Dear Business Owner,
Selling a commercial real estate property isn’t the same as selling a house. Unexpected obstacles tend to arise at the most inopportune time. Like the scenario described below, my experience as a commercial broker helps clients navigate through this complex transaction, one hurdle at a time.
At seventy-two, Frank wants to retire. He’s not sure what to do with the retail building he owns that was home to his successful music company of thirty years. So, how can we make that happen?
Frank’s invites me to tour his immaculate one-story retail building, built in the 70’s situated on a busy thoroughfare with tons of drive by traffic. A huge ‘grandfathered’ monument sign greets me as I maneuver into a front door parking space on a half-acre lot.
The 6,000 square foot commercial real estate building has five independent retail bays with standalone plumbing. A new owner of this property can occupy the entire building or a portion of it and lease the remaining space. The large backyard is fenced for storage with an alley entrance. All great amenities for a new buyer.
The Set Up
We linger in the baby grand piano showroom as I admire his life’s work.
“Frank, you have a great property here. It may be old, but you’ve clearly put your heart into it over the years.”
“Well, I’d like to think so.” A proud smile surfaces.
“Let’s discuss your sale options.”I begin.
“I have options?” Frank is new to selling a commercial building.
“Yes. Let me ask you a question, have you spoken to anyone about selling your music business and leasing the building to the new owner?”
Frank nods, “After speaking with a business broker and an attorney, it became clear, I am the business.Without me the company has little value.”
“You don’t want to go with the business, Frank?” A broad smile crosses me face. Sometimes a little humor lightens the mood.
“No, I’m ready for retirement. Once the building is under contract it’ll take me a few months to liquidate these pianos.I hope I have the energy for that!” Frank gestures around the room and chuckles back at me.
“So much for our first option. We won’t be selling the building to a new business owner.”
“Moving on to option two, we can sell the building to another owner/user; someone who wants the building for their business. Earlier I researched comparables to know what other buildings in your area recently sold for. Based on these comps, I suspect your commercial real estate building will sell for about $110 per square foot or $660,000 give or take a little.”
Frank straightens a pile of music books. “You know I leased for twenty years and when I bought ten years ago, I bought high. My landlady gave me a carryback when I purchased this. $660,000 is better than I expected. Are there any other options?” He lightly plays a few notes on the nearby piano.
“The last option is to lease the building to a long-term tenant and sell it as an investment. This requires two steps. First, we lease the property which can take up to a year. And second, we sell the investment. That may take six months, but an investment sale will net additional revenue.” I whip out my hp10BII calculator and punch in some rough numbers. “Maybe another $30,000 after all is said and done.”
Frank pauses for a moment, “I really don’t want to wait a year and a half to sell the building. I’m getting up there in years and my wife isn’t doing so well. Let’s sell it to a business owner.” He inhales deeply, “But if a buyer wants me to lease one or two of the bays for a year or so, I’ll consider that as part of the sale. I need that long to wind down my business properly.”
This is a new twist. “Ok. How about listing the property for $675,000 and see what the market brings us? We’ll go from there.”
Frank nods, yes.
Real Time Market Conditions
As long as Phoenix is a seller’s market, we’re optimistic the higher price might work. Sale prices have climbed steadily over the past two years and Frank might get close to his asking price.
Frank’s most difficult task will be inventory liquidation. If he liquidates too soon and the deal doesn’t close, his business falls off. If he waits to long to sell inventory, he won’t have time and he will have to ‘give’ the pianos away or pay for storage. This is a juggling act.
The Deal (Transaction)
Good news. The local firearms business around the corner wants to purchase Frank’s commercial real estate building. The buyer is a man of detail who has shopped the scarce market; he knows this building is a catch.
Round and round go negotiations before a purchase price of $650,000 is accepted. The buyer has 45 days for their due diligence, the time to do an inspection, an appraisal and any other homework they deem necessary. After 45 days the buyer’s $10,000 earnest monies are nonrefundable, and 30 days remain to close escrow.
A commercial inspection will cost the buyer from $1,500 upwards depending on the property size. It takes one to two weeks to receive the inspection report. In commercial purchases, an appraisal takes about two weeks to order, and after touring the property another week for the report costing the buyer around $2,500. This is not pocket change.
