Initially, a commercial property owner behind on its mortgage payments will likely receive a default notice. The notice effectively starts the clock for the lender to exercise its contractual remedies triggered by default on the loan. In most cases, the commercial landowner has the ability to “cure” the default within a specific time set forth in the loan documents. For example, payment of the outstanding amounts due and owing may rectify the default, restoring matters to the way things were before.

Next, it is important to note that a property owner in default will likely have some time to work through certain issues with its lender. Lenders usually have a variety of resolutions in loan documents, in addition to foreclosure. Upon receipt of a default notice, in most instances a property owner will have more than nine months before losing property rights. Lenders differ on how aggressively they proceed following the initial default.

Finally, it is important to note that a lender does not necessarily want to go through a time-consuming and costly foreclosure only to end up owning a commercial property. As such, banks are often willing to enter into negotiations for a loan workout. It is therefore important for commercial property owners to be professional and responsive to communications with a loan officer.

Falling behind on loan payments can happen to any business. In the event a default occurs, it is important to act quickly and decisively, and to consult with your advisers to understand what options may be available to avoid losing a property to foreclosure.

Watch for upcoming posts focusing on options available to business owners in default on their commercial property mortgage.

When the dot-com boom bursts, Company A halts construction. Now, the 400,000 square office space sits vacant, unfinished and for sale. History repeated itself in revised fashion during the last five years or so, as the housing market crash rendered commercial construction financing hard to come by – leaving mid-construction commercial projects stalled or foreclosed.

With the economy in a constant state of flux, these situations are frequent. In some cases, the property owner will attempt to sell the property in an unfinished state. In the most dire of situations, the property ends up in foreclosure and owned by the bank. In either case, a purchaser or bank faces finishing the job, and the estimated cost to do so becomes the primary consideration. In the case of bank-owned property, the cost and hassle of completing construction may outweigh the benefits of doing so, resulting in the bank itself listing the property for sale in an unfinished state. A savvy purchaser of an unfinished property will determine the cost to complete construction (and more) prior to closing.

When in the market for commercial real estate, unfinished properties may be an option worth considering. There are many advantages and disadvantages to consider, but a few of the biggest are the following:

Advantages

• Reduced purchase price
• Depending on stage of construction, ability to customize the space
• Zoning and other approvals may already be in place

Disadvantages

• Purchase terms will likely be “as is”, particularly where a bank is the seller
• Completed construction may not be up to par, or may have deteriorated depending on how long the project has sat unfinished and exposed to the elements
• Costly appraisals and opinions from engineers may be required to secure bank financing

As evident in the above pros/cons snapshot, purchasing an unfinished commercial property requires thorough consideration of legal and economic issues. Because the property will likely be purchased at a discount (sometimes significant), the typical seller will make close to zero representations or warranties regarding the property and the quality of construction that has been completed. This is particularly true if the seller is a bank. A commercial real estate attorney is an important resource for a purchaser of unfinished commercial property, because a well-drafted purchase agreement providing for a lengthy due diligence period and a variety of contingencies to closing may be essential. Since recourse against the seller will be limited, a buyer must expend the time and money prior to closing to determine what they are purchasing – assistance from a commercial real estate attorney, engineer and builder is highly recommended.

With the right advice and a little patience, purchasing unfinished commercial property may be the perfect opportunity to own your own space. As an added benefit, that eye-sore gets put to productive use, benefiting the entire surrounding community. But, just remember, it’s not time to be “penny-wise, pound foolish,” no matter how great the deal.

Many of these terms came from this article from David V. Tran, “Commercial Real Estate Jargon Investors Should Know,” and this commercial real estate terminology glossary from OfficeSpace.com. Visit those sites for more terms and definitions. Visit those sites for more terms and definitions, and look for our recurring “Easy as ABC” posts on The Dirt.

A IS FOR APPLE…

Anchored tenants are the establishments that serve as the main traffic draw to an area. Major shopping hubs like Wal-Mart and Target are examples.  A savvy tenant will look for space in a building boasting anchored tenants who attract the same or similar target consumer.

B IS FOR BASE BUILDING.

The base building is a structure’s skeleton before the tenant or landlord installs improvements.

C IS FOR CAM

Or common area maintenance. CAM fees are paid by tenants to landlords to cover property taxes, insurance and maintenance, typically in proportion to the percentage of the overall building space which each tenant occupies (see “Load Factor”).

D IS FOR DUE DILIGENCE PERIOD.

Buyers have a grace period of about 30-90 days after signing a contract to investigate the property. If conditions prove to be unsatisfactory during the DDP, the Buyer may have a number of options, including cancelling the deal and receiving a refund of their earnest money.

