If you’ve been leasing your building or your business is growing and you’re thinking about buying commercial property for the first time, our guest on this edition of “Deal Talk” tells you why you shouldn’t do it without the help of a real estate attorney. From structural problems to environmental issues to zoning laws, our guest expert, Chris Cali, an attorney specializing in real estate and M&A at Latimer LeVay Fyock in Chicago, talks about all the concerns that come with buying commercial property. Just wait until you hear his story about the salon and spa! It will make you think twice before buying real estate for your company without first talking to an attorney who specializes in real estate.
I like to deal with small business owners because it's fascinating to see people who really put in hard work get great results and be successful.
- Chris Cali
Jeff: Welcome to Deal Talk brought to you by Morgan & Westfield, I'm Jeff Allen. If you're looking to sell your company now or at some point in the future it's our mission to provide information and advice from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
Maintaining or improving your company's value important across every stage, every step, and every decision that you make and that includes when it's time to grow, it's time to look for new markets and that might include perhaps purchasing commercial property. And when it comes to looking at commercial property it's important to consult the services of an attorney and really, particularly one who specializes in real estate interests for small business owners. We have one of those people on the line right now. His name is Chris Cali. He's an attorney specializing in real estate, business, and corporate planning and transactions with the firm Latimer, LeVay and Fyock in Chicago, Illinois. Chris Cali, it's a pleasure to have you on Deal Talk sir, welcome aboard.
Chris: Thank you, a pleasure.
Jeff: Chris, if I hire a real estate broker why do I need an attorney?
Chris: First and foremost the real estate broker and the attorney are really serving two different functions. The real estate broker's main job is going to be one to help find you, locate the property that you're looking to purchase, and also get the value down. The brokers do comparative market analysis, they can have income analysis depending on the type of the commercial property that you're buying into. They're going to help you find that, they're going to help you figure out what you pay for it. Once you figure out what you want to buy and what you pay for it, now you got to figure out how to get from that space to the closing table. That's really where the attorney takes over.
The real estate broker's main job is going to be one to help find you, locate the property that you're looking to purchase, and also get the value down.
Jeff: The attorney kind of helps to step in and if there are questions that the business owner doesn't ask, or doesn't know to ask, or things that he or she doesn't know what to look for, you're there to serve their interest in making sure that there isn't anything that's hidden away, things that are going to be really, really important that the business owner know about before they get involved in something that really at the end of the day could have either a positive or very negative impact on their business. Do you work directly with the real estate broker at any point during the deal? Do you actually have any communication back and forth?
Chris: Absolutely, because when it comes to commercial real estate typically what'll happen is when you found a place that you want to buy, you'll have your broker put together what's called a letter of intent or an LOI. If you hear people throwing around the phrase LOI that's letter of intent. And that'll basically outline the basic terms of the transaction, purchase price, what the due diligence period is going to be, if there's going to be some financing, your anticipated closing time frame. It's basically a large two-page outline of the important aspects of the deal. That then comes to the attorney who's going to help put the contract together. And unlike residential real estate, commercial contracts are very specifically drafted and negotiated, and there's a lot of upfront work with that. And obviously the real estate broker's input is important when it comes to knowing how the deal is negotiated, if there are certain terms regarding the price that probably aren't going to change or if we're going to be looking to renegotiate once the due diligence period is over, and we're seeing certain things at the property.
Jeff: We're going to get to that by the way in a second. We'll talk about the real estate purchase contract. You touched on a difference between buying a house and buying commercial property. Can you tell us about maybe another important difference, or even differences between buying a house and buying a piece of property for your business?
Chris: Sure. Obviously, the things that you're looking for in each are going to be different. But from the deal itself, a lot of residential real estate contracts are pre-drafted and there's kind of a basic streamline way that it goes. You have a contract, and most times since they're trying to get these contracts executed quickly and they don't necessarily want to have attorney's fees spent on negotiating the actual terms of the deal, the various bar associations, real estate associations put together form contracts. So in Illinois I can tell you, if you're buying a piece of real estate residential, I may not speak with you as the attorney until you actually sign the contract and there'll be an attorney review provision post contract where I can change certain things. But for the most part if you're buying a condominium you don't look at the condominium documents and that sort of thing, but it's pretty straightforward. Commercial real estate is just completely different because there is really no ... A single family home is a single family home, a condo is a condo, but commercial real estate can either be free standing, it could be a shopping center where you're going to occupy one space and then lease out space to other tenants. It's unique. And each deal is unique, and that's really the main difference. There's no real way to streamline it like you do in residential real estate where they kind of push a lot of these out quickly.
