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Real estate is as much about finance and investment as it is about law and deal structure. For both seasoned commercial real estate investors and first-time buyers, understanding the legal framework of commercial real estate is essential. Why? Real estate law helps investors leverage legal structures to achieve better deal outcomes while also providing a mechanism for risk mitigation. Simply put, commercial real estate transactions are complex. To succeed as a commercial real estate investor, it’s essential that you embrace several key legal principles. Let’s review some important legal considerations now.
Due diligence lives at the forefront of any real estate transaction. Through due diligence, investors can investigate a property and all related legal and business issues before closing on a purchase of the underlying property. There are multiple aspects of due diligence, including:
Due diligence helps you identify potential issues early, which save you time and resources and avoid legal complications.
Negotiating legal contracts is a critical step in commercial real estate and provides the foundation for all transactions. Sound legal contracts clearly define terms, conditions, and the respective rights and responsibilities of all parties involved. During the negotiation, the parties – buyer and seller – should clearly define the purchase price, payment terms, and any financial contingencies. For example, is the transaction contingent upon financing or satisfactory property inspections? Does the buyer have to put down a deposit, and what are the terms and fees, if any, if the buyer cancels the contract during the due diligence phase? The parties should also determine who bears the risk for potential issues that may arise during the transaction, including those found during the due diligence phase and after the deal closes. Addressing as many issues as possible in the sale and purchase agreement can reduce legal disputes and provide mutual legal protections.
Although often grouped with law, compliance and legal considerations have distinct roles in commercial real estate transactions. Ensuring compliance with local, state, and federal laws is imperative in commercial real estate transactions. Complying with building codes, which affects property modifications and usage, to ensuring properties meet Americans with Disabilities Act (ADA) regulations, are essential for any real estate developer or investor. Moreover, understanding the tax implications associated with property transactions can significantly affect the total cost and profitability of an investment. Staying compliant not only helps in avoiding penalties but also can enhance the property’s total value and operational viability. Adding a head of compliance to your commercial real estate team can save significant costs in the long run once you invest in compliance today.
From multifamily and retail to office and industrial, negotiating lease agreements is foundational to your revenue. When you negotiate a lease, ensure that your agreement clearly outlines the amount of rent, how rent is calculated, the duration of the lease, renewal options, rent adjustments, and escalation clauses. Lease agreements should also clearly define the responsibilities of the landlord and tenants concerning maintenance and repairs as well rights to sublease and modify the property. Effective lease agreements are vital as they protect the interests of both the property owner and the tenants, while also ensuring a stable rental income and maintaining the property’s value over time.
It’s never too early to start thinking about exit strategies. The legal aspects of selling a property or transferring a property are as important as buying the property. For example, factors such as transfer taxes, which can vary widely by location, early termination clauses in leases, and capital gains taxes need careful consideration as they can affect the desirability of the property to potential buyers and the overall financial returns. Sellers should consider 1031 exchanges among other tax efficient strategies when planning their exit strategies. Building a team that understands the local market and all legal and tax considerations is essential as you prepare a sound exit strategy.
The legal aspects of commercial real estate transactions require a deep understanding of finance, business law, contracts, regulations and compliance. From the initial due diligence to the final stages of contract negotiation and compliance with legal standards, each phase carries its own set of challenges and requirements. By thoroughly understanding all legal considerations, investors can better protect their investments, ensure compliance with relevant laws, and achieve successful outcomes in their real estate deals.
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