Thought Leaders: Due diligence in purchasing income-producing real estate
If you are considering purchasing commercial real estate as a tool to earn rental income, you may be considering a property that already has a long-term tenant. This can be a terrific way to start seeing a return on your investment immediately. However, it is important to set yourself up for success by ensuring you have a clear understanding of all the details related to the existing lease before closing.
While negotiating the Purchase Agreement for the property, ensure that the provisions in the Contract related to the existing lease and assignment of the same, provide you adequate opportunity to review the lease and any related documents, such as side letters, amendments, and other documents specific to the lease. The Purchase Agreement should also detail what information you will receive in the Estoppel Statement or Estoppel Certificate (“Estoppel”).
The Estoppel is the document in which the Tenant, or in some cases the Seller, will provide information related to the current lease agreement. The Estoppel is a valuable tool in ensuring all parties have a clear understanding of the terms of the lease and any ongoing obligations of each. The Colorado Real Estate Commission (“CREC”) has a standard preprinted form that can be very helpful in many situations; however, it does not address every possible concern. Further, use of the CREC form is not generally required and a Seller may choose to fulfill this requirement using a form of their own design. As such, you may want to include a list of specific questions in the Contract that are to be answered in the Estoppel ensuring that you, as the incoming property owner, have a clear understanding of the status of the lease and the relationship with the Tenant.
In addition to questions related to rent rates, deposits, and lease terms, other things to consider asking include:
• Have there been any defaults under the lease by either the Tenant or Landlord?
• Are there any outstanding amounts owed by either Tenant or Landlord?
• What costs is the Tenant paying directly?
• What costs is the Tenant paying as reimbursement to the Landlord?
• What is the status of any security deposit?
• Are there any outstanding amounts owed to the Tenant as reimbursement for Tenant finish?
These are just a few of the areas you may need more information on. If you are considering purchasing a property that has a current lease, it is advisable to contact an experienced real estate attorney to assist you in reviewing the existing lease and advise on possible concerns and discuss ways to protect yourself from unexpected costs and headaches down the road.
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