When commercial real estate is bought or sold, the details of the deal are outlined in a document known as the “Purchase and Sale Agreement.”
In this article, we will define what a Purchase and Sale Agreement is, why it matters in commercial real estate, how it works, and why it is important for investors to understand. By the end, readers will be able to incorporate this knowledge into their pre-purchase due diligence process and/or their own efforts to negotiate a purchase and sale agreement.
At First National Realty Partners, we specialize in the purchase and management of grocery store anchored retail centers. Every time we buy or sell commercial real estate, we dedicate a significant amount of time towards negotiating a purchase and sale agreement that is amenable to all parties involved – including our investors.
What is a Purchase and Sale Agreement?
As described in the introduction, a Purchase and Sale Agreement (PSA) is the legal document upon which a formal offer to buy/sell a property is made. Usually, it is completed by the buyer or their broker/attorney and submitted to the seller as a starting point for negotiations. The details/text of the contract highlight three important components of the deal:
- It outlines the rights, warranties, liabilities, and obligations of each party (the buyer and seller) to the real estate contract
- It identifies the property – including personal property – that is to be sold or conveyed in the transaction and the proposed purchase price for it
- 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, which is why it is often prepared and negotiated by an attorney.
What Does a Purchase and Sale Agreement Include?
Every PSA is unique, but they typically include the following major clauses:
- Description of the Property: The real property to be sold is usually identified two ways. First by its street address. Second by its full legal description. This ensures that there is no question about what commercial real estate property is going to be sold.
- Purchase Price & Earnest Money: The contract defines the purchase price for the property and the amount of the “earnest money deposit” and/or security deposit that will be advanced as a sign of the buyer’s commitment to the deal. It may also define any necessary prorations that the buyer/seller must pay for in the interim period between when the PSA is executed and the closing date.
- Conveyance: This clause defines exactly what is being “conveyed” in the sale. Usually, it is a warranty deed, special warranty deed, or quitclaim deed depending on the state in which the transaction is occurring.
- Contingencies: Often, an offer is contingent upon several factors and this section will outline them. For example, the offer could be contingent upon the receipt of documentation like a: rent roll, phase I environmental survey, zoning clarification, identification of easements, existing leases, or financing approval – including the required loan covenants.
- Timing: This clause highlights the timing of the commercial real estate purchase. It may even define the timing of key milestones like: unit walkthroughs, inspections, due diligence, and the closing date.
- Seller Representations & Warranties: As part of the deal, the contract asks the seller to “represent and warrant” certain things about the property. For example, it may ask that they agree that the property is free from any liens or encumbrances, that the physical condition of the property is good, that it is in compliance with all zoning rules, or that it is free from harmful substances like radon gas or asbestos.
- Seller’s Obligations & Continued Operation: Finally, the contract usually outlines what the seller’s duties are in the time period between when the offer is accepted and the date of closing. For example, it may say that the seller is responsible for continuing to operate the property as usual, they they can’t add any additional debt to the property, that they must honor existing service contracts, that they must continue to maintain insurance on the property, that they must continue to pay real estate taxes and other operating expenses, that they must continue to follow all local laws and ordinances, and that they must do their best to maintain the property’s occupancy.
Again, it is important to note that every PSA is unique to the specifics of the property and the transaction so it may include clauses other than those described above.
How the Purchase and Sale Agreement Works in Commercial Real Estate
The way that the purchase agreement works is fairly simple. The document itself is prepared by the potential buyer and/or their representatives and presented to the seller. As described above, this is usually a starting point for negotiations. It would be rare for the seller to accept the first PSA accepted.
Once received, it is normal for the seller to review the PSA and to respond with their concerns about the proposal and their counter to them. For example, they may propose a counteroffer to the purchase price, different timing, or different allowable use of the property.
Often, there may be several rounds of negotiation between the buyer and seller (and their representatives) before they get to a draft of the PSA that they both agree on. When they do, it is signed by both and officially considered to be “executed.”
But, once it is executed, it is not the end of the road. Instead, it is the beginning of a process that involves due diligence, appraisals, estoppel certificates, and conversations with lenders. If everything goes as planned, the process will end in a closing where all transaction paperwork is signed and the purchase price is funded.
Purchase and Sale Agreement FAQ
Fundamentally, the PSA is a legal contract. For those that aren’t lawyers, it can be difficult to read and confusing to understand. To help with this, below are the answers to several frequently asked questions about PSAs.
Are Purchase and Sale Agreements Legally Binding?
Yes. Once both the buyer and the seller have agreed to the terms outlined in the document and signed it, the entire agreement becomes legally binding. “Legally binding” means that both the buyer and the seller are obligated to adhere to the terms outlined in the document. For example, if the contract says that the buyer must pay their own attorneys fees or that they have to provide written notice of cancellation, this is what they need to do.
Who Writes a Purchase and Sale Agreement?
Typically, the PSA is prepared by the seller and/or their attorney. For smaller commercial real estate deals, the seller may do it themselves.
When is the PSA Signed?
The PSA is signed when both parties agree to the terms outlined in the document. Again, this could take several rounds of negotiation until the final terms are agreed upon.
Is a PSA The Same as a Letter of Intent?
No, a PSA is not the same as a Letter of Intent (LOI). The key difference is that, once executed, a PSA is legally binding and a Letter of Intent is not. A LOI is an expression of interest in making a deal, but it is not legally binding. Instead, it provides a seller with a broad outline – in good faith – of the terms and conditions under which a buyer is willing to make a detail.
Investing Through Private Equity Real Estate
As this article describes, the PSA is a complicated document with important legal ramifications and negotiating the terms of it is a critical part of a commercial real estate investment transaction. Doing it correctly – and ensuring that all of the important points are covered – is a skill that takes a long time and many transactions to master, something that individual investors may not possess.
Fortunately, private equity firms negotiate purchase and sale agreements all the time and have a high degree of expertise in this phase of the real estate transaction. This is just one of many reasons that an individual investor may benefit from working with a private equity firm to make a commercial real estate investment. All they have to do is to select a deal and commit a certain amount of capital to it. The private equity firm does the rest.
However, it is important to note that private equity firms have a wide variety of commercial real estate investment strategies and products. For individuals who are considering working with one, a great deal of due diligence must be performed to ensure they are a good fit for an investor’s return objectives, risk tolerance, and time horizon.
Summary & Conclusion
A Purchase and Sale Agreement (PSA) is a legal contract upon which a formal offer to purchase a property is made.
A PSA is prepared by the buyer and/or their attorney and is presented to the seller. Once presented, there may be several rounds of negotiations between these two parties before the final deal terms are agreed upon.
Every PSA is unique, but they typically include clauses that outline: a description of the property; the purchase price and earnest money deposit, contingencies, and the timing of the transaction.
Because the PSA is a complex document with important legal ramifications, they should be prepared by an expert. For individuals, one of the major benefits of working with a private equity firm (the expert) is that they prepare the PSA on behalf of their investors.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, 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 would like to learn more about our commercial real estate investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
