Key Elements of Commercial Real Estate Purchase and Sale Agreements
A real estate purchase and sale agreement is a crucial document in a commercial property transaction and understanding its key terms is essential to negotiating the best deal. While there are countless ways to structure a contract, we put together this guide to help buyers and sellers understand the common provisions and processes used in the purchase and sale of commercial real estate.
What is a Commercial Real Estate Purchase and Sale Agreement?
A commercial real estate purchase and sale agreement is a legally binding contract that outlines the terms and conditions of the sale of a commercial property. The agreement is signed by both the buyer and the seller and defines the rights and obligations of each party involved in the transaction.
2. What is the Process of Drafting a CRE Purchase and Sale Agreement?
In certain jurisdictions, such as California, parties often rely on broker generated contracts based on a boilerplate form; however, for larger and more complicated transactions, the parties typically rely on attorneys to draft customized agreements. The initial draft is typically prepared by the seller’s attorney, and is then reviewed and revised by the buyer, with both parties trading drafts as necessary to arrive at a final document. The agreements typically include the standard provisions discussed below, but will also be tailored to fit the unique aspects of the transaction, such as the type of property involved.
3. Common Terms in a Commercial Real Estate Purchase and Sale Agreement
Below are some common provisions you are likely to encounter in a purchase and sale agreement, as well as a brief explanation of each concept.
a. Property Description:
The property description is an essential element of the contract that outlines the specific property being sold. This includes not only the land and improvements (otherwise known as the “real property”), but also any personal property used in connection with the property, as well as other types of property that may be relevant to the use and operation of the Property. Other common types of property that may be conveyed are:
Easements or other critical rights that run with the land;
Leases in effect as of the closing date;
Certain contracts that the buyer may want to assume;
Warranties for improvements or equipment included in the sale;
IP rights to names of a particular building or shopping center; and
Rights to websites and related media relating to a property.
It is important to verify that the property description accurately reflects the property being sold and that any items beyond the real property are clearly identified or scheduled in the agreement.
b. Buyer Contingencies:
Contingencies are an important aspect of a commercial real estate purchase and sale agreement. They allow the buyer a set period of time to thoroughly review and assess certain aspects of the property before making a final decision on the purchase. This allows the buyer to ensure that the property meets its expectations and requirements before committing to the transaction.
A buyer's review of the property may uncover issues that need to be addressed before the transaction can move forward. If the buyer determines that any of these items are not satisfactory, it may choose to (i) give the seller the opportunity to resolve the issue, (ii) accept the item as is and waive its right to terminate the contract, or (iii) terminate the contract altogether.
To properly evaluate the contingencies, the buyer will need access to a variety of property-related documents, including leases, a title report and a recent survey, copies of all property contracts, permits, licenses, financial information, and any notices of land use or environmental violations. The purchase and sale agreement should outline the seller's obligation to provide all of these documents, as well as any updates or new information up to and through the closing of the transaction.
The specific contingencies included in a commercial real estate purchase and sale agreement will vary depending on the particular transaction; however, some of the most common contingencies include:
The buyer's ability to secure financing;
Obtaining specific approvals for a particular use or for development of the property; and
Satisfactory due diligence review, including approval of the following matters:
a title report and survey of the property;
building and property inspections;
review of the leases;
review of property income and expenses;
review of property-related contracts;
confirmation of land use approvals related to the existing or proposed use of the property; and
an environmental site assessment (also referred to as a “Phase 1” report).
Some or all of the foregoing contingencies may be excluded or waived in order to make the purchase offer more competitive, and there are nuances to how each of these provisions should be negotiated. As a buyer, you will push to make these conditions as broad as possible to terminate the deal for “any reason or no reason” during the contingency period, while the seller will push to make the contingencies as narrow as possible to make ensure the buyer is not wasting time and needs a legitimate reason to terminate the deal.
c. Closing Date; Closing Mechanics:
Closing Date.
The closing section outlines the process and procedures for closing the transaction, including the delivery of necessary documents (such as the deed to the property) and the transfer of funds from the buyer to the seller. The date on which the sale of the property is finalized is typically referred to as the “Closing Date”.
2. Conveyance Documents.
While the purchase and sale agreement governs the rights and obligations of the parties in the transaction, the actual transfer of the property is done on the closing date by the delivery of separate instruments. The following instruments are usually provided depending on the exact property being conveyed
Deed - The deed conveys the real property to the new owner and is signed and typically notarized by the Seller for recording in the real property records. The contract should specify the type of deed to be used. The basic types of deed are general warranty deeds, special warranty deeds and quitclaim deeds, each of which provides different levels of assurance and warranty from the seller regarding title to the real estate, though it should be noted that certain states have forms of deeds with statutorily defined rights and benefits.
Assignments - A separate agreement, often called an Assignment of Leases or an Assignment of Contract, is usually used to transfer interests in leases, contracts, licenses, and other property-related items. The purchase and sale agreement should specify what contracts may be assumed by the buyer and which party will bear the cost of terminating any contracts that will not be assumed.
Bill of Sale - A bill of sale is used to convey personal property and should identify the items transferred as specifically as possible.
