Industrial Buyers Secrets
A simple process for outstanding results by Chris Condon Vice President, john greene Commercial
Chris Condon Vice President john greene Commercial 1311 S. Rt 59 Naperville, IL 60564 chriscondon@johngreenecommercial.com 815-693-3005 mobile
Thanks for taking the time to read Industrial Buyer Secrets. For nearly 20 years, I have been helping small business owners and investors buy, sell, and lease commercial property. In that time, there have been many successes, many failures, and many lessons along the way.
Buying commercial property is a process and not just an event.
In this guide, I share some of my best practices and my step-by-step process of preparation, search and negotiation, and contract to closing. Following my plan will allow you to successfully purchase and avoid the costly mistakes most buyers make. It’s the exact same process I’ve used to help hundreds of buyers successfully identify the perfect property. Buying commercial property is a process and not just an event. A little reflection and planning will greatly reduce the number of challenges that come up along the way. I have broken down the process into three simple steps that will guide you from your first thoughts of buying all the way to the closing table. Phase One: Preparation :: Criteria: Must Have & Nice To Have :: Team: Broker, Banker, Attorney :: Finances: Cash, Loan, 1031 Funds Phase Two: Search & Negotiation :: Auto Search :: Showings :: Offers: LOI vs Contract :: Negotiation Strategy Phase Three: Contract to Closing :: Due Diligence Process :: Financing Process :: Special Considerations :: Closing Prep
page 1
Phase One: Preparation
PHASE ONE: PREPARATION Criteria: Musts & Nice To Have.
What is the problem that buying a property needs to solve? From my perspective, the only reason to buy a commercial property is to solve a business problem. Understanding your business needs is a great place to start. And, hey, maybe that problem can be solved without buying a property, saving you hundreds of thousands or millions of dollars and many hours of time. Once you understand the problem(s) you’re trying to solve, ask yourself a few questions: :: Where does the property need to be located? :: How large does the property need to be? :: How much office space do you need? :: How much warehouse do you need? :: How much outdoor storage do you need? :: How many drive-in doors do you need? :: How many docks do you need? :: What zoning allows your use? :: How much money are you willing to spend? Take some time to brainstorm these questions and get as much detail out as possible. Keep in mind, even with an unlimited budget, no buyer finds a property that meets 100% of their criteria. A good rule of thumb we have developed over the years is the 85% perfect property. When we find a property that meets 85% of the criteria you have laid out, that’s a property you should strongly consider purchasing. As a result of the 85% perfect property rule, defining your must-haves vs. wants becomes a critical part of the process. Is there criteria you cannot compromise on? What criteria do you have flexibility on? The more flexibility you have, the more likely you are to find suitable options.
page 2
Phase One: Preparation
Team: Broker, Banker, Attorney
Buying a commercial property requires several professionals working together to help you complete a transaction. Having your team in place ahead of time reduces headaches and streamlines the process. Broker Are you working with a broker or just trying to find a property on your own? A good broker can save you countless hours of research and tens if not hundreds of thousands of dollars. A good broker also not only has access to all the properties on the market, but many know of properties that could be purchased even though they’re not currently on the open market. These may be past clients, listing prospects, and bank foreclosures. An outstanding broker knows the market and uses that expertise in their negotiation strategy. They will tailor their negotiation approach to best meet your objectives. For business owners, price is only one consideration. An effective strategy takes in all the considerations to get the best price and terms possible. Banker If you are purchasing in cash, you may not need a banker. If you need financing, having a great banker is an absolute must. We will talk about this later in the finances section, but here are a few questions to ask in qualifying your bank and banker. :: :: :: :: ::
How long has the person been in banking? Do they handle mostly C & I loans or commercial real estate loans? What is their approval process? Who makes the final decision on the loan? What types of loans have been getting approved lately?
