What are ‘pro-rations’?
Often there are taxes and utility bills that cover periods both before and after the closing. These expenses need to be allocated between buyer and seller. In the real estate industry, these allocations are called "pro-rations."
To avoid problems at closing over the details of these pro-rations, you should describe the mechanics in the sales contract.
Do contracts for the sale or purchase of commercial real estate have to be in writing?
Yes. A real estate agreement that consists only of an oral understanding and a handshake will not be enforced by a court. An ancient law called the Statute of Fraud requires that real estate sales contracts be in writing.
A contract does not have to very fancy to be valid. If it describes the property and the price, it usually will be enforceable in court. Obviously, however, it is not a good idea to rely on a bare-bones contract when you purchase commercial real estate. You need much more detail.
What does ‘escrow’ mean?
It’s simply an arrangement where a third party – such as a title insurance company or a lawyer – holds money or documents and distributes them according to instructions from both parties.
In a commercial real estate transaction, for example, the escrow agent may obtain funds and documents from the buyer, the seller, and the commercial lender. When everything is ready, the escrow agents make sure the money and papers wind up in the right hands. Escrow agents make transactions flow smoothly and reliably.
If I am buying commercial real estate, what should go into my contract?
Since every real estate deal is different, you will need to get advice from lawyer on how best to protect your interests in the contract. Typically, however, your contract should address at least the following issues:
(1) An exact description of the property you are buying, including the land surrounding the building.
(2) The purchase price and whether it is all due at closing or in installments.
(3) A list of any equipment or personal property that is included in your purchase.
(4) Any contingencies that must be met before you are obligated to complete the purchase, for example, you can make the deal contingent on your ability to get a mortgage loan.
(5) How property taxes and utility bill will be pro-rated (allocated) between you and the seller.
(6) The type of title evidence or title insurance the seller must provide.
(7) The date for closing and delivery of possession.
(8) What legal recourse a party has if the other party defaults.
Your lawyer may advise you to include several other provisions as well.
What is a ‘deed of trust’?
It is very similar to a mortgage. With a mortgage, you continue to hold full legal title to the property you have bought but you give the lender a lien on the property. If you do not make your mortgage payments, the lender can foreclose on the property.
In some states, a deed of trust is used instead of a mortgage. With a deed of trust, you give the lender a deed to the property but the lender can only use or sell the property if you do not meet the loan terms.
As a practical matter, there is very little difference between these two methods of giving the lender a security interest in the property.
My lease agreement on some commercial property rental states that I am responsible for all property taxes. The landlord forgot to tell me at the time of signing the lease that I was responsible for paying a school district tax on the property. Was this an error on the landlord?
It was up to you to inquire concerning the taxes due on the property. The reference was in the lease giving you notice. There are so many taxes on properties, and they change so often, that to have addressed each and every one, and to inform you whether any that are listed are still applicable, is more than what the laws require for disclosure.
What are fixtures?
They are the parts of the building that are permanently in place and which cannot be removed without damage to the building. The plumbing system is an example. Usually, fixtures are included when you buy a building.
On the other hand, items that are not attached or are easily removed are considered to be personal property. Office equipment is an example. Usually, personal property is not included when you buy a building, unless specifically listed in the sales contract.
Some items (like a window air conditioner) might fall into either category. To avoid disputes, it is a good idea to specify in the sales contract how such items are to be dealt with.
How can I stop someone from using my residential driveway for commercial purposes? I have a deed to the property.
If it's a private driveway that serves only your house, install a gate. If residential traffic is allowed, but commercial traffic is not, hire a real estate lawyer to obtain an injunction forbidding the offender from routing commercial traffic over the driveway and requesting damages for past instances of same (excessive wear and tear on driveway).
How should I take legal title to commercial property?
You can, of course, take title in your own name. But you may want to consider forming a corporation or limited liability company (LLC) and putting the legal title in the name of the business entity. This requires more paperwork and a bit more expense, but you limit your personal liability if someone gets hurt on your property.
By limiting personal liability, you decrease the risk that you could lose your other assets such as your home and personal bank accounts if there is a big verdict in favor of an injured person.
Your lawyer can help you decide if putting your commercial real estate into a separate legal entity is the best thing for you to do.
What is an option?
