Nick Kublicki (310) 383-6353 patcarlton@earthlink.net Real Estate Transactions 1/24/05 Types of Transactions: • Purchase and Sale • Leasing • Construction • Lending – Always follow the money (who’s getting the money, when is it paid out, etc.) • Environmental Concerns • Miscellaneous (easements, land-use, etc.) Timeline: Broker – Purchase/Sale – Construction – Leasing BROKERS Who are the parties? Listing Broker Buyer’s Broker There is the seller and the buyer. The seller’s broker is called either the listing broker or the seller’s broker. This is because you list your property for sale with the broker. The buyer’s broker is either called the cooperating broker, the buyer’s broker, selling broker. PURCHASE/SALE Buyer Seller Lender Title Company (usually play the role of escrow holder and title insurance – they insure the title and they insure the lien) Inspectors Appraiser Local Govt. Official Surveyor Attorneys Potential Lessees Homeowners Association (HOA) CONSTRUCTION General Contractors Sub Contractors Architects (design and sometimes act as project managers) Inspectors Engineers Geologist Lender Bond Company LEASING Broker Owner/Landlord/Lessor Tenant/Lessee/Sub-landlord Subtenant Property Manager Attorney Maintenance/Parking BROKERS Why do we need a broker? They know what is going on, they negotiate the deal. Motivation of brokers: they want the deal to get done Motivation of lawyers: they want the client to be protected What duties are owed and to whom? Seller’s Broker to the Seller: Fiduciary duty. More than just a duty of good faith, must do something for the seller even if it is against their best interest. Seller’s Broker to the Buyer: It depends, if there is a dual agency (seller’s broker is also the buyer’s broker) and no agreement was signed with the buyer then you are only the broker of the seller. If there is a dual agency agreement then owes a fiduciary duty to the seller and some duty to the buyer, but not sure. If there is no dual agency the seller’s broker has a duty to be trustworthy, honest, competent, and to disclose material defects that would be seen in a visual inspection. Buyer’s broker to the buyer: In California there is a fiduciary duty. In a majority of states the buyer’s broker has a duty only to the seller’s broker. Buyer’s broker to the seller: Duty to be trustworthy, honest, competent, and to disclose defects that are visual. The Department of Real Estate issues a license to brokers. There are agents and brokers. The seller goes to a seller’s broker and the broker pulls out a listing agreement. Exclusive right to sell: The tightest agreement, no matter who ends up finding a buyer for the property the seller’s broker gets the commission. Exclusive Agency: Anyone who buys the property the listing broker gets the commission, unless the seller find the buyer themselves. Open Listing: Anyone who procures the buyer gets the commission. Can list the property with 100 different brokers. In California these agreements must be in writing and the first two must have a termination date. Usually it is 60 or 90 days maybe 180 days. For the 3rd one, the seller can terminate at any time. 1/31/05 EXCLUSIVE AUTHORIZATION AND RIGHT TO SELL In California the % is generally 6%. 3 ways for the broker to get paid. 1. The property is sold. 2. After the agreement expires, if the property sells to a person that the broker has put on a list. 3. If the seller withdraws the property What if there is a failed deal? The broker earns his/her commission when there is an offer to purchase at the listing price, or any price acceptable to the seller if the buyer is ready, willing and able to close the deal. If you have special deal items, like you want to also sell the furniture, then put it in the agreement. In this agreement paragraph 7 allows the broker to become a dual agent to represent the buyer and the seller. PURCHASE AND SALE AGREEMENT FirstOffer Then counter-offer Then agreement Then deposit Due Diligence (time period during which the real property is inspected) • Financing • Title • Physical • Leases • Environmental • Governmentl Approvals • Soil • Survey • Mandatory Disclosure Schedule The first type of Due Diligence is the “free look.” You, buyer, have 10 days to satisfy yourself as to the property. You can look at anything you want. At the end of the period you tell us if you want to buy or not. This does not obligate the buyer to anything. Questions? 1. What type of a look do they have? 2. What right do they have to reject? 3. Seller’s right to cure? Sometimes each due diligence item has a different date, and if you are silent then you are deemed to have accepted. As a buyer you can put in that the deposit can be increased if you need more time for due diligence. Then Approving Due Diligence or canceling the deal Then Closing (exchange of money and deed) THE AGREEMENT The buyer generally can assign the right to purchase to someone else. If you don’t want this, put in the contract that the buyer has no right to assign his rights under the contract. How to identify the property? Commonly known street address is not a good way. A better way is the assessor’s parcel number (apn), the tax man’s number. This is still not the best way. The best way is using the parcel or subdivision map. The most precise way is metes and bounds. 