The 2019 California commercial real estate market is still quite strong, but shows signs of starting to plateau. In this shifting market, both buyers and sellers of commercial real estate need to thoughtfully protect their interests and limit their risk to the extent possible. Here are three tips for buyers and sellers seeking to successfully negotiate commercial real estate transactions in today's California market.
Letter of Intent
Buyers and sellers of California commercial real estate in 2019 should not overlook the importance of a carefully and thoughtfully negotiated letter of intent. In California, sophisticated parties typically agree that letters of intent are non-binding except for certain provisions which often cover exclusivity and confidentiality. The non-binding nature of these letters of intent can lull the unwary buyer or seller into complacency—the thinking being that the deal terms will simply be negotiated in the definitive purchase and sale agreement. However, the key business terms negotiated upfront in the letter of intent, although non-binding, often do not change (unless, for example, there is some unusual discovery made during the due diligence period) prior to closing.
Each party should engage their real estate counsel early in the transaction to carefully and thoughtfully negotiate the letter of intent to ensure their interests are sufficiently protected. In addition to price, the letter of intent can cover important items such as the deposit, timing considerations, closing costs, and contingencies. Effectively negotiating a letter of intent is especially important in the current market, which is still quite strong but shows signs that it is starting to plateau. Each party needs to protect its interests in this shifting market.
“AS IS” Transactions
Not all “as is” purchase and sale transactions are truly “as is.” “As is” suggests that the property is transferred by seller to buyer in its present, existing condition without any representations or warranties. However, even when the sale is “as is,” a seller typically makes some limited representations and warranties. Sophisticated buyers with a strong bargaining position can negotiate numerous representations and warranties from a seller, including representations about the environmental condition of the property. Sophisticated sellers can limit their liability with respect to any representations and warranties by adding knowledge qualifiers, a not-to-exceed cap on their liability, and a short survival period.
Additionally, an “as is” purchase and sale transaction typically includes a release by the buyer of the seller for all known and unknown issues with the property. Buyers should consider negotiating, with assistance from legal counsel, carve-outs from the blanket release—one of the key carve-outs being for environmental contamination caused by the seller or its affiliates during their ownership of the property.
Costs
Do not rely on “custom” for closing costs in California. The “custom” regarding who pays transfer taxes, recording fees, and escrow charges varies by county, but can be negotiated by sophisticated parties involved in commercial transactions. Transfer taxes should not be overlooked. Their sum can be significant in cities that impose their own city transfer tax in addition to the county-level transfer taxes. For example, on a large transaction in San Francisco with a purchase price of over $25 million, the transfer taxes are 3% of the purchase price. So, it can be worthwhile to negotiate how the payment of transfer taxes is allocated between the parties. Those that negotiate this upfront at the letter of intent stage are one-step ahead.
Other important costs that should not be overlooked are the amount of the deposit and due diligence expenses. It is quite standard for the parties to negotiate the amount of the buyer's deposit and agree that if the buyer breaches the contract and fails to close, the seller keeps the deposit as liquidated damages. What is sometimes overlooked is the buyer's due diligence expenses, including the costs associated with hiring the team of experts—including attorneys, land surveyors, engineers (e.g., environmental, geotechnical, and seismic engineers), etc.—needed to perform due diligence on the property. A savvy buyer will negotiate to have its due diligence costs reimbursed by the seller in the event the seller breaches the contract and fails to close.
Ian O'Banion is an associate in Nixon Peabody's San Francisco office. He represents developers, investors, lenders, and property owners in a variety of commercial transactions including real estate and general corporate matters. He is also a licensed architect and member of the American Institute of Architects. The views expressed here are the author's own and not that of ALM's real estate media.
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