Podcast Series 8: Understanding Commercial Real Estate Contracts and Letter of Intent.
Hey everyone Cordell Davenport here with a small apartment investor my thing that I always say is mindset plus skill set plus performance equals results and right now introducing once again. John is going to talk about skill sets when it comes to. Legal matters. That is a real estate attorney. The second time actually we’re gonna have a conversation.
I’m gonna have a conversation with them and as I learned you guys will learn but before we get started, I’ll talk about a letter of intense and purchase other agreements but John would’ve been up to what’s new in your life. That you want to share about it is might.
Today, thank you. Cordell nice to see you again glad to see you’re well covered continues to make life interesting in just about every aspect real estate-wise. You know, people are being cautious about entering into transactions but I see sort of a steady increase in activity. I speak with residential and commercial brokers practically every day and at the end of every conversation.
I always ask people what they see happening on the front lines and so far it seems like 2021 is a continuation of where we left off in 2020. So I’m hoping that with increasing vaccination rates with more access to units because one of the issues right now is inspecting a property before you commit to buying it tendon occupied properties can be challenging to get into and so I’ve seen a number of transactions just sort of remain in a state of suspended animation that’s the other transactions fall off the table because is inhibiting the normal process but I’m, An optimistic but.
It’s complicated. I just thought about knowing that when it comes to buying there is a course we have due diligence. You have a financial due diligence roll. Looking at the trailing 12 looking at least is verifying all that then you have the physical due diligence. But because the code if you can’t walk every unit and you can’t do a full inspection.
That’s gonna be interesting because I would think when you write a contract you have certain things embedded inside the contract that you know, if something happens you find something and then it can be like a credit or whatever but if you don’t have a traditional way. I don’t know why anybody will make a move right now because I know that personally I am trying things but in California where we’re at I know that on June 30th, I heard an attorney from San Francisco give a webinar.
I talked about Kobe as tenants, oh money, hey what he said in California is they will be able to get eighty percent of what is held to them if they file these paperwork. And then at the end of June 30th, they decide not to take the money they can go ahead and perceive the court proceedings and try to go to small claims court but there’s no given that’s gonna happen for them so until June 30th, basically there’s there’s that cause when eviction convicting people but at least now some of the owners in California are going to be able to get some of that money back.
But do you think that? It makes sense just to let the dust settle. Or how are you seeing you know, because like if you can’t truly do diligence just you know, you’re going to get caught with somebody else’s mess. And now their message is your mess. Yeah exactly as I tell clients when you buy property you step into the shoes of the previous owner no matter how clean or unclean those shoes are it’s an interesting question you’re referring to the latest piece of state legislation, it’s referred to as SB91 California has set up a rental assistance program.
As always the devil is in the details and we don’t have a lot of details yet as to how that’s going to work and how much money is there and when is it going to run out? But if that works then it will provide some relief to some property owners.
Tenants generally remain protected against eviction and will be protected against eviction if the reason for the eviction is they couldn’t pay rent during covet as a result of covet problems that they were experiencing so you know, if and when the dust finally settles. A there will be evictions that’s going to clog the courts and slow down what otherwise is supposed to be an expedited process.
And those are going to be evictions generally for non-covid rent reasons. And. Otherwise owners are going to have to go to small claims court to try to get some money but that is not going to result in an eviction that’s just going to be compensation or core payment of moneys that were owed.
Transactions that I’m seeing occurring with covet inspection problems, like I said generally either tend to remain in suspended animations, you know, the contract the contingency period comes up for expiration and it just gets renewed or there’s a provision that says the contingency period doesn’t start until I have access physical access to the unit.
In other cases people are doing virtual tours and inspection but I think you’re absolutely correct that it’s a it’s a risky proposition for for buyers but there are also some desperate sellers who are willing to take a haircut on the purchase price just to get rid of the property either because they absolutely need the the money or they just want to get out from being a landlord during times like this.
I think that’s when I sell it to play if it’s so things like that because. Yeah because even an article about someone in San Francisco. I think oh like 35,000 dollars and back pay. And he’s out of work and if you want to try to buy something you buy on the numbers, like how much money is this thing producing it’s not producing or what it used to be is it’s going to just be a mess so I don’t know yeah so it’s going to be interesting.
I think that when it comes to buying and selling this about finding problems and coming up with some solution that that person benefits from the other person can benefit from. Seller may have issues. Property may have issues, so how do you uncover that a lot of that is track finding?
