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Previously we discussed the importance of assembling a team of Key Players as a first step to any commercial real estate transaction. Once your team is assembled and discovered a suitable property, the next step is to draft and negotiate a purchase agreement that encapsulates the deal and protects your interest. A well-drafted purchase agreement should protect you from unforeseen costs and issues in the future, and your commercial real estate attorney is the key player to ensure that it does.
So, what should be included in a purchase agreement, and perhaps more importantly, what can be negotiated?
Very generally, purchase agreement provisions include a description of purchase price, earnest money, payment terms, due diligence, contingencies, representations and warranties, prorations and general provisions which allocate risk and liability between seller and buyer. And, good news, it’s all subject to negotiation. In this edition of The Dirt, we’ll talk about when your purchase agreement truly becomes “binding”, and different ways to structure the purchase price, earnest money and payment terms. Here is what you need to know:
BINDING V. NON-BINDING PURCHASE AGREEMENT
Once signed, a purchase agreement is always “binding” in the sense that you agree to move forward with purchasing (or selling) unless certain events do not (or do) occur, and often unless you provide notice of your desire to get out of the deal within agreed upon timeframes. However, there is typically a period of time in which a purchaser gets a “free look” – in other words, a time to conduct due diligence and otherwise inspect the property, before the earnest money becomes nonrefundable. Once the contingency period expires, the purchase agreement is truly binding, and backing out will cost the purchaser the earnest money (and maybe more). When entering into a purchase agreement, it’s important to consider what contingencies are important, and how much time you really need to learn what you can about the property.
PURCHASE PRICE, EARNEST MONEY AND PAYMENT TERMS
Depending on what kind of property is involved, the purchase price may be stated as a lump sum or a price per square foot. Most commonly, the price will be stated as a lump sum. However, occasionally a property will be listed for a per square foot price, and the actual square footage of the property may be subject to negotiation. For example, the purchase price may be set at $100 per square foot, and a preliminary building square footage may be 15,000 square feet. The results of a survey or building inspection may reveal a smaller or larger building, and the purchase price may be adjusted accordingly.
Earnest money is an amount paid by the purchaser to secure performance of its obligations under the purchase agreement. Stated differently, its gives a purchase some “skin in the game”. Earnest money provisions in purchase agreements may vary significantly, from simple, to more complex. In the most straight-forward scenario, a one-time payment of a percentage of the purchase price is due at the time the purchase agreement is signed. Some deals will require that the purchase deposit additional sums of money to extend its due diligence period, or sometimes even at the end of the due diligence period to confirm their desire to proceed to closing. A less common ask of sellers is for a purchaser to sign a promissory note for a sum in addition to a cash earnest money deposit which, by its terms, becomes due and payable in the event the purchase agreement is terminated as a result of purchaser default. This arrangement is somewhat unusual, but certainly enforceable in the commercial context.
Most commonly, a commercial real estate purchase is made by cash payment to the seller. The cash may come from the assets of the purchaser, or more often, from the proceeds of a real estate purchase loan secured by a mortgage against the subject property. In some instances, a seller will agree to “seller finance” all or a portion of the purchase price. In this scenario, the conveyance will often be evidenced by contract for deed. Although rates can be higher in a seller-financed transaction, it might be an appealing option for a purchaser who is unable to obtain bank financing for a multitude of reasons.
Watch for The Purchase Agreement: Part II, in which we explore due diligence.