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Stephen A. Cross, CCIM - Advisor to Tenants, Buyers and Investors

Going From Tenant to Owner

The 4 Key Concepts You Need to Understand

Leasing space affords business owners, doctors and dentists the opportunity to quickly establish a professional presence, focus their capital on growing the enterprise, and provides flexibility. However, there comes a time when the business or practice is an established going concern, space needs are known, the owner has accumulated cash reserves and comes to the realization that there is nothing tangible to show for years of increasing rent payments. 

When this “ah-ha” moment occurs, it’s time to consider buying an office building.

This article will explore some of the key concepts potential buyers should consider as they transition to ownership status, and provide insights into the process of buying commercial real estate. 

The Basics
Several characteristics make real estate a unique investment. First, real property is a tangible asset that can be acquired for a fraction of its market value. To clarify, a 5% to 20% down payment is all that is required to obtain a loan for the balance of the purchase price. Second, loan payments serve to increase the borrower’s equity position in the property. Third, there is a strong likelihood that real property will, over time, increase in value. Additionally, the property can become an income-producing asset.

No Second Bites
Once the purchase transaction is completed there are no second bites at the apple. Therefore, understanding four key concepts is essential to making fully-informed, fact-based buying decisions: 1) Caveat Emptor, 2) Due Diligence, 3) Arm’s Length Transaction, and 4) the difference between clients and customers.
Key Concept 1: “Caveat Emptor” is a Latin phrase for "let the buyer beware", and essentially proclaims that buyers need to be vigilant in performing due diligence.

Key Concept 2: “Due Diligence” is the process a reasonable and prudent person uses to acquire knowledge of facts that, if known, would materially influence the purchasing decision.

Key Concept 3: The modern real estate industry is founded on the concept of the “Arm’s Length Transaction” in which parties deal from equal bargaining positions. Parties are said to deal “at arm’s length” when each conducts business in a formal manner without trusting the other’s fairness or integrity and without being subject to the other’s control or influence. It also assumes that each party is willing, but not compelled to buy or sell.

The definition above comes from The Language of Real Estate by John Reilly, and demonstrates how real estate negotiations should theoretically be conducted. The reality is that owners of commercial property surround themselves with experienced advisors that have specialized legal, financial, and industry knowledge, while buyers typically do not… and that results in very unequal bargaining positions. So take a page from the property owner’s playbook and select a team of seasoned professionals to advise you. 

Your acquisition team should be dedicated to protecting your interests, have no conflicts of interest, be independent of each other, and include: an experienced real estate advisor, a real estate attorney, a commercial lender, and an accountant. Your real estate advisor should be charged with overseeing the time-intensive due diligence process, including reviewing your existing lease (to confirm the termination date, any automatic extensions and the holdover provisions), conducting the research for suitable buildings (regardless of the agent or company that lists them), compiling information on comparable sales, negotiating the purchase terms and conditions, verifying the representations of listing agents and property owners, and interfacing with your other advisors through the close of escrow.

Key Concept 4: Listing agents/brokers are salespeople that work for property owners. Their job is to sell the listed property for the highest price possible. Legally, the property owner is their client and the listing agent/broker has a fiduciary duty to protect the property owner’s interests at all times.

To a listing agent/broker, buyers are known as customers or prospects, and are not owed the same duties and bundle of rights as their client. By definition, one agent, or multiple agents within the same company, cannot have more than one client in the same transaction. Therefore, be skeptical of listing agents/brokers that soft-peddle or blur the distinction between client and customer, and try to persuade you that that they can fairly represent both your interests and those of the seller (see Caveat Emptor above.) If the truth were known, the underlying reasons listing agents attempt to represent both sides of the transaction are to control the parties and retain the entire commission. 

Speaking of commissions, most transactions include a commission which is paid by the seller and should be evenly split between the agents/brokers or advisors that represent each party. Therefore, the cost to the buyer for vague, self-serving representation is the same as for effective, tenacious representation. Which would you prefer?       

Summary Comments
Now that office condos are common, it’s possible to acquire space as small as 1,000 square feet. This means that real property ownership is open to nearly every business and medical practice. Once you can clearly anticipate your space requirements for the next 3 to 5 years it’s time to consider owning the building that houses your business or medical practice; doing so will help create wealth for your family, instead of your landlords.

Stephen A. Cross, CCIM owns CROSS Commercial Realty Advisors and represents business owners, healthcare professionals and corporate decision-makers in matters involving the lease and purchase of commercial real estate. Contact: 480-998-7998; steve@crossrealty.com.

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