Jeff: Let's say for example, this is jumping way ahead, I understand that. But let's say I'm a business owner and I've looked at several properties and I like many of them, but I'm ready to move forward on one. What information should a real estate purchase contract absolutely, positively include on it?
Chris: Good question. It absolutely needs to include the basic terms like the purchase price and then your closing time frame. What you absolutely need to have is you need to make sure that there are specific contingencies in your due diligence sections of the contract, that give you the opportunity to, one, get information that's going to be relevant to you in underwriting the deal and determining whether or not this piece of property is going to work for you. And second giving the ability to pull out and give yourself enough time to pull out if it looks like this isn't going to work out for you and you've already committed 10, maybe a hundred thousand dollars in earnest money that's sitting upfront. You want to protect that. You want to make sure that you know "Am I going to go in paying cash or am I going to finance it? If I'm going to finance it is there a provision in the contract that will allow me to pull out if I can't get the kind of financing I think I'm going to be able to get?”
What you absolutely need to have is you need to make sure that there are specific contingencies in your due diligence sections of the contract, that give you the opportunity to...
Jeff: Is that kind of commonplace? There is kind of a pull out provision in these contracts? I know that perhaps in your part of the country in Chicago in Illinois in the Midwest, but is that pretty much common, is that what you can look for, or will there be some deals in some states where there isn't a pullout provision?
Chris: Absolutely, and Illinois is actually unique in that we're one of a few states that do real estate closing, the actual closing itself somewhat differently. Most of the country does a deed in money escrow situation. But it's really going to depend on the terms of your contract. I've got contracts here that don't really have a pullout provision. You got to typically have an ability to do your due diligence before you're fully committed. So I would imagine for my experience there's some sort of way to pull out or at least to pull out and maybe you give up a little bit of your earnest money for the seller's cost of having to keep the property off the market for however long it took you to do your due diligence. But at least in the Midwest there's definitely an understanding that you're going to get to do your due diligence, and if the due diligence doesn't pan out you got the ability to walk away.
Jeff: Let me ask you something Chris, and we're talking by the way with Chris Cali in case you're listening over someone's shoulder. He's an attorney specializing in real estate, business and corporate planning and transactions with Latimer, LeVay and Fyock in Chicago. You're listening to Deal Talk. My name is Jeff Allen. I'd like to kind of jump over. If I'm touring a property there are going to be some things that I see that are going to be great. They’re pluses, and there are maybe some things that I see that I'm a little bit concerned about, but I can make a list of these things. What are some red flags though? Maybe some things that aren't readily apparent, and maybe some questions that I don't know as just kind of a Joe Blow business guy to ask about a new potential property for my business that I've got to get answers to. Maybe these might pose some red flags. Can you tell me and give me some examples of those?
Chris: Some examples that may or may not be readily apparent is the condition of certain aspects of the property. Like for example you may go and tour a property and you look at the roof. And the roof may look fine, but maybe there are issues with the roof and it hasn't been replaced in 20 years, and you're going to buy this property in the winter time and then the spring is going to come and you're going to get a bunch of rain, and you're going to find out that this roof needs to be replaced and it's going to cost you about $50,000 to do it. So when you're looking at the property you want to pay attention to the mechanical systems of the HVAC and just kind of take a look and see does this property look like it was built 10 years ago or 50 years ago? Does it look like it has an old boiler, or does it have a more modern HVAC system? That kind of gives you an idea of the condition of the property, and obviously you'll have an inspection done, or you'll want to have an inspection done by a qualified building inspector who can look into this. But aside from the property itself and this may or may not seem obvious, but look at the other properties in the area. Are you buying in a shopping center that has other units that appear to be vacant, or a commercial condominium and you've got a lot of vacancies, or the neighborhood is just looking like it's not well kept as a neighborhood. We've got a lot of nice properties in certain areas that are being built, but the neighborhood hasn't quite turned yet. So in addition to the property itself you want to look at the surrounding properties and see if you see a pattern of vacancies, or other things that just would not be attractive for your business. Would you want customers coming to this location, to this building? Are you proud to have this building represent your business - because it will.
