Jones Lang LaSalle

Avoiding the Landmines: Buying and Selling Commercial Real Estate

By Ilene Dorf Manahan, Contributing Writer

No matter how attractive and straightforward a commercial real estate transaction appears at the outset, buying and selling property can be loaded with landmines. For even the most experienced of developers, changing and emerging land-use, zoning and environmental regulations, on top of existing mandates, can muddy what appears to be the clearest and cleanest of deals.

Leading real estate and environmental attorneys throughout the state are helping clients navigate the minefields by not only being on top of existing regulations, but also monitoring proposed regulations to ensure developers are well aware of potential problems before a handshake gets translated to a signed contract.

While many of the development and contract issues today are the same as decades ago, attorneys agree that the process is more expensive and stressful than before because of the amount of government regulations and the number of land-use approvals needed for a project to get under way. Those approvals are not simply on the local level, but can involve a complicated and ever-changing maze of regulations and departments on the state level.

"Land use in New Jersey is extremely complex and difficult," states Kevin Coakley, a real estate and land-use partner at Roseland-based Connell Foley. "Many approvals are needed, even for minor projects. It used to be that a developer could get local approvals and be on his way. Today, the approval process is very expensive, time-consuming and risky. And it has pushed up the cost of development tremendously. Today, almost no one closes without having needed approvals."

"If a developer wants to use the property 'as is' and not make any alterations, all is well," says Ted Zangari, a member of Newark-based Sills Cummis Epstein & Gross. "But if a use change is requested or there are additions to the property, the developer must go back for land-use approvals. The process has become much more difficult. And beyond the NIMBY (Not In My BackYard) syndrome, you now have BANANA (Build Absolutely Nothing Anywhere Near Anything)."

Lawrenceville-based Stark & Stark Shareholder Daniel Haggerty suggests buyers chart out all necessary governmental approvals - local, county and state - and establish a realistic timeframe for obtaining them. "This can be a lengthy, cumbersome and expensive process. And it adds stress and pressure to the transaction," Haggerty admonishes.

A wise contract contingency would be that the deal is cancelled if the land can't be used as proposed, suggests Frank Wisniewski, a shareholder in Cherry-Hill-based Flaster/Greenberg. A buyer must have sufficient time to get necessary approvals and should not close until he gets them, he adds. While it can easily take as long as three years to get those approvals, Wisniewski maintains it is worth the seller's wait, as the buyer typically pays the seller for an option to buy contingent upon receiving his approvals; additionally, "the buyer is making the property more valuable by getting the approvals."

If New Jersey Department of Environmental Protection (DEP) approvals are required, developers are faced with volumes of regulations, including those dealing with wetlands, which are becoming more and more restrictive and can quickly eat into a site's buildable acreage, and therefore a project's financial feasibility. These mandates are "now moving to the next level, not by wetlands regulation, but by policy," reports Douglas Janacek, director of the real property and environmental group at Newark-based Gibbons, Del Deo, Dolan, Griffinger & Vecchione. "This is both unfair and tough on attorneys, since they provide advice to their clients based on the regulations."

A member of the New Jersey Department of Transportation Highway Access Advisory Committee, Janacek was involved in the formulation and drafting of the New Jersey Highway Access Management Code, one of the most comprehensive highway access regulations in the country. He maintains the DEP's wetlands mandates need to be clear and defined by black-and-white regulation, as opposed to by the gray area of policy. "Fortunately, we (at Gibbons, Del Deo) are involved in multiple projects, so we hear what's going on in the back rooms."
Susan E. Bacso, a shareholder and chairman of the real estate group at Marlton-based Parker McCay, adds that environmental issues not only can add significant time and costs to a transaction, but also typically emerge as the biggest detriment to closing a deal.

