Why Do Commercial Real Estate Contracts Fail?
“So, why do commercial real estate contracts fail anyway, Attorney Al?” asks Richard. “Well, Richard, there are many reasons why commercial real estate deals collapse. As a real estate attorney, I have unfortunately seen a few deals fail. Let me tell you a few.”
Billy is so excited. He cannot wait to build his new office building. He finally finds the perfect piece of commercial real estate. So, Billy contacts the owners, Bob and Sue. Bob and Sue are happy because they need to sell the property for retirement purposes. A deal is made and they sign a contract.
Billy applies for a loan to buy the commercial real estate. As part of the loan process, the bank performs an appraisal. Uh oh! The appraiser determines the value of the purchase price is more than the value of the loan. So, the bank will not issue the loan to Billy. Poor Billy, Bob, and Sue. Now the commercial real estate contract fails as Billy cannot afford to buy the property without a loan.
Unfortunately, this scenario happens a lot. Most people need a loan to buy real estate – whether commercial or residential. So, a loan is needed to complete the purchase.
In order to qualify for a loan, the buyer must be deemed credit worthy by the bank. And, the bank must determine that the collateral, or the real estate, is worth the loan amount.. So, the bank conducts an appraisal of the property.
If the value of the subject property is $1,000,000 but the sales price is $2,000,000, the bank is most likely not going to approve the loan. So, the commercial real estate deal falls apart.
Sometimes the potential buyer cannot get the property zoned for his proposed commercial use. Obviously if a potential buyer cannot use the commercial real estate for his intended use, he is not going to proceed with the purchase of the property.
Jack andJill own fifty acres of farmland. Jack and Jill are aging. They no longer want to farm and none of their children are interested in farming. So, Jack and Jill decide to sell the farmland.
Along comes Caring Hospital who is looking to build a new medical facility in Jack and Jill’s town. It’s representatives are interested in purchasing Jack and Jill’s land. The land is almost perfect. But, one problem. The land is zoned agriculture, not commercial.
So, Caring Hospital’s lawyers attend many town council meetings and file rezoning requests. Unfortunately, the town officials are not happy about a large hospital opening up in their small town. So, the members deny the rezoning request.
Caring Hospital has not interest in any type of agricultural use. So, Caring Hospital terminates its commercial real estate offer with Jack and Jill.
Failure to Qualify for a Loan
Sometimes the potential buyer cannot qualify for the loan to purchase the real estate. Remember Jack and Jill? Well, after the Caring Hospital deal collapsed, Frank Franchiser offered to purchase the property. Frank had already convinced the town officials to agree to rezone the property for his franchise idea. So, Jack and Jill were elated.
Unfortunately, while city counsel was impressed with Frank’s idea, the bank was not. Bill Banker noticed that Frank Franchiser had a lot of personal and business debt. Due to the current state of the market, Frank’s other franchises were struggling. Ultimately, Bill told Frank he could not get a commercial loan. So, once again, Jack and Jill’s property did not sell.
Sometimes the land is just not suitable for the commercial developer’s purpose. When a commercial buyer signs a commercial real estate contract, the contract gives him time to conduct a survey. A survey is necessary to make sure utilities can be hooked up to the property. The survey might reveal soil issues. In one case, a survey revealed the property was actually wetlands. Therefore, due to environmental concerns, building could not be performed on the property.
Surveys reveal recorded easements, access, parking and encroachment on the property. These property attributes may be at odds with the potential purchaser’s proposed plans or use of the commercial property. If so, then the commercial real estate deal will fail. After all, if you cannot use a commercial property for you intended use, why would you purchase the property in the first place?
Additional Costs and Expenses
Sometimes a commercial property deal fails due to renovations needed. Take Hansel and Gretel. After months of looking, they find Little Red Riding Hood’s restaurant. And, as luck would have it, Little Red Riding Hood was selling! The building was perfect for their Gingerbread House idea! And, the property was within their pre-approved commercial loan amount. So, Hansel and Gretel made an offer.
While conducting their search of the commercial property, Hansel and Gretel discovered that while the outside of the building was great, the interior was not. The interior had not been updated since the 1950’s. In order to conduct their restaurant, Hansel and Gretel would have to spend a lot of money bringing the electrical outlets up to code. The appliances were outdated and needed replacing. The building and its restrooms were not handicap accessible and needed to be in order for their restaurant to operate. And, the floors were warped and the linoleum was peeling. Oh and did I mention the furnace that was on it’s last legs?
Hansel and Gretel totaled all the renovations needed on the commercial property. All of a sudden, their affordable commercial real estate deal was not so affordable. So, Hansel and Gretel terminated their offer and the commercial real estate deal failed.
“Wow, I never knew there were so many reasons why commercial real estate deals fail,” says Richard. “Yes, Richard, and these are just a few,” responds Attorney Al. “This is why potential purchasers should have a great commercial real estate broker AND a great commercial real estate attorney to help them.”
As the above examples illustrate, there are many reasons why commercial real estate deals fail. An experienced commercial real estate lawyer can help you navigate these issues – whether you are buying or selling.
We have over twenty-years of commercial real estate experience here at Schweizer and Associates. We would love to help you with your commercial real estate needs.