Acquisition Process

The acquisition process includes a series of steps to acquire real estate.  This includes a non-binding letter of intent, a binding purchase and sale agreement, due diligence, deposits, escrow, and closing documents.

Due diligence is one of the most important components of the acquisition process.  It is a deep dive into all aspects of the property to minimize the risk of negative surprises once the property is owned.

Acquisition Process

LOI: “Letter of Intent” – typically non-binding agreement between buyer and seller (or landlord and tenant if a lease) that outlines the key terms of the transaction.

PSA: “Purchase and Sale Agreement” – a binding agreement, typically 15 pages with 20+ pages of exhibits documenting in detail the terms of the agreement by which buyer will buy real property from seller.  It may include joint escrow instructions.

·         Escrow Company/Agent: neutral party between buyer and seller on the transaction who is paid a fee for services.

·         Title Company: often the same company as escrow.  Provides title information and insurance.

Buyer Deposit: money put up by the buyer into escrow as a good faith deposit.  It will be non-refundable after a certain date or returned back to the buyer if the buyer chooses not to move forward with the purchase up until the expiration of the due diligence period. 

Due Diligence Period: Period of time during which a buyer investigates the property before making its deposit non-refundable (usually 30 days).  Due Diligence refers to the actual investigation.

Sole Order Escrow: Escrow set up by a buyer in a purchase transaction for the buyer’s deposit money; Only the buyer can instruct the escrow agent as to the deposit (greater protection for refundable deposit during DD period).

Go Hard (as in Hard Money): When a buyer waives its due diligence contingencies and the deposit becomes non-refundable.

Closing Documents: Various documents that evidence the closing of a transaction such as a grant deed, assignment of leases and service contracts, and tenant notices.

Closing Statement: a document that looks like a two column excel sheet that has charges (costs) and credits to the buyer (or seller).  The closing statement is created by the escrow officer.  A transaction manager, analyst or asset manager of the buyer or seller typically creates their own version in excel to check the math.  In the case of a buyer, typical charges would be:

• Purchase price.

• Escrow charges.

• Due diligence reports costs.

• Legal fees.

• Buyer’s portion of service contract costs if closing mid-month.

• Buyer’s portion of property tax bills if closing mid-property tax cycle (could also be a credit depending on county’s billing structure). 

In the case of a buyer, typical credits would be:

• Deposits made by the buyer.

• Credits from buyer for property issues.

• Loan from the lender.

• Buyer’s portion of rents collected by seller.

Template

Download template here: Acquisition Process & Due Diligence Reports

Purchase & Sale Agreement (PSA) Structure

A summary of items with ** are often included in a 3-6 page letter of intent (LOI)

General Guidelines: list section number where the information can be found for ease of reference.

Definitions: many legal documents are full of “defined terms”.  This is especially true for joint venture and loan agreements.  A defined term in typically a word that is capitalized and has a specific meaning that may or may not be like the normal definition of the word. 

Example: “capital expenditure” and “Capital Expenditure”.  The latter would be a defined term that would either be (a) listed before the first use of the term or (b) listed in a separate list of definitions.  “capital expenditures” may mean different things to different people whereas “Capital Expenditures” will be specifically defined as “in accordance with generally accepted accounting principles” or similar. Very important: don’t assume the meaning of a defined term.  Read the definition.

General

• Seller**: [legal name of seller; typically, a single purpose LLC – example: 123 Main Street, LLC]

• Buyer**: [legal name of buyer]

• Property**: [property address with legal description as an exhibit].  What is being sold:

  • Land, improvements (ie. Buildings), and personal property.

  • Various items associated with the property such as trademarks, trade names, service contracts, guarantees, plans, permits, and warranties.

• Purchase Price**: [enter amount]

• Deposit**: [enter amount; buyer will put up a deposit within X days of signing the purchase and sale agreement and then may or may not increase the deposit at the expiration of due diligence period.  This is deposited with escrow in a sole order account controlled by the buyer.  Upon buyer waiving due diligence and going non-refundable, the deposit is moved to an escrow account controlled by escrow in accordance with the PSA.]

• Broker**: [if any]

• Escrow Company**

• [escrow company – ex. First American Title Insurance Co. or Fidelity]

• The escrow company is a neutral third party that manages financial and procedural interactions (ex. document exchange) between the buyer and seller.

• Title Company**: [title company – ex. First American Title Insurance Co. or Fidelity]  The title company provides title documents and insurance.  See document on TITLE REPORTS AND INSURANCE for details.  It is typically the same company as escrow.

Key Dates

• Effective Date: [date of the agreement]

• Due Diligence Period Expiration Date**: [length of the due diligence period – ex. 30 days from effective date]

• Closing Date**: [date closing, often listed in days after the due diligence period expiration – ex. 10 or 30 days]

• Extended Closing Date**: [extended closing date if buyer or seller has the right to extend closing]

Title, Survey & Insurance

• Deed: Seller conveys property to buyer via deed.  Form of deed is an exhibit to the PSA.

• Title: See document on TITLE REPORTS AND INSURANCE for details. Buyer has a specific time period to review title.

Conditions During Escrow

• Contracts & Leases: Buyer will typically have approval rights over entering into contracts and leases from the effective date until the due diligence period expires.  If the buyer goes non-refundable, then buyer will typically have controlling rights.

• Leasing Costs: Buyer will typically be responsible for commissions and tenant improvements from leases executed after the effective date of the PSA.

Due Diligence

• Due Diligence Inspections: See document on ACQUISITION PROCESS & DUE DILIGENCE REPORTS for details.

