The commercial real estate purchase agreement is a binding document - a contract - that the buyer and seller of commercial real estate enter into after agreeing to the terms of the sale. There are usually multiple contingencies built into the contract such as if the buyer can obtain financing and the results of various inspections. Because of this, there is usually a timeframe that allows the buyer to go through these processes which varies from 30 days to 180 days.
The commercial purchase agreements in use across all fifty states are legal documents that describe the deal a buyer makes with the seller of commercial property to transfer ownership. It details whether it’s a cash transaction (this includes financing options) or whether some other type of consideration will be used.
At the execution of the purchase agreement, the buyer is often required to put down an earnest money deposit which they will be given a receipt for. The amount of earnest money put down as a deposit varies and is based on the agreement between the buyer and seller but typically ranges from 2% - 5% of the total purchase amount. It can be refunded to the buyer under most conditions and especially if issues are found during the due diligence process.
There are many types of commercial property available:
Apartments that have more than four units
Hotels and motels
Industrial spaces and warehouses
Undeveloped land that has been zoned for commercial use
Retail spaces which can accommodate a variety of tenants
Commercial property is unique because the price isn’t determined solely based on comparables but also on how well the property is run. If the property has no tenants then the price will be considerably less than a property in the same area with a full tenant list. In essence, the value can fluctuate based on the prevailing market.
From a practical sense, this means the value can increase quickly and it can also decrease quickly. Many people experienced this during COVID-19. With that being said, it’s often more lucrative than residential real estate if the buyer understands the market and manages the property well.
The first step should be for the buyer to do due diligence on themselves. Check their credit history to make sure it will allow them to finance a commercial property. If it’s an organized entity then the credit profile should be analyzed. The question is whether or not they’ll be able to get financing from a bank or other traditional financing institution.
At the very least those interested in buying commercial property should have a credit score of 680 or above and up to 25% of the purchase price as a down payment. Credit can be checked via the buyer’s credit card company for free or a third-party service such as Experian and CreditKarma can be used.
There are multiple ways to go about finding a quality commercial property. The method the buyer chooses will depend on their network and resources. Keep in mind that many of the best commercial real estate deals never make it to market because they’re snatched up via referrals. That’s why a real estate broker can be an asset when looking for commercial real estate. If that’s not ideal then there are many places to start a search such as:
Most commercial real estate sellers understand that the buyer isn’t paying for the property with cash they have saved up. Instead, they’re looking for those that have financing readily available so there won’t be an issue when it comes time to close the deal. Because of this, sellers usually won’t start the negotiation process until they see proof of financing. This can be in the form of a pre-approval or pre-qualification letter.
A pre-approval letter is a binding document from a bank or other type of financial institution. It shares the maximum amount that has been approved for the buyer, the applicable interest rate, and how large the down payment needs to be. Before a financial institution will issue a letter like this, they’ve usually done deep due diligence on the buyer.
A pre-qualification letter is a non-binding document from a bank or other type of financial institution that serves as evidence of the buyer being worthy of credit. It gives a general overview of the buyer’s financial position which includes things like income, debts, assets, liabilities, etc.
After a pre-approval or pre-qualification has been obtained, the seller will, in most cases, be ready to start the negotiation process. Before that, the buyer should make sure the property they’ve found meets their basic requirements in terms of size, type of property, location, etc. Once that is squared away, start by presenting an offer. Unless it’s an incredibly hot market, you should offer something lower than the asking price but not so low that the seller will be offended.
If you and the seller can agree on the price, it’s still necessary to hammer out other aspects of the purchase agreement such as the contingencies.
Purchase agreements contain contingencies which are clauses that state when and how the purchase agreement may be voided. These protect both the buyer and seller from being forced into a bad deal. For example, a contingency may be subject to securing financing. If the buyer is unable to finance the property then the purchase agreement is voided. That’s why sellers won’t usually talk to a potential buyer unless they show proof of their ability to finance the property. Other contingencies include:
Inspections - The buyer will do their due diligence on the property via a series of inspections. If new liabilities arise or something that wasn’t in the property disclosure supplied by the seller then the agreement can be called off.
Environmental - Environmental testing will need to be carried out and, depending on the results, the agreement may be voided.
Zoning - If the buyer wants to rezone the property or needs certain permits before they can set up their operations, this can be added as a contingency. For example, if they need approval for a waste processing facility.
Keep in mind that any kind of contingency is permissible as long as the buyer and seller agree to it beforehand and sign.
After all the terms and conditions have been agreed upon, it’s now time for the buyer to provide an earnest money deposit. This is a sum of money, usually between 2%-5% of the total purchase price of the commercial property, that is paid to the seller to show sincerity. It can be refunded if one of the contingency conditions is met.
Closing is agreed-upon beforehand and involves either a lawyer, a title company, or both. The intermediary will be responsible for verifying that funds have been transferred, all required documents are accounted for, and issuing a new deed to the buyer. It’s also at this point that the real estate agent will be paid their commission.
Unless it’s seller-held financing, the seller will receive full payment at the time of closing and the buyer will get the title which should be filled then submitted to the deed registry of their county or state.
This is a common tactic used by professional property investors to forgo taxes that would otherwise be applicable. It refers to IRS code 1031 which outlines the process that a real estate owner can use to avoid paying taxes after the sale of a property if they purchase another ‘like-kind’ property within a certain time after closing.
Like-kind property, as described by the IRS IRC 1.1031(a)-1(b), refers to the nature and character of the property as opposed to its quality. For example, if the property that was recently sold was retail space then the seller will likely need to buy retail property as well. If it was a 10 unit apartment building then they’ll likely have to buy another piece of residential real estate. The general timelines for a 1031 exchange are as follows:
45 days from closing to identify the real estate they want to buy
Within 180 days from closing, the property must be purchased
Section 1031(a)(1) provides an exception from the general rule requiring the recognition of gain or loss upon the sale or exchange of property. Under section 1031(a)(1), no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged solely for property of a like-kind to be held either for productive use in a trade or business or for investment. Under section 1031(a)(1), property held for productive use in a trade or business may be exchanged for property held for investment. Similarly, under section 1031(a)(1), property held for investment may be exchanged for property held for productive use in a trade or business.
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