Tuesday, February 16, 2010

Due Diligence

As you promote, sell and then document the property transaction you will soon come across the fact and event of ‘due diligence’.

This element of the commercial real estate sale is very common and will be the subject of most contracts with the exception of the auction method.

As you would expect the process of due diligence can make or break a sale. For this reason it is wise to question a seller well in the listing stage of the sale to ensure that no ‘deal breakers’ or problems are hidden in the cupboard. Due diligence will likely find most problems on and with the property.

So what can be looked at in ‘due diligence’? Consider these:
  • Due Diligence is simply a detailed checking process that is undertaken prior to sale and settlement by ‘experts’, to review all relevant data involved in the sale.
  • Usually solicitors and/or audit specialists are the nominated parties to undertake the work on behalf of the purchaser.
  • The concept of Due Diligence is that the sale and settlement of the property will only occur if the Due Diligence process is successful.
  • On large commercial properties it is not unusual for Due Diligence to continue for days if not weeks. A special condition of the contract will allow this to occur.
  • The process is undertaken under the strict control of the Seller. It usually occurs in the Seller’s property management office or at the Sellers solicitor’s offices, and is usually in a controlled environment (locked room). Only authorized parties are allowed into the room so as to preserve security and confidentiality of documentation.
  • A good Agent or Broker will provide total support to the Due Diligence activity. Expect Due Diligence to check just about everything involved in the sale.

The five professional areas usually covered are:-

  • Engineering
  • Environment
  • Finance
  • Legal
  • Management

Expect questioning and document discovery to include the following:-

  • Engineering: Includes verification that the property structures and building services comply with the Building Code of Australia and Local Government building Approvals. Questions will cover safety risks or non-compliance of structures, fire protection, air conditioning, electrical supply, hydraulics, lifts, escalators, and stand-by emergency power. Expect the questions to involve adequacy of structures, mandatory service compliance, remaining life expectancy, capital expenditure, and sinking fund requirements for future major repairs or replacements.
  • Environment: Includes a wide range of issues such as identification and analysis of environmental and physical risks to the property or land and its use. Issues will include site contamination, dangerous goods and hazardous substances, asbestos, hazardous industrial waste, trade waste, storm water management, occupational health and safety, heritage factors, and statutory requirements.
  • Finance: Includes all actions and dealings associated with property financing, review of taxation implications, substantiation of income and expenditure statements, arranging mortgages, financial analysis and modelling, company or entity investigations, plus all other supportive or related documentation.
  • Legal: Includes all conveyance documentation, easements, permits, titles, contracts, leases, searches, incentives to tenants, site details, compliance with any legislative requirements, outstanding litigation, and any town planning issues.
  • Management: Looks at any issues associated with ongoing asset management, facilities management, building management, lease management and negotiation, rent collection, arrears, financial reporting, insurance, car-park supervision, cleaning, pest control, landscaping etc.

Legal Aspects

A major pitfall for Commercial Real Estate Agents and Brokers when they first begin to list the property is that they inadvertently find themselves delving into aspects of law without the necessary deep experience.


 
Interpreting, creating, or even modifying leasing documents before a sale is the field of legal specialists and in particular the landlord’s solicitor. You will be regularly involved in negotiating new leases and changes to documentation to prepare the property for sale; hence a good working relationship with that solicitor is important.

 
Some lease proposals and leases are easier to create and process than others. Be aware of all potential problems, and take the precaution of getting your office manager’s approval on every lease proposal you negotiate. Take special care with retail tenancies as they are impacted by separate leasing legislation in most locations.

 
Never proceed to create a lease proposal or lease strategy unless you understand all the issues, and never alter any signed and final documentation.

 
Follow these fundamental rules; you then are not likely to slip into any legal minefields.

 

  1. Never rely on oral agreements. Put everything in writing.
  2. Keep a log of all contacts with buyers, sellers, landlords and tenants. Record and date all information obtained from these sources.
  3. Never permit your company’s approved forms to pass from your control. If you give a blank proposal or lease to prospects, you run the risk that they may modify it or use it for some unauthorized activity. In such a case, your firm might be held legally liable for the consequences.
  4. Choose your cooperating or conjunction agents carefully, and put all agreements with them in writing before you get involved with them.
  5. Consult your manager whenever you find yourself in an ambiguous legal or ethical situation.
  6. Remember that all written agreements must be signed by both parties to the agreement in order to be enforceable, and each signatory must receive a copy of the agreement.
  7. Never alter a proposal without your manager’s approval, and never change an original signed document without the full knowledge and consent of all the parties concerned. It is prudent practice to never change an original signed document, but to seek a fresh document as its replacement.
  8. Never sign a document of any type on behalf of your client (the Landlord or property owner) without the absolute written and correct authority to so act. It is prudent practice to always get the client to sign any critical document such as a contract or lease. If the Landlord is a corporate structure (Company) it is likely that the ability to sign on behalf of your client is not an assignable matter anyway. Certain ability to sign in those circumstances is governed by common and corporations law.

   
Make sure you understand your Appointment to Act well and use it to its fullest advantage. Never step outside that authority to act and the duties it describes.

 
Every property should be considered as unique. All of the items in the Leases and all the ‘standard’ conditions need to be tested against the particular circumstances of your client, your client’s tenants, the property with its services, and the requirements of local and regulatory authorities. This is done before you move towards sale. This will ensure a tailor-made sale process and that the best marketing and negotiation processes are achieved.

