I was invited recently to speak at the Illinois Institute for Continuing Legal Education Annual Real Estate Short Course to discuss what every lawyer should know about commercial real estate development agreements. In preparing for the presentation, a developer client suggested it is not only attorneys who need to know about development agreements – developer clients do as well.

So, on that note, the following is my list of the top 10 things attorneys and developers should know about commercial real estate development agreements.

TOP 10 THINGS TO KNOW ABOUT COMMERCIAL REAL ESTATE DEVELOPMENT AGREEMENTS

1.     Development Agreements are not the same thing as Construction Contracts.

2.     There are no “master form” Development Agreements.

3.     Each Development Agreement is unique to the specific development to which it relates, and must accommodate the sometimes conflicting needs, demands and desires of the constituent stakeholders, including the

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Of Course We Can Sue Them . . . But Can We Hold Them Liable?

No one knows everything. It’s a simple fact of life. Often, businesses turn to other businesses and professionals to obtain needed information. The range of commercial information providers assisting business owners and real estate investors, developers and lenders gather and analyse information is vast.

The question is: Do we have a legal right to rely on the information they provide? What if the information is wrong? What if we rely on that incorrect information and suffer a loss? Is the information provider liable?

It could be anything from hiring an appraiser to appraise a property to support a commercial loan; hiring a lab to analyze nutrition and caloric content of food products; or engaging a financial consultant to evaluate a company’s assets and liabilities as part of a business acquisition or merger; or seeking out a lending institution to provide information regarding the creditworthiness of a potential borrower. We might hire a structural engineer to evaluate the structural integrity of a building or bridge or other structure; or engage a surveyor to determine the scope and size of a parcel of land, or the location of easements and improvements located on the property, or the existence of rights of way to access the property; or we might retain a person or business holding itself out as a “due diligence” expert to investigate the essential facts necessary to enable us to determine whether to proceed with a particular transaction or project. The list of commercial information providers we rely upon to conduct our affairs is nearly endless.

Another simple fact of life is that people can and do make mistakes. They misinterpret information. Misstate the facts. Fail to discover and disclose all material information necessary to make information they have provided sufficient to enable informed action and decision-making.

What happens when your information provider gives you bad information and you suffer a loss as a result? Do you have any recourse? What if

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NOTICE TO MUNICIPALITIES:  If you want economic development, ACT LIKE IT!

Sometimes, municipalities can be their own worst enemies when it comes to economic development. At best, things they sometimes do, or don’t do, evidence disinterest, if not incompetence. Alternatively, it may evidence a breach of trust to the community and local taxpayers.

Here’s the situation:

Recently, in representing developers before a variety of municipal governments, I have been struck by the Jekyll and Hyde  approach many have when in comes to economic development. Often, the city, town or village will have a fully staffed economic development department. It may pay hundreds of thousands of dollars per year, if not millions of dollars per year, to pay economic development staff salaries and to cover associated overhead. It will allocate or approve millions of dollars per year in economic development grants, tax incentives, tax increment financing, real estate tax abatements, sales tax revenue sharing, and other economic incentives to encourage investors and developers to bring private development to the city to create jobs, remove blight, increase land values and otherwise improve the quality of life of the community.  These are all proper uses of public economic development funds.

Then what?

As is necessary, the developer has its architect submit plans to the municipal building department for review and approval to obtain a building permit. There is nothing controversial about that, right? But then, in a remarkably high number of circumstances, the permitting process proceeds at only glacial speed.

How long should it take to review plans and specifications for a modest sized project that will bring jobs and economic opportunity to the city? The city has already confirmed that it wants the project by granting development incentives to the developer for the project. When the developer’s architect is moving forward as quickly as practical to obtain the building permit, should it take the municipal building department 9 to 10 months to issue a building permit on a modest sized structure? I’m not talking about a building the size of Trump Tower – I’m referring to buildings of less than 30,000 square feet. How long is reasonable?  Is a building permit review process that takes 9 to 10 months necessary or reasonable? How is that promoting economic development?

And once the building permit is issued, and work begins – how often should work have to stop because city building inspectors fail to show up for scheduled inspections?

