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Due Diligence In A Commercial Real Estate Transaction

In the context of a commercial real estate transaction, a buyer performs certain due diligence in order to unearth issues affecting a property so that the buyer can properly evaluate his/her risk-and, ultimately to help the buyer make an informed decision about whether to proceed with the closing of the deal.
When purchasing commercial real estate, consider completing these items as part of your “Due Diligence”:
1. Property Inspection-  A thorough property inspection by a qualified and licensed inspector is imperative; and the best way for a buyer to discover potentially large and expense repair items.  Certain types of commercial properties may also require further investigation by a specialist, such as an architect, engineer, stucco inspector, etc.
2. Review Documents-  

Buyers often fail to take the time to review key documents that shed insight into the condition/operation of the property.  Buyers should always take the time to review current leases, past inspection reports, construction permits, zoning approvals, surveys, drawings, rent rolls, building plans, environmental reports, operating budgets, code enforcement letters, etc.
3. Environmental Testing– A Buyer should consider conducting Phase I and, in some cases, Phase II environmental testing–especially, if the property is of a type in which hazardous materials are used/stored or is located in close proximity to where such materials are used/stored. Many lenders will require a Phase I environmental study as a condition to providing financing.
4. Pay Attention to Timing– You need to allow for enough time to complete all testing and document review; make sure to negotiate a big enough time period in the Agreement of Sale to complete all due diligence needed to properly evaluate the risks of moving forward in the transaction.
Part of making a smart real estate investment is gathering as much information about a property as possible and minimizing your exposure to expensive repairs.

Financing Your Business Purchase

So, you have decided to leave corporate America and purchase your own business.  After months of research, you have found a great business for sale that suits your skills and passion.  Now…how are you going to pay for it?
One of the biggest challenges for entrepreneurs who want to purchase an existing business is coming up with the money to pay the Seller’s asking (or negotiated) price.
Here are some options to consider:

 

1. Cash– As we all know, cash is king. If you are fortunate enough to have saved enough money to purchase a business without having to obtain a loan, then you are in good shape–and, you will be making the Seller very happy;

 

2. Financing from a traditional bank-If your balance sheet and credit are very strong, you may be a candidate to obtain financing from a traditional bank.  Beware…many traditional banks will not finance certain types of industries such as bars/restaurants–especially if you have no prior operating experience;

 

3.  Seller Financing– Some sellers are willing to finance a portion of the purchase price.  In these situations, it is typical for the Buyer to sign a Note and pay back the Seller over a period of time with interest.  The Seller will also want some additional security for the loan.  Be prepared to come up with at least 50% of the sale price (and sometimes more) to be paid to Seller at closing.

 

4. Private Lenders– There are many third-party private lending groups that lend “hard money”.  Typically, these loans involve high interest rates and fees.  In many cases, borrowing  hard money is not the ideal situation for a buyer, but it may be the only option available.

 

5. Community Banks– There are several community and local banks that are aggressively seeking to lend–and, will often times provide financing in situations from which traditional banks tend to shy away.

 

6. SBA Financing– There are government backed SBA programs (Small Business Administration) that are offered through many banks. SBA loans can offer opportunities to less experienced owner/operators who also have limited cash to buy a business.

LLCs vs. Corporations

In today’s world, everyone with access to a Smartphone, tablet or laptop has the tools to start and grow a successful business.

From virtual assistants and freelance web designers to financial professionals, retailers and your best friend who’s trying to create the next hottest trend, the internet (and all of its social media platforms) has become a foundation from which businesses are built.

The common link that many of these entrepreneurs share is that they are part of a community that comprises the economic backbone of this country—the small business owner.

Although small business owners have a laundry list of crucial decisions to make, one of the most important is choosing the most beneficial entity structure for the business.  

While there are several options to choose from, the Limited Liability Company (“LLC”) and “S” Corporation (“S” Corp) are among the most common entities selected by small business owners.

What is a Limited Liability Company (LLC)?

Limited Liability Companies are a hybrid between a partnership and a corporation. They typically do not require the same formalities that must be followed by a corporation.  Additionally, the LLC combines pass-through taxation while simultaneously offering limited liability to its owners (members).

Pros to LLCs

  • Number of members: Unlimited
  • Taxation: Pass-through taxation (the LLC is disregarded for tax purposes); Members report profits/losses on individual tax returns (no double taxation);
  • Flexibility: No requirement to have a board of directors; generally involve less paperwork/record-keeping than a corporation;
  • Liability: Members are not held personally liable for company debts

Cons to LLCs

  • Taxation: Profits and losses are reported on each Member’s individual tax return regardless of whether such Member receives distributions
  • Credibility: In some instances, such as when a venture capital firm is investing into a company, the LLC may not be the preferred company structure
  • Fees: Some states require annual registration fees for an LLC that may exceed the costs for other types of business entities.

What is a "S" Corporation?

A "S" Corporation is an entity that is separate and distinct from its owners (shareholders), however the shareholders pay taxes on the income of the business (pass-through taxation).  

