Key Takeaways
- Not unlike their residential counterparts, those investing in commercial properties can benefit greatly from contingency plans.
- With the right contingencies added to a commercial real estate contract, both buyers and sellers can mitigate a significant amount of unnecessary risk.
- Not all contingencies are created equal; you need to decide which ones will work best for your situation.
While far from common knowledge to the average investor, contingencies need to be introduced into your common vernacular. In fact, I maintain that no commercial real estate contract, or residential contract, is complete without the addition of at least a few carefully crafted contingency plans. At the very least, a contract with contingencies in place is an important safety measure — for both the buyer and the seller.
Commercial real estate contracts are riddled with jargon, provisions and context that even some of the most experienced real estate investors don’t fully comprehend, and that’s understandable. Most likely, real estate investors will work with lawyers to draft a proper contract that lives up to their expectations. It is worth noting, however, that there are a few things investors should grasp, not the least of which are the contingencies contained within a respective commercial real estate contract. If for nothing else, contingencies serve savvy investors as an added safety measure; one that could mean the difference between a disaster and a success.
If you are in the midst of signing a commercial real estate contract, you should try your hardest to include contingencies that benefit your end of the deal. And if you are less certain of where to start, the following contingencies represent some of the most common safety measures investors should use in their own contracts:
- Ability to secure financing
- Satisfactory title
- Property survey
- Inspection contingency
- Review leases
- Property income and expenses
- Land use approval
- Environmental conditions
Popular Contingencies For Commercial Real Estate Contracts
I want to make it abundantly clear: there isn’t a real estate deal that isn’t inherently exposed to risk. Regardless of how careful you are, or how much due diligence you mind, there will always be a certain degree of risk exposure. That said, it’s those investors capable of mitigating risk who stand the best chance of completing (what they deem) a successful transaction.
Every chance awarded to investors to mitigate risk should be taken, and commercial real estate contracts are certainly no exception. Fortunately, there are some simple steps to take during the contract portion of a deal that can reduce the amount of risk you are exposed to. Of the steps to reduce risk, however, there is one you should prioritize: a contingency plan.
Instead of subjecting yourself to potentially unnecessary ramifications, be sure to include the following contingencies in your contract. And while they are far form the only options at your disposal, they are the most popular.
1. Financing Contingencies
You could argue that not one, single aspect is more central to the success of a real estate deal than the buyer’s access to funding. After all, you can’t facilitate a transaction in the event there is no money trading hands, right? You simply can’t expect a deal to take place if the buyer’s access to capital was interrupted, or — even worse — cut off altogether. What is a real estate deal if not an exchange of funds for a respective asset?
Having said that, not everyone expects to lose funding for an impending deal at the eleventh hour. In fact, it’s entirely possible for any number of reasons to impede your access to funding. Perhaps lending guidelines changed the week before you were expected to close and you are no longer approved for the same amount. Perhaps your request for a loan was declined entirely. There’s even a chance your private money lender got cold feet and refused to fund the same deal they were ecstatic about just one week prior. Case in point: a buyer can lose access to their funding for a number of reasons. And failure to account for such a possibility is a practice in ignorance.
As such, I maintain that most commercial real estate contracts should contain a financing contingency; one that will allow the buyer to terminate the contract in the event they are unable to secure financing. As a general rule of thumb, the seller will typically define the terms he or she deems satisfactory, as to set clear standards for this specific contingency.
2. Title Contingencies
Title issues are a legitimate concern over the course of your average, everyday real estate transaction. Titles are a complicated matter, and commercial real estate contracts are no exception. Not unlike the typical single-family residential property, commercial real estate can be subject to errors in public record, unknown liens, missing heirs, unknown easements and a whole slew of other discrepancies that could potentially impede the purchase process.
In order to protect yourself from any of these issues, I implore you to include a title contingency in your commercial real estate contract. There is no better way, at least that I am aware of, to account for the unexpected.
As PropertyMetrics so eloquently puts it, the “buyer’s title contingency will generally provide that if the buyer objects to any title conditions, it can give seller the opportunity to cure or insure over buyer’s title objections. Where the seller can’t or won’t cure or insure, the buyer has the option of terminating the contract or waiving its objection.”
It’s also worth noting that the title can impact what you do with the property. So if you have a specific plan, you had better make sure the title is exactly how you want it.
3. Survey Contingencies
Not unlike their residential counterparts, it’s not a bad idea to survey commercial buildings prior to a purchase. At the very least, a proper survey will tell you two things you probably already know: the size and location of the asset in question. It’s worth noting, however, that a good survey can tell you so much more. Done correctly, a professionally conducted survey will reveal a number of important details, at least as they relate to commercial properties. For starters, a survey can identify whether or not the building has access to public roads and sufficient utilities. Perhaps even more importantly, however, is a survey’s ability to locate easements and their potential impact on what you intend to use the land for.
Since the results of a survey are less than obvious (sometimes the owner may be unaware of any red flags surveys uncover), it stands to reason that the sale of a commercial property shouldn’t be brought to a close until every issue uncovered is resolved. And therein lies the benefit of a great survey contingency. As a potential buyer, a survey contingency can help you avoid making a huge mistake; one that would have you buy a property you can’t even use.
In drafting a commercial real estate contract, be sure to include a survey contingency. In it, be sure to state which party will pay for the survey, how long the buyer has to make objections to the completed survey, and how long seller has to cure them. It’s worth pointing out that the seller can refuse the cures brought to them, but, as a result, the buyer could potentially terminate the contract if they see something they don’t like.
4. Inspection Contingencies
Again, similar to that of your typical residential property, commercial real estate is usually subjected to an inspection prior to being sold. The process essentially provides a detailed account of the state of the building. A good inspector will, therefore, take a look at the entire property and provide a detailed account of their findings. More often than not, inspections won’t come back with anything out of the ordinary. However, there is a possibility that an inspection could uncover some red flags; issues the buyer would rather do without. So if you don’t want to risk ending up with more problems than you can handle, I highly recommend implementing an inspection contingency in your commercial real estate contract.
As their name would suggest, inspection contingencies grant buyers the ability to back out of a deal in the event an inspection uncovers any undisclosed red flags. However, buyers are awarded more options if they word their contingency correctly. If termination isn’t your goal, you could do one of two things: negotiate a lower price or get the seller to cover the costs of repairs out of their own pocket. Just be certain the language in your contingency says as much.
Protecting Your Assets
While different from its residential counterpart, a commercial real estate contract is a living, breathing entity — figuratively, of course. Language can be included in a contract that allows both buyers and sellers a little “wiggle room.” Namely, contingency plans can award interested parties a way out of a potentially bad deal. If you want to mitigate risk within your next commercial real estate contract, may I recommend adding the vary contingencies I hit on above? It’s one of the easiest ways to protect yourself in an industry wrought with risk and complications.
Have you ever found yourself executing any of these contingency plans on a commercial real estate deal? Let us know in the comments below just how helpful these contingencies have been for you.