E IS FOR ESTOPPEL CERTIFICATE.

Signed by the tenant and landlord, the Estoppel Certificate confirms the terms and facts of the lease, in addition to any oral or other agreements between tenant and landlord made after the original lease was signed. After signing, neither party can make claims disagreeing with its terms.

F IS FOR FULL SERVICE LEASE.

When the tenant’s rent (not including CAM) covers everything from utilities to maintenance, they are engaged in a full service lease.

G IS FOR GROSS LEASE.

In a gross lease, the tenant pays rent to the landlord, who covers tax, insurance and maintenance.

H IS FOR HOTELLING.

Some office spaces contain space for hotelling, which is when a telecommuter or visiting employee from another location uses an office or desk temporarily.

I IS FOR IMPERFECT MARKET.

No market is truly perfect, but this is especially true in commercial real estate where the matching of buyers and sellers is not immediate, supply and demand are constantly changing, and valuations are not always predictable.

J IS FOR JUNK BOND.

Also known as a “high-yield bond,” a junk bond is rated below the BB level for having high default risk. Junk bonds usually offer higher interest rates than safer, government-issued bonds.

K IS FOR KICKER.

In real estate, a kicker is an added expense that must be paid prior to real estate loan approval. Buyers should take caution with kickers, as they can be a shady practice and in some cases are illegal.

L IS FOR LOAD FACTOR.

A tenant’s rentable area divided by the useable area, minus 1, creates the load factor. Usually expressed as a percentage, the load factor is used to determine a tenant’s proportionate share of common areas in relation to other tenants (see “CAM”).

M IS FOR MASTER LEASE.

When properties are subleased, the original tenant (or sometimes called, the “prime tenant”) holds the master lease. For example, Ted leased a building with five units to Judy, who then subleased them to five separate business owners. Ted and Judy hold the master lease.

N IS FOR NNN LEASE.

In a triple net, or NNN lease, the tenant is required to pay the net real estate taxes, net building insurance and net common area maintenance. Because the tenant is taking on responsibilities normally delegated to the landlord, the cost of rent is usually lower.

O IS FOR OPEN LISTING.

Properties leased directly by the owner are open listings.

P IS FOR PASS THROUGHS.

Paid above base rent, pass throughs sum up insurance, property tax and CAM fees that the tenant owes the landlord.

Q IS FOR QUALIFY.

Qualify is the first stage in the 4-part process of transaction management. To help with this stage, the word can be broken down into an acronym meaning Quantify, Usage, Authority, Latitude, Intention, Financial and Yield.

R IS FOR RIGHT OF FIRST OFFER.

A right given to the tenant by the owner saying that if the owner looks to sell the property, the tenant will have the first chance to make an offer to buy or lease out a portion.

S IS FOR SPACE POCKET.

Usually leased by an existing tenant, a space pocket is set aside for future use with expected expansion, and typically rent terms are different than space in actual use.

T IS FOR TURNKEY.

A property made ready for a tenant to begin business without doing much or any preparation work is called a turnkey. The owner makes all preparations prior to the tenant taking occupancy.

U IS FOR USEABLE AREA.

The area (usually in square footage) of a property occupied solely by the tenant within their leased space.

V IS FOR VALUE ENGINEERING.

Changes made to a project or process to add value or diminish costs. 

W IS FOR WORK LETTER.

The work letter contains specifications for tenant improvements, information on the timeframe to complete projects and pricing for the involved parties to agree upon.

X IS FOR X-FACTOR

The term “X-factor” refers to any variable not easily quantifiable or identifiable that has a significant impact on the outcome of a situation. X-factors are always at play in commercial real estate. (See Imperfect Market for evidence)

Y IS FOR YIELD.

Also known as the rate of return, yield refers to the amount of interest gained on money invested.

Z IS FOR ZONING.

Zoning is the act of legally defining the boundaries and usage for land and property, performed by the authorities in a given jurisdiction.

In a typical CRE deal, there are various standard contingencies that work to benefit Buyers (provided that a Buyer is savvy enough to include such contingencies in the purchase agreement).  Essentially, the Buyer is given a “free look” or a period of time during which they can conduct their due diligence and determine whether or not they want to go forward.  The scope of the Buyer’s due diligence is essentially determined by the types of contingencies in the purchase agreement.  Typically, the Buyer’s free look period ends on a contingency date.  On the contingency date, the Buyer’s earnest money likely becomes non-refundable, unless the Buyer has objected to conditions on the property (or terminated the deal, if available).  Contingencies are often very deal-specific, but there are a number of common contingency concepts that come up time and again and generally apply in any deal.  They include:

THE INSPECTION CONTINGENCY

It is standard for a Buyer to be granted the right to inspect the physical condition of the property.  This may include invasive testing of the soil surrounding a piece of property, among other things.  Typically, a Buyer will pay the costs associated with this type of investigation.