Private investors and developers cannot afford – literally – to sit around and wait extended periods of time to move a project to completion. Market conditions change. The cost and availability of money changes. Commercial tenants choose other options.

The Point?

The point here is that municipalities need to get their act together if they want to promote economic development in their communities. Not all cities, towns and villages are guilty of dragging their feet or sending mixed messages, but there are many more than you may think. For developers, time really is money.

It is counterproductive – and more than a bit silly – for local governments to “give away” economic incentives to promote economic development, and then have their building departments drag their municipal feet in facilitating completion of the project. Economic development staff and their building department siblings need to get on the same page and follow the same agenda if a municipality truly wants to promote economic development.

Promoting Economic Development

Promoting economic development is not merely a matter of handing out economic incentives. That can be useful – and sometimes necessary – to promote economic development in your community, but it is not the whole story. To get the economic development engine running, local governments need to take a holistic approach that fully embraces and encourages desired economic development. It needs to walk the walk.  It needs to expedite services to facilitate development. It needs to get its collective act together – in all municipal departments – to genuinely do what is in the best economic interests of the community.

Commercial developers and their prospective commercial tenants and users have choices as to where to invest their money to build new projects that promote economic growth. Most development opportunities are regional, if not national or global. If your town will not do all it can reasonably do to truly promote economic development in a meaningful way, some other town likely will.

This is not a threat – it is a practical reality. If you are in local government and genuinely want economic development, I suggest, with all due respect, that you act like it.

Thanks for listening.

Kymn

This is the second installment of a three-part series on Section 1031 like-kind exchanges. Part 1 explained WHY you should consider use of a Section 1031 like-kind exchange when selling commercial or investment real property. Part 2 covers the key rules for HOW to implement a Section 1031 like-kind exchange. Part 3 will cover special issues applicable to a Section 1031 like-kind exchange when a Tenant-In-Common [TIC] interest is being acquired.

KEY RULES FOR SECTION 1031 EXCHANGES

The following is an outline of key rules applicable to Section 1031 exchanges. Become familiar with these rules. Unless you intend to completely cash out of real estate investing, a Section 1031 exchange may work to your benefit. If you intend to keep investing in real estate or using real estate in your trade or business, a Section 1031 exchange will maximize the capital you have available to reinvest.

Key Elements of a Section 1031 Exchange*

What is Section 1031?

Section 1031 refers to Section 1031 of the Internal Revenue Code of 1986, as amended.

What does it do?

Section 1031 permits a taxpayer (the Exchangor) to dispose of certain real estate and personal property and replace it with like-kind property without being required to pay taxes on the transaction.

What property qualifies?

To qualify for a Section 1031 exchange, the property being disposed of (the Relinquished Property) must have been used in the Exchangor’s trade or business and/or must have been held for investment purposes. The property being acquired (the Replacement Property) must likewise be acquired for use in the Exchangor’s trade or business or for investment.

What property is considered like-kind?

For real estate, to be like-kind means simply that real estate must be exchanged for real estate. The rules related to personal property are significantly more complex. Personal property is any property that is not real estate.

Real estate exchanges are fairly straightforward. A warehouse may be exchanged for another warehouse or for any other qualifying real estate including, for instance, a factory building, office building, shopping center, single-tenant store, parking garage, or even a parcel of vacant ground so long as it qualifies as being acquired for use in the Exchangor’s trade or business or is to be held for investment. This is not a difficult test to pass. Similarly, a qualifying parcel of vacant ground or a shopping center or office building or factory or other parcels of investment real estate may be exchanged for any other qualifying real estate investment.

Personal property exchanges are not so straightforward. For personal property, the property must be substantially similar and of the same type or class. For example: a car can be exchanged for another car; and a bull can be exchanged for another bull; and a cow can be exchanged for another cow; but, a bull may not be exchanged for either a cow or a car.

Although personal property exchange rules are substantially more technical and complicated than real property exchange rules, generally speaking, depreciable tangible personal property held for productive use in a trade or business can be exchanged for other depreciable tangible personal property held for productive use in a trade or business so long as they fall within the same NAICS classification code.