"Any buyer without good legal and environmental consultants is just asking for trouble," states Jonathan Stark, a partner at Princeton-based Reed Smith. Steven Picco, also a partner at Reed Smith, who served as assistant commissioner in both the New Jersey DEP and the state Department of Energy, adds that sometimes neither the buyer nor the seller knows all the conditions of a site. Picco notes that insurance products now are available that will cover some upside risk on old commercial or industrial sites that might be contaminated and require long-term remediation. "This provides both sides with some comfort" on how a site's cleanup can be paid for.

Builders also are restricted by such state development plans as the Highlands, Pinelands, Meadowlands and CAFRA (Coastal Area Facility Review) acts, which supersede local ordinances. One of the more recent regulations to emerge from the DEP, which Acting Governor Codey recently put on hold, would restrict sewer hookups and mandate individual septic systems in all but the state-designated development areas. Aside from the general legal issues, attorneys express concern about where the one million new residents expected to move to New Jersey over the next seven years will live.

"With these regulations, the state essentially is stopping development," asserts Wisniewski. "On the one hand, the state wants to create jobs - but it apparently doesn't want to provide affordable housing. Where are people supposed to live?"

Janacek adds, "These new regulations slipped in under the radar, so awareness of them is almost non-existent. They're on the fast track unless something happens. Yet their magnitude and potential impact are staggering, as it appears there are not a lot of exemptions. This essentially will shut down development in New Jersey."

These are just samples of the head-spinning issues that demonstrate how critical it is for developers to have knowledgeable legal counsel as they approach a transaction. While the issues that need to be addressed by the buyer and seller differ, both need protection, maintains Wisniewski. Both can benefit from the comprehensive exercise of "due diligence" to explore fully the condition of any buildings and the property, to ensure no zoning or code violations exist in the structure and to determine whether the site is "clean or dirty" or has other environmental issues that will affect the costs of - or the ability to use - the property as planned. "Any prudent purchaser does considerable investigation of the property, since those issues affect its marketability," Haggerty emphasizes.

"A buyer shouldn't rely solely on input from the seller, but should do his own investigation before consummating a deal, instead of having to bring claims and litigation after the fact," Wisniewski says. Conversely, he urges the seller to disclose whatever he knows about the property to avoid the buyer coming back after the transaction is completed saying there were problems on the site he didn't know about. The seller also should grant the buyer sufficient time to fully assess the site. "If the buyer doesn't do his due diligence and there is (an environmental) problem, the government will charge whoever owns the property with cleaning it up. There are no absolute guarantees, but as a buyer, you have to do your best effort." While at one time due diligence could be accomplished in 30 days, today it can take as long as 60 to 90 days, if not more.

"If you don't do your due diligence, you're buying a pig in a poke - what you bought versus what you think you bought," warns Picco. "Our goal is to ensure that, for both sides, a final deal is really final."

Due diligence extends beyond the state of buildings and property to ownership and tenancy. Wisniewski suggests that if a buyer is purchasing real estate or a company with a transfer of stock or membership interest in an LLC, "a lot of investigating is required to see whether a company has any outstanding obligations." An attorney should ensure that the buyer has clear title and that there are no liens against the property.

If a commercial property is leased, due diligence should include a comprehensive review of all tenant leases and broker agreements, as well as of contracts with such support services as janitors and landscapers. On improved residential property, a "green card" should be obtained confirming state inspections have been conducted, life-safety issues addressed and that the building is habitable.

Purchasers of industrial or office parks need to make sure their due diligence extends to park associations, if any. What fees are the tenants expected to pay - and are they current? Who is responsible for the maintenance of detention basins, for ice and snow removal and for landscaping? Does the association have the right to review and approve - or oppose - any proposed changes in the building? "The association can be another layer of approval, in addition to governmental, before a new owner can build on the property," warns Glenn S. Pantel, a partner in Florham Park-based Drinker Biddle & Reath. "Inheriting less than a neat and clean organization can run into significant dollars."

If the purchase is conditioned upon getting financing, the terms of that contingency should be clearly stated in the contract, since "the prospective buyer is not obligated to buy what he can't afford," Wisniewski says. The buyer must be given a reasonable amount of time to obtain needed financing, which can be as long as three to six months. On the other hand, with rising interest rates and some softening of the real estate market, many developers are pushing to obtain financing and close on their deals as soon as possible, before rates climb further.