THE TITLE CONTINGENCY

A Buyer is granted the right to review the status of title to the property, and to object to certain deficiencies or issues with the title prior to the contingency date.  The Seller will usually have a period of time in which to cure any title defects (typically right up to the closing date), and in some instances, the Buyer may have the right to proceed despite certain objections but may escrow portions of the purchase price to remedy such title issues.

THE GOVERNMENT APPROVAL CONTINGENCY

In some cases, property needs to be platted, or subdivided, or the intended use of the Buyer must be approved via special use or conditional use permit.  Or, the plans for the Buyer’s intended development of the property must be approved, among other things.  Obtaining the requisite government approvals under these circumstances is a common contingency in commercial purchase agreements.

THE FINANCING CONTINGENCY

Financing contingencies are common, and like other provisions, vary substantially in complexity.  Commonly, a Buyer must waive this contingency if they find “reasonably acceptable” financing options.  In other cases, a Buyer may negotiate for a provision that allows them to cancel the purchase agreement in the event they do not get approved for financing at a particular interest rate.  In connection with a financing contingency, a Buyer will typically covenant to use its best efforts to obtain approval for whatever type of financing is required under the purchase agreement.

There are a variety of other general contingencies which give the Buyer an “out” if the contingencies are not met by the specified contingency date.  During the due diligence process, the Buyer will determine which contingencies can be waived, and what issues need to be resolved prior to closing.  Well-drafted due diligence and contingency provisions in a purchase agreement will give the Buyer a leg up when it comes to managing the unforeseen costs and risks of acquiring a piece of commercial real estate.

Watch for The Purchase Agreement: Part IV, in which we discuss representations and warranties, pro-rations, and general provisions which allocate risk and liability between Seller and Buyer.

During the due diligence process, the Buyer will inspect and investigate the property to determine if the contingencies running in its favor can be waived, or lifted, to proceed to closing.  A thorough and comprehensive discussion of the due diligence process would read like a treatise.  In an effort to stabilize excitement levels, I’ll stick to the basics.  The most common areas in which due diligence is conducted are the following:

ENVIRONMENTAL

This category covers a wide array of issues, focusing on environmental regulatory schemes that may affect the property.  Environmental due diligence includes obtaining and reviewing Phase I and Phase II environmental assessments, which provide the Buyer with an overview of the environmental condition and history of a particular property, focusing on the possible presence of hazardous materials.  The Phase II assessment will explore at greater length issues revealed by Phase I.  Other environmental due diligence items include designating the locations of underground or aboveground storage tanks, the presence of asbestos, lead and mold, and determining whether or not there are any particular restrictions regarding the use of the property.  The extent to which a Buyer conducts environmental due diligence depends in part on their intended use of the property, but also on factors like the age of the property and the historical uses of the property.

PHYSICAL CONDITION / CODE COMPLIANCE

A Buyer will want to conduct a physical inspection of the property, which will also include taking an inventory of the surrounding area.  The most prudent Buyer will hire an engineer or qualified building inspector to determine the condition of the improvements on the property and design areas in need of maintenance or repair.  The improvements on the property must also be reviewed for code compliance, which entails checking with the applicable jurisdictions (county and municipality) to determine the applicable requirements.  The Buyer will also want to check the surrounding improvements, such as retaining walls, drainage systems, access, and the condition of surrounding roads and sidewalks.  All of these items determine whether or not the Buyer can expect to pay special assessments in the near future following their purchase of the property.  Issues revealed in this type of inspection are commonly resolved prior to closing as a result of the parties’ negotiations.

TITLE ISSUES

The title review process is used to determine the condition of the title to be transferred to the Buyer at closing, and also to identify title problems.  In this day and age, Buyers and their attorneys work with a title company to have a title commitment issued and eventually to purchase an owner’s policy of title insurance.  A title commitment sets forth the record ownership, legal description, and all encumbrances or memorials affecting the property which the title company uncovers.  Based on the title commitment, the Buyer may object to certain aspects of title, and the Seller will proceed to have them resolved in accordance with the purchase agreement.

ZONING

If the Buyer intends to develop the property, change the use of the property or make significant changes to the existing improvements, it is often useful to determine what approvals might be necessary to accomplish those intentions.

