I. THE "BIG PICTURE:
A. OVERVIEW OF THE DEVELOPMENT PROCESS:
Each commercial real estate development project varies in many ways depending upon the particular type and size of the project to be developed as well as the particular zoning and engineering requirements for the project. However, every project will involve the same major principal phases.
1. Identifying the desired site from potential properties: In general, new construction sites and properties available for acquisition can be identified in two principal ways.
(a) Many state or local economic development offices maintain inventory lists of existing available properties and development sites within their jurisdiction, including industrial parks they may manage.
(b) Utilizing commercial realtors who have been provided the parameters of the site requirements, business brokers or other referral sources.
(c) Any final site selection process will include among other things construction feasibility, transportation access, customer sources, usage patterns, demographic reports, physical surroundings, image, trade area, growth strategies, and competition.
2. Tying up the Land Pending Completion of Due Diligence and Closing: The most common ways to tie up property to remove in from the market pending the developer's due diligence review and completion arrangements for necessary financing consist of:
(a) Binding letter of intent specifying terms of purchase. These agreements typically provide that the seller will cease marketing the property until during the period required for the parties to complete a full contract. Letters of intent can be binding or non-binding at the election of the parties.);
(b) Option to Purchase Agreement with (i) some designated monetary payment to hold the property available to the prospective buyer for a stated period of time, (ii) an outline of the terms of the purchase transaction in the event the buyer elects proceed with the purchase transaction, and (iii) provisions for entry on the property for a range of due diligence inspections, and (iv) a time and place for settlement; if the
(c) Purchase and Sale Agreement with detailed provisions for purchase price, entry on the property for due diligence inspections, representations and warranties of the parties, and time and place of settlement.
3. Due Diligence Review and Inspections. The purpose of due diligence is simply put, to confirm marketability of title to the project site and to ensure that all construction/development requirements can be satisfied before settlement occurs. Among the usual due diligence requirements are the following:
(a) Title examination and Survey (typically commercial lenders will specify their survey requirements);
(b) Environmental inspections - Phase I and/or Phase II assessment;
(c) Soils Test Report and Engineering Study;
(d) Evidence of Utility Availability;
(e) Zoning Classification and Requirements; other Land Use Issues.
4. Settlement and Loan Closing: Settlement is when all purchase transaction and Loan Transactions are executed and delivered in order to (i) vest the buyer with marketable, insurable title to the property, (ii) convey a first lien to the lending institution and (iii) satisfy all requirements in the title commitment. These documents vary from transaction to transaction, but typically include:
(a) Documents Relating to Acquisition of Property:
(i) Deed and Bill of Sale, if applicable;
(ii) Assignment of Rents, Leases and Security Deposits, if Applicable;
(iii) Settlement Statement;
(iv) Owner/Seller Affidavit to Title Company;
(v) Documents and Materials satisfying all Title Commitment Requirements;
(vi) Tax Compliance Documents, including 1445 Certification.
(b) Documents Relating to the Loan:
(i) Commitment Letter;
(ii) Estimated Cost Breakdown;
(iii) Deed of Trust
(iv) Assignment of Rents and Leases;
(v) Security Agreement and UCC-1 Financing Statements;
(vi) Guaranties of Principals;
(vii) Assignment of Construction Documents;
(viii) Loan Agreement;
(ix) Title Commitment, with Mechanic's Lien Coverage, ALTA 8-Environmental; ALTA 6-Variable Rate; Credit Line Endorsement; Zoning Endorsement; Non-Imputation Endorsement; Same as Survey Endorsement
(x) Opinion of Borrower
B. DUE DILIGENCE ISSUES. Perhaps the most critical aspect of any commercial real estate development transaction is making sure appropriate and complete due diligence investigation is undertaken in a timely manner and in a contractual context that allows the buyer to terminate the transaction and receive a refund of its earnest money deposit should any of the investigations prove unsatisfactory. Often these same due diligence issues will tie into requirements of an institutional lender proposing to provide the acquisition and development/redevelopment funding. It is absolutely crucial that any purchase contract executed by the buyer provides an adequate inspection period for all necessary inspections to be conducted.
1. Due Diligence Inspection Period. If possible, a buyer should be able to conduct due diligence investigations right up through the date of settlement. More typically, sellers will be unwilling to have the project site tie up for an extended period. Therefore, if a seller insists upon a specified period during which all inspections must be conducted, the buyer should consider adding a provision to the contract. Whatever inspection period is designated should be realistic so as to avoid putting the buyer in a position of having to terminate the contract if the inspection period expires before all necessary inspections can be completed. Frequently, it is helpful to draft a timeline that includes necessary zoning and other approvals, the loan approval process in order to calculate a realistic inspection period. The following is a sample contract provision:
Right Of Entry; Review Period; Termination Rights Of Buyer. Buyer shall have a period of 90 days from the date that this contract is fully executed by all parties ("Review Period") to conduct all such tests and studies as Buyer may deem necessary.