For instance, Limited Service Restaurants such as fast food restaurants, pizza delivery, sandwich shops, etc. fall within 2012 NAICS Code 722513. Accordingly, the assets of one can be exchanged for the assets of the other under Section 1031. But, note that the NAICS Code for a bar, tavern or nightclub is 722410, and the NAICS Code for a full service restaurant is 722511, so an exchange of assets of either of these for the assets of the other, or the assets of a Limited Service Restaurant (even though otherwise physically identical), may not likely be considered “like kind”.

The point, for purposes of this post, is that exchange rules for personal property are substantially more complex than exchange rules for real property. Accordingly, if you are exchanging personal property – either in conjunction with an exchange of real property or purely as a personal property exchange – great care must be taken to comply with the personal property exchange rules to receive the benefits of a tax deferred exchange under Section 1031.

What property is excluded?

Some types of property are expressly excluded from tax deferred exchange treatment by statute, rule or regulation The following types of property do not qualify for aSection 1031 exchange: stocks, bonds, partnership interests, limited liability company interests, personal residences, stocks in trade or inventory, and certain other intangible property.

Are there timing issues?

Section 1031 exchanges can be simultaneous, but they are not required to be. In fact, most exchanges made pursuant to Section 1031 are not simultaneous. There are, however, strict timing rules that apply tonon-simultaneous exchanges and strict rules prohibiting access to funds.

What are the time limits?

The Replacement Property or properties must be identified, in writing, not later than forty-five days after the Relinquished Property is transferred (the Identification Period). The Replacement Property or properties must be acquired not later than the earlier of (i) 180 days after the Relinquished Property was transferred, or (ii) the due date for the Exchangor’s tax return, including any extensions (the Acquisition Period). The Identification Period is included within the Acquisition Period.

How many Replacement Properties may be identified?

There is no fixed limit to the number of Replacement Properties that may be identified, but there are two primary rules that apply: (1) the Three-Property Rule, and (2) the 200% Rule.

1. The Three-Property Rule allows you to identify up to three (3) properties as potential Replacement Properties, regardless of value. You need not acquire all three properties, but as of the end of the Identification Period, not more than three properties may be identified. This is the most commonly used identification rule.

2. The 200% Rule allows you to identify any number of potential Replacement Properties so long as the aggregate value of all identified properties does not exceed 200% of the value of the Relinquished Property. You need not acquire all identified properties.

Generally, if you identify more properties than permitted, you are treated as if you have not identified any properties. However, there is one more rule that might save the day. The 95% Rule allows you to identify any number of potential Replacement Properties, regardless of value, so long as you actually acquire within the Acquisition Period at least 95% of the value of all properties identified. Use of the 95% Rule is rare, and is generally considered more a safety valve rule than an intentionally used exchange rule

Must all exchange proceeds be used?

There is no requirement that all proceeds received upon sale of the Relinquished Property be used to acquire the Replacement Property. Any exchange proceeds not used, however, are taxable.

What constitutes exchange proceeds?

Exchange proceeds means the net sale price of the Relinquished Property, including all net equity and the amount of any mortgage encumbering the Relinquished Property, whether paid off at closing or assumed by the purchaser. It is not sufficient to merely reinvest the net equity received upon sale. The purchase price of the Replacement Property must equal or exceed the aggregate of the net equity received upon sale of the RelinquishedProperty plus any mortgage encumbering the Relinquished Property at the time of the sale closing.

Example: If the Relinquished Property is encumbered by a $700,000 mortgage and is sold for $1 million as part of a Section 1031 exchange transaction, to defer all taxes, the purchase price of the Replacement Property must be at least $1 million, not merely $300,000.

When can the Exchangor obtain access to unused proceeds?

Proceeds from sale of the Relinquished Property may be accessed only when the exchange is completed, fails, or expires. If no potential Replacement Properties are identified within the Identification Period, the exchange fails, and the Exchangor may receive the funds. Those funds will, however, be taxed in the year received. But note: If a mortgage was paid off at the Closing of the Relinquished Property, and the amount of the mortgage was greater than the tax basis of the Relinquished Property, the amount paid to satisfy the mortgage in excess of the tax basis of the Relinquished Property is taxable in the year of Closing of the Relinquished Property.