3. Prorations and Adjustments.
The purchase price is typically adjusted prior to closing to reflect credits and/or charges to buyer and seller for things like deal related expenses (such as title fees), apportionment of property taxes, and rents, with the seller typically being responsible for all expenses prorated through the closing date and buyer being responsible for all expenses from and after the closing date. For example, if the seller has already paid taxes through the end of the calendar year and the sale closes in November, the buyer will be charged for its share of the taxes already paid by the seller. You will need to understand how local tax and utility ordinances operate to ensure these amounts are accurately reflected at closing, or you can also agree to reconcile certain expenses later once they are known, such as may be the case if taxes are assessed in arrears and not yet billed as of the closing date.
d. Seller’s Representations and Warranties:
Representations and warranties are statements made by the seller about the property and its condition. They typically serve three main purposes (i) to provide information to the buyer about the property; (ii) to provide a basis for the buyer to terminate the transaction if the reps prove to be false or misleading; and (iii) to provide recourse against the seller post-closing should any of the reps prove to be false or misleading. These statements are intended to protect the interests of the buyer and to ensure that they are fully informed about the property they are purchasing. Some of the most common representations and warranties include:
The property is unencumbered and clear of all liabilities;
No land use violations exist, such as zoning or building code violations;
All necessary permits for the operation of the property are in place;
There is no environmental contamination or environmental violation present;
No other parties have the right to occupy the property besides the tenants specified in the leases disclosed by seller;
The leases, contracts, and financial documents provided to the buyer are accurate and complete;
There are no defaults under leases except as disclosed in the rent roll, and the rent roll is complete and accurate;
The seller has the legal authority to sign the contract; and
The improvements on the property are free of significant defects and suitable for their intended use.
e. Closing Conditions:
This section outlines the essential requirements that must be met in order for the parties to proceed with the transaction. Unlike contingencies, which are specific conditions, such as inspections or financing, that must be fulfilled, these closing conditions are broader in nature and set forth the conditions that must be met in order for the buyer and seller to be obligated to close the transaction. There are usually separate closing conditions for buyer and seller, and usually include the following:
The other party must have fully satisfied all of its obligations under the agreement;
The other party’s representations and warranties must be true and correct as of the closing date;
All necessary consents, approvals, and authorizations required for the transaction must have been obtained;
All necessary tenant estoppel certificates must be delivered and must be consistent with the rent and not disclose any previously undisclosed landlord and/or tenant defaults;
Any third-party agreements, such as leases or contracts, must be in full force and effect;
Escrow must have received a fully executed copy of all closing documents; and
All funds required for closing must have been deposited and cleared.
These closing conditions ensure that both parties are fully satisfied and that the transaction can be completed smoothly and efficiently. If any of these conditions are not met, the parties may elect to (i) waive the condition and close anyway; (ii) renegotiate the terms of the agreement; or (iii) cancel the transaction altogether, subject to any remedies available to the parties should the failure be due to a default of the agreement by the other party.
f. Seller’s Covenants:
In order to ensure the property remains in a similar condition as when the contract was executed, the buyer should insist that the seller adhere to a set of covenants or promises regarding the property. These include maintaining and operating the property in a reasonable manner, not entering into new leases or contracts that will survive the closing date without the buyer’s consent, continuing to maintain insurance on the property through the closing date, and not encumbering the property without the buyer's consent.
g. Remedies:
The remedies clause outlines the steps that will be taken in the event that one party breaches the terms of the agreement. This may include the termination of the agreement, the payment of damages, or the imposition of specific performance.
The seller’s remedy in the case of a buyer breach is typically to keep the deposit. If the expectation is that this is the seller’s sole remedy, then the purchase agreement should state that it is the seller's “sole and exclusive” remedy for a breach of the agreement. Buyer’s should attempt to negotiate a notice and cure period for any breach, though this can often be difficult with respect to obligations that are clearly defined in the agreement, such as payment of funds on a certain date.
The buyer’s remedies for a seller breach can be more complicated. As a buyer, you will want both the right to seek specific performance, but also the right to terminate and walk away from the deal in the event the default is of a nature that makes the property less desirable, say for example the seller signed a new lease without your consent that will prevent you from demolishing the building as soon as you buy it. In such cases, buyers can also try to negotiate payment of damages if buyer elects to terminate upon a seller breach, which damages include the costs incurred by buyer in the transaction.
h. Other Common Provisions:
(i) As-Is Sale. Most commercial real estate purchase and sale agreements include a disclaimer that the property is being purchased in its “as-is” condition with no reps or warranties from the seller or any obligation to make repairs or improvements. This section should specifically exclude any express representations or warranties that the seller is making in the agreement, or any work that the seller has actually agreed to complete.
(ii) Casualty and Condemnation. If the property sustains damage prior to closing, the parties' rights and responsibilities will be outlined in the casualty and condemnation sections of the purchase agreement. Depending on the extent of the damage, the seller or buyer may elect to terminate the transaction, or elect to move forward with the transaction subject to the seller either making the repairs prior to closing, or their insurance proceeds being assigned to the buyer at closing so that it can make the repairs itself post-closing. Similarly, if all or a portion of the property is taken by eminent domain proceedings, the buyer may have the right to terminate the agreement or elect to close anyway subject to an adjustment to the purchase price or assignment of the condemnation award to the buyer.
4. Conclusion:
Understanding the terms and conditions of a commercial real estate purchase and sale agreement is crucial for ensuring a successful transaction. It outlines the rights and obligations of both parties as well and defines the process for closing the transaction. By familiarizing yourself with the key components of this agreement, you can ensure that your commercial real estate purchase or sale goes smoothly and that you negotiate the best deal possible under the circumstances.
