11 common mistakes made in commercial real estate transactions
I have given a lot of thought to the real estate mistakes that I have seen since starting my business 30 years ago. This is a topic I cover extensively in the Nonprofit Real Estate 101 course that I teach for the Real Estate Council. As a “birthday present,” I thought I would share some of the major mistakes I have seen and in some cases have tried unsuccessfully to avoid.
1. Fall in love with real estate
Falling in love with real estate usually happens in two different situations. The first is when I take a client to see a property that is for sale or for rent and no matter how hard I have tried to warn them in advance, the client starts to gush out of the way. the property is absolutely perfect – in front of the owner or the owner’s broker. Prices or tariffs harden, and negotiations become much more difficult because the owner knows he has the upper hand.
The second example is where a client owns real estate that has increased significantly in value but will not sell when it should because the client has a “vision” that can only be satisfied with this singular real estate.
A non-profit organization bought land but did not have the money to build its new building. Eventually, the developer who had acquired the remaining three quarters of the block offered to buy the land. The initial offer was 15 times what the association had paid for the land. The owner would not sell at any price because the organization had a vision for that specific piece of land. It was not the highest and best use on earth. The developer built a high rise office building next to the land on the rest of the block. The land itself is not large enough to build a high rise office building. The nonprofit could have sold the land and earned enough to buy less valuable land elsewhere and have the funds to build its new building. But the owner was in love with his property and lost an opportunity.
2. Talk about an agreement before it is under contract or a lease is signed.
The WWII propaganda poster “Loose Lips Sink Ships” is a tip we give to our customers. The point is to avoid reckless words that can lead to disaster. Unfortunately, many enthusiastic tenants or potential buyers talk about a deal before a lease is signed or the property is under contract. This careless speech can catch the attention of another tenant or potential buyer who makes a better or faster offer and gets the deal.
3. Closure prior to zoning approval
It can be difficult to get a landlord to extend the closure until a zoning change or a specific use permit is approved. Frequently, it requires the buyer to agree to pay a non-refundable extension fee. However, the risk of closing before zoning approval is granted could be even more costly.
Unfortunately, we had a client from the school who assumed the neighborhood would not object to a school and bought the property (not while we were representing them). Not having obtained the necessary zoning, they retained us to sell the property, which was not easy. They had to pay property taxes for many years and eventually sold the property at a loss. As we advise you, an initial job will save you money in the long run.
4. Not knowing that a client has poor finances
One of the biggest wasters of time is a client who doesn’t have the funds to buy or rent the property. With our nonprofit clients, financial information is generally easy to obtain as they have to provide financial information to the IRS, potential donors, and government agencies.
It is the small private companies that may be the most reluctant to share financial information with their broker in advance. While it is not fun to survey potential clients about their financial situation, it is an important part of the due diligence process that brokers should go through before spending a lot of time with a new client.
5. Unrealistic forms
I encourage our clients to buy or rent space that allows for future growth. However, I caution against buying or building a building with substantial unused space in the hope that they can rent the space and use the income to cover debt and operating costs. If they rely on this income in their proforma, it is a very risky plan. Most of our clients have little expertise as a landlord and do not understand the risks and expenses of renting office space.
6. No existing banking relationship
There are many potential lenders to acquire real estate. They all have different requirements and target customers. The market for good bank loans is very competitive and there are many things to negotiate beyond the required rate, term and equity.
As the manager of Origin Bank, I have seen countless loans approved and rejected. I’ve observed that for most banks it’s all about relationships. It is so much easier if the buyer has an established banking relationship before starting the loan application process. Their banker can help budget the potential transaction, set realistic goals, and guide their loan through the approval process.
7. Being insulted by a cheap offer
It is always interesting when a customer wants to make a low-ball offer for real estate and is then surprised when the seller chooses not to respond. However, when they sell a property, they get insulted when someone makes a very low bid. Either way, I recommend responding, even if the two sides are far apart. Most of the time, I find the low offer is just an initial posture, and the parties can easily move on to a reasonable negotiation process.
8. Don’t hire an experienced real estate lawyer
I can certainly stress the importance of retaining the services of a real estate broker. However, it is just as important to hire an experienced real estate lawyer. It’s amazing how many buyers and sellers don’t want to hire a lawyer.
Quite often they expect their broker (assuming they have one) to write a contract using the Texas Association of Realtors or North Texas Commercial Association of Realtors forms to avoid paying fees. legal. What they really want is for their broker to act like their lawyer. Forms are good and can save on legal fees, but in my experience it is not a good idea for the broker to try to serve in this capacity. A good lawyer, working in partnership with the broker, can save their client money, time and future legal problems.
9. Not willing to pay the costs of proper due diligence
Failure to hire experts to do your due diligence is another big mistake. Obtaining a property condition report and environmental assessment will help the buyer or tenant understand the potential repair and remediation costs associated with the property and budget accordingly. A cursory inspection almost guarantees unpleasant and costly surprises later.
10. Using a Residential Ownership Company for a Business Transaction
Over the years, I have learned that the right firm-holders of commercial titles make a big difference. They understand the complexities of a business transaction and the expectations of different parties. They are used to working with lawyers and following the instructions in a closing letter. Residential door closers work in a whole different world. Title policy fees are regulated by the state of Texas, so there is no saving in using a closer one whose expertise is in residential transactions.
11. Neglecting to plan for delays
Buyers and renters must have deadlines that reflect the inevitable delays that occur (even before the pandemic). They include things like uncertain licensing processes, labor and material shortages, lengthy zoning procedures, and funding approvals. Hiring experts can dramatically alleviate delays and help create realistic deadlines. Even so, the unexpected can happen, and it can be very important to have a back-up plan or a cushion in the timeline.
Most of these mistakes are the ones experienced brokers have come across and despite our best efforts they still happen. I know there are many more that I could have included. Please feel free to share this list with your customers and contribute to an expanded list in the comments. It can save everyone a lot of mistakes and costly headaches.
Eliza Solender is President of Solender / Hall, Inc. and sits on the Board of Directors of Origin Bancorp.