5 Hidden Keys to Commercial Real Estate Contracts

Discover the 5 hidden keys to great commercial real estate contracts. Understanding real estate purchase agreements is essential because they are legally binding documents that either help you make great property acquisitions or cost you money and even get you sued! Even with the counsel of an attorney, smart investors (like those that we mentor) always take into account the following 5 keys in their commercial real estate contracts so that they can structure good deals and avoid downside risks:

 

Key #1: The 4 Essential Contingency Clauses

Some beginner investors are afraid to use a purchase contract when they submit an offer because it locks them into certain contractual commitments. But if you have these 4 contingencies clauses, you can get out of a bad deal if you need to. You MUST have these 4 contingency clauses in your commercial real estate contract.

1. Property Inspection: Your transaction should be contingent on you inspecting the property within a certain number of days.
2. Financing: Finding an acceptable loan for the property.
3. Title: Verifying the property has a clean title and no liens on it.
4. Appraisal: The ability for the property to appraise for the contract price.

The Broker, Seller, or the Seller’s attorney, can remove any of these clauses, so don’t make assumptions about the contract. If they aren’t in the purchase contract, then you need to walk away from the deal.

Caveat Emptor

We have an expert on our mentoring team who specializes in commercial real estate contracts. Their sole responsibility is to ensure that all our contracts are well written and include these 4 contingencies. And here’s why: caveat emptor, which means buyer beware! Commercial real estate is different from residential. Residential real estate has certain protections for the buyer if the Seller lies about the property or fails to disclose defects or problems. Whereas in commercial real estate you don’t have those protections, so the risk is all on you. The seller can lie through his teeth and there’s nothing you can do about it. This is why these contingencies are so important to include in commercial real estate contracts.

 

Key #2: Sufficient Time for Due Diligence

In a purchase contract it will stipulate a certain number of days for you to complete your physical, legal, and financial inspections. This also includes securing the financing from the lender. When a broker or Seller is pushing you to finish all your due diligence within a ten-day period, that’s a huge red flag. Rushing the due diligence period may indicate that they have something to hide. Or maybe they know it’s impossible to do and they intend to keep your earnest money deposit. Regardless of their motives, don’t fall for a 10 day or even 20-day contingency period.

You need to get at minimum 30 business days to do a thorough inspections and get funding for the deal because it takes time to get all the necessary professionals out to evaluate the property. Not only that, but lenders are taking twice as long to approve financing. Some deals have died at this point because high interest rates have killed the deal. Also, you may uncover problems with the property or financing during your inspections which means you need time to renegotiate with the Seller. It is impossible to do all that in ten or even twenty days.

 

Key #3: Understand the Earnest Money Deposit Clause

Novice commercial real estate investors oftentimes do not fully understand the earnest money deposit clause and then after they’ve signed the contract and paid the earnest money, they seek help to fix a problem that can’t be fixed. Once the purchase agreement is fully executed by both parties and the earnest money has been delivered, it’s too late to fix an earnest money clause issue. In fact, its very common for beginners to lose their earnest money on a bad deal because they didn’t completely understand the circumstances by which they could get their earnest money back.

You must know and understand all of the intricacies of your earnest money deposit (EMD) clause. Earnest money is essentially a deposit on the property and signifies that you intend to follow through with the contract. Your contract will include conditions for refunding the earnest money, or contingencies. However, you could miss some hidden things within that clause, and if you miss them you risk losing your earnest money.

When does the EMD become non-refundable?

Usually, you have about 30 business days for due diligence. If you don’t uncover any problems in all your inspections and have financing terms that work, that’s when your earnest money deposit becomes non-refundable. From a contractual perspective, this is when you are either going to confirm the expiration of the contingencies or you are going to cancel the contract based on those contingencies. So, know when that deadline is because if you don’t complete your inspections and make a decision within that time frame, you will lose your deposit.

Is it non-refundable on day one?

The contract could stipulate that the earnest money deposit is non-refundable as soon as you sign the contract. Watch out for this  because it’s easy to read right over this and get trapped in the deal.

Did the Seller’s attorney write the contract in such a way as to make it impossible to get it refunded if you terminate the contract?

Remember the Seller’s attorney is working for them, not you. Which means, any advantage the attorney can give to the Seller to make money or to make money for themselves, they will do. And if you misinterpret or don’t understand something, that’s on you.

 

Key #4: Two Way Seller/Buyer Default Clause

Almost all commercial real estate contracts have a default clause which stipulates what the penalties are when either party defaults. You want to make sure that your contract have a two way seller/buyer default clause, as opposed to one that only favors the seller. Both sellers and buyers should have equal rights and equal penalties if either does not fulfill the terms in the contract. This is quite common when attorneys or brokers representing the Sellers write the contracts. They include harsh penalties if the buyer backs out, but minimal consequences for the Seller if they back out of the deal. So, beware when you’re looking at attorney or broker contracts on listed properties. The default clause needs to be a two way street and protect both the buyer and seller.

 

Key #5: Insurance Cost Contingency Clause

This fifth hidden key to commercial real estate contracts applies to everyone but is extremely important to investors in high insurance risk areas like Florida, California, Texas and Louisiana; where natural disasters like hurricanes, wild fires, floods and tornadoes are most common and insurance costs have skyrocketed in recent years. Existing owners may be “grandfathered-in” on their insurance costs but when you attempt to purchase, the new policy you originate may have a much higher cost. When your new policy is drastically higher than the current owner, it increases your expenses, lowers your NOI and requires you to pay less for the property in order to meet your investment standards. You need an insurance cost contingency in your contract so that you can terminate the deal without penalty if you can’t find affordable or reasonable insurance and the seller will not lower the price to compensate for the lower NOI.

 

The Best Commercial Real Estate Contract Helper

It takes tremendous experience over a very long period of time to be able to determine the right offer that is written up with the most well crafted commercial real estate contract and then is negotiated wisely with the seller so that they actually say Yes! The best contract helper is the right mentoring team that already has that experience. This is yet another example of why every successful commercial real estate investor has a mentor. Get you mentor here: Commercial Property Advisors Protege Program