If all properties identified within the Identification Period are acquired within the Acquisition Period, the exchange is completed, and any remaining funds may be received by the Exchangor. Those remaining funds are taxable. If less than all identified properties are acquired, but the Acquisition Period expires, all remaining funds may be received by the Exchangor, but are taxable.

Conclusion:

These are the basics. As tax rates rise, Section 1031 exchanges become increasingly valuable.

A Section 1031 exchange is not a new and exotic tax shelter scheme. Tax deferred exchanges of like-kind property have been recognized by the Internal Revenue Service as a valid tax deferral strategy since the early 1920s. The structure and effect of a Section 1031 exchange were specifically authorized by Congress by enacting Section 1031 of the Internal Revenue Code of 1986, as amended, and the Internal Revenue Service has promulgated extensive regulations for its implementation.

Use Section 1031 to your advantage, but be sure to strictly comply with the Section 1031 rules.

* Special Thanks to my tax partner, James M. Mainzer, for consulting on this post.

_________________________________

As required by the Internal Revenue Service under Circular 230, you are advised that any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this article.

This is the first installment of a three-part series on Section 1031 like-kind exchanges. Part 1 explains WHY you should consider use of a Section 1031 like-kind exchange when selling commercial or investment real property. Part 2 covers the key rules for HOW to implement a Section 1031 like-kind exchange. Part 3 covers special issues applicable to a Section 1031 like-kind exchange when a Tenant-In-Common [TIC] interest is being acquired.

Why Consider a §1031 Like-Kind Exchange?

What if I told you that you could get a hefty 0% interest loan from the federal government to invest in commercial or industrial real estate? Would you be interested?

Better yet, what if that loan has no fixed monthly, quarterly, or annual repayment obligations and does not show up on your credit report or balance sheet as an outstanding liability?

Still better yet, what if the terms of the loan provide that it may never have to be repaid? Are you interested now?

In effect,* that’s what a Section 1031 like-kind exchange can do for you.

Here’s how:

Section 1031 of the Internal Revenue Code permits

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 Tips on Selling Commercial Real Estate

Sellers are funny people. Not “ha ha” funny, but funny in the sense that they sometimes have an odd way of looking at things when they are selling commercial real estate.

This is not an indictment against any unique class of people. Let’s face it, sooner or later virtually all commercial real estate Buyers become commercial real estate Sellers. It is simply a recognition of an odd twist that occurs in the mindset of many commercial real estate investors when the tables are turned and they become Sellers instead of Buyers. If you are selling commercial real estate, or are a listing broker representing a party selling commercial real estate, here’s what you should do.

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Albert Einstein:           “Everything should be made as simple as possible, but not simpler.”

 

Commercial Real Estate Due Diligence – the Four Areas of Inquiry

I’m a big fan of Albert Einstein. He’s one of my intellectual heroes.  He could see and understand what others could barely imagine. His greatest gift, I believe, was his ability to find answers to questions others didn’t even know existed.

Real estate due diligence requires insight as well. To find the answers, you must

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This article is being republished as a welcoming salutation to many of my long-lost Real Estate Developer friends.  You have been missed over the past several years. Call me.  Let’s do lunch!

Did I happen to mention I love Real Estate Developers? Not like I love my wife or my kids, or even my dog, but Real Estate Developers are definitely among my favorite people.

Think about it.

Real Estate Developers are like Gods. [Well, miniature gods, at least.] They create much of the physical world we inhabit. The homes and condominiums we live in. The grocery store and pharmacy down the street. The resorts and casinos and golf courses we enjoy for leisure. Restaurants. Shopping centers. Office buildings. Movie theaters. Truck terminals. Medical and surgical centers. Spas. Factories. Warehouses. Auditoriums. Parking garages. Hotels.

You name it; if its man-made, attached to dirt, and we can get inside it, a Real Estate Developer was probably involved.

