The real estate market has received quite a bit of attention over the last couple of years but has hardly been limited to residential properties. Investors took advantage of the market frenzy and snatched everything from apartment buildings, hotels, warehouses, and more. While rising interest rates are posing a risk to economic growth in real estate, commercial real estate continues to strengthen. Title agents play a crucial role in the commercial real estate sector and are held to the highest due diligence standards on the more complicated side of real estate transactions. It’s not uncommon for title professionals to only work within the residential or commercial worlds as they tend to be more familiar with one or the other. Understanding what sets commercial property closings apart from residential can help grow your title business and bring more value to your customers.
Commercial Closings at a Glance
On paper, the difference between commercial and residential is the “use” of the land.
Residential properties are classified as any complex with 1-4 units. This includes single-family homes, condos, and duplexes. On the contrary, commercial properties are classified as property that is intended for profit-generating activities. This includes office space, restaurants, multi-family units, etc.
But for title professionals, it’s more complex than surface-level definition. Requirements are different, paperwork is dense, and more money is at stake. While residential and commercial closings share similarities, commercial real estate transactions are more intricate than residential real estate deals. Some legal descriptions alone for commercial property have been over 100 pages. We’re here to break down what key differences set commercial transactions apart.
Risks of Commercial Closings
Lack of RESPA regulations
The Real Estate Settlement Procedures Act (RESPA), the federal law that governs residential home sales, does not cover any commercial transaction. Without this governance, there are no guarantees and warranties about the condition of the property. Therefore, independent due diligence is required to ensure the investment doesn’t become a money pit. While there is more freedom in structuring the deal and the closing documents, creativity and tactful negotiating power are crucial in protecting the buyer.
Determining legal ownership within a commercial transaction can often be difficult.
It’s usually easy enough to identify your borrowers, buyers, and sellers in a residential transaction. A commercial policy is typically much more convoluted and often involves companies with multiple owners and not individuals. Any time a corporation, LLC, or LLP is involved, additional steps must be taken to confirm their ability to conduct the transaction.
Commercial documents are indexed by name, not by address, as in residential cases. The level of information available to the public regarding the origins of an LLC varies widely between states and often requires research spanning multiple jurisdictions.
If a company changes names or is inconsistent in filing its name, the search is even more difficult. It’s not uncommon for legal entities to create a new legal entity to isolate the risk of selling a piece of property.
More money, more (potential) problems
Commercial real estate transactions typically involve a lot more money than residential transactions. Like Biggie Smalls once said, “It’s like the more money we come across, the more problems we see.” Large sums of money coming from various sources gets confusing and can sometimes raise red flags. Money laundering has been on the high as of late, with more than US$2.3 billion was laundered through U.S. real estate over a recent five-year period, and commercial real estate is involved in many of those transactions.
For more related content on wire fraud and cyber security, check out our latest blog
Thorough due diligence allows lenders to be more willing to provide large sums of capital.
Potential for UCC Liens
A UCC lien is placed on a business when it enters into a financing agreement that is secured by collateral. In other words, it’s a public notice that a party obtained a business loan and allowed the creditor to take a security interest in certain business property. The business’s assets are pledged to the lender until the debt is repaid and is good for five years.
Title professionals have a couple of options when conducting a UCC lien search:
1) Do it yourself
2) Outsource to a third-party
If you opt for the DIY method, you can search the state UCC records for liens online. This can be a bit tricky if you don’t have ample experience with this type of search, and/or the seller’s exact legal name is hard to track down. Allowing third party professionals with extensive experience to conduct a UCC Search is generally a better use of your time and efforts.
Title Clearing and Closing Documents
Type of Deed
A residential closing generally involves a warranty deed. Commercial transactions typically utilize a quitclaim deed or a special warranty deed.
Escrow in a commercial property transaction is formal and tightly controlled. Most of the time, the title agent will act as the escrow agent since there is no requirement for who the seller and buyer must choose to serve as the escrow agent. Unlike residential sales, the escrow agreement in commercial real estate closings is unique for each deal.
While obtaining an environmental report would benefit both a residential and commercial transaction, a document detailing any environmental issues and future
liability will be part of most commercial real estate closings. Since commercial real estate is such a large business investment with a lot at stake, buyers will want to know the probability of any problem that would impact the property value. Any environmental, health and safety concerns could not only impact the property’s value, but lead to later lawsuits down the road.
Commercial Purchase Agreement
With the typical provisions like deadlines and the purchase price, each type of purchase agreement may have variations such as whether there are existing tenants, development of the property, etc.
Signing Authority Verification
A human being will need to sign and execute documents on behalf of the entity, creating an extra layer of paperwork and both the seller(s) and the buyer(s) will want confirmation that the person signing off has the authority to do so. This additional paperwork is needed before the escrow money can be dispersed. The ‘proof’ can include:
- Resolution from the Board of Directors/Equity Partners
- Corporate charter that expressly gives the individual such authority,
- Letters of authorization from the president, CEO, or board of directors
Commercial real estate is a long-term investment, and buyers want to be assured that their newly purchased property is in a condition that sets them up for a secure future.
Buyers look for title professionals they can trust to be thorough and have a strong understanding of the commercial real estate purchase and sale process as well as local knowledge and laws. Otherwise, they’ll be adding unnecessary risk to their purchase. Commercial real estate is a huge investment so buyers are (rightfully) picky about the safety of their deal.