(a) During the Review Period, Buyer and its agents, contractors, employees and assigns shall have the right with notice to the Seller (i) to enter upon, and have free access to, the Property for the purpose of making such studies, tests and investigations of the Property as Buyer deems necessary or advisable, and (ii) to make application for, and to obtain, any and all licenses, permits, plats, use permits and approvals necessary or desirable in connection with the use of the Property or any portion thereof required by Buyer and financing. Seller agrees to cooperate with Buyer at all times to assist Buyer in obtaining any and all licenses, permits, plats, soil borings, environmental evaluations, approvals and permits, necessary or desirable in connection with Buyer's intended use of the Property (which is a convenience store with retail gasoline facilities). Buyer shall indemnify and save Seller harmless from any liability resulting from Buyer's presence or actions on the Property and restore the Property to its original condition in the event settlement does not occur under the terms of this Agreement.
(b) If, during the Review Period, Buyer determines, in its reasonable discretion, that the Property is not suitable in all respects for Buyer's intended use thereof, or Buyer is not satisfied, in its reasonable, with the results of any tests, surveys, reports, market analysis or other studies regarding the Business and the Property or Buyer's intended use thereof, then Buyer shall have the right, exercisable by the giving of written notice to Seller on or before the expiration of the Review Period, to terminate this Agreement, whereupon all monies deposited hereunder shall immediately be returned to Buyer and none of the parties hereto shall have any further rights against, or obligations or liabilities to any party hereto.
2. Marketability of Title. Every purchase agreement - be it a letter of intent, option agreement or detailed purchase agreement - must provide the buyer with the ability to have title examined and to terminate the contract (and receive a refund of any earnest money deposit) if title proves unsatisfactory for the proposed development. Sample contract provisions for these rights are as follows:
B. Marketable Title. Seller shall convey and transfer to Buyer on the Closing Date good, indefeasible and marketable title to the Property, free and clear of all liens, encumbrances, easements and other title objections other than those to which Buyer fails to object as provided in paragraph 2.C. In addition, such title shall be insurable under an ALTA Owner's Policy (Form B, as amended) by a reputable title insurance company selected by Buyer licensed to do business in Virginia at regular premium rates.
(d) Objections to Title. Buyer, at Buyer's sole expense, shall order a commitment for a title policy ("Title Commitment") for the Property. Buyer shall deliver to Seller a copy of the Title Commitment, together with a written list of the objections to title that are disclosed in the Title Commitment that are not acceptable to Buyer in Buyer's sole discretion. In addition, Buyer shall have the right to notify Seller of any additional objections to title disclosed in any subsequent Title Commitment or any endorsement to the Commitment under the terms and conditions of this paragraph. If Buyer disapproves of any title objections that are disclosed in the Title Commitment, Seller shall have the right, but not the obligation (except for the obligation to remove existing liens or encumbrances that can be removed by the payment of money which shall be paid on or before Closing) to correct any such title objections within ninety (90) days after receipt of Buyer's notice. If Seller is unwilling or unable to correct such objections within the ninety (90) day period, Buyer shall have the option of (i) taking such title as Seller can give without abatement of the purchase price or (ii) terminating this Agreement, in which event the Deposit shall be returned, together with all interest earned, if any, to Buyer and this Agreement shall become null and void and neither party shall have any further obligations hereunder.
3. Easements, Wetlands and Survey Matters. Closely related to marketable title issues are matters that will be disclosed by a proper survey, including among others (1) an accurate metes and bounds description of the Property and determination of the actual acreage of the Property; (2) delineation of all of portions of the Property, if any, lying within wetlands areas, (3) the location of all existing easements and rights-of-way, alleys, streets and roads; (4) delineation of any encroachments upon the Property; (5) location of all existing improvements (such as buildings, power lines, fences, etc.), if any; and (6) the location of all dedicated public streets or private roadways for any access to the Property and whether such access is paved to the property line of the Property.
4. Environmental Contamination. In commercial real estate transactions, virtually every loan transaction will involve obtaining an environmental inspection of the project site. Institutional lenders will, at a minimum, require a Phase I environmental survey. Should the Phase I disclose any questionable matters, a Phase II survey will be required and/or other further testing (e.g., monitoring wells to test for the migration of contamination). Depending on the final results, remediation may be required or restrictions may be imposed on the site's usage (e.g., lead contamination limiting ground disturbing activities and/or prohibition on young children residing in the housing facility).