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Are you planning to purchase, finance or develop any of the following types of Commercial or Industrial Real Estate?

• • Shopping Center?
• • Office Building?
• • Large Multifamily residential?
• • Parking Lot/Parking garage?
• • Retail Store?
• • Mixed-Use?
• • Restaurant/Banquet property?
• • Sports and Entertainment Venue?
• • Intermodal Logistics Terminal?
• • Medical Building?
• • Gas Station?
• • Distribution Center?
• • Manufacturing facility?
• • Pharmacy?
• • Special Use facility ?
• • Other?

A KEY element to successfully investing in commercial or industrial real estate is performing an adequate Due Diligence Investigation prior to becoming legally bound to acquire the property. An adequate Due Diligence Investigation will assure awareness of all material facts relevant to the intended use or disposition of the property after closing.

 The following checklists will help you conduct a focused and meaningful Due Diligence Investigation.

 BASIC DUE DILIGENCE CONCEPTS

 Caveat Emptor: Let the Buyer beware.

Consumer protection laws applicable to home purchases seldom apply to commercial real estate transactions. The rule that a Buyer must examine, judge, and test for himself, applies to the purchase of commercial real estate.

Due Diligence:

“Such a measure of prudence, activity, or assiduity, as is proper to be expected from, and ordinarily exercised by, a reasonable and prudent (person) under the particular circumstances; not measured by any absolute standard, but depending upon the relative facts of the special case.” Black’s Law Dictionary; West Publishing Company.

Contractual representations and warranties are NOT a substitute for Due Diligence. Breach of representations and warranties = Litigation, time and $$$$$.

The point of commercial real estate due diligence is to avoid transaction surprises and confirm the Property can be used as intended.

 WHAT DILIGENCE IS DUE?

The scope, intensity and focus of any Due Diligence Investigation of commercial or industrial real estate depends upon the objectives of the party for whom the investigation is conducted. These objectives may vary depending upon whether the investigation is conducted for the benefit of: (i) a Strategic Buyer (or long-term lessee); (ii) a Financial Buyer; (iii) a Developer; or (iv) a Lender.

If you are a Seller, understand that to close the transaction your Buyer and its Lender must address all issues material to their respective objectives – some of which require information only you, as Owner, can adequately provide.

GENERAL OBJECTIVES:

 (i) A “Strategic Buyer” (or long-term lessee) is acquiring the property for its own use and must verify that the property is suitable for that intended use.

 (ii) A “Financial Buyer” is acquiring the property for the expected return on investment generated by the property’s anticipated revenue stream, and must determine the amount, velocity and durability of the revenue stream. A sophisticated Financial Buyer will likely calculate its yield based upon discounted cash-flows rather than the much less precise capitalization rate (“Cap. Rate”), and will need adequate financial information to do so.

 (iii) A “Developer” is seeking to add value by changing the character or use of the property – usually with a short-term to intermediate-term exit strategy to dispose of the property; although, a Developer might plan to hold the property long term as a Financial Buyer after development or redevelopment. The Developer must focus on whether the planned change in character or use can be accomplished in a cost-effective manner.

 (iv) A “Lender” is seeking to establish two basic lending criteria:

 (1) “Ability to Repay” – The ability of the property to generate sufficient revenue to repay the loan on a timely basis; and

 (2) “Sufficiency of Collateral” – The objective disposal value of the collateral in the event of a loan default, to assure adequate funds to repay the loan, carrying costs and costs of collection in the event forced collection becomes necessary.

The amount of diligent inquiry due to be expended (i.e. “Due Diligence”) to investigate any particular commercial or industrial real estate project is the amount of inquiry required to answer each of the following questions to the extent relevant to the objectives of the party conducting the investigation:

I. THE PROPERTY:

 1. Exactly what PROPERTY does Purchaser believe it is acquiring?

• Land?

• Building?

• Fixtures?

• Other Improvements?

• Other Rights?

• The entire fee title interest including all air rights and subterranean rights?

• All development rights?

 2. What is Purchaser’s planned use of the Property?

 3. Does the physical condition of the Property permit use as planned?

• Commercially adequate access to public streets and ways?

