Understanding the differences between commercial real estate contract language or terminology is obviously an important step to being successful in commercial real estate investing. This article explains a few terms and their use in a commercial real estate contract.

Commercial real estate contract language or terminology is different in many ways from what you may be used to seeing in a residential deal. Listed below are a few of these terms. You should become familiar with these terms, what they mean, and how and why they are used in a commercial real estate contract.

Representations and Warranties

In a residential closing, everyone buys homeowner’s insurance because the Seller’s representations and warranties expire at the closing unless you insist that they don’t. These are the property facts to which the Seller alleges in the sale, such as a solid roof or that no illegal action, including legal cases, are threatening against the property. Always include a representations and warranties clause in your contract that the Seller must live up to even after closing.

Although most commercial sellers won’t warrant the roof, sometimes they’ll warrant the structure. For instance, they might say that although there are cracks in a certain wall, they had testing done. They would give you a copy of that test and agree to stand behind the safety of the wall. Any warranty that the Seller makes to you should survive the closing.

Commercial Closings

The closing, like the inspection period, is based on a formula. It starts at the end of the inspection period, so it’s like a moving window.

Brokerages

Your contract must contain language regarding any brokerages involved. If this inclusion is not applicable, each of you wants to hold the other side harmless. This protects both Buyer and Seller if a finder’s fee suddenly appears or a broker shows up at the closing, making unexpected claims.

If any brokers are involved in the deal, the contract should list each broker’s name and indicate the manner of payment. Often, they may be paid based on a separate agreement between Seller and Broker.

Key Point: Many people write contracts for themselves with no broker language. Even if the broker clause is not applicable, include the broker language in your contract.

Assigning a Contract

Many contracts will either not have any assigning ability checked or include no assigning ability at all. If there’s a specific paragraph that says the Buyer may assign the contract, the Buyer may freely assign it. However, if the signed contract has no assignment clause, then it is assignable. You don’t have to include an assignment clause. Tip: To be safe, always include the assignment clause and specify whether it can be assigned.

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Myths and Reality

NO LENDER offers a 100% Loan to Value commercial real estate loan.

And I define “lender” to mean a source of capital that provides debt financing, secured by real property.

So, for all of you seeking that 20% Seller Carry and the 80% purchase money loan on a property you think is worth three times the purchase price … please, join us back here in reality.  If pigs had wings, they would fly.  So, if a lender was willing to allow you to purchase a property on those terms, why would they need you?  They would make a whole lot more money doing the transaction themselves!

Here is the reality concerning commercial real estate from a lender’s perspective:  Commercial real estate is considered an investment, not a basic need, such as a roof over your head.  Because investment real estate is “secondary” to a borrower’s personal residence, it is usually considered a higher risk loan.

Why?

If the fit hits the shan in a borrower’s personal life and money becomes tight, lender’s conventional wisdom says that the borrower will shift his resources to protect his personal residence ahead of his commercial investments.  This may not seem immediately apparent when you look at the spread between home loan rates and Wall Street conduit rates (these commercial rates are actually lower than most residential ones).  However, you need to check the terms to see the difference.

You can still buy a primary residence with no money down and good credit.  You cannot purchase a commercial property without some form of equity investment.  In most cases, the commercial lender wants to see a minimum of 15% equity in the deal, although you can find some that will allow 10% provided the property meets minimum debt service requirements.  But good luck finding that situation in most good markets.  Oh, and very few commercial loans go full term like residential loans (yes, I know that there are exceptions).  Most are balloons at 10 years.

Yes, you can engage a mezzanine lender to fund almost all of the equity difference, but you are really going to pay for it either in points and rate or in some form of equity kicker … which takes us away from my definition of the lender.  And mezzanine lenders don’t make loans on the property itself … which is a whole other story.

Thus, it bears repeating:  There are no 100% LTV commercial loan programs!  Commercial real estate is for serious investors with equity to risk, a positive net worth, and an asset that a lender would feel comfortable encumbering.  So, the next time someone approaches you with a map to a pot of commercial real estate loan “gold” … save your money for a latte at Starbucks!