Ideally you want the process to be simple, with a single person making the decision based on their signature authority, not a loan committee. Attorney Having a competent and experienced attorney is a must. In the Chicago market, more than 95% of real estate transactions are handled by an attorney. Like most professions, attorneys can specialize in different aspects of law.
page 3
Phase One: Preparation
You will want to work with an attorney who primarily handles commercial real estate transactions. They will best understand the process and can guide you through from contract to closing. I have found the best attorneys typically own real estate themselves. They usually have a bit of a dealmaker side. They have the understanding and experience to make sure that you are covered legally, but at the same time are not overly aggressive. The last thing you want is an overzealous attorney killing your deal. An attorney that knows commercial real estate and likely owns commercial real estate can also be a little more creative as a problem solver because they have personally been in your shoes as a buyer.
If possible, purchasing with cash is the best option
Finances: Cash, Loan, 1031 Funds
Financial preparation is an often overlooked, yet critical step in purchasing a property. I can’t tell you how many times I have heard, “Financing won’t be a problem” only to find out midway through a transaction that financing is, in fact, a problem. Cash Purchase If possible, purchasing with cash is the best option. This will allow you to negotiate the best possible price and terms. Ideally you will want to be able to prove to the seller that you have the funds available. This can be accomplished by a copy of account statement or a letter from your banker stating that you have the funds to cover your offer price. If using an account statement, just black out the account number prior to scanning or taking a picture of it. Loan Have conversations with banks in advance and have all the necessary financial documents ready or pre submitted. For commercial loans, most banks don’t have a pre-approval letter. However, most will review your financials and provide you with a pre-qualification letter. The prequalification letter typically states that the lender has reviewed your financial information and that you will likely be approved for a loan up to $X. They can issue a letter that can be used to give the seller assurance that you have a high likelihood of receiving approval for the loan.
page 4
Phase One: Preparation
Documentation Checklist: :: Personal Financial Statement for guarantors: Typically includes anyone with 20% or greater ownership in the borrowing entity or operating company. :: Minimum two years fiscal year end personal and business financial statements: This includes management or CPA-prepared profit and loss statement, balance sheet, and tax returns. :: Year-to-date financial statements for the occupying company. :: Account statements to verify liquidity for equity injection. :: Corporate Documentation – Filed Articles of Incorporation – Bylaws or Operating Agreement – Evidence of Tax ID number for borrowing entity 1031 Exchange If you are purchasing a replacement property with 1031 Exchange funds, things get a little more complicated. In this situation, you can either purchase with cash or with financing. You will want to get guidance from all your team, especially from your accountant and attorney. No matter how you choose to pay, it is critical to have a good understanding of the timeline involved with a 1031 Exchange. This can include: :: Expected closing date of existing property :: Closing Date + 45 Days. This is your time to identify your replacement property. :: Closing Day + 180 days. This is the time you must complete due diligence and close on your replacement property.
page 5
Phase Two: Search & Negotiate These dates are critical when negotiating terms on your replacement property. The seller will want to understand the likelihood of the closing of your existing property. For sellers, the two most important considerations are the price and certainty of sale. The more certain the sale, usually the better the price a seller will give. Being prepared allows you to provide the seller with certainty of sale. This will allow you to get the best price and terms, and minimize potential problems and headaches going forward.
PHASE TWO: SEARCH & NEGOTIATE Clearly Defined Needs & Expectations
Over the years I have found the clients I am best able to help are clear on their needs from the start. They know what they need to accomplish and are realistic in their expectations, flexible in their approach, and prepared enough to move quickly. When it’s time to search, most brokers have access to the listing databases such as the Multiple Listing Service and LoopNet. The best brokers have access to several others including CoStar and Crexi. This expands your ability to find properties and increases the likelihood of finding one that meets your needs.
Good brokers will do research in advance to best make sure the property meets your needs.
