The Transaction Process in Commercial Real Estate
There is far more complexity involved in commercial real estate transactions when comparing to residential real estate transactions. For each type of commercial deal, which will comprise months of work before reaching a signing, there will be numerous parameters for the terms of sale and type of contract. This is because the deal could vary from a multi-tenant shopping office building to a mixed-use building as opposed to just a single tenant commercial space.
The Initial Phase – Identifying the Opportunity
Setting out a viable business plan and strategy ahead of time is imperative. This should be done prior to starting the research to find a pool of assets relevant to your investment requirements, which include locations, asset types and classes, as well as risk profiles. This phase requires a high level of commercial real estate proficiency as well as local market expertise. A comprehensive methodology should be utilized to acquire focus on the particular potential acquisitions that might be of interest. Experienced investors who are familiar with the commercial real estate field will have an edge to win deals at preferable terms over less experienced players.
Evaluating the Opportunity – Underwriting Process
Once you have an asset in your crosshairs, it is time to conduct a thorough underwriting process. This entails a deep dive into the deal financials, based upon all the data that can be exploited. The financial analysis should provide final end figures that provide the potential best case and worst case return levels of the proposed asset being evaluated for acquisition. There are many variables that can change within the framework of financial models in the short term. These include rental price, occupancy, maintenance, utilities, deferred maintenance and improvements of the asset, as well as appreciation as a part of an exit strategy in the long term.
Green Light – Taking a Run at the Deal
Following a successful underwriting process and a decision that the asset meets the requirements and returns criteria, it is time to move towards finalizing a deal at your target price. At this stage, a thorough due diligence process is initiated to acquire any relevant missing information regarding the asset. This happens alongside further visits to the property and meetings with the submarket leasing brokers to assess the rental competitiveness of the asset vis-à-vis the other options on the market.
In unison, talks are taken to the next level with the seller to build rapport and position your party as a credible buyer. Creating a feeling of certainty with the seller that your party’s intentions are credible could play out in favor of a preferred contract price, as the seller will be more confident that the deal will go through.
If all looks credible, it is time to submit your first round bid for the asset.
Process from Bidding to Awarding the Deal
The aim of the first bid is to reach the next round of finalists. This is referred to as “the best and final.” In order to reach this milestone, it is imperative to ascertain leverage and a good relationship with the seller/seller’s representatives in addition to obviously putting in a competitive offer to contend. In this high stakes game, the seller will aim to raise the price while trying not to lose out on the most credible buyers who might back out of the competition.
Once the initial bidders are narrowed down to a field of only a few “ideal” candidates, the situation will automatically become more intense; now, true competition for the asset begins. It will often occur that the strongest of the potential buyers will be less amicable on price at this point, as there is an air of confidence that the seller may be more comfortable seeing through a deal with this party. Weaker parties are forced at this point to usually raise the bar on their offer. The buyer interview stage is where the seller decides on the preferred party, which is the buyer that the seller is convinced will go through with the acquisition at the closing price. Then, the deal is awarded.
The final transaction of the deal will include escrow, signing authority verification, a final due diligence, and finally the closing documentation and the processing of the title deed. A commercial real estate closing process is far more complicated than a residential real estate one. Each side of the deal will conduct a due diligence process with a high level of scrutiny as, in general, there is far more at stake in terms of finances. Usually, each of the sides is also a legal entity, and there is a wide variety of ways to structure the deal. Parties tend to form corporations, LLC, or LLP legal entities in order to facilitate the deals. This is done to limit personal liability and exposure as both buyers and sellers in the cases of large deals. Depending on the state, there are also tax benefits for legal entities that own commercial real estate.
In order to facilitate the transaction in commercial real estate closing processes, a third party will be tasked with holding the funds in a neutral account until all the preconditions set in the escrow agreement are met. This process is strictly handled to assure both sides overcome trust issues and see through their sides of the deal prior to the escrow agent releasing the funds. As there is far less regulation in commercial real estate deals in comparison to buying a home, the level of due diligence is higher and the legal documentation is more lengthy.
Signing Authority Verification and Closing Due Diligence Documentation
The legal entities will need to provide each other with proof of signing power for the specified individuals who will be signing on behalf of each party. Both the buyer and seller need to be sure that the other side is legally enabled to execute the transaction on the company’s behalf.
The buyer will also want to establish that the contract of sale has been prepared correctly. This is in addition to receiving copies of all of the leases, the seller’s books and records, an up-to-date survey report, the latest insurance policy for the asset, and a compilation of all tenant estoppels.
The buyer must also receive the confirmation of zoning compliance as well as proof of an environmental audit to be certain that the use of the property is completely legal in the eyes of the municipal authorities. It is also important to understand what additional rights the buyer will have relating to the asset regarding adding floors and below-ground rights.
The Deal is Struck
Finally, after a lengthy process and signing, the buyer will receive the assignment documentation and will assume ownership over the leases in conjunction with a release of the escrow funds into the seller’s account. All future liability from this point onwards lies solely with the buyer.
Now it is time to fulfill your initial business plan’s objectives and enter the property management and rental collection phase. Good luck!
It is important to take note that, in general, the real estate entrepreneur takes care of the abovementioned phases prior to bringing a potential deal to iintoo for a due diligence review. iintoo only works with established realtors with exceptional track records who have the local market experience required to analyze and bring lucrative deals to the table. Once the due diligence phase is completed, iintoo will continue along the transaction process and take a run at the deal.
iintoo provides its community of investors with the opportunity to take part in such commercial real estate endeavors from as little as a $25,000 investment. Join our social investment platform to empower your investment prowess. Leave the arduous part of the journey to the most professional of teams out there to conduct the entire transaction process for you at the highest level of professionalism.