Depending on the size of a project, even an eighth-of-a-point increase in the interest rate can mean a significant increase in the cost of a development, notes Russell B. Bershad, who chairs the real property and environmental department at Gibbons, Del Deo.

Attorneys can help identify appropriate lenders for buyers. Parker McCay's Bacso says clients frequently ask their attorneys to recommend commercial bankers. "Different lenders have different customer bases or portfolio sizes," Bacso points out. "With our experience and contacts, we can help direct them."

Bershad says attorneys also can help direct clients to innovative financing options that support redevelopment and remediation, including low- or no-interest loans, tax exemptions, tax-exempt bonds, favorable bond funding, equity-investment loan guarantees, funding loans and guarantees, cost-recovery agreements and the creation of Revenue Allocation Districts within municipal redevelopment areas, where bonds or notes may be secured by a number of special revenue sources.

The Realty Transfer Fee and Farmland Assessment are two high-ticket items attorneys flag for clients. The Realty Transfer Fee is money paid to the state based on the property's sale price. Until about two years ago, the fee was $5 for every $1,000 of the sale price. Today, the fee is $12 per $1,000. While the seller historically paid the fee, attorneys report they are now seeing it as a negotiable item, with the seller and buyer often splitting the fee.

The Farmland Assessment was enacted to encourage continued agricultural land use in New Jersey. If the land is farmed, the property taxes are relatively low - say $500 per acre versus $200,000 an acre for developed property. If the use of the property changes from farming to a developed use, the owner must pay "rollback taxes," the differential between the Farmland Assessment and the real property tax for that year - PLUS the two preceding years. This assessment obviously can be significant, so the buyer and seller often negotiate how the fee will be paid. Drinker Biddle's Pantel adds that if farming is expected to continue on the property, the attorney should remind the new owner to submit an application for a new farmland assessment by the annual August 1 deadline, or the assessment will be lost.

"Often buyers and sellers think they have a meeting of the minds on a deal," says Parker McCay's Bacso. "Then they see the first draft of a contract and it's totally contrary to what they each thought. The buyer and seller each need to sit with an attorney to make sure every 'i' is dotted and 't' crossed to state their position."

She adds that the buyer and seller are approaching the deal from different perspectives. "The buyer is often coming to a deal based on input from a financial advisor. Then the due diligence reveals problems of which the advisor wasn't aware. That can sour the buyer on the property, and he's not as excited about the deal as he was at the outset. The seller, on the other hand, wants to get the most he can for the property and often is not willing to renegotiate the deal. So an attorney has to look at what each client expects, and each client must have flexibility in the contract if issues do come up - whether that means calling for remediation of the property or terminating the contract.

"The goal is to reach a happy medium between the buyer and seller," she concludes. "We want everyone to be content."

"The most important thing I attempt to do with any commercial real estate deal is to draw up a contract that is as complete and clear as possible to the essential terms and to the rights and obligations of each party," says Stark & Stark's Haggerty. Even if a contract provides that it is an "as is" deal, he counsels sellers to disclose any known defects, so there are no problems in the future. "I believe it is prudent to be forthright," he says. "The expectations of each party are important if they are going to get to a closing. A real estate transaction should be a win-win situation for both parties, unless it's a distress situation. There is no reason the transaction should not be amicable and mutually successful. If each side has clear expectations and the transaction is well-documented, there is a better chance of smoothly closing the deal."
Zangari maintains his job is to be well-versed in law, as well as in public policy, "so we can navigate the treacherous federal, state and local waters for clients, help them understand the myriad development issues and help them avoid contentious contract situations. Being an ombudsman for our clients is an added value that attorneys can provide."

Bottom line, perhaps the greatest piece of advice to both buyers and sellers - especially in New Jersey, with its complicated, demanding and frequently changing land-use and environmental mandates - is to make an investment in good legal counsel before making an investment in bad real estate.