5. Subdivision and Zoning Compliance. Along with marketable title and survey issues, proper zoning and the legal subdivision of the property is a key due diligence issue. Depending upon the nature of the proposed development, it may be necessary to have the site re-zoned or to secure a conditional use permit (e.g., for an elderly housing facility with reduced parking requirements). The purchase agreement should provide that the seller agrees to cooperate with buyer in obtaining any rezoning of the property or conditional use permits required for buyer's intended development of the project site and operation of the project, since the seller, as record title holder, must join in the execution of the rezoning or conditional use permit application.
6. Utility Availability. Another important due diligence issues is that of availability of utilities. If utilities are not available at the boundaries of the project site, it is imperative that a cost analysis be done to determine what costs may be involved in installing such utilities. Frequently, institutional lenders will require that the borrower furnish letters from the utility providers confirming that said utilities are available.
7. Proposed Development Feasibility. If possible through the contract negotiation process, the purchase agreement should contain some variation of the following provision: "Buyer shall have determined, in its sole and absolute discretion, that the property and the project site (including, without limitation, applicable zoning restrictions, buildable area, soil condition, environmental condition, drainage, access, and on and off site utility requirements) are suitable in all respects for buyer's intended development, construction and operation of the project on the property and the project site.
8. Financing Contingency. While not a due diligence matter per se, a financing contingency should be included in the purchase agreement for two reasons: (1) to protect the earnest money deposit if financing is needed for proceeding with the development and (2) most institutional lenders will have their own due diligence requirements that must be satisfied prior to closing and, therefore, the financing contingency can serve to give the buyer "second bite at the apple," if a due diligence item is otherwise overlooked. The following is a sample financing contingency provision:
"Buyer shall have (A) obtained a commitment from a commercial lending institution for an acquisition/development loan for the property (the "Loan Commitment"). Buyer represents to seller that upon final execution of this Agreement, buyer shall promptly make application for such Loan Commitment and diligently seek the same."
II. ACQUIRING THE PROPERTY:
A. STRATEGIES FOR OPENING NEGOTIATIONS:
Commercial Realtors/Business Brokers. In many instances, the first phase of the negotiations will be undertaken by commercial realtors who have assisted a buyer in identifying a potential project site. If the property is listed for sale, the realtor will have the seller's asking price and the listing will provide preliminary zoning and utility availability information. In addition, the commercial realtor in many instances will have begun discussions with the seller's agent as to what matters may or may not be negotiable. If this is the case, often the realtor can provide the buyer's counsel with a term sheet from which a letter of intent or contract can be prepared.
1. Letter of Intent. Absent preliminary negotiations via a commercial realtor, the other most common approach to opening negotiations is to submit a letter of intent specifying proposed terms of purchase. These agreements typically provide that the seller will cease marketing the property until during the period required for the parties to complete a full contract.
2. Conference Calls or Face to Face Negotiations. From time to time, representatives of the parties will either conduct a working group conference call or schedule a meeting to work out the details of a purchase agreement. Typically, this occurs after a proposed letter of intent or proposed purchase agreement has been previously submitted. An obvious advantage of this strategy is the ability to expedite the negotiation process. Once the parties reach a meeting of the minds draft documents can be circulated for further review and comment, often via e-mail.
B. TYING UP THE LAND:
In addition to utilizing a letter of intent as described, above, the most common means of tying up the land are by way of an option agreement or a detailed purchase agreement. From a negotiating stand point, it is usually better to submit the buyer's preferred draft contract rather than endeavoring to renegotiate the seller's draft contract.
1. Option to Purchase Agreement. An option agreement provides (i) a payment by the buyer for the right to elect to purchase the real property on or before the expiration of a specified time period, (ii) sets forth the terms of purchase transaction in the event the buyer exercises the option and elects proceed with the purchase transaction, and (iii) provisions for entry on the property for a range of due diligence inspections, and (iv) a time and place for settlement. Unlike a detailed purchase agreement, an option agreement does not need to set forth the buyer's due diligence contingencies inasmuch as the buyer can simply elect not to exercise the option if any due diligence inspections prove unsatisfactory.
2. Purchase and Sale Agreement. A detailed commercial purchase agreement should include detailed provisions for purchase price, entry on the property for due diligence inspections, representations and warranties of the parties, detailed buyer contingencies, including a financing contingency, and time and place of settlement. Unless otherwise agreed by the buyer, the earnest money deposit ("Deposit") should be refundable in the event the buyer terminates the contract based upon unsatisfactory due diligence inspection results. Occasionally, if a buyer needs an extension of the due diligence period, a seller may require that (i) a portion of the Deposit will become non-refundable, or (ii) the Deposit be increased.