Figuring out motivations from people but in this conversation, we’re gonna have today. We talked a little bit and you said something about me and said something about contingencies. I know what those are a little bit operate what contingencies are when it comes to the purchase celebrant for commercial property. Sure, um, a contingency is just a condition that the buyer or the seller imposes on the transaction.
If I have access and I am satisfied with my inspection, that could be one contingency. I need financing and so before I commit to buying I want to make sure that a the property will appraise and this goes to the issue that you just brought up about what happens to the appraisal value of a property under covet when nobody’s getting rent and we don’t know for sure what the rents are going to be in the future but typical contingencies are.
As a buyer I want to inspect the property before I have to commit to buying it. I want to make sure that I’m going to get the financing which includes. Having the property of prey is at a level high enough so that I can borrow as much as I need to in order to buy the property.
And even with an appraisal I just got to make sure that I get approval from the lender for that loan. Sometimes there are other contingencies that buyers put into the transaction and those often include. I own another piece of property. And before I commit to buying your property Cordell, I have to sell my other property because I need the money from that transaction in order to buy this transaction.
And people can come up with other contingencies, but I would say, you know inspection and financing are the two most common and inspection, of course means not only the physical inspection, but as you said reviewing the rentals inspections also can and quite often I would say should include looking at things that are not specifically in the property like the condition of the property but also looking at public records in order to understand.
Is this property currently in compliance with local laws or does somebody think that there are code violations right has the city or has the county communicated with the owner to say, you know we’ve received a complaint and inspected or have we seen that you’re operating illegally. For any number of reasons including these are not legal units or you know, you’ve got electrical outlets next to the sink that are grounded.
All kinds of different things like. There’s a statement. I know there’s a phrase. That says if this then this. So this is the continuity that someone has If this happens then this is what we’re going to do. Like okay this is broken we want twenty thousand dollars off or this is this all one extra ten days how does a person figure out okay, this is a problem my contingency is this and I want to get this like how do you?
Is it the same thing recycled through a contractor contract like common common theory or common practices that people use or? Is it up to the person to figure it out?
Yeah, probably the latter. I mean, a typical contract will state the expected closing date, right? So depending on the property that could be 30 days, it could be 60 days it could be 90 days and you know, one of the other things is that there might be SBA money involved and SBA has its own.
The loan approval process that’s different from the lenders. But typically, the contract will say, you know, we’ll sign a contract dated March 1st and it will say closing is supposed to occur by May 1st or April 30th.
So we’ve got roughly two months to close this transaction. During that time. I as the buyer want to inspect the property and I want to make sure that I get financing. So I would put in provisions that say. Even though I’m supposed to close in 60 days, I want 21 days to inspect the property and kick the tires.
So to speak I want 28 days to get my lender’s satisfactory appraisal and loan approval. And when those dates come up 21 days 28 days of my example, if the buyer hasn’t had access to the property. Then both the buyer and the seller have to agree to extend the time period for that inspection.
Otherwise buyers could be deemed out of contract if they don’t act to either remove or otherwise wave their contingency. So typically when the process of clearing the inspections is delayed because of external factors usually the parties can agree to some reasonable extension of time. So, okay, we’ll give you another 20 days.
To do an inspection and now we’re going to have to extend the closing date that we otherwise thought was going to be a 60-day date. Now, we’re going to kick that date out further as well. But another scenario is the buyer does have access to the property and maybe they’re making it all cash offers so they’re not worried about appraisals and financing.
So the buyer has access to the property and she doesn’t like what she sees. Something about the physical condition of the property, maybe they met a tenant or you know, tenants put nasty signs out on the door basically saying, you know, I don’t like you. I don’t want you here that kind of thing.
And so the buyer then has to decide. Do I still want to buy this property or should I just walk away? And if they’ve decided to walk away, then they would tell the seller. I haven’t satisfied my contingency. I’m not going to go forward with the transaction and then typically both the buyer and the seller will sign a cancellation and deliver it to the escrow and the buyer should get their money back.
They’re deposited back. In other instances where the buyer isn’t as afraid of the property the buyer might say hmm, it’s not perfect but I can probably live with it. But seller if you want me to stay in this deal give me something right which is as you said typically a discount on the price, whether it’s because the roof needs replacement the foundation is cracked, there’s a nasty dispute going on with a tenant that’s likely to involve, you know litigation or proceedings and so it’s up to the buyer to decide am I in and if so am I in under the same terms as we originally negotiated or is this an opportunity for me to cut a better deal for myself?