When searching for a client, it’s a combination of waiting for the right property to come on the market and proactively networking with past clients and other brokers to find possibilities that aren’t on the open market. When inventory is tight, this can be an effective way to find properties before the rest of the market has access to them. Once a suitable property is found, schedule showings quickly. During times of low inventory and high demand, properties that are in good condition and well-priced are going under contract very quickly. Many buyers are sitting on the sidelines, ready to pounce when the right property becomes available. As I write this in 2021, multiple offers are very common in our current market and probably will be for some time which is why being prepared is so important. When scheduling showings, know what questions you need answered to feel comfortable with the property. Good brokers will do research in advance to best make sure the property meets your needs.
page 6
Phase Two: Search & Negotiate After the showing, ask yourself what additional information you still need or what questions need to be answered to make an offer. Offer: Letter of Intent vs. Contract Now it’s time to make an offer. Do you submit a Letter of Intent or Contract? I personally like making offers with a contract. I use a commercial sales contract that is available on the multiple listing service. This version is very fair and rarely requires significant revisions by an attorney. I like this because I believe it brings significantly more seriousness to the offer. It also allows a transaction to move forward more quickly, typically saving 1-2 weeks’ time going back and forth with attorneys drafting the contract. In a market where good properties are gone very quickly, I think it gives a buyer a leg up in a negotiation. I use a Letter of Intent where the offer is more complicated. An example of such a situation might be a development transaction where there are multiple due diligence components, or where there needs to be additional details on when earnest money is deposited or becomes non-refundable. Negotiation Strategy: This depends a lot on the buyer’s objectives. There are a few different strategies to use. Often, I write an offer and draft a cover letter to explain the buyer’s reasoning for how the offer price was computed. Rather than getting an emotional response to a low offer, I explain why the offer is low based on comparable sales in the marketplace. Often, this is effective in getting a counteroffer or agreement when most brokers would just get a NO and the conversation is over. Many brokers are not willing to do the extra work it takes to draft this letter. But many times, this is the difference maker between an emotional NO vs. a more reasonable response that turns into a good deal for the buyer.
page 7
Phase Three: Contract & Due Diligence
Phase Three: Contract & Due Diligence
Once you have agreement on price and terms, if the offer was made in a letter of intent format, it’s now time to have your attorney draft the sales contract. Most attorneys have a format they typically use and have improved over the years. It will likely take them a few days to update the contact with the relevant terms from the letter of intent. If it’s a more complicated transaction, they may have to draft several clauses that are specific to your deal. It’s fairly common for this phase of negotiations to take 1-2 weeks before a legally binding contract is in place. If the offer was made in contract form, typically there is a clause within the contract for an attorney to review and suggest any changes. You will want to send the contract to your attorney for review ASAP. With such a short timeline, this is another reason why having your team in place ahead of time is so important. Common Legal Mistakes To Avoid: If you’re unsure about timeframes for due diligence and contingencies, mark on your calendar the dates that due diligence and contingencies are set to expire. Double Check Addresses, PINs, and legal descriptions to ensure that the real property is going to be properly conveyed. Due Diligence Checklist: Typical Requested Documents To Request :: Copies of all leases :: Copies of all service contracts :: Utility bills :: Taxes :: Capital improvements for the last 3-5 years :: Maintenance records for the last 3-5 years :: Past phase one environmental reports :: NFR Letter from past environmental cleanup :: Past survey :: Past title policy :: Building code violations :: Building plans :: Inspection reports :: Fire alarm / sprinkler inspection records :: Records from protesting real estate taxes
page 8
Phase Three: Contract & Due Diligence This is a comprehensive list. Some of the items may not apply to the property you are purchasing.
An inspector will do a thorough review of all the building systems to ensure they are in good repair and functioning properly.
