If, after performing the initial due diligence on a commercial property, a commercial real estate investor decides that he or she would like to proceed with a purchase, the next step is to submit an offer. In most cases, the offer is submitted on an official document known as a purchase and sale contract.
What is a Purchase and Sale Agreement?
The purchase and sale agreement is the official legal document upon which a formal offer is made. In most cases, it is submitted by the potential buyer as a starting point for negotiations.
The purchase agreement serves three important purposes:
- It outlines the rights, warranties, liabilities, and obligations of each party (the buyer and seller) to the real estate contract
- It identifies the property that is to be sold or conveyed
- It defines the steps necessary to consummate the transaction
In a private commercial real estate transaction, a PSA can be lengthy, dense, and filled with complex legal language. It is often prepared and negotiated by an attorney. For investors involved in a private real estate transaction, there are seven key clauses to be aware of and familiar with.
Clause #1: Description of the Property
There are two potential descriptions of the investment property that are to be conveyed with the contract. The first is the relatively simple address, city, and state that are frequently used to identify a location—however, if this is used alone, it may be insufficient for the legal transfer of title. For these purposes, the “legal description” of the property may be used. The legal description describes the real property using a government survey, metes and bounds survey, or the lot numbers in a recorded plat.
The description can be incredibly complex and lengthy, but the important point is that it is widely accepted as a way to identify a property.
Clause #2: The Money
This section of the contract describes the financial terms of the contract, and there are two important components: the purchase price and the earnest money.
Naturally, the purchase price describes the amount of money that will be paid for the property. It may or may not be similar to the asking price, but it represents the amount of money that the buyer is willing to pay.
Earnest money is the down payment that is to be placed in escrow in good faith to demonstrate that the buyer is serious about the purchase. The specifics of the contract outline who is responsible for holding the earnest money deposit, as well as what happens to it if the deal does not close; it may or may not be refunded.
Clause #3: What is Being Conveyed
Depending on what is being conveyed in the sale, there are different instruments used to accomplish it. For example, there are general warranty deeds, specialty warranty deeds, and quitclaim deeds, all of which accomplish a different task. The PSA should detail exactly what type of deed is being conveyed in the sale and the amount of protection it gives to the buyer.
Clause #4: The Contingencies
At the time the buyers make the offer, they likely don’t know all the information they’ll need to know about the property. As such, they will make their offer contingent upon getting information and inspections to validate their initial due diligence. Typically, contingencies include things like:
- Receipt of all property documentation including financial statements, invoices, inspections, property taxes, and repair history
- Receipt of a satisfactory phase 1 environmental survey
- Financing approval from a real estate lender
- A satisfactory review of existing property leases
- Satisfactory review of all existing contracts for things like property management
These sorts of contingencies give the buyer an opportunity to cancel the purchase contract if something does not check out. It also gives the seller a chance to cancel the contract if the buyer is unable to meet one of the seller’s own conditions. For example, if the buyer is unable to obtain financing, the contract could be deemed null and void.
Clause #5: The Timing
The contract involves several key dates. Most importantly, the due diligence dates and the closing date.
The due diligence dates provide a specified time for how long the buyer will have to perform due diligence on the property. Typically, this includes activities like unit walk-throughs, electrical inspections, plumbing inspections, and a final review of the property’s finances, bank accounts and legal documents. Often, due diligence can uncover previously unknown information, such as an easement or encumbrance that could change the buyer’s perception of the property or their financial model. If it does, buyers may elect to try and renegotiate the purchase price.
The closing date is just that—the date the purchase is expected to close. This is important for a few reasons. First, it provides the lender with a timeline needed to complete the loan documentation. Second, it gives the title company a timeline to get their documents in order. Finally, it gives the seller an indication of when they can expect their sales proceeds. This way, they can start planning what to do with them.
Clause #6: Seller Representations and Warranties
As part of the sales contract, it is common for the seller to represent and warrant that a series of statements about the property are true. These statements typically include things like:
- The property is free of liens and encumbrances and the title is clear
- There aren’t any zoning or building code violations
- The seller has the legal right to sell the property
- No other party, besides the tenants, have a right to occupy the property
- All legal and financial documents provided to the buyer are true
- The property is free from harmful substances like radon gas or other environmental contaminants
There may be other representations and warranties that are unique to the contract and they will be spelled out in this section.
Clause #7: Seller Duties & Continued Operation
Commercial properties are large and complex to operate, and as such, they can’t just be handed over in a day. So, the contract outlines the seller’s duties to continue operating the property in the period from which the property is officially under contract to the time the sale closes. The exact provisions of this clause can vary, but they typically include things like:
- The seller must continue to operate the property in a similar manner
- The seller must continue their normal leasing efforts—for example, if the seller is on the verge of signing several new leases, they must continue to try and do so
- The seller must continue to maintain adequate insurance on the property
- The seller must not add any additional debt to the property
This section may also obligate the seller to maintain tenant files and instruct them on how to handle the changeover once the transaction is closed.
Final Thoughts
A purchase and sale contract is one of the most critical documents in a commercial real estate deal. Often, it is prepared by a real estate attorney in partnership with the buyer and seller. The document outlines the terms and conditions of the transaction, and it obligates both parties to perform a series of actions.
Once all of the clauses and terms have been negotiated, it is signed by both the buyer and seller and/or their representatives. Then, once executed, the property is under contract and the clock starts clicking toward the closing date.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
