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How is a Commercial Real Estate Deal Different From a Residential Purchase?

 

Some people will tell you that buying a house is a more emotional transaction than a commercial real estate deal. In my experience, commercial real estate deals can be just as emotional. Even though it’s a business deal, the owner is still going to occupy the building with his or her company — and that carries a tremendous amount of personal meaning.

There are some real differences to be aware of, however. It boils down to this: A commercial real estate transaction is a business deal, and you’re dealing with business entities. An owner of commercial real estate is typically a sophisticated individual.

A residential purchase is a consumer sale, transacted between a couple folks like you and me, not between a business and a sophisticated owner. I own a house, you want to buy it, and we strike a deal.

As a result of these differences, there’s another level of disclosure that’s involved in a residential deal in order to protect consumers, and that can actually cause the disclosure portion of a residential deal to be more extensive than a commercial deal. Here are a few more things that make commercial and residential real estate transactions fundamentally different….

Contingency Periods

In California, residential deals include a 17-day contingency period from the time the buyer and the seller sign a purchase and sale agreement. During those 17 days, you as the buyer have to satisfy yourself to all aspects of the purchase. You have to arrange for your financing, you have to review a title report, you have to conduct a termite inspection, and you have a right to perform a physical inspection of the property where you look at the roof, the air conditioning, the landscaping, and so on.

All of that has to be accomplished within that 17-day period, and the transaction closes shortly thereafter, so most residential deals are done in 30-45 days, start to finish.

In commercial purchases, the typical contingency period is a minimum of 30 days, and in many instances can be as much as 60 days, because there are so many other items that have to be researched. Inspection of the property includes the physical structure as well as the environmental history, therefore the inspections take longer. Because the financing requires an underwriting of the individuals as well as business entities in a commercial deal, more time elapses, thus, the process take longer than a residential house purchase.

Usage Concerns

Use of the building is where commercial deals can get extraordinarily complex. Let’s say you represent a warehouse distribution company and they’re buying a building. Their plan is to go in and install racking in the warehouse and stack their products on these racks and distribute them from the ground level or out of a loading dock. In the state of California, there are probably three different permits that you have to get in order to do that.

You also have to ask yourself, what’s the nature of the commodity that your business deals in? Is it a flammable commodity or is it a non-flammable commodity? If it’s flammable, you can only stack at a certain height. You have to worry about seismic issues with respect to the racking, to make sure it’s properly attached and supported.

There’s a complex layer of approvals that have to occur and variables to consider: The number of employees that are going to occupy a building. The resultant number of parking spaces. The process in which the building will be used. Is there sufficient fire sprinkler calculation to support it all? It’s a long, agonizing arm wrestle that drives a lot of businesses absolutely crazy — and it’s an aspect of a commercial deal that, thankfully, residential home-buyers never have to deal with.

Negotiation and “Must Haves”

Negotiating on price is less common in commercial deals than it is in residential deals. And the reason is, commercial deals are priced appropriately most of the time. In rare occasions, you’ll have a goofball who thinks his property is worth 50% more than the market will bear, but since prices for commercial real estate are based on a very specific set of factors, prices are easier to predict.

In residential real estate, you’ll see these wide swings in value based on the house’s features, like the quality of the kitchen, or the presence of a swimming pool or sauna. As a result, a seller might be asking for a million bucks for his house, when a nearly identical model down the street just sold for $750,000.

For commercial buildings, it goes back to what the property will be used for. There have been occasions where I’ve tried to find a building for a client, and there were maybe 20 buildings on the market that fit the buyer’s size range, but none of them worked because one element isn’t right — whether it’s the amount of office space, the electrical power distribution, or the type of loading.

If I find a building where I can check all the boxes, price becomes very, very secondary, because utility is the most important aspect of a commercial building. I don’t care if I have to pay an extra $20,000 or $30,000, because it’s the right building. You wouldn’t settle for a building that didn’t have sufficient power, because fixing that issue would cost you far in excess of that $30,000.

While residential home buyers are advised to be realistic with their “must haves” when looking for a house, you should never sacrifice utility when it comes to commercial real estate. Make sure the building can support everything your business needs before committing to a commercial real estate deal.