Obviously that depends on the cooperation of the seller so it can just say not interested. Take it as is or move on. And I’ve heard when it comes to contracts when you know negotiating certain things okay? I’m gonna give you your price which if you give me my terms or vice versa, that’s a common thing that I’ve read tremendously.
When it comes to the negotiation, yes. Yeah and but regards to the contract. What is the most common is if the buyer comes to the attorney with the contract or is it the seller comes with their contract and then the buyer has their attorney scratch it up and then make some addendums to it, how does that work?
Well it depends on a few different considerations, you know first is the buyer working with a broker or an agent or is the buyer representing himself okay, you don’t have to be an attorney you can create your own contract whether you find some form or. Create something out of whole cloth.
Typically the buyer will prepare the offer in the form of the contract. And then the seller will receive it and either accept it as is or make a counteroffer right and so they may play ping pong with the contract for one or two rounds in most transactions. Where agents are involved they tend to use a common form of purchase contract the California Association of Realtors publishes contracts as you know, both residential and income property and so quite often especially in Alameda County there’s a form that everybody has seen and it’s mostly you know, fill in the box fill in the blanks and check off the appropriate boxes in other transactions.
I’m handling the transaction for the sale of a fairly big building. It’s a custom. Contract we’re now three rounds into ping pong on the contract. And it’s heavily negotiated. Every turn can be heavily negotiated whereas often in these form contracts people focus on one or two items.
So it’s a world of different possibilities depending on the property depending on the sophistication of the owner. And so on. Now when the parties come together there’s an agreement meeting of the minds is there someone to notarize it or they just sign the paperwork or they do it in front of an escrow company, or how does that work?
Yeah, there are a lot of misconceptions about notaries in different countries lawyers are referred to as notaries, especially in Latin America or the people that we consider lawyers or are described as notaries in in this country in different states different documents have to be acknowledged by a notary and essentially what that means is that the person who is signing the contract has proven their identity to the notary.
A notary is a licensed person. And there are licenses at risk if they notarize bogus documents. So they insist on seeing you know, valid proof of a driver’s license, a passport birth certificate, something like that. In most cases. Signing a contract does not require a notary’s technology. I mean, if one party is suspicious about the other party then there’s probably bigger problems in the transaction and you know, they should obtain proof of the identity of that person quite often that’s simply using a title company opening up an escrow and the escrow the time company will identify according to the public records who they believe is the current owner or owners.
So if there’s a discrepancy between you know, James Smith who’s signing a contract but, According to the title company, it’s actually John Jones who owns the property then there would be some discussion improved but typically it’s not a notary’s acknowledgement. More commonly notary acknowledgments are required in California for documents that are going to be delivered to the county recorder and put in the public records.
So private documents between two parties generally. Don’t require notarization documents or instruments like deeds easements leans things like that have to be notarized. In regards to talking to the other about it earlier negotiating, you know, you’re going back and forth you mentioned that one big contract the third goes around.
What kind of tactics do you see for negotiating that seems to work over and over again and what doesn’t that work over again? It’s like someone you know, the traditional I want a hundred okay, or I want 50 on let’s put the middle you know, how does that all work that you see?
That’s a big question. On. I guess to keep it simple one basic rule is who wants this deal more okay the buyer or the seller, right? I did another transaction where we went through a similar large transaction. We went through 16 rounds of kicking the purchase and sale agreement back and forth back and forth back and forth.
And my client had taken a position, that was basically. Buyer when you buy this property you are taking it as is and I never want to hear from you again and you’re gonna sign and you’re gonna sign something in this contract this contract is gonna have it’s sort of an extraordinary provision that says you understand and agree that you’re buying this thing in whatever way shape or form it’s in good bad or ugly and when we close.
You can send me a Christmas card but otherwise don’t call me right so that’s a tough sell sometimes but you know the buyer hung in there long enough until we finally got the terms that the seller wanted. Unfortunately the buyer was dissatisfied with their inspection and they went away after being inspected again.
Or he’s probably had about that’s not especially if he’s working with brokers, they’re not going to hear all that someone just farts around not serious. You know, this person was serious, this is big money, this is you know more than 20 million dollars, so everybody was serious.
But yeah brokers that’s a whole different conversation about their motivation and how they influence a transaction but again just to keep it simple, you know, generally speaking.
Some people like to play hardball and they just simply insist it’s gonna be my way or no way and sometimes they just keep saying no no no right until the other side either gets tired of that and says, okay, then go away or again if they’re motivated they’ll hang in there and they’ll say well, I’ll give you a little bit of that a little bit of that a little bit of that.