Property Inspection I recommend having a licensed property inspector complete a physical property inspection on the building you intend to purchase. An inspector will do a thorough review of all the building systems to ensure they are in good repair and functioning properly. They will review the following systems: :: :: :: :: :: :: :: :: :: ::
Site review: paving, landscaping, utilities Structural frame Building exterior and envelope Roofing systems Windows and doors Plumbing system and components Electrical system and components Installed mechanical systems Installed interior elements HVAC Systems: heating, cooling, ventilation systems
Taxes I advise clients to review the real estate tax history from the county assessor website. I do this so there is not a shock if the taxes go up significantly once a sale takes place. When reviewing the property history, if the assessed market value is low, relative to the contract price, there is a high probability that in the next 1-3 years, the taxes will be reassessed based on the contract price. For instance, if the market value is currently $100,000 at a rate of 9.1245, the current tax bill is likely $3,041.49. If you purchase the property for $150,000, the new market value will likely rise as well. So, the new market price of $150,000 at the same rate of 9.1245, will likely increase the tax bill to $4,562.25. Remember, in IL real estate taxes are calculated based on the assessed value. The assessed value is 1/3rd the market value. So, $150,000 market value / 3 = $50,000 assessed value. $50,000 (assessed value) X .091245 (local tax rate) = $4,562.25 tax bill
page 9
Phase Three: Contract & Due Diligence
If the assessor has the market value significantly higher than the contract price, take the contract and closing statement to the township assessor’s office the protest the taxes after the closing. They should reduce the market value to the closing price. You can calculate your new tax bill that same way as outlined above. Zoning Each municipality is different in their zoning ordinances. If the zoning does not allow for your use, the municipality can shut down your business, and not allow you to operate from this location. I suggest doing some research on your own and then confirming with the municipality that your research is correct. Most municipalities have websites that have a zoning map and the municipal code for each zoning. You will use the map to confirm the zoning and the code to confirm your use is allowed in that zoning. Depending on your use, it may require a variance or a special use permit. If this is the case, it will require the contract be amended to allow for the additional time this will take. Depending on the municipality and their process, it may take an additional 30-90 days to work through the process. Environmental Assessments Depending on the type of property, location, and financing, you may want to or be required to conduct an environmental assessment.
page 10
Phase Three: Contract & Due Diligence
A Phase One Environmental Assessment is completed to research the current and historical uses of the property to determine if there is currently or historically there had been a use of the property that could have caused a potential threat to the environment or to human health. A Phase I ESA typically includes the following: :: A site visit to observe current and past conditions and uses of the property and adjacent properties :: A review of federal, state, tribal, and local regulatory databases including, but not limited to, underground storage tanks (USTs), aboveground storage tanks (ASTs), known or suspected release cases, the storage of hazardous substances and disposal of hazardous wastes including petroleum products, and institutional and engineering controls :: A review of historical records, such as historical aerial photographs, fire insurance maps (Sanborn maps), historical city directories, and historical topographic maps :: A review of state and local agency records, including but not limited to state environmental agencies, Building Departments, Fire Departments, and Health Departments :: Interviews with current and past property owners, operators, and occupants, or others familiar with the property :: Interviews with the Report User for title or judicial records for environmental liens and activity and use limitations (AULs); specialized knowledge or experience; actual knowledge; commonly known or reasonably ascertainable information; the reason for a significantly lower purchase price; and the reason for the preparation of the Phase I ESA. It is the User responsibility to provide this information to qualify for the innocent landowner defense.
