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Commercial Real EstateWhat exactly is commercial real estate? Broadly defined, the term “commercial real estate” can be used to refer to any dealing with real property in a business context. Commercial real estate could involve leasing out office space, owning an apartment complex, or selling real property along with and as part of the sale of a business. Commercial real estate might be industrial or agricultural property. Commercial real estate could even involve residential properties like apartment complexes or rental houses being held for business or income-producing purposes. Unless the property is a residence where the homeowner is living, you are probably dealing with commercial real estate.
While many of the concepts are the same, there can be huge differences between commercial real estate and residential real estate. Commercial real estate transactions can be far more diverse and wide-ranging than selling homes. Any real estate deal has its share of risks, and problems can arise that you could never possibly foresee. In general, however, the risk and potential liability exposure that you face on a commercial real estate deal can be much greater than when you buy a house. Look at it from this perspective: by and large, we all have a pretty good idea of what goes on in a typical family home, but can you say the same thing about a piece of business property? Depending on the nature of the business, commercial real estate may have all kinds of liens and title problems. There may be greater concerns about hazardous materials or zoning issues with commercial real estate. And there will always be questions about the suitability of the commercial real estate’s location for your business needs. Furthermore, in many instances, you are not afforded the same consumer protections on a commercial real estate deal that may be available when you purchase a residence.
As a purchaser of commercial real estate, you need time to confirm that the seller really owns the commercial real estate, to investigate the physical condition of the commercial real estate, to locate favorable financing, and to perform a myriad of other investigations, also called due diligence. As a buyer, you do not want to spend the time and money it takes to go through due diligence, only to have the seller or owner of the commercial real estate sell the commercial real estate to someone else. As a seller, you do not want to commit the commercial real estate to the buyer only to have the buyer back out months later because it gets cold feet or finds a better deal elsewhere.
Regardless of whether you’re buying a home or a piece of investment property, there will always be risks involved. Your goal should be to lessen these risks as much as you can. Examples of potential problems that oftentimes lead to legal disputes include:
Commercial real estate purchase contracts can be extraordinarily simple but usually end up being very complex and lengthy documents, in order to try to address all the “what if’s” that are typically involved in a commercial real estate transaction. Points that would typically be covered include:
In many instances, it’s possible to use standard form documents prepared by realtor associations that help to facilitate the drafting process. At a minimum, these standard form agreements can serve as effective checklists of issues you may want to address in your commercial real estate transaction.
Recordation of the commercial real estate contract or of a memorandum of contract at the local register of deeds provides notice to the public or other potential commercial real estate buyers that a contract for sale exists on the commercial real estate. A buyer may want to record when there is a lengthy due diligence period. If the seller conveys the commercial real estate to a second buyer during this time, and the contract is not recorded, the first buyer would have a contract claim against the seller, but the second buyer will get to keep the commercial real estate if it had no notice of the prior contract. Recordation would provide that notice to the second buyer. A seller may not want to record the contract. Should the closing for the commercial real estate not occur, the recorded contract will continue to cloud the seller’s title to the commercial real estate unless it is properly cancelled or released.
There are many issues that can arise with respect to how you take title to your real estate, and especially so in a commercial real estate context. If you take title as an individual, you may be exposing yourself to potential legal and financial liability exposure that you might want to try to avoid or at least minimize. You may take title through a business corporation, but doing this could be disaster from a tax standpoint. Sometimes, there may be other alternatives such as forming a limited liability company that you would own and control that, in turn, could lease the commercial real estate to your business entity.
Some lenders may require an environmental site assessment on your commercial real estate, and there are certain situations where it only makes sense to get one (such as when you’re buying a service station or a manufacturing business). Otherwise, though, the chance of there being any problem may seem remote and it may be tempting to pass on doing an expensive assessment on your commercial real estate. But you’re probably doing yourself a disservice if you don’t get one, as any problem that arises could result in catastrophic liability exposure for you even if you didn’t cause the problem.
A “1031 exchange” refers to a method of deferring tax on the sale of an interest in real property allowed under section 1031 of the Internal Revenue Code. In brief, it allows a seller to defer tax on a gain that would otherwise be realized on a sale of property if the proceeds from the sale were reinvested in like-kind property. It’s quite common for a 1031 exchange to be involved in some manner in a commercial real estate transaction.
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