 
Some Recommendations

 

  •  Sort out any tenancy situations or problems early in any sale listing appointment. This may require the assistance of the Landlord’s legal advisor.
  • Undertake your own ‘Due Diligence’ process of the seller’s property. Start with the current title search. Also look at the lawfulness of existing uses and lease and search the Local Council and the Environmental control bodies. 
  • Workplace Health and Safety issues should also be looked at to ensure compliance to the current regulations, and if food handling is involved in any of the tenancies, inspections by the local health inspectors may be prudent
  • Do not rely on disclaimer clauses. If a document was entered into as a result of misleading conduct, the disclaimer clause will not help or protect you from any legal action.
  • A disgruntled tenant will not only target the actual Landlord, but will most likely join the Selling Agent in any action as a third party.
  • Poor tenant relations should be understood before the sale promotion starts as many a tenant has impacted a property sale and price. Buyers will usually talk to tenants about the property before they sign a contract.

Monday, February 8, 2010

Property Lease Negotiation

The structure of a lease negotiation and tenancy placement is very much related to the financial requirements of the owners, so information is essential if those negotiations are to be successful. You need to understand what lease priorities exist for the client landlord and how those priorities will need to be integrated into the tenancy mix and lease models. You also need to know about the property and its ability to serve the tenants and customers into the future.



 
The Landlords Focus

 
In relation to lease documents, landlords are generally basic and particularly concerned with:

 
· The period of the lease

 
· The level of rent

 
· The type of rent

 
· The renewal of the lease

 
· Landlords costs to establish a lease

 
· Tenants make good requirements at the end of the lease

 
· Permitted use of the premises

 
· The frequency and method of adjustment of rent

 
You should take this further and be focused on the calibre of the tenant and the suitability of the tenant to other tenants within a building. This is the start of tenancy mix considerations and real strategy.


 
Good Leases are Essential

 
Some clients will overlook the essential terms of the lease and think that ‘any lease will do’. This narrow view is wrong and must be shaped to encourage good lease and tenant placement outcomes. Good tenant placements are supported by great leases. Underpinning this is a good solicitor who knows how to write a good lease that suits the needs of the property and its future for the client.


 
Choose Generic Leases or Great Leases?

 
First and foremost, if the Solicitors that are responsible for doing the leases for the property are not fully aware of the property in reasonable detail, it is wise to encourage them to inspect the property with you and the client so that all key issues and potential problems are identified for the client allowing the lease to be designed to suit. A great property and tenancy mix are supported by a great lease. Generic leases do not suit the purpose well because they do not relate to the special issues that the individual property needs or creates.

 
A final word on generic leases is that they are commonly used where the landlord (client) is trying to save money on legal costs. This is not a positive practice. A good lease matches the property and the client’s investment model. It then makes it easier for the Agent to undertake the leasing process and the tenant mix. All the key issues of occupancy are already on paper in the lease.


 
Features of the Property

 

 
Details of physical and other features of properties should be noted in your inspections so that you can build on the opportunities and positive aspects of the property with potential new tenants.

 
All the information gained should be included on an appropriate and organised listing form and recorded as both hard copy and as part of a computerised listing package. Ultimately you will be producing a leasing brochure and information package to present to potential tenants. All positive aspects of the property should therefore be well understood and documented.


 
Preferences
 

 
All investors and owners of commercial property have differing investment and ownership needs. They could want the property to produce certain levels of growth or stability for their investment needs. They could also want to hold the property for a period of time.

 
These issues then lead to the core decisions that they will make when you locate a tenant or adjust the tenancy mix. It could be that the client has a preference to hold the property for a short period of time and then undertake a redevelopment or expansion of the property. This will have significant impact on how you would construct the tenancy mix and lease profile for the property. You may need redevelopment clauses or relocation clauses in the lease to give the client flexibility.

 
To handle these facts you will fully interview the client and discuss the investor’s property requirements before proceeding with any part of the professional leasing and tenancy services that comes with commercial real estate. You must match your leasing and tenancy services to their needs.

 
Your skill is in assessing the potential leasing and tenant balance of the property and then shaping the leases to support the rental income needs is essential.

 
What’s the lease impact and potential?  What size and type of rental can you get from the property? When looking at the potential return of the property from the tenancy mix angle, the cash flow aspects requiring future awareness include:

 
  1. • rent review profiles 
  2. • lease expiries 
  3. • lease term 
  4. • rent types 
  5. • incentives 
  6. • option periods 
  7. • outgoings recoveries 

 
The more tenants you have in a property the more complex this gets. Lease elements such as these will affect the potential income from the property into the future. Look for the peaks and troughs as well as opportunities in tenant mix and placement.


 
Tenant Lease Events

 
You should explore the ramifications of all such tenant events, and all others in the relative property leases, so that the property is carefully prepared for any later sales activity, leasing opportunity, and all other future income opportunity.

 
Seek to minimise major 'dips' in cash flow and the threat of vacancy periods.

 
The lease and the balance of all the leases against each other is therefore a big part of tenant balance and your service.

 
You would not normally want or have a number of leases falling vacant at or around the same time. This is only done when you want to remix or redevelop the property and hence the only way to achieve that would be through the creation of vacancies.

 
The best way to consider and construct the multiple tenant activities and plans in a complex property is to graph the tenants in a calendar or graph display. You can then see where you need to handle cash flow exposure issues created by lease vacancies and expirees. You can then give the landlord client some real logic in doing a certain type of lease at a certain time.

You can get more detail on this at our website http://www.commercial-realestate-training.com/