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.
This is not an indictment against any unique class of people. Lets 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.
Generally, once a Seller has made the decision to "sell", most Sellers want to move ahead with as little pain and delay as possible. Right?
What typically happens? The Seller finds a commercial real estate broker and lists the property. Once the Seller receives a letter of intent or contract offer, the Seller contacts its attorney to prepare or review the contract. The contract is virtually always subject to a "due diligence review" period during which the Buyer is to investigate the property to determine whether it satisfies Buyer's use or investment criteria. The contract invariably includes a variety of "Seller deliveries": a title commitment; copies of documents of record; ALTA survey; a rent roll; copies of leases; service contracts; etc. etc. etc.
So, what does the typical Seller do?
Often, the Seller waits until the contract is fully executed before ordering title, obtaining copies of documents of record, compiling leases, ordering a Survey, and gathering other required Seller deliveries.
Worse, many Seller's adopt the attitude that: "Buyer's financing and due diligence is Buyer's problem – leave me out of it."
While it is certainly true that Buyer's financing and due diligence is the responsibility of the Buyer, it is also true that much of the information a Buyer needs must be obtained from the Seller. If the Buyer is delayed or obstructed in obtaining necessary information it will be delayed in performing its due diligence review and unable to satisfy necessary conditions for financing. Even if the contract is "not contingent on financing", the practical reality – in most cases - is that if financing is not obtained the transaction will not Close. Failure to take reasonable steps to facilitate Buyer's due diligence and financing, then, ultimately becomes the "Seller's problem”.
What SHOULD a Seller do?
Sellers should become proactive instead of reactive.
Instead of waiting until a letter or intent is received or a contract is signed before compiling information a Buyer will almost certainly need, a Seller should compile the information a Buyer will need as soon as the Seller decides to sell.
How does Seller know what the Buyer will need? Interesting question. When the Seller was a Buyer, he/she knew exactly what a Buyer needed to evaluate the property, get financing, and Close. Still, even if amnesia has set in, what a Buyer needs is fairly predictable. [See my article "10 Things Every Buyer Needs to Close a Commercial Real Estate Loan" from August 2003/Updated February 2006.]
If you are a Seller and are, indeed, committed to selling your property, sooner or later you are going to be called upon to deliver at least the typical Seller deliveries. Sooner is better than later. It will speed up the due diligence process and enable the Buyer to determine at the earliest possible date whether there are obstacles to Closing.
Once gathered, the Seller Deliveries should be bound in a "Due Diligence Binder" for distribution to interested Buyers.
It will typically expedite the transaction if the Due Diligence Binder is delivered to the Buyer when the Buyer is first seriously considering purchase of a property – even before the purchase contract is drafted. If, in fact, conditions do exist that prevent a Buyer from proceeding to Closing, it is in Seller’s interest to find out now rather than later so the property can be kept on the market and made available to a Buyer who may be in a position to proceed.
Certainly, Seller may require a prospective Buyer to sign a Confidentiality, Non-Use and Non-Disclosure Agreement as a condition to receiving the Due Diligence Binder if the Seller feels this is desirable.
If the documents are voluminous (such as if the property is a large shopping center, office building or mixed use development with many tenants), an alternative is the establishment of a so-called "war room" where copies of all the documents are maintained and can be made readily available for inspection by prospective Buyers. Even then, all title related documents should be compiled in a Due Diligence Binder for ready review by Buyer’s attorney.
What should the Due Diligence Binder or war room include? At a minimum, it should include the following:
1. Current Commitment for Title Insurance
2. Copies of all documents of record referred to in the Commitment for Title Insurance which will remain on Schedule B of the Commitment of Title Insurance after Closing (i.e. easements, restrictions, covenants, etc.)
3. Current real estate tax bill(s)
4. A current ALTA Survey showing all improvements as currently exist, ideally including items 1 through 4, 6, 7(a), 7(b)(1), 8 through 11(a) and 14 from Table A of the Optional Survey Requirements for ALTA Surveys.
5. If the property is income producing, operating statements for the past 3 years, a Rent Roll and copies of all leases, licenses and concessions. [Don't forget about cell-tower leases and billboard or sign leases, and parking leases.]
