You should know THIS about purchase agreements
I’m obligated to start out this week’s Bright Build post with the following disclaimer.
I am not your commercial real estate attorney.
Shoot, I’m not any kind of attorney. Asking me for legal advice is literally a forbidden line item on a sticky note, written by my wife, stuck to our fridge.
Other things on that list?
Sean is not a plumber.
Sean is not a licensed electrician.
Sean is not Uber Eats.
Sean is not a Wizard* (I wrote THAT in response to some of the requests I receive from my kids that, honestly, would require magic. Someone in my house wrote, just underneath this line, “No kidding! Pop is a Muggle”.
Harry Potter insults are a regular thing in my house.
At any rate, every single person I live with has a clear understanding of my limitations. You should, too :-)
Okay, so let’s talk Purchase Agreements, or “PAs” as the cool kids call them.
Just to be clear, a PA takes the major items from the Letter of Intent that we've now signed with the seller (or at least agreed to with the seller) and makes those terms legally binding. Once this document is 1) signed by the buyer, 2) the seller, and 3) the title company, it is a binding legal document, which means the seller can't just willy-nilly (←not a legal term) sell the land to someone else. At this point, YOU, the buyer, now have what’s called “full-site control.” You’re now allowed to do things on the site with the seller's permission. The seller can't sell the site to someone else now that you have it tied up unless and until your contract is made null and void. The PA is a legally binding document. That's super important.
And while I’m not an attorney, you definitely need one to create your PA. More specifically, you need a commercial real estate attorney with significant experience. This is not the place to cut a corner in a development project. The terms here are really important, and it's a lot of the legalese prescribing, perhaps most importantly, what happens if something goes wrong i.e. the seller is in breach of contract, you want to back out of the PA, a giant comet falls from the sky and turns your dream site into an Ashy Pit Of Oblivion.
As a buyer, I always want to be the one to create the document rather than have the seller create the document and give it to me. Sure, maybe the seller is making these types of deals regularly and “doesn’t want to reinvent the wheel” and thinks you should just use the PA his lawyers drew up on the last ten deals he made. “It’ll save you money,” he might say.
I always start out with a buyer-friendly agreement, drafted by my own attorney and THEN the seller can advocate for the changes they want to make. Obviously, don't spend a fortune. You don't need to pay somebody $1,000 an hour to do this, but this is not something you should do by yourself. This is not something your friend's uncle, who's a residential realtor, should do for you. You need a commercial real estate attorney. And, honestly, if you're doing a development deal, you need to have a good commercial real estate attorney on your team. Don't spend a fortune. Don’t do it yourself. And, no, don’t use Chat GPT.
Okay, so let’s jump into the important elements of a PA:
Effective Date: This is the date the PA is signed by the buyer and the seller. So, if the buyer signs it on one date and the seller doesn't sign it until two days later, the effective date that gets put into the agreement is the date that the second person signs it.
Exhibit A: This is the legal description of the land. You want to make sure that there's always a legal description of the land attached, and your attorney needs to scrutinize this description.
Earnest money gets deposited with the title company. As the buyer, I typically want to select the title company because I want to work with somebody I know and trust - someone I've worked with many times. When you’re just starting out, you want to ask other developers who they use - who they like and trust. The purchase agreement will indicate how many days after the effective date (the date the second person signed the agreement) the earnest money must be sent to title via wire or check. Typically, earnest money is due three to five days after the effective date.
The inspection period really is our due diligence period. This is where we are doing any number of things, including a physical investigation of the building (if the site comes with a pre-existing building), a regulatory investigation, and an environmental investigation. As related to the inspection period, I always have a line that prescribes, in exquisite detail, what must happen PRIOR to the expiration of the inspection period. Does the buyer have to inform the seller if the buyer intends to proceed with the project, OR if the buyer doesn’t say anything, is it automatically assumed that the earnest money “goes hard” and thus the buyer has committed that money to the seller?