• Due Diligence Materials and Review: Provided by Seller to Buyer.  Typical materials:

  • Leases and tenant contact list.

  • Operating statements such as income statements, current year budget, reimbursement (aka CAM) reports and calculations, property tax statements and appeals, service contracts and vendor lists, utility lists and invoices.

  • Legal & Insurance: any pending legal and/or insurance actions.

  • Reports & Inspections: environmental, asbestos survey and/or operations and maintenance plan, roof and HVAC reports, hazardous material surveys, structural report, soil report, ADA report, building square footage calculations, fire sprinkler reports, backflow preventor reports, and any permits/inspections.  Some sellers will not have all reports nor be willing to provide old reports.

  • Title & Zoning: preliminary title report with underlying documents (from title company), any CC&Rs with contact information, occupancy certificates, building permits, zoning ordinances from city, natural hazard disclosure reports, and development agreements/bonds.

  • Other: capital improvement schedule for past [3] years, warranties/guaranties (especially roof), and any other relevant property information. 

Representations & Warranties

• Seller: [list here.  These are things the seller is saying are true now and until the end of a specific survival period post closing (ex. 12 months).  Examples:

  • Seller has authority to sell the property without breach of any other agreement.

  • Seller is not bankrupt.  There is no pending litigation against property.  There is no known environmental or zoning issue.

  • There are no other tenants/leases other than the ones provided.

  • Seller will maintain required insurance until closing.

  • The due diligence materials provided are true and correct.

  • Post closing, the seller will maintain a specific minimum net worth to satisfy the post-closing warranty period.

If the seller defaults on any reps & warranties, they may be liable for financial damages up to a certain amount as agreed to in the PSA.]

• Buyer: [list here.  These are things the buyer is saying are true.  Examples: Buyer has authority to buy the property without breach of any other agreement.

Damage & Destruction, Condemnation

• Damage or Destruction: [what happens in the event the premise is damaged or destroyed; typically, there will be a materiality threshold – ex. more than 5% of the purchase price]

• Condemnation: [what happens in the event the premise is condemned; typically, the PSA will be terminated without penalty to either party]

Closing

• Extension**: [enter extension duration and provisions, if any]

• Buyer Conditions to Closing: [list of conditions buyer must satisfy to close.  Examples:

  • removed due diligence contingency,

  • received a title policy from title company,

  • representations and warranties of the seller are still true, and

  • seller has performed its required covenants.]

• Seller Conditions to Closing: [list of conditions seller must satisfy to close.  Examples:

  • delivered fully executed documents to escrow: deed, bill of sale. general assignment, any required tenant estoppels (unilateral statement signed by tenant for benefit of a buyer/landlord and lender stating the key terms of the lease), warranties and guaranties.

  • any required affidavits required by title company.]

• Closing Costs, Charges & Prorations: See document on ACQUISITION PROCESS & DUE DILIGENCE REPORTS for details.  Typically, there will be a post-closing review and check of any prorations within 30-90 days following closing as sometimes there are only estimates available at time of closing.  All of this is documented on a closing statement prepared by escrow and approved by both buyer and seller.

Exhibits

• Legal Description: [legal description of the property being sold]

• Due Diligence Materials**: [list of materials seller must provide to buyer]

• Form of Deed: [recorded document evidencing sale of the land and buildings]

• Form of Bill of Sale: [document evidencing sale of the personal property]

• Form of General Assignment: [document evidencing transfer of contract such as leases, warranties, and service contracts]

• Form of Estoppel: [unilateral statement signed by tenant for benefit of a buyer/landlord and lender stating the key terms of the lease]

Template

Download template here: Purchase & Sale Agreement (PSA) Structure & Abstract Template

Due Diligence Reports

PCA: “Property Condition Assessment” (aka Property Condition Report or PCR) – written report of the physical condition of a property.

Roof Report: written report of the roof condition of a property.  This is sometimes in addition to the PCA.  Other examples of specialized reports:

·         Curtain Wall: the exterior structure of glass office buildings.

·         ADA (Americans with Disabilities Act): lists upgrades that might be required to meet ADA criteria.

·         HVAC (Heating Ventilation and Air Conditioning): evaluates condition of the units or central plant.

Seismic Risk Assessment: written report of the seismic / earthquake risk for a property.  It combines two factors to come up with a SEL and SUL (see below): (a) structural condition of the property and (b) distance from major earthquake faults.  More typical for industrial and office buildings in the western US.

SEL and SUL: “Scenario Expected Loss” and “Scenario Upper Loss” – measure in percentages of the loss expected during an earthquake; SEL used to be known as PML (probable maximum loss); typically the SEL is used and needs to be less than 20% for the lender not to require earthquake insurance.

Phase I: The initial environmental analysis of a property; If further analysis is needed, then a Phase II (field sampling for environmental issues) is performed.

ALTA Survey: “Map” of a property done by a surveyor that shows the property along with all the recorded easements (legal rights of others to use the property) affecting the property; Required for ALTA extended coverage under a title policy.

Title Report: summary of documents recorded against the property that have some legal rights to the property.  Examples: purchase right, easement, loan.  This is provided by the title company.  Note that the title report typically includes a list of the documents.  When buying a property, you want to get the actual underlying documents to understand the details of each right.

Template

Download template here: Acquisition Process & Due Diligence Reports

Disclaimer: This information is provided to help you better understand commercial real estate.  It is based on my experience over 20+ years.  There is no guarantee that this information will allow you to be successful.  No guarantee is provided as to the accuracy of the information.  It is provided for educational purposes only.