Real Estate is Contingent if the Buyer is not Diligent

Purchasing real property is a big investment, whether you are an investor, a developer, a small business, a nonprofit, or a homebuyer. Purchasing commercial real estate is usually an even bigger investment.

In the commercial real estate setting, where earnest money deposits and purchase prices are high and the investment risks are even higher, closing on the deal is really contingent on buyers making use of the contingency periods and learning as much about their prospective property as possible.

Everyone understands the risks of going into a purchase blindly and the need to conduct due diligence before closing the deal. However, with the markets ever evolving and even the smallest deal requiring quite a bit of earnest money, buyers need to ensure they have a way out of the contract and save their earnest money, if a particular property does not fit their plans.

This is where contingencies in the real estate purchase and sale agreement come to save the day. Contingencies allow the buyer to mitigate the risk and terminate the contract before their earnest money becomes non-refundable. The most common contingencies can be grouped as follows:

• Inspection and feasibility contingencies

• Land use and environmental contingencies

• Title and survey contingencies

• Appraisal and financing contingencies

Of course, depending on the nature of the deal, buyers and their attorneys will include additional contingencies and modify the common contingencies listed above. If these contingencies are not satisfied, then buyers will seek to save their earnest money by modifying the terms, extending the contingency periods, or terminating the agreement.

Inspection and feasibility contingencies

The inspection and feasibility contingencies usually afford the buyer a certain period of time to conduct its due diligence and make a decision on whether to continue to close on the property. While the various aspects of due diligence deserve another article, the most common questions a commercial buyer will seek to answer are around the income and expenses of owning a particular property.

During the inspection and feasibility contingency period, buyers will conduct a physical inspection of the property to determine whether any repairs or improvements are required. If so, buyers may seek to modify the purchase price or demand that sellers complete the repairs before closing. Buyers will also look at the costs of owning the property, such as real property taxes, regular maintenance, and insurance. If the property is an income-generating property, buyers will certainly review the property's performance over the last few years. Other items of due diligence could include engineering and architectural inspections. Buyers will also conduct an environmental assessment, especially if purchasing through a mortgage loan, which might trigger the environmental contingencies.

Land use and environmental contingencies

Another important category of contingencies, land use and environmental contingencies allow buyers to save themselves from buying a piece of real property that they will not be able to use.

If there are known environmental issues with a property or if the environmental assessments during the inspection period reveal issues that need remedial action, buyers will certainly ask to include environmental contingencies in the purchase and sale agreement. While these terms will be deal-specific, the main goals are to ensure the environmental issues are mitigated, any remedial action needed before the property can be used for the buyer's purposes is completed, and the costs for the foregoing are allocated.

Land use contingencies also directly relate to the buyer's intended use for the property. This contingency could be a lifesaver, especially in heavily zoned urban areas or commercial sites in deed-restricted suburban neighborhoods. If the buyer is not diligent in making sure the local ordinances allow for its intended use, the entire purchase could become a worthless investment.

Title and survey contingencies

While many commercial buyers rely on the title company to alert them to title issues and insure their title to the property, the responsibility still lies with the buyers to make use of their title and survey contingencies and determine whether there are title issues that will affect their intended use and development of the property.

Most purchase and sale agreements will afford buyers a certain period of time after the title commitment is produced to notify sellers and the title company of their title objections. The contractual language could be drafted to where failure to make such objections means the buyers approve the title as is. If the buyers realize problems in the title report later on in the process, not only have they lost some leverage (or even all, if the feasibility period has run out as well), but they have also lost valuable time during which such issues could be cured.

Sometimes, even a basic review of the property's title will reveal an uncurable title exception that will lead to termination of the agreement and save buyers time and money and preserve their earnest money. Other times, a survey will reveal that a title exception that could have been problematic does not affect the property at all.

Appraisal and financing contingencies

Two of the most important contingencies to include in a purchase and sale agreement, especially when the buyers are relying on third-party financing, the appraisal and financing contingencies allow the buyer to save themselves from a default if they cannot secure the funds to complete the purchase.

The appraisal contingency, as its name suggests, allows the buyer to terminate or renegotiate the agreement if the property does not appraise at or above a certain price. Since the appraisal affects how much financing a lender is willing to provide, this contingency is closely related to the financing contingency.

When including a financing contingency in a purchase and sale agreement, buyers should make sure that the terms of the financing are not only realistic in their market but also fit with their investment plans. If the limits on the amortization are too low or the interest rate are too high, then the contingency might not serve its purpose, and the buyer is left with two options: complete a financially bad deal or give up that sizeable earnest money.

Diligence is key

All of the above and other deal-specific contingencies can only take a buyer as far as its due diligence. Counsel may draft effective contingency terms into a purchase and sale agreement, but if buyers and their teams do not conduct proper due diligence, they will have to decide whether to complete the purchase with imperfect and incomplete information or lose out on the deal to save their earnest money.

Atik Law PLLC specializes in commercial real estate purchase and sale agreements, as well as other real estate and business transactions, and brings experience, quality, and a personal touch to the purchase and sale process. We add value to any buyer's team by providing expert legal guidance and counsel during the due diligence period and beyond.