• Sufficient parking?

• Structural condition of improvements?

• Environmental contamination?

• Innocent Purchaser defense vs. exemption from liability

• All Appropriate Inquiry

 4. Is there any legal restriction to Purchaser’s use of the Property as planned?

• Zoning?

• Private land use controls?

• Americans with Disabilities Act?

• Availability of licenses?

• Liquor license?

• Entertainment license?

• Outdoor dining license?

• Drive through windows permitted?

• Other impediments?

 5. How much does Purchaser expect to pay for the property?

 6. Is there any condition on or within the Property that is likely to increase Purchaser’s effective cost to acquire or use the Property?

• Property owner’s assessments?

• Real estate tax in line with value?

• Special Assessment?

• Required user fees for necessary amenities?

• Drainage?

• Access?

• Parking?

• Other?

 7. Any encroachments onto the Property, or from the Property onto other lands?

 8. Are there any encumbrances on the Property that will not be cleared at Closing?

• Easements?

• Covenants Running with the Land?

• Liens or other financial servitudes?

• Leases?

9. If the Property is subject to any Leases, are there any:

• Security Deposits?

• Options to Extend Term?

• Options to Purchase?

• Rights of First Refusal?

• Rights of First Offer?

• Maintenance Obligations?

• Duty of Landlord to provide utilities?

• Real estate tax or CAM escrows?

• Delinquent rent?

• Pre-Paid rent?

• Tenant mix/use controls?

• Tenant exclusives?

• Tenant parking requirements?

• Automatic subordination of Lease to future mortgages?

• Other material Lease terms?

10. New Construction?

• Availability of construction permits?

• Soil conditions?

• Utilities?

• NPDES (National Pollutant Discharge Elimination System) Permit?

• Permit required if earth is disturbed on one acre or more of land.

• If applicable, Storm Water Pollution Prevention Plan (SWPPP) is required.

II. THE SELLER:

1. Who is the Seller?

• Individual?

• Trust?

• Partnership?

• Corporation?

• Limited Liability Company?

• Other legally existing entity?

2. If other than natural person, does Seller validly exist and is Seller in good standing?

3. Does the Seller own the Property?

4. Does Seller have authority to convey the Property?

• Board of Director Approvals?

• Shareholder or Member approval?

• Other consents?

• If foreign individual or entity, are any special requirements applicable?

• Qualification to do business in jurisdiction of Property?

• Federal Tax Withholding?

• US Patriot Act compliance?

5. Who has authority to bind Seller?

6. Are sale proceeds sufficient to pay off all liens?

III. THE PURCHASER:

1. Who is the Purchaser?

2. What is the Purchaser/Grantee’s exact legal name?

3. If Purchaser/Grantee is an entity, has it been validly created and is it in good standing?

• Articles or Incorporation – Articles of Organization

• Certificate of Good Standing

4. Is Purchaser/Grantee authorized to own and operate the Property and, if applicable, finance acquisition of the Property?

• Board of Director Approvals?

• Shareholder or Member approval?

• If foreign individual or entity, are any special requirements applicable?

• Qualification to do business in jurisdiction of the Property?

• US Patriot Act compliance?

• Bank Secrecy Act/Anti-Money Laundering compliance?

5. Who is authorized to bind the Purchaser/Grantee?

IV. PURCHASER FINANCING:

A. BUSINESS TERMS OF THE LOAN:

1. What loan terms have the Borrower and its Lender agreed to?

• What is the amount of the loan?

• What is the interest rate?

• What are the repayment terms?

• What is the collateral?

• Commercial real estate only?

• Real estate and personal property together?

• First lien?

• A junior lien?

• Is it a single advance loan?

• A multiple advance loan?

• A construction loan?

• If it is a multiple advance loan, can the principal be re-borrowed once repaid prior to maturity of the loan; making it, in effect, a revolving line of credit?

• Are there reserve requirements?

• Interest reserves?

• Repair reserves?

• Real estate tax reserves?

• Insurance reserves?

• Environmental remediation reserves?

• Other reserves?