2/7/05 The single easiest thing you can do to change the value of the house is landscaping. All times are counted from the date of acceptance. At the beginning the deposit is given to escrow and then the due diligence process starts. The buyer wants a “free look,” the seller wants to list the items that the buyer can inspect. The other way is to have a standard. This means that at the end of the due diligence period there must be a reasonable reason to reject an item. The seller also wants a right to cure the defect before closing. Some things the seller can’t cure: If someone died on the property (in California if someone died on the property and it was not AIDS related, then you must disclose if you know about it), also if the buyer can’t get financing. The two things the seller’s right to cure does not apply to is environmental and financing. After due diligence is over, the next step is closing. Questions: Is the buyer restricted? What property is included in the deal? (furniture, equipment, etc.) Description of the property: 1. Assessor’s parcel number (tax); 2. Legal description (lot, block, track) this is for property that has been subdivided; 3. Metes and Bounds The purchase price? This is composed of the initial deposit + any additional deposits (maybe to extend the due diligence period) + Loan (new loan, assumption of existing loan, seller carryback) + rest. Sometimes the seller will say that the additional deposit will be above and beyond the purchase price. The other issue is refundability of the deposit. A lot of times the deposit is refundable up until the end of the due diligence period. There is a section on Brokers: List the names of the brokers so it is clear who is getting paid. Closing date? Can be listed as a particular date, or x number of days after deposit. If you are the seller you want to make sure that there is a time is of the essence clause. If so, then after the closing date, the seller can kill the deal and keep the deposit. Contingencies to closing: • Disclosures: this must be done by the seller. In CA, the seller must give notice to the buyer of any known defect on the property. Rule of thumb is that if you think there is a doubt, just disclose it. • Under CA law there is a mandatory disclosure report. • There is a physical inspection (can be small or huge, depending on what you are buying). Make sure that you are using licensed people, make sure they are insured, make sure you have a binding contract with them. If there is a problem, get an estimate. • All the due diligence is paid for by the buyer. • Environmental inspection. You could be subject for cleanup costs. The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) aka “Superfund.” This act imposed a strict liability scheme that if you own or operate property that is contaminated then you are liable for cleanup costs. There are almost no defenses, there is one exemption: If a buyer has done a reasonable due diligence review of the environmental condition of the property and did not find any recognized environmental condition, then they are not considered an owner or operator. The question is what does reasonable mean? In 1986 there was a standard that came about by ASTM (American Society for Testing and Materials). If you have complied with the ASTM standard, then if you find nothing you are probably exempt. The first thing that is done is called a Phase I environmental site assessment. If nothing is found that is a recognized environmental condition, you are done. If you find something that could maybe be a problem then you must go further to the Phase II. This is a targeted review of the problems found in Phase I. The next step is remediation. This is when you have actually found a problem and you want to remove it. The main agencies that will supervise the remediation are DTSC, RWQCB, FD, BD. What you should get is a NFA (no further action) letter from the agency. What is in the Phase I? See handouts. • Site Location • Site Operations • Adjacent Locations o Important to know what the adjacent and surrounding uses are because your property can be contaminated through the groundwater • History o Find it through title, interviewing people, looking at the structure, also look at the state’s archive of photographs (fire insurance), construction permits at the building department. • On Site Observation • Physio/Hydrogeology o Depth o Gradient o Soil • Above Ground Storage Tanks/Under Ground Storage Tanks 2/14/05 One more point about deposits. The deposit often forms part of liquidated damages. When suing someone you can get damages or specific performance. Because property is unique, the law allows the buyer the right of specific performance. Because of mutuality, the seller also has the right of specific performance, but it is not usually enforced (they just want the money). The buyer and the seller agree that if one of them seeks damages, they will fix that amount to the amount of liquidated damages. When you contract for this, you