Essential Terms Of A Real Estate Contract: Your Comprehensive Guide

What Are The Essential Terms In Commercial Real Estate: Your Comprehensive Guide

Inna Radford | 26th May 2024 | 12 minute read

This is an image of investment properties in Houston

Let's Discover The Key Terms And Considerations Within Commercial Real Estate...

When navigating a commercial real estate transaction, there are several critical components to understand and processes to follow.

This guide outlines the essential terms and procedures, providing a structured approach to ensure a smooth and informed buying experience.

Understanding these elements can help buyers make informed decisions, minimize risks, and successfully close on a commercial property.

What is the Feasibility Period (Inspection Period)?

The Feasibility Period, also known as the Inspection Period, is the time the buyer has to review all information about the property, referred to as Due Diligence Information.

This review period requires the buyer to pay a negotiated Option Fee (Independent Consideration). Additionally, the buyer deposits Earnest Money into escrow as a sign of good faith. The earnest money becomes non-refundable after the Feasibility Period ends but is applied to the purchase price at closing.

Sometimes, there are additional fees for extending the feasibility or closing periods, which may or may not count towards the purchase price.

Key Points:


Escrow: Always deposit the earnest money with a third-party title company to ensure secure handling.


Distribution: Both the seller and buyer must agree to release and distribute the earnest money deposit. The title company cannot release the funds without mutual agreement, even if the contract outlines specific instructions.

  • Time to Assess: The Feasibility Period is crucial as it allows buyers to thoroughly evaluate the property to ensure it meets their investment criteria and expectations. This period typically involves inspections, appraisals, and reviews of financial and legal documents.
  •  
  • Option Fee: A non-refundable fee paid for the privilege of this review period, signaling the buyer’s serious interest. The amount of this fee is negotiated between the buyer and the seller and compensates the seller for taking the property off the market during this period.
  •  

Activities During Feasibility Period

 

  • Property Inspection: Physical inspection of the property’s condition, including the structure, systems, and any existing issues.
  •  
  • Review of Financials: Analysis of the property’s income and expenses, including rent rolls, operating expenses, and profit and loss statements.
  •  
  • Legal Due Diligence: Examination of title, zoning, and any legal encumbrances or restrictions on the property.
  •  
  • Environmental Assessment: Conducting environmental site assessments (ESA) to identify potential contamination or other environmental risks.

We'll Find Your Ideal Commercial Real Estate

Guiding Buyers, Sellers and Tenants Through Commercial Real Estate Deals

What is an Earnest Money Deposit?

An Earnest Money Deposit is a sum of money deposited by the buyer in escrow as a sign of good faith to pursue the purchase. This deposit shows the seller that the buyer is serious and committed to closing the deal.

 

  • Non-refundable Post-Feasibility: The deposit becomes non-refundable after the Feasibility Period but is applicable to the sales price at closing. If the buyer decides not to proceed with the purchase during the Feasibility Period, the deposit is typically refunded.
  •  
  • Escrow Requirement: It is crucial to escrow the earnest money deposit with a third-party title company to ensure that the funds are handled properly and impartially.
  •  
  • Return and Distribution: Both the seller and buyer must agree to return and distribute the earnest money deposit. Title companies cannot release the funds without mutual agreement, regardless of the contract’s instructions for such distribution.
  •  
  • Protects Both Parties: Provides a level of security for both parties; the seller knows the buyer is serious, and the buyer has a secure mechanism for retrieving their deposit if the deal falls through during the Feasibility Period.

Why Should You Obtain a Property Survey?

Necessity

 

  • Accurate Information: Always request a survey of the property to ensure there is no missing or incorrect information. A survey provides a detailed map of the property, showing boundaries, easements, and any encroachments.
  •  
  • Title Company Examination: Submit the survey to the title company to compare against the current title report. This helps identify any discrepancies or potential issues that could affect ownership or use of the property.
  •  

Benefits

 

  • Boundary Verification: Ensures that the property’s boundaries are accurately defined and that there are no encroachments by neighboring properties.
  •  
  • Easements and Restrictions: Identifies any easements, rights-of-way, or restrictions that could affect the property’s use.
  •  
  • Development Planning: Essential for planning any future development or improvements on the property.

What Are Environmental Rep

What Are Environmental Reports and Why Are They Needed?

Your lender will likely require a “Phase I Environmental Site Assessment” (ESA), which includes findings from public records and obvious surface observations.

If the Phase I report identifies potential environmental issues or if the property is near hazardous sites like oil change facilities or dry cleaners, it may recommend a “Phase II Environmental Site Assessment,” which involves soil sampling.

If you suspect environmental issues but want to avoid high costs, you can opt for a quick “desktop search.” Here are the approximate costs for these reports:


Phase I ESA: $2,000-$2,500
Phase II ESA: $8,000-$12,000
Desktop Search: $350-$550

 

 

Phase I Environmental Site Assessment (ESA)

 

  • Requirement: Most lenders will require a Phase I ESA to identify any potential environmental liabilities.
  •  
  • Scope: This report includes findings from public records and obvious surface observations, examining past uses of the property and surrounding areas for potential contamination.
  •  
  • Cost: Approximately $2,000-$2,500.
  •  

Phase II Environmental Site Assessment (ESA)

 

  • Conditional Requirement: If the Phase I ESA indicates potential environmental issues, a Phase II ESA involving soil, water, and air sampling may be necessary to further investigate the extent of contamination.
  •  
  • Cost: Approximately $8,000-$12,000.
  •  

Desktop Environmental Report

 

  • Alternative: A quicker and less expensive option to assess potential environmental issues based on existing data and records.
  •  
  • Cost: Approximately $350-$550.
  •  

Importance

 

  • Risk Management: Identifying environmental issues early can prevent future liabilities and costs associated with remediation.
  •  
  • Lender Requirement: Necessary to secure financing, as lenders want to ensure the property is free from significant environmental risks.
  •  
  • Regulatory Compliance: Helps ensure compliance with local, state, and federal environmental regulations.