page 11
Phase Three: Contract & Due Diligence If concerns are identified, they may suggest additional research be conducted, including a Phase Two Environmental Site Assessment. The purpose of a Phase II Environmental Report is to determine the presence, or absence of, petroleum products or hazardous waste in the subsurface of the site. This will require an environmental engineering company visit the site and drill some test holes to be able to sample the subsurface soils to determine if there is presence of hazardous chemicals. If there is, they will design and recommend a remediation plan to be able to address this contamination. They will also prepare an estimate of cost associated with remediating this contamination and securing a no further action letter from the EPA. Appraisal If you are securing financing, the lender will likely require an appraisal. This is a report conducted by a third party to determine the fair market value of the property. This is to protect you and the bank from overpaying for a property. The appraiser will come out to tour the property and then conduct market research to determine a fair market value. What happens if the appraisal is less than the contract price? How to handle this situation depends on your personal or business situation and the market dynamics at the time. Option 1: Ask the seller to reduce the contract price to the appraised amount. They may or may not be willing to do that. Option 2: You can move forward with the transaction, provided you have the available cash to make up the difference between the contract amount and the appraised amount. Why would you pay more than the appraised value? A few reasons can include: You really need the property. It’s a highly competitive market where the only way you beat out another buyer was to increase your offer. You know it will cost significantly more to build a similar property.
page 12
Phase Three: Contract & Due Diligence Contrary to what many bankers believe, an appraised value is just a third party’s OPINION of what the property value is. This is based on recent comparable sales. An appraisal is always looking backwards. In an appreciating market, current pricing can be increasing at a rate faster than appraisals are keeping up. The property may also be unique where there really aren’t any comparable sales to justify the contract price. Title Insurance Title insurance exists to ensure that when you buy a property, there are no outstanding liens, or claims against the property that could cause a legal challenge to your ownership in the future. A title insurance company is taking on that liability and will make it right should such an event take place.
In an appreciating market, current pricing can be increasing at a rate faster than appraisals are keeping up.
Common title issues: :: False impersonation of the true owner of the property :: Forged deed, releases or wills, instruments executed under invalid or expired power of attorney :: Undisclosed or missing heirs :: Mistakes in recording legal documents :: Misinterpretations of wills :: Deeds by persons of unsound mind :: Deeds by minors :: Deeds by persons supposedly single, but in fact married :: Fraud :: Improperly recorded documents :: Liens for unpaid estate, inheritance, income or gift taxes :: Past Bank Liens not released :: Past Mechanics Liens not released :: Past City Liens not released :: Past HOA Leins :: Condemnation Proceedings As you can see, there are several types of liens and claims against a property that could potentially cost NO ADDITIONAL TEXT IN WORD FILE TO COPY
Preparing for Closing and Beyond
At this point, you have thoroughly investigated the property and understand what you are purchasing. You have your finances in place with approval from your lender. Now is usually the easy part, preparing to close.
page 13
Phase Three: Contract & Due Diligence In the Chicago market, most closings are handled by attorneys and title companies. Your attorney will coordinate with the seller’s attorney to create, review, and agree to all the documents that are required to close the transaction. Your responsibilities will likely be: :: Schedule final walkthrough :: Contact insurance provider and secure insurance policy :: Coordinate with utilities to transfer accounts :: Coordinate with US Postal Service to transfer mail :: Coordinate with service providers for maintenance :: Schedule / coordinate moving During the final walkthrough, you will want to ensure that everything is the condition it was during due diligence. You will want to confirm that any seller provided repairs or improvements have been completed and that the property is in the agreed to condition prior to closing. In the post Covid-19 world, there are many ways the closing can take place. You have the option to attend or not. If not, you will want to coordinate with your attorney as to signing the documents. You will also coordinate with your banker/ lender to transfer the funds to the title company. Once the closing takes place and the transaction has been funded, you will be the rightful owner to the property. If you attend the closing, you will most likely receive keys to the property. If you do not attend, it will be necessary to coordinate with the seller to get keys.
After Closing and Beyond:
I always suggest having all the doors re-keyed. It can be difficult to ensure that all the key holders have returned their keys and that the property is secure. It’s not that expensive and will give you piece of mind. If you need resources to complete this, your broker should be able to provide some suggestions. For my buyer clients, I provide a property value report each year of their ownership. This is meant keep them aware of market condition and the approximate value of the property in current market condition. As time passes, I can help them prepare for what’s next and ensure that they are maximizing their property’s value.
page 14