6. A schedule of any personal property to be included.
7. If the property is an out-lot or otherwise part of a larger whole and is required to participate in payment of common area maintenance (CAM) charges, copies of invoices and CAM charge breakdowns for at least the past 2 years.
8. Service contracts (for elevator, fire/sprinkler maintenance, scavenger, snow removal and landscaping, security, etc.).
9. Any available environmental site assessment reports (Phase I and Phase 2) and, certainly, any NFR letters or governmental notices relating to environmental issues.
10. Blueprints, building plans, site plans, schematics, soil compaction test reports, structural reports, roof warranties and other information relating to existing improvements.
To the extent practical, a Seller should compile all information in its possession or control that Seller would reasonably want to see if it were a Buyer conducting its own due diligence review to decide whether to purchase the property. [Ask for a copy of my January 2006 article: Due Diligence Checklists for Commercial Real Estate Transactions].
If you are a REALLY bold Seller, you might even consider preparing and including with the Due Diligence Binder a bare-boned but workable form of Purchase Agreement you would be willing to accept if tendered with an acceptable purchase price from a qualified Buyer.
Of course, to be a “PERFECT SELLER”, you need to understand the issues presented by the Due Diligence Binder’s contents, especially as they relate to access, use and financing, and be prepared to work with the Buyer to resolve problematic issues to get the transaction to Closing.
Sellers are sometimes reluctant to voluntarily offer this information up front. Why? There are four common reasons.
1. Some Sellers think they should not volunteer anything. That maybe the Buyer will forget to ask for that “one document” that reveals a defect, thereby enabling the Seller to "get away with" selling the property without addressing the issue.
If this is the thinking, it is naïve and short sighted. What is more likely to happen is that the Buyer will discover the defect during its due diligence investigation and will either terminate the transaction or demand a significant price concession under the threat of contract termination.
On the other hand, it has been my experience that if the defect is disclosed at the outset, when the Buyer is enthusiastically formulating the project concept, resolution of the issue may be factored into the Buyers' development plan and never again become a major transaction issue.
2 Another reason I hear is that the Seller does not wish to prematurely spend the money to put the due diligence materials together “in case transaction falls apart”. The Seller is concerned with “wasting money”.
My response to this is two-fold: i) If the Seller is committed to Selling the property, the expenditure is not wasted even if the current transaction fails because most of the information will be useful when the next Buyer comes along; and ii) the benefit of facilitating Buyer's due diligence and accelerating Closing will often far exceed the carrying cost of compiling this information in advance. Besides, the sooner you can get to Closing, the more likely the transaction is to close.
3. A variation of the "money" theme is the notion that once a Buyer spends large amounts of money performing due diligence the Buyer becomes committed to the deal and is more likely to Close. This may occasionally be true, but experience shows that most Buyers will walk away rather than throw good money away chasing a bad deal. The result is that the property may then need to go back on the market to start from square one. If this happens more than once, the property may gain an reputation as a "problem property", thereby depressing its value in the marketplace.
4. The best reason I hear (usually from other lawyers) is that volunteering this information risks exposing Seller to liability on a theory of Seller implicitly warranting the accuracy of the contents of the Due Diligence Binder.
My response is that it only takes a little bit of creative draftsmanship to mitigate this risk. Further, preparing and offering a well-constructed Due Diligence Binder documents Seller’s deliveries and positions the Seller to avoid most contractual warranties, thereby reducing Seller’s exposure to liability.
WHAT ARE THE ADVANTAGES TO SELLER?
If you are a Seller of Commercial or Industrial Real Estate and conscientiously follow the recommendations outlined above, your transaction will proceed more smoothly and quickly, the likelihood of Closing will increase, and you will save money by avoiding the need to renegotiate issues that should have been addressed at the outset of the transaction.
To be sure, other issues will arise. They always do. But your chances of proceeding to Closing on-time and on-budget will greatly increase if you make the effort to be as close to a Perfect Seller as possible.
Thank you for listening,
R. Kymn Harp
PS. If you are a commercial real estate broker, I encourage you to discuss with your Seller the strategy outlined in this article the moment the property is listed for sale. Send your Seller a copy of this article if you wish. I assure you, if your Seller follows the advice in this article, everyone will benefit.
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