C. SURVEYS, ABSTRACTS AND TITLE INSURANCE
While in some states it is common that a seller provide a buyer with an abstract of title, in Virginia abstracts are not generally used. Rather, commercial title commitments are issued by title insurance companies that set forth (i) the requirements for issuance of a final title insurance policy, and (ii) all exceptions to title. If requested, the same title insurance companies will provide copies of all exceptions listed in the title commitment, which comprise a critical part of the due diligence process and which are required for the preparation of the ALTA survey required by most institutional lenders.
1. Surveys. An ALTA survey is one that meets the minimum requirements of the American Land Title Association and the National Society of Professional Surveyors. An ALTA survey will show in detail, among other things, all boundaries, easements of record, encroachments, zoning and set back restrictions, and all physical details of the property and provides the basis (a certification to the title insurance copy is included on the survey) on which the insuring title insurance company ("Title Company") will insure against all matters except as shown on said survey.
(a) Role of Buyer's Counsel. In order for an ALTA survey to be prepared, the surveyor must be provided with the record title legal description of the property to be surveyed or, in the case of an original survey, the record description of the parent parcel that contains the property to be surveyed. Buyer's counsel must coordinate with the Title Company to insure that complete copies of the record title description of the property (or, in the case of an original survey, the parent parcel), any recorded easements benefiting the property; the recorded easements or servitudes and covenants burdening the property ("Record Documents"); and any other documents containing desired appropriate information affecting the property being surveyed are provided to the surveyor for notation on the plat or map of survey.
Once the survey is delivered to the Title Company, buyer's counsel should carefully review the survey to confirm (i) exceptions listed in the title commitment are referenced on the survey and (ii) the certifications required by the Survey Standards are properly set out on the survey.
(b) Costs and Timing. Unlike the typical residential survey which can be usually be prepared in a matter of a few days and a relative low cost, an ALTA survey takes a significant period to prepare and can cost thousands of dollars. Therefore, the buyer must (i) order the survey in writing and (ii) allow sufficient time in calculating the due diligence inspection period/closing date to accommodate preparation and review of the survey.
2. Title Insurance.
(a) Owners Policy. In its simplest analysis, an owner's title insurance policy insures that the estate or interest in the land identified in Schedule A of the policy is vested in the owner named therein in respect to the covered risks, subject to (i) stated exclusions in the policy and (ii) the matters identified on Schedule B of the policy.
(b) Loan Policy. In the case of a loan policy, a mortgagee title insurance policy insures that, at Date of Policy, the land which is encumbered by the insured mortgage is fee simple (or such other estate or interest as specifically identified in the insured mortgage) subject to the exclusions from coverage, the exceptions from coverage contained in Schedule B and the conditions and stipulations vested in the borrower(s) shown in the insured mortgage. Covered risks typically include: (i) title to the estate or interest described in Schedule A being vested other than as stated therein; (ii) any defect in or lien or encumbrance on the title; (iii) unmarketability of the title; (iv) lack of a right of access to and from the land; (v) the invalidity or unenforceability of the lien of the insured mortgage upon the title; (vi) The priority of any lien or encumbrance over the lien of the insured mortgage; and (vii) the invalidity or unenforceability of any assignment of the insured mortgage, provided the assignment is shown in Schedule A, or the failure of the assignment shown in Schedule A to vest title to the insured mortgage in the named insured assignee free and clear of all liens.
(c) Role of Buyer's Counsel. In commercial real estate transactions, as in residential purchases, the role of buyer's counsel is to make sure that (A) all requirements set forth in Schedule B-1 of the title commitment are satisfied, and (B) the title policy when issued will include the special endorse required by the buyer's institutional lender. All curative documents - other than releases of deeds of trust being paid off with the sales proceeds based on written pay off letters, are submitted to and approved by the Title Company prior to closing. These requirements will vary depending upon (i) what title exceptions have been disclosed by the title examination, (ii) whether or not the buyer and seller are entities, and particular requirements specified for the endorsements required by the buyer's institutional lender (e.g., it may be necessary to secure a zoning letter confirming the zoning and permitted uses of the property).
(d) Typical Commercial Transaction Endorsement. Typically, the buyer's institutional lender will specify the endorsements it will require to be included in the mortgagee title policy in its loan instructions or commitment letter. The required endorsements will vary from transaction to transaction.
Comments(0)