How to Navigate a Challenging Commercial Real Estate Market
July 19, 2023
The commercial real estate market is in a period of transition. Previously, with historically low interest rates, buyers were eager to get into the “seller’s market” and would accept more seller-favorable terms to distinguish themselves against competing bidders. Now, with some real estate investors sitting on the sidelines as the Federal Reserve continues to raise interest rates, the pool of potential buyers has, in most instances, diminished. Some real estate investors are taking a “wait and see” approach as they try to predict when rates will level off or even start to come down.
With fewer buyers, sellers are less likely to see the number of multiple bids on their properties that occurred over the prior several years. Sellers may need to be more open to negotiation without a backup offer and may not be in a position to say, “take it or leave it”. On the other hand, as the markets shift, we may not see a complete change to a “buyer’s market” that permits the buyer to entirely dictate their terms. Buyers still need to be reasonable, as sellers may walk away entirely if a buyer tries to completely rewrite the contract.
How the Market Changes Have Impacted the Legal Aspects of Deals
Fluctuations in the market may impact the legal aspects of commercial real estate deals. The following are some potential shifts in today’s market:
Refundable Earnest Money.
Previously buyers offered large amounts of non-refundable earnest money upon contract execution to win against multiple bid offers. Today, we are more likely to see a standard earnest money provision that is refundable during the diligence period. However, savvy sellers may still try to limit the ways buyers can back out of the deal and get their earnest money back by providing various diligence documents up front before contract execution.
Depending on where the property is located, real estate taxes are either paid in arrears or for the current year the tax bill comes out. Parties generally prorate the tax liability on an accrual or cash basis based upon how the tax bill is handled by the applicable taxing authority. However, sellers have pushed for a cash basis proration in recent years regardless of how the property was taxed. Commercial real estate attorneys need to know how tax bills are handled for each property to advise their clients on the risks of each proration approach.
Many contracts state that sellers remain liable for a breach of certain representations and warranties first discovered post-closing. Sellers often limit and cap this liability up to a certain dollar amount (typically based on a percentage of the purchase price) and for a specific amount of time after the closing date. Buyers often request that someone or something stand behind this post-closing liability (i.e. as security) because almost all sellers are now single-purpose entities, meaning such sellers may not be able to satisfy such post-closing liabilities after closing proceeds are distributed upstream to a seller’s investors. While buyers may push for additional protections such as holdbacks or guarantees, many sellers remain unwilling to agree to such points. It is crucial for sellers to engage in a conversation about market standards and their reputation in the commercial real estate industry for honoring their representations on a post-closing basis.
Of course, deal terms may vary depending on location, asset class, and other variable circumstances and situations. For example, properties with assumable loans at lower interest rates may generate more interest from multiple investors. In these cases, buyers may have less negotiating power and need to be cognizant of the market to avoid losing these potentially attractive deals.
How Adjustments in the Commercial Real Estate Market Are Impacting Parties
With fewer potential buyers, the market has shifted and negotiation of deal terms has also changed as compared to prior years. Commercial real estate attorneys should be prepared to be creative and find solutions to challenges and help their clients get deals over the finish line.