It is a right a seller grants a buyer to buy real estate within a certain period of time. For example, suppose you are interested in buying an office building but want more time to investigate the cash flow and compare this building to others in your area. You might offer to pay the owner an option fee to tie up the property. In return, the owner might be willing to grant you the right to buy the building within a certain period (say, six months) at a stated price. The owner would not be able to sell to anyone else in meantime.
You could agree that all or part of the option fee would apply toward the purchase if you decided to actually purchase the property. If you did not exercise your option, you would forfeit your option fee.
Can a deal go ahead even if there is a defect in the legal title?
Yes, the buyer is always free to accept the risk of a title defect, but should first consult with a lawyer to make sure the risk is minimal. There often are ways to reduce the risk to manageable proportions. For example, the title insurance may be willing to insure over the risk if appropriate affidavits are signed or if money is placed in escrow to cover the risk. In some cases, the seller may be willing to put money in escrow so there are funds on hand to pay off a construction lien if the lien holder goes to court during the statutory period and wins.
Or if there is a boundary line dispute, you as the buyer may decide to buy the property anyway if only a small piece of the property is involved in the dispute. Your reasoning may be that even if you lose the disputed area, the remaining land that you are buying is well worth what you are paying.
Similarly, if there is some problem with the building itself – say, a defective heating and air conditioning system – and the seller is not willing to fix it, you may decide that you are getting such a good deal on the building that you will proceed with the purchase despite the defect.
What are contingencies?
Contingencies are escape hatches in a real estate contract. They let you walk away from the deal without penalty if certain conditions are not met. You might, for example, sign a contract to buy a building, but make your obligation to close contingent on things such as the following:
(1) Your being able to get a mortgage loan of at least 75% of the purchase price.
(2) Your having a contractor inspect the condition of the building and your being satisfied with the contractor’s report.
(3) Your determination that the building can be renovated to your satisfaction.
(4) Your being satisfied with a report you will order concerning environmental hazards.
Your lawyer can help you put the right contingencies in the contract for your deal.
What is ‘eminient domain’?
It is another word for condemnation – the right of the government to take private property for a public purpose, for example, to make way for a road. The Constitution requires the government to pay you fair compensation if it takes your property.
I am interested in buying a building but my intended use is not permitted under the local zoning ordinance. What can I do?
You may be able to get the zoning changed or perhaps the local zoning board has authority to grant you a variance or exception so that you can use the building the way you would like to. See our section on "Zoning" for more information.
One way to proceed is to sign a sales contract, but include a clause that makes your obligation to close contingent on your being able to change the zoning or getting permission from the local zoning people for your intended use. Another possibility is to get an option from the owner, and then investigate the possibility of a getting the zoning the way you want it. If you get what you want during the option period, you can exercise your option and buy the property.
What is a ‘nuisance’?
Legally speaking, it is some condition on your property or some use of your property that interferes with a neighboring owner’s ability to enjoy their property. For example, if dense smoke or loud noises are emitted from your property, a neighboring owner can claim it is a nuisance.
A judge may require you to stop creating the nuisance and to compensate the other owner for any losses.
I am looking at a small shopping center that I may want to buy. How do shopping center leases work?
Quite commonly, the tenant pays a base rent – often tied to the amount of square feet the store occupies. In addition, the lease may require the tenant to pay a certain percentage of gross sales.
Shopping tenants often contribute a portion of the expenses of maintaining the common areas of the shopping center and may also pay for part of the property taxes.
I have a contract to purchase a building. What if the seller refuses to close?
If you have done everything required of you in the sales contract, you can go to court and seek "specific performance" – a judge’s order requiring the seller to transfer the property to you.
As an alternative, you can sue for monetary damages. For example, if the contract has a purchase price of $500,000 and you can show its fair market value is $550,000, the judge may award you the $50,000 difference.
Should I be concerned about environmental problems in purchasing commercial property?
Absolutely. If the building or the surrounding land have been contaminated by hazardous substances, you could face a very expensive clean-up mandated by state and federal laws.
You need at least a Phase One Environmental Report to help you evaluate the environmental risks. It is also a good idea to require the owner to give you a disclosure statement listing any known hazards or possible hazards.
The seller is suggesting that we sign a letter of intent before we prepare a contract. Is this a good idea?