So it really depends on negotiating style it depends on the motivation depends on other obvious factors like the physical condition of the property whether they’re not there are legal problems affecting the property or swirling around that could become issues specifically landlord tenant disputes those kinds of things so I would say for the most part what works is using objective factors.
As the reason for negotiating hardware if it’s just your personality you like to say no you like to be the boss you like to be the person that wins all the time. That’ll work in some cases but it’s gonna be a lot of cases where it’s not gonna work.
Thank you a couple things come to mind is that even I probably find third party reports that back up your viewpoint and that’s that’s kind of yep neutral it’s not it’s not me this is what this report says other thing that I think about reading is great book called never split the difference is only if you’ve heard the book yeah, oh god it’s great book no but I’d like to prison yeah that’s Chris somebody yeah for you guys don’t know he was like an ex FBI negotiator.
I took time. I have to go through the interesting act, but okay, there’s unrelated go ahead, no go ahead now. I’m gonna ask you one more. I was gonna say that. Yeah, no, but I just wanted to say that split the difference is a phrase that comes up often in the context of mediation or arbitration of disputes.
The parties are trying to negotiate to get to some sort of settlement party a is over here part of B is over here and they just can’t get to the middle and then somebody says okay, let’s just split the difference or sometimes a criticism that I’ve heard about arbitrators is, you know, arbitrators generally speaking are not judgments.
I suppose you could be a retired judge and still lead arbitrator, but often I hear criticism in arbitration. Which is an alternative to a lawsuit we could talk about that probably some other time sometimes the rap is that in arbitration the arbitrator doesn’t do the hard work of telling somebody sorry you lose.
And they split the difference so that you get a little bit and I get a little bit and maybe we’re both equally happy or unhappy at the result but we’re both in the same boat and maybe both of us might one day in the future use that same arbitrary again.
So splitting the difference is basically a way of avoiding the harder process of saying absolutely my way or no way. Yet a god is crazy says the negotiation starts when the other person rather than the person says, no. Games begin. You want to get you first so but yeah never spent the difference, check it out you guys.
Wow, ask people the other corollary the other corollary to that. Cordell is. Tried not to negotiate against yourself. Right? Don’t just be the person who’s tossing up softballs and having the other party just hit him out of the park all the time or specifically in this case, the example is one party says well how much do you want to pay?
Yeah, the other party says X the first time says, nope what else have you got? Okay, why? No, that’s still not good enough. How about Z? No, not good. So, Don’t negotiate against yourself try to use a reasoned or rational or logical or objective approach and that usually is something like when you tell me you don’t like what I’m offering you then I would turn around and say well, what do you like?
It’s going to be trying to get when you like. Why don’t you just tell me what you like? And it’s about questions. I remember. Many years ago. I wanted this real estate bootcamp. It was like a one-day thing that got around LaGrange. Basically it was if you’re going to try to buy something you say, okay, I want to buy some from you and let’s say you of course you don’t want to give it the first price, you know, how much do you want?
And then you can say, okay, I want a million dollars I go. Million dollars. Man. Is that the best you can do? Or what do you say? Okay. There’s something like okay, what’s the least amount you’ll be willing to take without losing sleep at night. Say your friends. So if you don’t get X amount, you’re not going to do the deal.
Okay, what’s the least amount? So if you just ask two questions, they may go from a million to eight hundred thousand just by asking the questions pausing and don’t leaving. So yeah, you’ve heard that expression if you don’t if you don’t ask you, don’t get. Right? All right, and I got our last conversation last topic and then we can wrap it up.
John I know you’re a busy man, but we talked a lot about contracts, but how do letters? Relate to contrast why why are there important you know what to look out for as well when comes a letter of contracts like what’s the whole process there that you can later others well that’s a timely question because this morning I prepared a letter of intent for a client who owns commercial property and they’re about to begin discussions with tenants commercial tenants.
Letters of intent are sometimes also referred to as memoranda of understanding LOIs or MOU’s. Are. Useful tools for. Flushing out these disagreements or issues about the major terms of account attract before you actually start drafting the contract. So it can be a good way to sort of test the other parties seriousness and generally a letter of intent or an MOU or an LOI is a term sheet that’s another way of describing it it’s just a series of line items that says who other parties what’s the property how much is the price how much is the rent what contingencies are there etc etc, and usually it’s one party that prepares the LOI and gives it to the other and says here the terms that, I’m expecting.