PAs also include the types of buyer contingencies related to government approvals we discussed in the Letter of Intent. If you need city approval to build your project, then you, the buyer, need a mechanism to withdraw from the deal if you can’t get that approval. If we can’t build on the land, we don’t want it.
Except in the following situation!
There are those magical moments when you want to assign your purchase agreement to another developer. Maybe you put something under contract, and the market skyrocketed, and the value of the land is worth twice what you put it under contract for. In this case, you may find yourself standing on the edge of a vacant, trash-strewn lot, wondering if you shouldn't simply capture that additional value and put it towards your next project. If you have the ability to assign the PA to someone else, you create added flexibility to respond to the market.
Another practical reason why you want the ability to assign the PA to another entity is you may not have prepared the final entity into which you will place the future project at the time your attorney creates the PA. For example, normally, my company will be the buyer listed in the purchase agreement. But, down the road, when I'm ready to close on my construction financing, I'll set up a separate entity, which I control and contains all of my investors, i.e., “3500 Main Street LLC” or “5216 Lyndale LLC” or whatever the address is of the property. Make sure that you have the ability to assign your purchase agreement.
Your PA will include representations and warranties related to seller performance. That means the seller must also perform all the obligations under your agreement. And, if they don't live up to those representations and warranties, you have legal recourse. It will also include a lot of smaller but still important items related to the closing date, prorations, and who’s paying for what. For example, real estate taxes and assessments, depending on when you close, are usually pro-rated per that date. So, anything before that date, the seller's paying, and then anything on or after that date, the buyer's paying. Your PA will call out who pays for title insurance and closing fees. It will also indicate who's paying the broker’s commission, if any. Many times on these off-market deals, like if you're going to buy Uncle Frankie's, there's no broker, so your PA must spell out that seller and buyer represent to each other that they have dealt with no brokers and no commissions are being paid.
The last thing I want to emphasize is that while the success of your development requires all of these legal elements, your deal also requires the proper ordering of these elements. Never has a horse pushed a cart and we don’t put our pants on head first. I can’t tell you how often I’ve consulted on projects that look like some version of this:
A buyer (let’s call him John) walks his dreamland and finds the ideal site. He tracks down the owner and scores an off-market deal to develop that site. John and Joe (seller) agree on the terms of their LOI and shake hands. In between signing the LOI and drafting the PA, a neighbor to the site informs John that at one point, there used to be a dry cleaning operation on the site (environmental issues!), and so John, as part of his due diligence, hires a soil testing company to confirm safe soil.
Turns out the soil is not safe.
John gets bids for remediation and then incorporates those expenses into his draft PA. He sure as heck isn’t going to pay for the remediation. It needs to come out of the purchase price.
Only the seller is not at all interested in covering the costs of remediation and isn’t convinced the soil is a problem. Joe says, “Heck, there’s a community garden on the site, and not a darn person has sprouted two heads from eating the squash!”
They go back and forth. And eventually, the deal falls through.
Not only does it fall through, but in the time it’s taken John’s company to complete the soil testing and for John to try to renegotiate the draft PA, another buyer has swooped in. A buyer that, up to this point, didn’t even know Joe was willing to sell.
But John’s a good talker AND listener, and he’s read my recent post on understanding a seller’s needs.
Only John isn’t a good planner.
What’s he left with? He’s left with an unsigned PA, zero site control, and a whopping five thousand dollar soil study and remediation plan for a site that someone else just put under contract.
That is one long and expensive date! All because John did things out of order. (Don’t get me wrong. I’m all for expensive dates, but I’d rather take my wife to Vegas than blow my dollars on Sam the Soil Tester)
Whew! Okay. Is that a lot for you to digest? Yes, but I’ve tried here to give you the highlights so that you’re familiar with a PA’s moving parts. As far as I’m concerned, all of these elements in the world of real estate development need to be demystified so that your ability to wish and work your own buildings into existence has everything to do with planning and persistence and zero to do with fear of the unknown.
Questions? I know you have them :-). Hit me up in the comments section. Oh, and also: You read this super-detailed article all the way to the end! You better hit that “like” button.
It makes me feel good.