So in addition to the property itself you want to look at the surrounding properties and see if you see a pattern of vacancies, or other things that just would not be attractive for your business.
Jeff: And we know that it all really depends on the industry. If you're a manufacturer maybe it doesn't really matter what the appearance looks like so much, Chris, but your points are very well taken indeed. What about certain things that we hear that manufacturers often need for example. Like environmental studies and reports, and things like that. How common is that? Does it really just depend again by industry, or how often is this needed?
Chris: It's actually needed a lot and it's not necessarily always just by industry but it's also by location. Manufacturer plants or industrial areas you're absolutely going to want to have due diligence done, one, just as if there's any outstanding environmental matters that need to be taking care of prior to closing, or that you may be taking subject to. But even if it's not an industrial area or a manufacturing area, you may be buying a free standing building that's close to, say next to a gas station, or maybe the building that you're buying to put your new pizza franchise in used to be a paint shop 20 years ago or an auto repair shop 20 years ago, and there could've been some environmental leakage or some sort of exposure that wouldn't be apparent just by looking at it. And this is going to be important to know for a couple of reasons. One, because there are a number of state and federal laws that you can be caught up in if you're buying a site that has some sort of environmental hazard or some sort of violation on it. And there are certain exemptions from liability based on the due diligence that you do before you want to buy it. The most common one you're going to hear is a phase one or you'll hear the phase two environmental report. And the phase one environmental report will basically want to have a qualified environmental specialist and physically inspect the property, do a review of the title and the other transactions in the neighborhood to see if there's any red flags that could be raised that there could be, or there was at some point in the past an environmental problem. And these can absolutely come up and bite you particularly if you're going to be in the food industry, or some sort of other industry where you're going to be having customers coming to your property. There's an outstanding environmental issue, it can be very expensive to clean up post-closing and you may not be able to get your business license to operate there.
Jeff: Those environmental studies, who pays for those?
Chris: If you know there's going to be ... Typically it's going to be the buyer. The buyer typically pays for their own due diligence. That being said, if there is reason to believe at the time of contract that there could an issue or if the seller's kind of aware that there is an issue and it gets negotiated, you can negotiate a split. I've had deals where sometimes they didn't think they were going to have to do an environmental, or they did an environmental phase one and it turned out that there was a problem. And now we’ve going to go on to phase two. What the phase two does is actual physical testing. So they'll drill holes into the ground where they'll pull up soil samples and do some actual testing to see what's down there. Those could be more expensive, and a lot of times those might be negotiated during the due diligence period. But from your phase one standard just the initial inspection of the property, it's typically a buyer expense. And like other things, buyers are looking at their costs and wanting to save as much money as possible. But the money you're spending on your due diligence is money well spent, even if you have to pull out. Because it's that money that you spent to do the due diligence if you need to try to get out of the transaction or re-negotiate the terms based on what you found, that could just save you tenfold if you didn't find the problem upfront.
Because it's that money that you spent to do the due diligence if you need to try to get out of the transaction or re-negotiate the terms based on what you found, that could just save you tenfold if you didn't find the problem upfront.
Jeff: Pay a little now versus pay a ton later and potentially to the very detriment of your company and we've seen stuff like this over the course of history happen before. Chris Cali is that man over on the other side over there. He's an attorney specializing in real estate business and corporate planning, and transactions with the firm Latimer, LeVay and Fyock in Chicago. We're happy to have him. My name is Jeff Allen and we'll continue our conversation when Deal Talk returns after this.
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Jeff: Welcome back to Deal Talk, Jeff Allen with Chris Cali, attorney in Chicago with Latimer, LeVay and Fyock and we're talking about commercial property. We're talking about purchasing commercial property when you're growing your business no matter where you're growing it, the things that you need to know, the things you need to watch out for. And right now what I'd like to do, Chris, is I'd like to kind of ask you about what kinds of questions should we make sure that we ask that will benefit us both in the short and long-term when we're out looking for a brand new venue.