PERSONAL PROPERTY

The Buyer should also inspect and review any items of personal property or fixtures sold with the property.  Fixtures should be inspected for condition and UCC searches should be conducted to determine whether any third party has a security interest in any of the personal property being transferred to the Buyer at closing.

Now that we have the basics of due diligence covered, watch for The Purchase Agreement: Part III, in which we discuss common contingencies benefiting Buyers.

Previously, we discussed the applicability of regulations promulgated under the Americans with Disabilities Act (ADA) as well as the ADA Amendments that took effect January 1, 2009 to commercial real estate owners and developers.  While requirements of the ADA impact commercial real estate owners and builders in numerous ways, they do not override other health and safety laws and codes when it comes to places of public accommodation.

The ADA does not supersede any health or safety requirements established under federal law, such as the requirements of the U.S. Occupational Safety and Health Administration (OSHA).  Even if the federal standard adversely affects a person with a disability or does not present a business necessity, an employer or building owner must comply with it.  Where you are able to comply with both federal regulations and the ADA, however, you must do so.

The ADA does not take precedence over state or local laws regarding public health and safety, except where the law would exclude an individual with a disability from a particular job due to a health or safety risk.  If this is the case, you as an employer or business owner must evaluate whether the employee poses a “direct threat” to health or safety under the ADA or where a reasonable accommodation would alleviate the threat.  Local laws are not a defense to a failure to comply with the ADA.

As it relates more directly to commercial real estate owners, builders and owners are still expected to follow existing state and local building codes.  The ADA allows the Attorney General of each state to “certify” specific state laws, building codes, and similar ordinances as meeting accessibility requirements under the ADA.  If you as a business owner or real estate developer follow a code or ordinance that is “certified” when building or renovating your property, that is considered valid rebuttal evidence in the case you are accused of not meeting ADA standards for construction or renovation.

Hopefully understanding how and when the Americans with Disabilities Act applies to commercial real estate development, the consequences of its regulations, and its impact on other codes and laws provides commercial real estate owners and developers with valuable insight into their obligations to make and maintain facilities that are accessible to people of all abilities, in the true spirit of the 1990 federal legislation.

Read the rest in our series:

Part 1

Part 2

Federal laws that don’t focus primarily on regulating the commercial real estate industry can still have a substantial impact on business and real estate owners. The Americans with Disabilities Act (ADA) prohibits discrimination against people with disabilities. On the heels of amendments to the Act implemented January 1, 2009, the impact of the ADA on commercial real estate continues to evolve. This is the first in a series of articles discussing some of the central provisions and amendments to the ADA and its effects on the commercial real estate industry.

FIRST, IS YOUR BUILDING OR BUSINESS SUBJECT TO ADA REGULATIONS?

Even if you operate a small, private, retail or services business, you are subject to the ADA as long as your business is a place of public accommodation. A “place of public accommodation” is a facility that operates to affect commerce in some way; this includes hotels, restaurants, movie theaters, convention centers, retail stores, museums, libraries, parks, gyms, schools, and most similar establishments.

The ADA prohibits places of public accommodation from discriminating against any individual on the basis of disability in the “full and equal enjoyment of the goods, services…etc.” of the establishment. Essentially, people with disabilities must be able to access the goods and services at your establishment to the same or similar extent as people without disabilities.

NEXT, WHO QUALIFIES AS A PERSON WITH A DISABILITY?

The ADA defines a “disability” as an impairment that substantially limits one or more major life activities, a record of such an impairment, or being regarded as having such an impairment. The 2008 Amendments to the ADA expanded this definition to encompass a wider range of major life activities, including major bodily functions, and episodic disabilities if they would substantially limit the person when active. The result was to broaden the definition of “disability” to include more types of disabilities.

While some disabilities do not impact a person’s ability to access public accommodations, it’s important to recognize that accommodations go beyond providing wheelchair ramps or signs using Braille. Under this new, broadened interpretation of disability, conditions such as obesity, and certainly morbid obesity, have been ruled to be disabilities for which reasonable public accommodation is required.

Therefore, whether you’re setting up your store front, organizing products, or deciding on the general layout of your establishment, it’s important to keep in mind that your services and goods must be accessible to people with a wide range of disabilities. If you don’t comply with the ADA requirements, you risk a lawsuit from a disabled individual or from the Department of Justice. These requirements, in detail, are in the Act itself as well as on the United States Department of Labor website at: http://www.dol.gov/dol/topic/disability/ada.htm

later, we’ll discuss what the ADA requirements you must consider when you undertake new construction or major renovations to your property or business establishment.

Read the rest in our series:

Part 2

Part 3