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Are there many differences between a commercial real estate deal and buying a house?

Are there many differences between a commercial real estate deal and buying a house?

Residential buildingDepending on the circumstances, yes, there can be significant differences.

Occasionally, an investor may want to buy a house or small commercial property to use as a residential rental property or to develop quickly and sell for a profit. In that case, and, except for underwriting or lending purposes, the documentation may be very similar to a residential transaction.

For the most part, however, commercial and residential transactions are significantly different. For example, a commercial transaction will typically involve months, if not years, of due diligence into the property. The buyer will want to delve into the particulars of the property’s zoning, environmental issues, title and survey matters, potential to produce income, and many other factors. A residential due diligence period typically lasts about 30 days – long enough for the buyer to line up financing and have an inspection performed. This reflects the fact that the stakes are typically greater, in terms of sheer dollars, in a commercial transaction, and mistakes can be far costlier – although it certainly doesn’t feel that way when it’s your house and your money.

Commercial and residential transactions also differ significantly when it comes to financing. Not only is the underwriting process significantly different, but the documentation differs as well. Because the residential real estate market is heavily regulated, most lending transactions use the Fannie Mae/Freddie Mac uniform instruments, the HUD-1 closing statement forms, and other forms mandated by statute. And aside from confirming that the lender has filled in all the blanks correctly, you will not have a lot of room to negotiate the documents in a residential real estate loan.

The commercial lending arena is far more flexible. Each lender and title company has developed its own set of forms to suit its own preferences, but with some exceptions, the provisions of those forms are not set in stone, and the borrower may have some room to negotiate both the economic and legal terms of the loan.

Commercial property can also be financed in creative ways not available to residential owners. Although various federal and state programs exist that are aimed at expanding homeownership, they are all based on the same model where the homeowner gives the lender a note (a promise to pay) and mortgage (which allows the lender to take title to the property if the owner fails to pay) and pays the principal and interest on the loan. Commercial owners, on the other hand, can take advantage of many inventive public/private partnership programs such as tax increment financing, special assessment financing, historical tax credits, or new market tax credits.

Because purchasing and developing commercial property tends to be significantly more expensive than purchasing and developing residential property, it is often acquired and developed by a group of individuals or entities, rather than just one person or a couple of individuals. As a result, the owners of a commercial property should put a significant amount of time and thought into structuring that relationship from the beginning and into drafting documents that accurately reflect the deal between the individuals purchasing the property and adequately protect those individuals. Of course, the same can be true in a residential situation – if, for example, a set of siblings wants to purchase a house for investment purposes, we recommend they document the relationship and allocate the responsibilities between them prior to purchasing the property – who’s coming up with how much money? who will be responsible for maintaining the property? what happens if one member of the group wants out of the deal? etc. But that scenario is far less common in a residential purchase.

All of this leads to a question we commonly hear: do I need to hire an attorney to purchase a house? Of course, it’s not required, unless it’s a completely sale-by-owner cash deal with no title company involved – in a typical residential deal, the real estate agent generates the contract and the lender and title company generate the closing documents. But we recommend consulting an attorney before signing the contract, when amending the contract, and for a quick review of the lending documents, if nothing else, and for no other reason than to be sure the documents conform to your understanding of the deal and that you understand your rights, obligations, and potential pitfalls.

If you have more questions about the differences between residential and commercial real estate transactions, contact Griffin Fletcher & Herndon LLP today.

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