Often it is. By signing a letter of intent – especially in a complex transaction – you know earlier on that you and the seller agree on the major terms of the deal. Obviously, it is better to know this before you put time and expense into preparing the contract itself.
A word of caution, however: The letter of intent should state specifically that it is not a binding agreement. Only the contract itself should be binding. The devil is in the details; you want to be free to get out of the deal if, later, you and the seller cannot reach agreement on the details of the contract.
Consider having a lawyer draft – or at least review – the letter of intent.
A building I am considering is occupied by several commercial tenants. If I buy the building, can I evict them?
Generally not. If a tenant has a legally valid tenancy, i.e., a written lease, and is current on the rent and all other lease obligations, the law usually lets the tenant remain in possession until the end of the lease, regardless of who owns the building.
Your best bet is to ask the owner for the legal status of each tenant since your ownership of the building will be subject to those leases. It is a good idea to get the seller to get an "estoppel certificate" from each tenant. You may need a lawyer’s help in evaluating how to deal with the tenants.
What happens if there is damage to the property from fire, hail, flood or windstorm during the term of the contract and before closing?
In most states, if your contract does not cover this subject, the risk of loss is on the seller. In other words, if the building is damaged by fire before the closing, the buyer can cancel the purchase unless the seller restores the building to its prior condition.
Since this is an important issue, it is best to cover it in the contract rather than to rely on the prevailing law. You and the seller can tailor this term to meet your own needs and wishes. In case of a legal dispute, a judge or arbitrator will make every effort to carry out the intentions of the parties as stated in the contract.
What is a ‘work letter’?
It’s a letter signed by a commercial landlord and a commercial tenant dealing with all the issues pertaining to the build-out of the tenant’s space.
Sometimes it is a separate letter. Others times it is simply an exhibit attached to the lease.
What is title insurance and why do I need it?
Title insurance guarantees that you are receiving full legal ownership of the commercial property that you are buying. If a lien later shows up or it turns out some other property owner has the right to use your parking lot, you can sue the title insurance company to recover any loss that you have suffered.
Having a title insurance policy takes much of the legal risk out of buying a building. Usually the seller pays the insurance premium for this coverage but sometimes it is paid by both parties or the buyer alone.
What legal recourse does a buyer or seller have if the other party refuses to close?
Typically, a sales contract drafted by a lawyer will spell out the remedies for default. For example, if the buyer defaults, the contract may say that the seller can keep the deposit as liquidated damages.
If there is nothing in the contract dealing with default, then in most states, if the seller defaults, the buyer can go to court and seek an order of specific performance. This order commands the seller – under penalty of being held in contempt of court – to transfer the property to the buyer upon payment of the agreed purchase price. This is based on the assumption that each piece of real estate is unique and that money alone may not adequately compensate the buyer for loss of the desired property.
Alternatively, the buyer can sue for difference money damages: the difference between the contract price and the fair market value of the property (assuming it is higher than the contract price). The buyer may also be able to recover consequential damages such as mortgage application fees and appraisal fees paid in reliance on the contract.
I have heard the term ‘build-out.’ what does it mean?
Every business has its own jargon and the commercial real estate business is no exception. Many office and retail buildings start out with tenant spaces consisting of little more than four walls and a door. The idea is that the spaces will be finished to meet the specific needs of each tenant.
The process of finishing this raw space is known as the "build-out." There can be extensive negotiations between the building owner (landlord) and the tenant over:
(1) What improvements will be made?
(2) Who will pay for these improvements?
(3) Who will be in charge of getting the work done?
(4) What will the tenant be permitted (or required) to remove at the end of the lease?
When is either party obligated to pay a broker’s fee upon the sale of commercial real estate?
First of all, for either party to owe a broker’s fee (often called a commission), there must be a written agreement (often called a listing agreement) signed by the party who is to pay the fee. No agreement, no fee. The fee is usually stated as a percentage of the sales price.
Assuming there is a written agreement, it alone will determine when the fee is owed. Commonly, the fee agreement will provide that the seller will owe the broker’s fee when the property is sold to a person produced by the broker during the listing period – 90 day or six months, for example. The fee agreement may also say that the seller owes the broker’s fee if the property is sold to anyone during the listing period, whether or not the buyer was produced by the broker.
In some commercial real estate deals, the buyer and seller agree to split the broker’s fee.
Commercial Real Estate in Frederick, MD
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