2. Are there requirements for Borrower to open business operating accounts with the Lender? If so, is the Borrower obligated to maintain minimum compensating balances?

3. Is the Borrower required to pledge business accounts as additional collateral?

4. Are there early repayment fees or yield maintenance requirements (each sometimes referred to as “pre-payment penalties”)?

5. Are there repayment blackout periods during which Borrower is not permitted to repay the loan?

6. Is a profit participation payment to Lender required upon disposition?

7. Is there a Loan Commitment fee or “good faith deposit” due upon Borrower’s acceptance of the Loan Commitment?

8. Is there a loan funding fee or loan brokerage fee or other loan fee due Lender or a loan broker at closing?

9. What are the Borrower’s expense reimbursement obligations to Lender? When are they due? What is the Borrower’s obligation to pay Lender’s expenses if the loan does not close?

B. DOCUMENTING THE COMMERCIAL REAL ESTATE LOAN

Does Purchaser have all information necessary to comply with the Lender’s loan closing requirements?

Not all loan documentation requirements may be known at the outset of a transaction, although most commercial real estate loan documentation requirements are fairly typical. Some required information can be obtained only from the Seller. Production of that information to Purchaser for delivery to its lender must be required in the purchase contract.

As guidance to what a commercial real estate lender may require, the following sets forth a typical Closing Checklist for a loan secured by commercial real estate.

Commercial Real Estate Loan Closing Checklist

1. Promissory Note

2. Personal Guaranties (which may be full, partial, secured, unsecured, payment guaranties, collection guaranties or a variety of other types of guarantees as may be required by Lender)

3. Loan Agreement (often incorporated into the Promissory Note and/or Mortgage in lieu of being a separate document)

4. Mortgage (sometimes expanded to be a Mortgage, Security Agreement and Fixture Filing)

5. Assignment of Rents and Leases.

6. Security Agreement

7. Financing Statement (sometimes referred to as a “UCC-1”, or “Initial Filing”).

8. Evidence of Borrower’s Existence In Good Standing; including :

(a) Certified copy of organizational documents of borrowing entity (including Articles of Incorporation, if Borrower is a corporation; Articles of Organization and written Operating Agreement, if Borrower is a limited liability company; certified copy of trust agreement with all amendments, if Borrower is a land trust or other trust; etc.)

(b) Certificate of Good Standing (if a corporation or LLC) or Certificate of Existence (if a limited partnership) or Certificate of Qualification to Transact Business (if Borrower is an entity doing business in a State other than its State of formation)

9. Evidence of Borrower’s Authority to Borrow; including:

(a) Borrower’s Certificate

(b) Certified Resolutions

(c) Incumbency Certificate

10. Satisfactory Commitment for Title Insurance (which will typically require, for analysis by the Lender, copies of all documents of record appearing on Schedule B of the title commitment which are to remain after closing), with required commercial title insurance endorsements, often including:

(a) ALTA 3.1 Zoning Endorsement modified to include parking [although if the property is a multi-user property, such as a retail shopping center, an ALTA 3.0 Zoning Endorsement may be appropriate]

(b) ALTA Comprehensive Endorsement 1

(c) Location Endorsement (street address)

(d) Access Endorsement (vehicular access to public streets and ways)

(e) Contiguity Endorsement (the insured land comprises a single parcel with no gaps or gores)

(f) PIN Endorsement (insuring that the identified real estate tax permanent index numbers are the only applicable PIN numbers affecting the collateral and that they relate solely to the real property comprising the collateral)

(g) Usury Endorsement (insuring that the loan does not violate any prohibitions against excessive interest charges)

(h) other title insurance endorsements applicable to protect the intended use and value of the col- lateral, as may be determined upon review of the Commitment for Title Insurance and Survey or arising from the existence of special issues pertaining to the transaction or the Borrower.

