Real Estate

Buying and Selling Commercial Real Estate

By Will Van Vactor, J.D.

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Commercial real estate transactions are, with rare exception, more complex than residential transactions. They often involve larger sums of money and greater liability for both parties.

Unlike with a residential transaction, where the law provides basic consumer protections for the buyer, the law takes a neutral approach to its treatment of commercial transactions. This is because courts expect that both parties to commercial real estate transactions are sophisticated enough to understand the contract terms. Therefore, judges are more likely to hold the parties to the terms of any sales agreement, absent illegality or fraud.

For these reasons and others, both the buyer and seller should have professional help in negotiating and closing any commercial real estate deal.

How Commercial Property Is Valued

A large part of buying and selling commercial real estate is the process of determining a value for the property. By nature, commercial real estate is a unique product that may have no exact sales comparison. For example, a buyer may be looking to purchase a movie theater in an area where there is no other theater at all, much less one that has sold recently. In such a case, no comparison is available to help establish a market value for the property.

Commercial property also has an income component that adds to its value. The current and future income stream of commercial property is normally a factor when determining a sales price.

To help determine a proper sales price for commercial property, buyers and sellers often have to hire a professional appraiser to help set a price. Hiring a well respected valuation expert who will not be easily influenced by one party is important.

Negotiation and Due Diligence in Commercial Property Sale

Commercial real estate transactions are ordinarily subject to intense sales negotiations. During these negotiations, the buyer has leeway to determine facts that impact the value of the property and to attempt to gain concessions from the seller in order to offset any problems. This negotiation can ultimately impact the bottom line and whether the commercial asset makes or loses money.

While the doctrine of “caveat emptor” (buyer beware) does not often apply to buyers in a residential real estate sale, it still regularly applies to buyers of commercial real estate. Unlike in the residential context, commercial buyers cannot fall back on consumer protection laws if an aspect of the deal ends up not being fair, or if the seller didn't take proactive steps to warn them about material flaws in the property. Buyers of commercial property are expected to conduct due diligence. In other words, they must investigate the transaction thoroughly before making a decision.

Also unlike with residential property purchases, where only one inspector may be necessary to inspect the condition of the house, with a commercial property the buyer may need to hire multiple inspectors and experts. For example, you may need to hire:

  • a building inspector to inspect the building
  • a soil scientist to identify environmental hazards
  • a lawyer to review land use entitlements, title reports, and existing leases (and probably much more)
  • a business valuation expert to determine the financial strength and long-term viability of existing tenants, and
  • a surveyor to make sure the property lines are properly identified.

While conducting due diligence, it is important for buyers to use the information they learn to negotiate a fair price with the seller. If a buyer fails to do so, unless the seller fraudulently conceals material facts from the buyer, the buyer may have no recourse.

Who Assumes Legal Liability for Commercial Property

Another important aspect of buying and selling commercial real estate is the potential transfer of legal liability to the new owner. If commercial property is found to violate certain laws, it can be subject to government regulation. For example, once it is determined that a commercial property is the site of an environmental hazard, the current owner must clean it up, regardless of who created the hazard. An environmental or toxic waste cleanup can cost more than the property itself is worth.

The process of buying and selling commercial real estate requires various types of professional assessments to ensure that the new buyer is not taking on an eventual liability.

Loss of Liquidity

Commercial real estate transactions typically tie up large sums of liquid assets. In a down market, owners can have a hard time selling the property. Owners can also have trouble with tenants who do not pay rent, and vacancy rates that affect their ability to make ongoing financing payments on the property. If payments to the lender fall behind, commercial property is subject to foreclosure, just like with a house.

Typically, commercial real estate purchases come with a lot of long-term risk. This risk must be evaluated prior to making the purchase, to make sure it makes financial sense for the buyer.

A Commercial Real Estate Lawyer Can Help

The law surrounding the purchase and sale of commercial reseal estate is complicated. And the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a lawyer who deals in commercial real estate.

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