Pros to "S" Corporations

  • Liability: Shareholders enjoy limited liability for the entity’s activities and debts, so long as corporate formalities are followed
  • Credibility: Since corporations can issue stock, they are generally considered more favorable—thereby making it easier to raise capital from investors
  • Structure: Clearly defined roles for directors, officers and shareholders
  • Taxation: Pass-through taxation to shareholders 

Cons to "S" Corporations

  • Formality: The Corporation must adhere to certain formalities such as holding regular meetings for the board of directors, keeping minutes of meetings, and maintaining proper corporate records
  • Shareholders: Limited number of shareholders
  • Taxation: Profit and Loss allocation based on stock ownership

Building a Commercial Real Estate Team

building-a-commercial-real-estate-team

Even seasoned real estate investors and entrepreneurs require a great “team” to insure success.  An effective team can consist of an accountant, attorney, broker, financial advisor, lender, and other investors/entrepreneurs serving as mentors. Each team member brings an area of expertise to the table that can be extremely valuable in your next transaction.

When getting into commercial real estate keep these team building tips in mind:

Hire a commercial real estate attorney

It is important that your attorney has skill in the particular type of transaction involved.  An attorney who concentrates in personal injury law may not have the necessary expertise to review complicated commercial real estate agreements.  When hiring a commercial real estate attorney, make sure you have discussed the attorney’s pricing, projected turnaround time on reviewing documents and policy on returning emails/voicemails.

Find a commercial real estate broker

A savvy commercial real estate broker is invaluable in a real estate transaction. Knowledge of market trends, pricing, conditions affecting a property, township/municipality politics, and tendencies of Sellers or Landlords are essential when negotiating a deal.

Rely on the experience of a commercial real estate mentor

Commercial real estate mentors have been through many battles.  They have experienced the pitfalls and hopefully the successes of numerous transactions. You can learn a lot from their trials and tribulations-and most importantly, they can offer unbiased insight and advice.  

Contact us for more info on how to build a real estate team

Building a winning team is the first step to building a successful commercial real estate business. There is no right or wrong way to build a team, but getting the right people in the right positions is imperative. At JM LAW GROUP, we pride ourselves on being the commercial real estate attorney Philadelphia and NJ businesses and professionals can rely on. For more information on how to build a real estate team, please contact us to schedule an appointment.

DO YOU KNOW THE TERMS OF YOUR BUSINESS LEASE?

business-lease-terms-jm-law

The success of any business often relies heavily on the location and functionality of its office or retail space. Therefore, it is extremely important for business owners and entrepreneurs to completely understand the business terms of their lease agreements. Here are 5 key business lease terms you should be familiar with before signing on the dotted line:

  1. Rent: This includes your “Base Rent” (the minimum amount of rent due each month), plus your share of the landlord’s expenses to operate the building or shopping center, plus your share of the Landlord’s insurance and property taxes. It is extremely important that you calculate these monthly costs in advance.
  2. Exclusive Use: This type of clause is very important when it comes to leasing a retail space. An Exclusive Use clause typically prevents the landlord from renting a space to a competitor or someone who owns the same type of business as you (for example: you don’t want another pizza shop opening up in the same shopping center as your pizza shop).
  3. Landlord Work vs. Tenant Work: In preparing your space (construction of walls, paint, carpet, HVAC and electrical systems, etc.), your lease should include an accurate description of the work the landlord is responsible to perform (or pay for), as well as a description of the work that the tenant will perform (or pay for).
  4. Repair Responsibilities: This clause spells out which repairs the landlord will take care of throughout the duration of the lease, and which repairs the tenant is responsible to handle.
  5. Assignment/Sublet: If you need the flexibility to either assign or sublet your space in the future, then you need to have such language included in the lease. Landlords are often very restricting in a tenant’s ability to assign or sublet space.

Buyer Beware: Including Certain Contingencies In Your Purchase Agreement Can Save You In A Real Estate Deal.

So you just found a great, mixed-use piece of real estate that you want to purchase as an investment. You decide to have your real-estate agent submit a written offer on the property. Afterwards, you start to think to yourself: What happens if I can’t get a mortgage? What if the building is falling apart? What if there are hazardous materials below ground?

The good news is that you can address these concerns and limit your risk by making sure that certain contingencies are built-in to your purchase agreement.

Contingencies To Consider:

1: Mortgage Contingency:
-Buyer’s obligation to complete the deal depends on getting financing from a lender
-Tip: Include a maximum interest rate that Buyer is willing to pay

2: Inspections/Due Diligence:
-Build in enough time to allow for Buyer’s property inspections, environmental inspections and review of key documents such as existing leases, survey, title report and any specific testing reports (well-water, septic, mold etc.)
-Tip: Include language stating that Buyer has the right to terminate the Agreement for any reason during the Due Diligence period.

3: Approvals/Permits:
-Include language stating that Buyer can terminate the Agreement and receive deposit back if unable to obtain necessary approvals (zoning, construction, etc.) within a certain period of time.

These are just some examples of common contingencies that can help to limit a Buyer’s risk in a real estate transaction.

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