Commercial buyers should leave 60 days for due diligence, and use more caution with transactions.
By John Weaver, The Business Journals, February 1, 2023
The last 24 to 30 months were a strange time to buy and sell real estate, both commercial and residential. Numerous factors contributed to that, particularly pandemic conditions and incredibly low interest rates. The result was an epic seller’s market where many conveyancing norms were ignored or discarded. As real estate transactions begin to more closely resemble the prepandemic market, what skills and processes should sellers and buyers relearn?
Buyers should remember that “due diligence” is not a four-letter word. Far too frequently over the last two years, I saw purchasers waive physical inspections of homes, environmental investigations and surveys because they did not want to lose a property. Rightly or wrongly, since mid-2020, many purchasers acted under the belief that the seller had an eager backup, one who would buy the property without checking if there were encroachments, improperly permitted alterations, municipal ordinance violations, etc. Many of those buyers found issues after the closing that they would have discovered during a standard due diligence review and regretted not conducting that.
In a commercial purchase, buyers should remember that 30 to 60 days for due diligence is reasonable and appropriate, that they can ask sellers to produce existing property documents (including surveys, environmental assessments, insurance policies and leases), and ordering their own surveys and Phase 1 investigations can be beneficial even if there is no lender requiring them. Residential buyers should only waive a home inspection as a last resort or when they are going to tear down the home and there aren’t other factors that warrant an inspection, like an old heating system and oil tank.
Representation, warranty, financing and negotiation
Similarly, purchasers should relearn the art of representation and warranty. It is not unreasonable to request that the seller make representations about the state of the property, including that there are no conditions at the property that constitute a violation of law, there are no open building permits, there are no underground storage tanks and those representations survive for some period after the closing. The seller may object or refuse, but it is not unreasonable to ask.
Although this might be apparent, financing is much more expensive than it has been, so buyers need to consider this when looking to purchase a property. They should adjust their price range and be prepared to work with the lender to satisfy their due diligence concerns. Most commercial lenders will want the survey exception waived from a title insurance policy and a Phase I conducted. Sellers may be less willing to offer seller financing because of the economic outlook over the next 12 months, although sellers should think about that (see below). Given that outlook, it is prudent to carefully review (and possibly negotiate) the default provisions of your loan agreement and the mortgage securing the property as collateral.
Sellers should reevaluate their negotiating position. Many will not have the leverage they had in 2021 or 2022. If that’s true, they should be prepared to concede points they have not had to, including due diligence inspections and representations about their property.
More cautions for buyers and sellers
With financing more expensive, buyers and their lenders will want to take a closer look at their investment to confirm it is worth the price. In some cases, they might object to issues that were not red flags recently. Buyers might insist that sellers obtain a certificate of compliance to address an old order of condition before closing or require that some of the purchase price be held in escrow pending the post-closing recording of a certificate. Buyers might also insist that representations survive closing because they are concerned their investment will be devalued by something like an open building permit or undiscovered malfunction in a building system.
With financing more expensive, sellers may also want to reconsider related issues, including asking price, seller financing and seller fit-up work. Not all sellers will be able to serve as their buyers’ lender, but some sellers may find a viable way to get to closing. Another financing concern: I have seen sellers have to renegotiate purchase and sale agreements when they were unable to secure their own financing to perform fit-up work the agreements required as a closing condition.
As real estate transactions change to reflect new market conditions, buyers and sellers should dust off the skills and processes that they relied on before the pandemic. They still create valuable protections and can help get deals closed.
John Weaver is a director at McLane Middleton and chair of the firm’s Real Estate Practice Group. He can be reached at firstname.lastname@example.org.