Chris: Sure. First of all, before you even get into the process and you should answer the same thing of all your professionals, make sure that your real estate broker knows how to value commercial property. Commercial property is valued a number of ways. There is comparative market analysis, there's income analysis, there's other sorts of ways of evaluating what property is worth other than just the typical residential, commercial comparative market analysis. That's your first question. That should be your same question to your attorney as well because there are some nuances between residential and commercial property. But assuming you've got a broker who knows what they're doing, obviously location's going to be important, but make sure your broker helps you pull up some background information on the property that's not necessarily always provided upfront like the property tax history. And other sort of leasing history on the property that may give you an indication of what this property is actually valued at and what the county or the taxing authority thinks it's valued at. Because you may be buying a piece of property that was foreclosed on say by a bank in what's called an REO. You're buying it from a bank that foreclosed on the property. And perhaps it was vacant for a number of years. So the seller may say, The taxes I hear are $10,000 a year” but what you don't know is that the place has been vacant for five years and the county is taxing it as if it's vacant. And all of a sudden you're going to buy it and your tax bill's going to quadruple because now you've got an operating business there. And now you've got an expense in the future that is a little bit more than you were anticipating because you're looking at your budget and you're thinking, “Tax is about 10,000 a year and that's part of my business cost”, you weren't expecting to pay 40. So getting as much information about the background, and a lot of the stuff can be found on commercial or broker websites, LoopNet’s one that I know a lot of brokers use. And just from county information and state information, a lot of those background information can be found and it can be useful in kind of making an informed decision what the true value of this property could be. And what potential increase in costs you could face based on your particular transaction.
Jeff: Does “as is” Chris really mean “as is”, or can I pursue certain kinds of improvements, renovations that I need to suit my particular business that the seller should be responsible for making, whether those be repairs due to wear and tear or are there other major or significant damage that would be very costly for me to make?
Chris: Yeah, that's actually a great question and I get that a lot from clients who may run into a problem with a physical issue with the property or some sort of expense with the property or problem that they just weren't anticipating at the time they made the transaction. And they're saying, "I said this was going to be as is. I guess there's nothing you can do.” As is if you're still on your due diligence period, you still have an opportunity to tell the seller, “Based on my due diligence of the property, this isn’t the deal I thought it was and I'm going to pull out”. You can always renegotiate. And as long as the seller is being reasonable and willing to, even if there's something written in stone, the two parties can always change it. What's important to know is really when it comes to as is what that really means is the seller is not making any sort of representations or warranties with respect to the property. Once this property closes or once you get to post closing or post due diligence you're taking it subject to whatever happens to be wrong with it. And depending on as where or how the expensive the contract is you may be taking subject to building code violations and other things with it. If you find out after closing because you didn't do proper due diligence and your professional didn't do due diligence that there's a building code violation or some sort of other major issue, you can't go back to the seller then because you were doing this without any representations or warranties. As is in a practical sense, it can be renegotiated either upfront or during the due diligence period. But as a legal matter, once you close the deal you're taking it literally at that point as is.
First of all, before you even get into the process and you should answer the same thing of all your professionals, make sure that your real estate broker knows how to value commercial property.
Jeff: Chris, I can just imagine, we're listening to some of the things that you're saying and we're kind of putting ourselves into the position of someone who may not have legal representation when they work with a real estate broker in buying a piece of real estate, a commercial property. Maybe we're building on at some place where maybe there's some problems that end up manifesting themselves somehow, some way after the deal is already done. And so we're thinking about that and it just seems like it would be a mistake not to have an attorney look these things over with you before you pull this string on the deal. Can you point to maybe any examples that either you have come in and had to kind of advise a client after the fact on? Maybe they decided to call you after they've had some problems. Or any examples that you can think of that you've read about where someone got themselves involved in a property matter and it just became a big mess, and it ended up costing them a lot of money to get this matter fixed, or maybe ended up in them resulting in losing their business as a result of it?
