When it comes to dealing with real estate sellers, both in commercial and residential property, it pays to keep your eyes and ears open at every stage of the game, and always – ALWAYS – verify the reality of the number claims by doing thorough research. Today we’ll focus on a few sneaky tricks that can get you in trouble while buying commercial investment property.
Come One, Come All
It should come as no surprise that a seller knows that a half empty property is a serious red flag to potential buyers. Unfortunately, this can sometimes lead to an ethical lapse in the form of a sudden lowering of tenant screening standards prior to putting the property up for sale. If the standards are low enough, it’s not difficult to achieve zero percent (or very close to it) vacancy. But woe be unto the buyer who discovers all these new renters have little intention of ever actually paying rent and are only looking for a place to crash for a few months or weeks until they can be legally evicted.
The best way to uncover this gambit is to conduct a lease audit early in the process. If tenants have not been properly screened, you can bail out of the contract and re-claim your earnest money.
Vendor Contract Games
It’s not unusual for a large commercial property like an apartment complex to generate a sizable bonus upon entering into an agreement with a vendor to provide services on a multi-year basis. Consider as an example the laundry facilities. It’s standard operating procedure for a third party to be contracted to maintain and upkeep the coin-operated washers and dryers. This can be a lucrative business deal for both sides but an unscrupulous party might sign a company to a long-term deal under terms contrary to the economic well-being of the property. What does he care? He’s getting out and wants to take as much cash as he can with him.
Maybe the seller agreed to a 90/10 percent revenue share with the vendor in order to grab a fat $10K upfront bonus. Then you, the unsuspecting buyer, find yourself saddled with an onerous five-year contract where you’re only being paid a pittance of the revenue generated by the on-site laundry room.
The easy way to avoid such a situation is to require the seller provide copies of all vendor contracts during due diligence. After examining these, you’ll be able to determine if there have been any recent contractual arrangements designed to financially benefit the present owner. If so, that doesn’t mean it’s an automatic deal breaker. Just make sure that the seller agrees to a “pro-rations” clause in the final contract. This divides any signing bonus between old and new owner proportionately equal to the amount of time spent in ownership under the terms of the vending contract, which means the majority share of a hefty signing bonus signed just prior to a sale goes primarily to the new owner.
Whether human nature or something more insidious, it’s not unheard of for the seller to lose his motivation to properly manage the property once he has a good inclination it will be bought. When you consider that three or more months might pass before the deal is officially consummated – that’s a lot of time for the seller to develop a lackadaisical approach to maintenance. Trust us, you don’t want to walk in on Day One of your official ownership to find hundreds of work orders from tenants waiting. Not only can it be a huge expense off the bat, but could be a source of ill-will between tenants and new owner. This you do not need!
To avoid such a scenario, make sure the purchase contract contains a clause that allows weekly inspections of property management reports. Also include terms that require the seller to continue normal operations and maintenance activities during the entirety of the contract period. With a well-written contract, you should be able to visit the property with 24 hour notice and personally review the work order logs.
As you can see, buying a commercial property is not only about having the legal guys or gals create a well-worded contract. Of course, not every seller would try to get by with even one of these nefarious strategies, but you have to walk into every deal with the assumption that they might. An honest seller will have no problem with allowing unfettered access to records such as we’ve mentioned in the above paragraphs. If they kick up a fuss, be suspicious. Be VERY suspicious.
The Commercial Investing Center Team
Flickr / The Lane Team