are not giving up the right to specific performance, but you do give up your right to go to court and ask for more damages. It has to be reasonable, in CA for residential the maximum liquidated damages is 3%. In commercial there is not presumption that 3% is the maximum, but it is usually not far off. Maybe 4% or 5%. The accepted standard for environmental review is the ASTM standard. If you do you environmental review based on the ASTM standard and you don’t find any evidence of contamination, then you are exempt for the definition of liable owner or operator. The Phase I stops short of intrusive testing. There is no digging or testing of samples. They are looking to see if there is something not quite right. • Hazardous Material • Solid Waste • Waste Water – Where is the facility dumping their waste. • Databases – Where are hazardous places in relation to your property • Wetlands • Specific Chemicals: Lead based paint, PCB, Pesticides, Methane, Radon, Asbestos (friable asbestos is dangerous, this means that it will crush with one hand) • Mold – you need a cellulose based substance and water. There is almost always mold, the question is how much and how concentrated is it. If there is heavy evidence of mold that means that there is water that is not evaporating. • Conclusion o 1) No evidence of any trouble o 2) Huge contamination problem and here is where it is o 3) We don’t know for sure, but there might be, here the next step is more review Phase II – Intrusive testing The problem is that you do not own the property, so you can not do all the testing you want. You need to ask permission for that, and you also need to ask permission to disclose any information to the government. The environmental engineer wants to test everything (makes money and reduces his liability), the seller wants no testing (because if they know about it they have to disclose it to other buyers). If you do find contamination, then it needs to be remediated. Again you need the seller’s permission and a governmental agency needs to oversee it. Who pays for the remediation? If you get an approved remediation plan and it is done properly, you will get a NFA (no further action) letter from the governmental agencies. SOIL More of an issue when building on vacant land. Can the soil support the building. Governmental approvals (Land Use) 1. What can you use the property for? 2. What physical improvements can be built on the property (measurements, height, etc.) 3. Entitlements (subdividing land) Under the subdivision map act, you can not transfer property unless the boundary has been approved by the city. For each Zone there are two types of uses: 1. Permissive uses (automatically allowed) 2. Conditional uses (maybe you can do it, but we want to review it first) Entitlements restrict transfers of real property, basically the city needs to approve the boundaries of property. In order to subdivide, the city will take a cut, they will require you to build stoplights and streets, etc. 1. To change uses under zoning to can get a conditional use permit, this is only for conditional uses. 2. Variance – Generally this use is allowed, but because your property is not configured adequately you can not use your land for this. 3. Re-Zoning – you basically want to change the zone. Very tough. First you have to apply with the city. Then you need to give a notice to all the surrounding landowners. Then there is a public hearing, and finally you get it or you don’t get it, or something in between. 2/21/05 HYPOS First do the timeline. Jan 1 they enter into a purchase agreement. Ben has 90 days to inspect all conditions affecting the property. $10,000,000 purchase price. $100,000 deposit up front and $100,000 more after the due diligence period. 1. The first question is what kind of due diligence rights does Ben have? If he has a free look he can reject for any reason. We also need to look at the seller’s cure rights. In the standard agreement we looked at, the seller had a right to cure. Must be cured by closing. If the seller knew of the roof leak and did not disclose, then that would be a breach of duty and he probably could get out with his deposit. 2. Silence is considered an approval or a waiver of the contingency. The due diligence period passed so that is considered a waiver of inspection. Ben is stuck. 3. Ben completes due diligence on March 30th. Now he does not have any contingencies. He now has a duty to purchase the property. The question is: Is there a liquidated damages clause? What is the amount of liquidated damages? Is that reasonable? For residential the law presumes (rebutable) that 3% is the maximum. For commercial it should be around 3%. 4. The issue is: Does the $50,000 go towards the purchase price. 5. The question becomes: What does the 15 day period cover. Initially he wanted it because he did not have enough time to do the environment inspection. Now he finds a physical problem. Does it only cover environmental? Also, the question becomes, if you can get out, does the additional $50,000 get refunded as well? Generally yes, unless it is earned upon receipt and not “part of the deposits.” 