Chris: Yeah, absolutely, and I wish I didn't have any examples to give you but unfortunately I do. I did have a client, this was probably about two years ago, this was in Chicago and was ... I did not represent this person when they bought this particular commercial condominium. I was brought in after the fact. But they did this commercial condominium and they were going to be putting a salon and massage parlor in this space. And they bought this brand new, beautiful building. They bought it and it was a new construction. They after closing went and then basically put everything in and they did $50,000 worth of remodeling. They got their tables in, the thing they were doing, nail manicures and pedicures as well. So they had a full service spa going on. They had everything set-up and they're going to get their business license and they found out based on this particular area, the Chicago department of zoning will absolutely not allow a massage parlor there. They have an appeal process where you can go before a zoning board of appeals and that gives you the opportunity and it also gives your neighbors the opportunity to either give an opinion for or against why they should go here. And after putting all those money into it and buying this specific location they were denied by the department of zoning to put their massage parlor there, and that was money down the drain. That was their business. They weren't going to be doing anything else with it. And unfortunately if they had come to me in the beginning, you're always going to look at ... There's a lot of general businesses that you can get a general business license. And every municipality space is going to be different, so you want to check with your local state, municipality, villages, cities and find out what the business zoning requirements is. And you'd think that this would be something that would, for someone who had everything else together, they would've thought about but for whatever reason they just didn't. And they didn't investigate the zoning before they bought it and they were stuck with a piece of property that they couldn't use for their business. Ultimately I told them, "I'm sorry, there's nothing else I can do for you at this point.” And it's unfortunate. I like to deal with small business owners because it's fascinating to see people who really put in hard work get great results and be successful, and unfortunately it doesn't always work out. And a lot of times it's because while they may be good at what they do they're not ... Real estate or other sort of business experts when it comes to some of this stuff and by not having the proper people in place to help guide you through that, you can run into these pitfalls.
Jeff: My gosh, I can't imagine what that must have been like for that company because it seems like there's no way that you could really overcome that and kind of move forward very quickly at all in any case. Chris, we're kind of nearing the end of the program and this has been a really insightful discussion and I could see us having you back on this program again to talk about matters in greater depth regarding real estate, and we can also talk about other matters as well because I know that you really do have extensive background and business transactions also of various types. What I was wondering is if you have just a few quick tips or important things that you would be able to leave for our listeners today in the form of take aways based on our discussion, things they need to be mindful of when they're considering moving their business or expanding their business that would involve purchasing real estate.
Chris: Absolutely. First I like to say it's definitely been a pleasure and I hope your listeners have enjoyed this, and I would definitely love to come back and chat with you some more. One thing I actually do have is a tip, and we haven't had it yet. And I think it's very, very important. When you're going to buy a piece of property for your business I strongly recommend that you purchase a property in an entity that's separate from the one that you operate your business out of. So if you're going to be operating the business under a corporation or an LLC you want to set-up a second corporation or LLC. And that second corporation or LLC, all that LLC does is own this piece of property separate from your business. And you can even have your business lease the property from your LLC that buys it. There are certain income and tax advantages which I won't get into, for doing that. But for liability purposes you don't want to have a liability against your property affect your business and vice versa. You don't want a claim against your business to attach to the property. And as much as you can you want to keep those two separate. I can't recommend that enough. That's probably my number one recommendation, is to not have the entity that's operating your business, paying your employees, and doing everything else be the same entity that owns the property.
Real estate or other sort of business experts when it comes to some of this stuff and by not having the proper people in place to help guide you through that, you can run into these pitfalls.
Jeff: Really huge, Chris, and I appreciate your bringing that up. And you're right, we did not talk about it. It was probably something that we could've talked about up toward the top of the show but very important indeed. If we've got people listening to the program today and they'd like to reach out to you. They may be in your area in the Midwest in Chicago area, anywhere in that neighborhood that your firm serves. They'd like to talk with you, any questions that they might have specific to their situation, how can they reach you?
Chris: Absolutely. We're located at 55 West Monroe St., the heart in the downtown Chicago, suite 1100. And our main office line is 312-422-8000. And they can absolutely call and ask for me and mention that they heard me on your show, and I would be happy to have a conversation with them and see if there's anything that I can do or follow-up on for them.
Jeff: That's Chris Cali. His last name is Cali, attorney specializing, once again, real estate business, corporate planning, and transactions with the firm Latimer, LeVay and Fyock in Chicago. Chris, we appreciate it. Thanks so much. We'll talk to you again.
Chris: Thank you.
Deal Talk has been presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. So if you're thinking about selling a business or buying one call Morgan & Westfield at 888-693-7834 or of course visit morganandwestfield.com for more information. And for more valuable information and insight from our growing list of small business experts make sure to join us again here on Deal Talk. I'm Jeff Allen, thanks again for listening. We'll talk again soon.