfathering. This also needs to be verified in cases of planned redevelopment, as new improvements need to be built in compliance with current zoning laws.
Due Diligence concerns: The residential form contracts are very standardized, and allow for broad inspections during the defined inspection period with differing rights as to cancellation and repair requests. In commercial deals, the contract is often attorney-prepared; and therefore, it may be heavily in favor of one party over the other. Commercial properties and their use vary greatly; therefore, the due diligence required can also vary greatly. Many different inspections may be required during this timeframe. Residential properties typically involve general inspections, 4 point inspections, wind mitigation, and termite inspections. Commercial properties often involve additional inspections, e.g., environmental inspections (i.e. Phase I and Phase II), asbestos, or engineering and architectural inspections. Extra caution needs to be taken in inspecting commercial property. It is not uncommon that a commercial property was used for the storage of hazardous substances; therefore, an environmental soil and groundwater inspection may be necessary.
Financing: Residential properties have several commonly known options: Conventional, FHA, VA, USDA, seller-financing, private financing. Commercial properties have several other options, including: short term loans, interest-only, fixed rate, variable rate (tied to any number of indices), SBA loans (most common 7(a) and 504), business credit lines, equipment loans, blanket asset loans, cross-collateralization, or bridge loans. Collateral other than the real estate will often be taken by the lender, including UCC liens on business assets (e.g. furniture, fixtures, and equipment, other tangible assets, inventory, receivables, bank accounts). The client will also be required to sign an Assignment of Leases, Rents and Profits, assigning to the lender the rental income and other profits from the property in case of a default, along with a personal guaranty of the loan, as most often in commercial deals the purchaser/borrower is some form of business entity.
Lease Matters: In residential deals, usually the property is going to be owner-occupied, as a primary residence or second home. However, in commercial property deals, more often the property is leased, and therefore additional considerations must be taken into account. Careful review of the leases, rent roll, tenant estoppels, and confirmation of prepaid rents and deposits is always necessary to adequately review the profitability and cash flow of the property. Ensuring the tenant signs an agreement subordinating the lease to the mortgage prior to closing is important. This states that the lease is subordinate to the commercial mortgage (despite being prior in time to the mortgage), that the tenant shall not be disturbed by the lender as long as it is not in default of the lease, and that the tenant agrees to “attorn” to the lender and accept the lender as the new landlord in the case of a foreclosure or deed in lieu of foreclosure.
Other Miscellaneous Matters: Potential “impact Fees” should be reviewed for new development or redevelopment to determine if the property acquisition makes sense for the client. These are often overlooked costs charged by local government to the property owner for offsetting costs of additional public services necessary for the development/redevelopment and other impacts to the surrounding area. “Complex access issues,” are another common commercial property related issue, for example, an out parcel property in a larger strip center. Does the out parcel have legal access and/or cross-easements over the strip center parcel? Does the outparcel have its own assigned parking? If not, easements will need to be negotiated, drafted and recorded. “Common Area Maintenance” (i.e. CAM) must be determined prior to closing for an adequate review of all costs associated with ownership. This may be passed onto the tenant(s) to pay in a net lease scenario, thus knowing what a potential tenant’s expectations are during due diligence is essential. Finally, the “Commercial Real Estate Sales Commission Lien Act” which provides that in commercial deals, brokers have the right to impose a lien on the seller’s net proceeds (not the property itself) to protect the payment of their commissions. This does not exist in residential deals.
If you ever find yourself deciding whether to take on a commercial real estate deal, it is always recommended to involve the services of a licensed Florida real estate attorney, and the services of an experienced commercial real estate agent, to help you navigate the murky waters of commercial real estate transactions.
This blog is intended for informational purposes only and it is not intended to be, nor should it be construed as, legal advice or legal opinion. The reader should not consider this information to be an invitation to an attorney/client relationship, should not rely on information presented here for any purpose, and should always seek the legal advice of counsel in the appropriate jurisdiction.