11. Current ALTA/ACSM Land Title Survey (3 sets), prepared in accordance with the 2011 (or current) Minimum Standard Detail Requirements for ALTA/ACSM Land Title Surveys

12. Current Rent Roll

13. Certified copy of all Leases (4 sets – 1 each for Buyer, Buyer’s attorney, Title Company and Lender)

14. Lessee Estoppel Certificates

15. Lessee Subordination, Non-Disturbance and Attornment Agreements [sometimes referred to simply as “SNDAs”]

16. UCC, Judgment, Pending Litigation, Bankruptcy and Tax Lien Search Report

17. Appraisal -complying with Title XI of FIRREA (Financial Institutions Reform, Recovery and Enforcement Act of 1989, as amended)

18. Environmental Site Assessment Report (sometimes referred to as Environmental Phase I and/or Phase 2 Audit Reports)

19. Environmental Indemnity Agreement (signed by Borrower and guarantors)

20. Site Improvements Inspection Report

21. Evidence of Hazard Insurance naming Lender as the Mortgagee/Lender Loss Payee; and Liability Insurance naming Lender as an “additional insured” (sometimes listed as simply “Acord 27 and Acord 25, respectively)

22. Legal Opinion of Borrower’s Attorney

23. Credit Underwriting documents, such as signed tax returns, property operating statements, etc. as may be specified by Lender

24. Compliance Agreement (sometimes also called an Errors and Omissions Agreement), whereby the Borrower agrees to correct, after closing, errors or omissions in loan documentation.

* * * * *

It is useful to become familiar with the Lender’s loan documentation requirements as early in the transaction as practical. The requirements will likely be set forth with some detail in the lender’s Loan Commitment – which is typically much more detailed than most loan commitments issued in residential transactions.

Conducting the Due Diligence Investigation in a commercial real estate transaction can be time consuming and expensive in all events.

If the loan requirements cannot be satisfied, it is better to make that determination during the contractual “due diligence period” – which typically provides for a so-called “free out” – rather than at a later date when the earnest money may be at risk of forfeiture or when other liability for failure to close may attach.

CONCLUSION

Conducting an effective Due Diligence Investigation in a commercial or industrial real estate transaction to discover all material facts and conditions affecting the Property and the transaction is of critical importance.

Unlike owner occupied residential real estate, when a house can nearly always be occupied as the purchaser’s home, commercial and industrial real estate acquired for business use or for investment is impacted by numerous factors that may limit its use and value.

The existence of these factors and their impact on a Purchaser’s ability to use the Property as intended can only be discovered through diligent and focused investigation and attention to detail.

Exercise Due Diligence.

If you need assistance, please ask for help.

Commercial Real Estate Closings

Since 1978, I have represented borrowers and lenders in commercial real estate transactions. Throughout the process of negotiating the sale contract, all parties must keep their eye on what the Buyer’s lender will reasonably require as a condition to financing the purchase. This may not be what the parties want to focus on, but if this aspect of the transaction is ignored, the deal may not close at all.

Sellers and their agents often express the attitude that the Buyer’s financing is the Buyer’s problem, not theirs. Perhaps, but facilitating Buyer’s financing should certainly be of interest to Sellers.  How many sale transactions will close if the Buyer cannot get financing?

This is not to suggest that Sellers should intrude upon the relationship between the Buyer and its lender, or become actively involved in obtaining Buyer’s financing. It does mean, however, that the Seller should understand what information concerning the property the Buyer will need to produce to its lender to obtain financing, and that Seller should be prepared to fully cooperate with the Buyer in all reasonable respects to produce that information.

Basic Lending Criteria

Lenders actively involved in making loans secured by commercial real estate typically have the same or similar documentation requirements.  Unless these requirements can be satisfied, the loan will not be funded.  If the loan is not funded, the sale transaction will not likely close.

 For Lenders, the object, always, is to establish two basic lending criteria:

 1.         The ability of the borrower to repay the loan; and

 2.         The ability of the lender to recover the full amount of the loan, including outstanding principal, accrued and unpaid interest, and all reasonable costs of collection, in the event the borrower fails to repay the loan.

In nearly every loan of every type, these two lending criteria form the basis of the lender’s willingness to make the loan. Virtually all documentation in the loan closing process points to satisfying these two criteria.  There are other legal requirements and regulations requiring lender compliance, but these two basic lending criteria represent, for the lender, what the loan closing process seeks to establish.  They are also

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