How to negotiate effectively when buying commercial real estate
8 minutes read
Buying commercial real estate could be the biggest and riskiest transaction your business ever undertakes. However, many entrepreneurs make costly mistakes that can affect their investment and saddle them with unforeseen expenses.
It’s important to take time to properly prepare for your negotiations for a real estate purchase. “Buying real estate shouldn’t be a last-minute decision,” says BDC Major Accounts Manager Brett Prikker, who has financed numerous commercial real estate transactions.
“You need to do your homework to be well prepared to negotiate with the vendor. Rushing into a purchase can leave you stuck with more building space than you need, an unexpected environmental mess or no bank financing,” he says.
Here are Prikker’s seven steps to help you negotiate your commercial real estate purchase to your best advantage.
1. Think about your needs
An essential starting point to help you negotiate more effectively is a thorough evaluation of your business needs and how the building’s current setup might meet them. “Make a list of what you need from the building,” Prikker says.
- Location is usually a prime concern, especially for retail businesses. Related issues include accessibility for clients and employees, parking and public transit, convenience for shipping and receiving needs, nearby services, zoning issues, and room to grow.
- The amount of space you need is also key. Don’t forget to anticipate growth. Before deciding how much is enough, analyze how your current workspace is organized. Could you rearrange it more efficiently to reduce your space needs or avoid moving altogether?
Tip: An operational efficiency expert may be able to help you find major space savings. Using your facility more efficiently can not only reduce your space costs, but also make your operations more productive and profitable.
2. Set your budget
Setting an effective budget up front can give you more negotiating power with the vendor because you will be clear on what you can afford.
Speak with the accountant and financial partners on your commercial real estate advisory team early on to determine your budget and get pre-approved for financing.
Tip: Be sure to ask for the right level of financing and explore all your real estate financing options. Remember that the budget has to cover more than just the building purchase price. Other costs include due diligence (such as environmental and structural assessments), renovations, moving, down time during the transition, land transfer tax, legal fees, any realty commission and an amount for contingencies.
Also, ask your bank how much time it will need to review the transaction before agreeing to financing and what conditions you will need to meet. For instance, you may need to provide an environmental report from an authorized assessor and up-to-date financial statements from your business.
3. Find good advisors
Find a good commercial real estate agent who understands your needs and knows the local market, including unlisted properties. An agent can be critical in your negotiations with vendors. Ask for recommendations from your accountant, lawyer, banker, advisory board and other entrepreneurs.
Ask your agent to research market real estate values for the kind of space and location you want. Compare those values with your budget to see whether your expectations are realistic and ensure you’re properly informed to talk to vendors.
“A company’s needs often don’t go hand in hand with its budget,” Prikker says. “You may have to pay more than you expect to get what you need.”
A good lawyer can also be crucial to negotiating a beneficial purchase. “It’s best to hire an actual commercial lawyer who deals with this kind of transaction on a daily basis,” Prikker says. “It may cost a little more than a general lawyer, but it’s worth it.”
4. Cast a wide net to save on price
In today’s real estate market, it’s important to explore ways to negotiate a lower purchase price. Here are some tips:
- If you don’t need to be centrally located, more remote sites can offer much cheaper real estate.
- You may find bargains by looking at former special-use properties. Examples include buildings specially designed to house a bank or chain restaurant. Their distinct design features can make them harder to sell—and thus cheaper.
- Ask your realtor to look for municipal property that is being sold off, distress sales of repossessed buildings and spaces in an industrial condo building.
- Don’t be shy to approach building owners whose properties aren’t on the market to see whether they’re interested in selling. “It’s amazing how many properties are actually for sale but aren’t on the market,” Prikker says. You can save money on the realtor commission if you’re able to make such a deal privately, without an agent.
- If a promising building has more square footage than you need, don’t cross it off your list. You may be able to find a tenant to lease part of the space. (Be sure to sign a lease with the tenant before making a purchase offer. Your bank may want to see the lease before releasing financing.)
5. Investigate your site thoroughly
Look carefully at any promising properties before making an offer. The better informed you are, the more ammunition you’ll have to bargain with the vendor.
- For starters, be sure to ask about allowable uses, to make sure your business can operate there.
- If you expect your space needs to grow, also check whether you can expand within the prospective space. Some locations may not allow for building expansion because of municipal planning restrictions.
- You may want to bring a contractor and key employees to look over the space. Discuss what renovations are needed to accommodate your business and repair major components, such as the roof, foundation, plumbing or electricity. Get an idea of the costs to confirm they fit your budget, and adjust your offer price, if necessary.
- Find out the building’s age, who the neighbours are, and whether the area is declining or developing.
- Find out whether the building has tenants and, if so, when leases expire.
- Also ask the vendor about any other factors that could affect the property’s value. These may include environmental, structural, zoning, permit and title issues—for example, encroachments (structures that cross onto a neighbour’s property) or easements (a right to use part of a neighbour’s property).
It’s best to find out about serious issues early on, not a few days before the closing date, when they can jeopardize financing or the entire transaction.
6. Make an effective offer
Now that you’ve done your homework, use your findings to prepare an offer that reflects your budget and needs. When you do so, consider the following factors.
- You can sometimes obtain a better price and shorter closing period if you make an offer with fewer conditions. (Be sure not to waive structural and environmental assessments, which are vital due diligence conditions.)
- You may want to ask for vendor financing. It’s not uncommon for vendors to provide some of the financing for commercial real estate transactions.
- Some owners may be interested in a deal that allows them to sell the building but rent part of the space, where they can operate their business.
- Your offer should build in sufficient time for due diligence and bank financing approval. Banks often need six weeks or more to review transactions.
7. Before you close the deal
Be sure to do a thorough due diligence exercise. That typically includes asking for the vendor’s property tax statements, utility bills, and a list of recent repairs and capital improvements (going back five years, typically).
It’s important to also ask the vendor for any recent environmental assessments to verify contamination of the site or hazardous building materials. Check to see that the assessor is authorized by your bank. If not, your bank may require another assessment by a recognized expert. You can also have an assessment done yourself, if a recent or reliable one doesn’t exist.
“Environmental issues are one of the biggest problems encountered in due diligence,” says Prikker. “They can affect employee health and the building’s saleability, and cause a bank to refuse financing.”
Due diligence is also the time to get a building condition assessment (the commercial equivalent of a home inspection); an appraisal, especially in the case of larger buildings; and a title search. For example, a title search may show the parking lot encroaches on a neighbour’s land, even if this isn’t registered on title.
If the due diligence identifies issues, you can negotiate a reduction in the purchase price or walk away, if you’ve changed your mind about the deal.
Important: Be sure not to sign off on the conditions of the due diligence process until your bank has reviewed the contract and agreed to provide financing. “Businesses often make the mistake of involving the bank only after the purchase has been completed,” says Prikker. “They sometimes feel pressured to close the transaction too quickly, but the bank can refuse financing if its review finds outstanding issues. If that happens and a business has already completed the purchase, it’s too late to go back and change your mind.”