Can you live with this or not and so hopefully you cut down on the number of hours and the number of dollars spent trying to negotiate the transaction because you find out quickly you and the other party are just in completely different solar systems, you’re not you’re not even in the same general vicinity as each other and maybe it’s not worth it okay, or you find out that you are close and then you can come to some understanding about the price or some of these other terms.
The important thing. Also to understand about Illinois as an MRUs is that in general they should not be binding contracts. However people make the mistakes of preparing LOIS and not putting in the right qualifying language and unwittingly when both parties have signed the LOI suddenly there’s a contract an LOIS can be, you know short it can be a page it can be two pages at three pages, whereas the contract itself the lease or the PSA the purchase and sale agreement might be forty or fifty pages, but if you write an LOI that doesn’t have the right language that says, hey, we’re just talking here we don’t have a deal until there’s a lead.
Or a PSA that we both agree on that has our signatures on. Okay so important to note that LOIs can backfire if you’re not aware that it could become a contract then you don’t put in the appropriate language and otherwise can be a good thing the flush out issues early quickly and inexpensively before the parties make the commitment to do the heavy lifting then going on to that 40 or 50 page contract.
So a good LOI is like a road map for the person who’s drafting the contract. There are still other provisions in the contract that aren’t addressed in the LY the LOI typically concentrates on the material economic and legal terms but the bill rice okay yeah basically yeah, it’s the yes the the foundation of the contract but there could still be details in the actual contract that the parties might not be able to get over.
So signing an LOI doesn’t obligate anybody there are some other cautions to bear in mind among them is that if the yellow eyes says the parties will negotiate a contract. Then under California law. There’s an obligation in the context of negotiating contracts to act in good faith. Right now you and I sign an LOI and we say in the LOI now we’re going to go out and and you know negotiate the rest of the contract that means both of us have to take you know, somewhat reasonable positions we can’t just suddenly arbitrarily pull out of negotiations.
I don’t feel like talking to you anymore right you could be soon. For that so an LOI in addition to having certain basic terms also has to make it clear whether. It’s binding or not binding whether portions of it are binding other portions may not be binding binding portions might be for example you and I are both going to keep this conversation confidential we’re not going to tell anybody else about this or you the seller agree that you’re not going to negotiate with anybody else while you and I continue to negotiate the terms of the contract.
Okay, so there’s important stuff to put in an LOI in addition to the basic terms that you’re trying to flush out and the additional stuff is to protect the parties against the possibility that they unwittingly have made a contract or that they have somehow bound themselves to continue to talk to the other side and negotiate even when they don’t feel like it.
So. They’re simple, they’re simple documents, but they have like most documents, you know, trap doors and pot holes in them that you also need to be aware of. What I will basket and look the same let me just say in larger transactions you typically see LOIs. In advance of the agreement and if I could just say from a personal point of view.
At least half the time that clients asked me to prepare or review commercial leases or purchase contracts, they’ve already signed the LOI and they’ve already made some sort of commitment on some of those terms. Right, it’s not necessarily a binding contract, but you and I have both agreed that the price is going to be 1.5 million and so.
You know, when you come to me and you say here would you look at this I might say really is 1.5 the right price, maybe it should have been like 1.1 or something else due to these other circumstances. Okay well this is how did the seller need to sign so or the just the buyers like I said one party one party prepares the yellowy for the other party to sign and say yeah, I agree to these basic road map milestones, okay, but my point that I was gonna make is.
Often brokers are involved in the drafting of LOIs, and if you’ve got a good broker that could be good that could be all right like I say at least half the time I only hear about the transaction after the LOI is signed and sometimes in that context. I have to tell the client gosh it’s too bad you made that commitment.
You know, maybe we should have talked at least two days before you signed the LOI so that you had more information going into that. LOI.
The same anyway the two pages opportunities can’t put it back yeah right right all right well thank you for John and everyone thank you small apartment investor calm times and stuff on there. John, how can people get in contact with you with their needs or questions? I don’t know if you have a link on your website to mine otherwise they can find me at the law office of John Gutierrez, that’s g u t i e r, r e z or john at j gut tiara’s law.
Dot com. Right and on the website you guys you can the first episode that I have with John and it’s these out and have other things other videos and. All kinds of stuff. So, thank you all. Hope this has been helpful for you to take some action and but the right action I all action it equals progress.
So just. Thank you for your time. Cornell. Cordell is always a pleasure. Take care everyone. Okay, bye now.