What Are Tenant Estoppel Certificates?

Estoppel certificates are documents that tenants sign to confirm they and the landlord are current on lease obligations. These certificates provide assurance to the buyer and lender that there are no undisclosed agreements or disputes with the tenants.

 

Requirements

 

  • Lender’s Requirement: Some lenders may require all or some tenants to sign these certificates to verify lease terms and conditions.
  •  
  • Seller’s Affidavit: In some cases, lenders may accept estoppel certificates signed only by the seller, which serve as affidavits regarding the status of tenant leases.
  •  

Benefits

 

  • Lease Verification: Confirms the accuracy of lease terms, including rent amounts, security deposits, and lease expiration dates.
  •  
  • Dispute Prevention: Helps prevent future disputes by ensuring all lease terms are clear and agreed upon by both the landlord and tenants.
  •  
  • Lender Assurance: Provides lenders with the necessary documentation to confirm the stability and reliability of the property’s income stream.

How to Perform a UCC Search (Uniform Commercial Code Search)?

If the property includes equipment or fixtures, the buyer should perform a Uniform Commercial Code (UCC) search to check for any outstanding liens or third-party claims on these items.

Options for Conducting a UCC Search:


1. Do It Yourself: Use the Texas state SOSDirect system at [https://www.sos.texas.gov/ucc/index.shtml](https://www.sos.texas.gov/ucc/index.shtml). You can search by the tenant’s name (both company and personal) or by the property address.


2. Hire an Agency: Use a service like [CSC Global](https://www.cscglobal.com/service/cls/ucc-search/) to conduct the search on your behalf.

A UCC search identifies any outstanding liens on equipment or fixtures that are part of the property sale. This is important to ensure that the buyer receives clear title to all personal property included in the sale.

  • Self-Search: Use the TX state SOSDirect system to search by the tenant’s name (both company and personal) or by property address.
  •  
  • Agency Search: Utilize a service like CSC Global for conducting the search on your behalf, which can provide a more comprehensive and accurate report.
  •  

Importance

  • Clear Title: Ensures that the property’s fixtures and equipment are free from liens, preventing third-party claims after the purchase.
  •  
  • Financial Security: Protects the buyer from inheriting the seller’s debts associated with the property’s personal property.

What is a Financing Contingency?

Definition

 

A financing contingency clause allows the buyer to cancel the contract and receive their earnest money deposit back if they cannot obtain financing. This provides a safeguard for buyers who are relying on a loan to complete the purchase.

Note

 

  • Uncommon in Commercial Contracts: Financing contingencies are less common in commercial real estate contracts compared to residential ones. Buyers need to arrange their financing during the Feasibility Period to avoid complications.
  •  
  • Importance of Pre-Approval: Buyers should seek loan pre-approval to ensure they have the necessary funds available by the closing date.
  •  

Benefits

 

  • Risk Mitigation: Protects buyers from losing their deposit if financing falls through.
  •  
  • Encourages Due Diligence: Ensures buyers take the necessary steps to secure financing early in the transaction process.

What Does a Cash Offer Mean?

A cash offer does not mean the buyer will pay cash for the property. Instead, it indicates there is no financing contingency in the contract, meaning the buyer is committed to closing regardless of whether they secure a loan.

Implications

 

  • Stronger Offer: Often perceived as stronger by sellers since it eliminates the risk of the deal falling through due to financing issues.
  •  
  • Flexibility for Buyer: Allows buyers to still seek financing but commits them to closing the deal even if financing is not obtained.
  •  

Benefits

 

  • Seller Assurance: Provides sellers with greater confidence that the transaction will close.
  •  
  • Competitive Edge: Can make the buyer’s offer more attractive in a competitive market.

What Should You Know About Land Sales and Purchase Contracts?

Land sales contracts often include more conditions and complexities than typical real estate transactions. These conditions may involve:

  • Platting: Approval of property divisions and subdivision plans.
  •  
  • Easement Agreements: Reciprocal access rights with neighboring properties, ensuring legal access to utilities and roads.
  •  
  • Architectural Guidelines: Standards for property development, including design and construction requirements.
  •  
  • Utilities Access: Availability and connection to wet (water and sewer) and dry (electric, gas, and telecommunications) utilities.
  •  
  • Detention Requirements: Stormwater management and detention facilities to control runoff.
  •  
  • Associated Costs: Financial responsibilities for the above conditions, including development and infrastructure costs.
  •  

Recommendation

 

Due to the complexity and potential for unforeseen issues in land transactions, it is strongly recommended to hire an experienced land broker like us to assist with the process. A professional can provide valuable insights, negotiate terms, and help navigate the regulatory landscape.

Benefits

 

  • Expert Guidance: Ensures all legal and regulatory requirements are met.
  •  
  • Risk Mitigation: Identifies and addresses potential issues early in the process.
  •  
  • Negotiation: Helps secure favorable terms and conditions in the contract.