The transaction progresses as expected.
The Commercial Real Estate Inspection
The commercial real estate building inspector combs the property for flaws. After the inspection I can’t help but ask, “How did the inspection go? Did you find any problems with the property?”
The inspector looks the buyer straight in the eye and says, “The bulk of my inspections are for older properties. This is a stellar building, stellar. For its age, it is rock solid and is meticulously maintained. The only defect is minor roof repairs. The details will be highlighted in my report.”
“Just what I expected,” replies the buyer, “Piano tuners are meticulous.”
“You are getting a stellar building,” the inspector repeats before we depart.
The Appraisal Glitch
The buyer’s first lender is notified from their corporate office that they will not finance a gun shop and the buyer must find another lender. The 45-day due diligence clock is ticking. The buyer’s new lender informs all parties that the expedited appraisal will not be ready before the due diligence period expires. If the appraisal comes in close to the asking price, the lender will fund, if it comes in low, the buyer must cover the balance out of pocket or renegotiate the purchase price.
The buyer asks for an extension on the due diligence timeline because of the delayed appraisal. This only allows one week to fund the deal, and close on the property. Commercial closings can take up to four weeks. Buyer, seller, title, lender, attorneys, and brokers are on high alert. The clock is ticking, and the pressure is on.
Once all is in motion, Frank, the seller, needs to know he has a committed buyer with earnest money at risk. Against professional advice, inventory liquidation began a weeks ago in preparation for the closing date.
The buyer needs to occupy his new location before his prime sales season opens, otherwise his annual revenue is cut in half. The deal needs to close on time even though the appraisal is late.
The due diligence extension is granted by the seller.
The Commercial Real Estate Conflict
The day before the due diligence period expires, the buyer receives the appraisal. It comes in at $590,000 – $60,000 less than the agreed upon price. The buyer emails the seller an objection letter and states he will cancel escrow if the price isn’t adjusted to the appraised value.
How could a stellar building not appraise?
We, on the sellers’ side, are flabbergasted. In my twenty years of transactions, I have not witnessed such a large discrepancy between ‘agreed upon purchase price’ and ‘appraised value’. We consult an outside experienced appraiser and he agrees the appraisal is unusually low for this property. “I don’t agree with the valuation, yet there’s not much to do about it. Just the luck of the draw.”
After much deliberation we counter. The seller is willing to meet the buyer in the middle and reduce the purchase price to $605,000. The building will close as scheduled.
The buyer’s broker responds. A termination letter canceling the deal is sent to the title company along with a request to return their earnest monies. The buyer’s broker advises me, “If the seller agrees to reduce the price to $590,000, the buyer will reopen escrow and close as scheduled.
Frank now has an empty store except for one bay where music lessons are held and no buyer. The buyer will lose out on a larger, safer building in a prominent retail location for his business.
The difference in the value Frank wants for his commercial real estate building and the appraised value is $15,000. After discussions, Frank reveals he would like to retain the music lesson business for a year. For Frank to move the music business, it will cost him $15,000 in rent. I ask Frank, “Will you entertain selling the building for $590,000 if we can secure a year of free rent on the bay you use for music lessons? This will cover the difference.”
Franks voice flows with enthusiasm, “That’s a great idea and I have another one. I’ve paid my landlady twenty years of rent and ten years on the carryback note. I’m going to ask her if she’ll reduce my payoff amount. God is my witness, I’ve paid her way more than I’ll ever get for this building.”
The ex-landlady generously agrees to reduce Frank’s payoff by $50,000. The buyer accepts the counter, escrow is reopened and amazingly the building closes as scheduled.
Name of the Game
$$$ Tip: Don’t give up on a deal even if escrow is canceled. Brainstorming achieved the value Frank wanted for his commercial real estate property sale.
Business Owner Tip: Be open to innovative ways to make up the difference of a sale price if it helps you achieve your personal and financial goals.
- Frank smoothly shifts into his retirement plan by selling the commercial real estate building and leasing back one bay for a year for $0.
- The firearms retailer is on track to open for his profitable season.
- The ex-landlady is paid off ten years early.
- Both brokers earned a commission after five months of negotiations, deal making and problem solving.