BUYING REAL ESTATE IN THE U.S.
By Shepard A. Federgreen, Gibbons P.C.
Buying real estate in the United States follows a predictable pattern involving multiple steps and multiple professionals. This outline focuses on the common steps which are virtually universal.
Hiring a Competent, Experienced Transactional Real Estate Attorney
Although I admit to a certain bias, hiring an attorney at the start of the process should facilitate the entire transaction. You will have input from someone who knows how any number of different situations might, from a legal perspective, impact the acquisition (including its financing), thereby reducing the chance of unforeseen issues and headaches down the road.
Finding the Property – the Broker
Obviously there are many types of property (undeveloped land, retail, commercial, industrial, lodging), any of which might be located in urban, suburban or rural locations. Once you have defined the parameters of what and where you want to buy, the next step is almost always to hire a broker. Good brokers not only know the market but can guide you through local customs and expectations. A formal brokerage agreement is recommended.
The single asset limited liability company has become the almost universal choice for property ownership, due to that entity type shielding its members from liability arising out of property ownership and operation, while being a “pass-through” entity for income tax purposes. But no solution is correct in every circumstance – especially for foreign entities. So legal and specifically tax advice should be sought as to the entity structure to be created to acquire property.
When buyer and seller agree on basic deal terms the broker usually prepares a non-binding “term sheet” which addresses basic provisions such as price. Term sheets can run the gamut from very light on details to exceptionally complete, and everything in between. Term sheets usually specify that they are non-binding and that neither buyer nor seller is bound until a formal contract is executed and delivered. But be wary. If a term sheet is signed by both parties, does not specify it is non-binding, and has the material terms of the agreement, it might very well constitute an enforceable contract – so proceed with caution.
Contract of Sale and Due Diligence
After a term sheet is signed the parties proceed to a formal contract. Convention dictates that seller’s attorney drafts the contract (although, of course, this is not always the case). The contract typically addresses 1) a description of the property, 2) price, 3) down payment (and whether this is held in escrow – which it almost always is), 4) representations to be made by the seller (which can vary from a detailed litany of statements about multiple topics to almost nothing) and whether misrepresentations can be sued on by the buyer after closing, 5) the length of the due diligence review period, 6) closing date, 7) other conditions to closing such as receipt of financing (which is usually not a condition in a commercial transaction), tenant estoppels or zoning approvals, 8) payment of the broker, 9) transfer taxes (amounts due to local governments triggered by the sale of the property – the amount thereof and whether seller or buyer pays varies by jurisdiction), 10) the need to comply with local or state filing procedures, and 11) other topics which are jurisdiction or transaction driven.
Practices and expectations vary in different states and even within different parts of different states. So you should expect your lead U.S. counsel to seek the assistance of local practitioners on a variety of topics addressed in the contract.
Typical due diligence permitted by a contract includes a review of: (i) the environmental status (which might be limited to a review of historical documents or might include physical tests of varying levels of intrusiveness) and environmental history of the property (almost always conducted by an environmental consultant), (ii) the physical condition of the property (often done by an engineer or construction person), (iii) title (almost always done by an attorney), (iv) zoning (almost always done by an attorney or architect), (v) the ability to finance (usually done by the buyer with the help of mortgage brokers), (vi) leases and service contracts (usually done by the buyer or attorney), and (vii) specialized contracts, e.g. hotel management agreements (usually done by the attorney). During the due diligence period the buyer will do its best to understand the revenues generated by and the costs associated with owning the property. And finally during this period the buyer might seek to interview significant tenants or other third parties having a material impact on the potential value of the investment. At the end of the due diligence period the buyer either has to terminate (in which case its down payment is typically returned) or proceed with the transaction. However, the contractual basis on which a buyer may terminate varies, Many contracts allow the buyer to terminate for “any or no reason”, but some have carefully delineated, limited reasons for which a buyer can terminate. So a buyer has to be careful to build in a right to terminate which is broad enough so as ot protect the buyer in the given circumstances.
Finally it is worth noting that in very “hot” market, where buyers are clamoring and sellers control the process, contracts might not include due diligence review periods. In this circumstance buyers are forced to spend the time and money to conduct its due diligence before signing, without having a contract allowing it to buy should it decide to proceed. So all monies spent on due diligence are at risk.
If the transaction is not terminated during the due diligence review then the parties next move to satisfy whatever other conditions the parties agreed to in the contract – the satisfaction of which will be up to seller or buyer depending on the nature thereof (e.g., receipt of local development approvals would almost always be buyer’s obligation, whereas receipt of tenant estoppels would almost always be seller’s obligation).
Financing the Acquisition
If the transaction is being financed by a third party then the buyer obviously has to locate a willing lender, which often involves the use of a mortgage broker (separate from the property broker). To qualify for a loan the borrower obviously must satisfy the lender’s underwriting criteria. The application and closing process can be arduous. Third party financings materially increase the amount of paper involved in any closing. Your attorney will spend a decent amount of time negotiating loan documents and working to satisfy the lender’s attorneys. Conditions which must be satisfied to close a loan do not always make perfect sense. But lenders tend to be conservative, and, generally, are much less flexible than sellers or buyers.
Upon meeting the conditions of the Contract and the lender, money and many papers change hands and the conveyance “closes”, i.e. ownership is passed from seller to buyer.
Need for Operating Cash
Although most transactions depend on financing to complete the acquisition, cash will be required to conduct due diligence, pay professionals, pay lender fees, and post the down payment. Depending on the transaction size this will almost certainly run into the low tens of thousands of dollars and for more substantial transactions can easily run north of a hundred thousand dollars or more. So a buyer should make sure it has sufficient resources to complete the process of buying before it starts that process. If a buyer can’t see the process through to its conclusion, it not only can’t complete the transaction being pursued, but it risks wasting any monies spent.
The process of buying real estate in the United States, like most things, is complicated. But it is not unknown. The use of competent professionals is an intelligent investment which is justified, and might on occasion even pay for itself in terms of money and aggravation saved.
Shepard A. FedergreenGibbons P.C., Newark, NJ, USA
T: +1 973 596 4923
Shepard A. Federgreen provides advice in connection with a wide range of real estate transactions, presenting clients with strategic options to meet their business goals.
With 230 attorneys and five offices in four states, Gibbons P.C. is ranked among the nation’s top 200 law firms by The American Lawyer. The firm provides comprehensive litigation and transactional services to clients ranging from dynamic start-ups to the Fortune 100.
Published: August 2018 l Photo: Omid - Fotolia.com