6. If he really wants the building he can seek specific performance. Once all the obligations are performed then there are no contingencies on the buyer’s part. If it is a residential property he may really want it, if it is commercial he may not want the property as much. Damages are hard to determine. If he really wants the property he can sue for specific performance. Specific performance is not gone if there is a liquidated damages clause, that clause only substitutes for when parties go to court. 7. What do you have the right to reject the property for? TITLE INSURANCE – Most important part of the due diligence process. Title talks about the condition of the legal right to the property. 2 components 1. Interest in real property that is being purchased. 2. Condition of that interest. What kind of interests are there? Fee Simple, life estate, leasehold, easement, lien. Once you find out the interest you will be holding, next check the condition of that interest (marketable, insurable, record, etc.) What kind of rights do 3rd parties have? The buyer gives the title insurance company the address or the legal description of the property involved. Who picks the escrow and the title insurance company? Seller picks the escrow company and the buyer picks the title insurance company. The insurance company prepares a preliminary title report (in California) or a commitment or a binder. PTR – This is a report, it tells you who the owner is, what the legal description is, if there is any encumbrances. This is just a report, it is not insurance. Commitment – Looks just like a PTR, if you give the insurance company the premium at closing, it becomes insurance. Binder – Closer to insurance but it is limited. It may give you insurance of a limited period of time. Less expensive, less broad in scope than the other two. In California we deal with a PTR. You need the PTR and the underlying documents. You may want to object to some of the items in the PTR. Some of the items can be cleared. If you want forms go to these agencies. AIR CAR AAGLA AIA Back to title insurance What are you covered for? Section A • Others owning your property • Documents are improperly signed or forged • You are covered if your property has no legal access to a public road • No restrictive covenants • Liens • Other parties who have right to property, easements • Unmarketable title • Use of the property is not prohibited by the zoning commission Exceptions Section B General and Specific General • Govt Police Power and Laws • Condemnation (If govt. comes in and takes your property, then you are not covered) • Title risks created by insured (bought property with drug money) • Defects revealed by inspection • Failure to pay consideration for property • Covers only you interest in this particular property Specific • Specifically listed exclusions Title insurance is not transferable. SURVEYS Matters disclosed by a survey • Survey is a visual representation of the boundaries of the property, improvements on the property and where the rights of other parties are on the property. They are licensed by the State. • Types of Surveys o Boundary o Construction: What space is available for construction o As built survey: After construction, what has been built in relation to boundries o MATTERS DISCLOSED BY A SURVEY relates to the ALTA/ACSM survey. This is the most important. Boundary of the property Improvements and where they are located Map of all of the easements Parking lot Landscaping Encroachments 2/28/05 Types of encumbrances found in a preliminary title report. 1. Monetary encumbrances – Deeds of trust for whatever amounts, judgment liens, back taxes, etc. These are easy to clear, when the money comes in from the buyer, the escrow will pay them off. 2. Non-monetary encumbrances – Easements, CC&R, Leases, Encroachments, etc. Easements can be for access, for utilities, for putting construction materials on a property, for landscaping, etc. Problem with easements is the right of the easement holder to remove improvements that are built on the easements. If there are easements the questions are, where is the easement? And what rights does the easement holder have? You can get an endorsement from the title insurance company – This is added insurance for a particular issue. There are also CC&R – Tell you what you can’t do, and what you have to do. Some CC&R’s are unconstitutional and others are not applicable because of the passage of time. Sometimes you must also look at who is going to enforce the CC&R. Leases may or may not be recorded. Generally there is a memorandum of lease, this gives notice to bona fide purchasers that there is a lessee. Purchasers take subject to. There are also encroachments – A lot of times these will not be in the preliminary title report. Existing Leases and Tenancy Statements Usually review the leases and determine if you are willing to purchase the property. But how do you know that there are no modifications to the lease that you are reading? There is an estoppel certificate that given to the tenant, he signs it and it sets forth all the material terms of the lease, and the buyer can rely on it. • There is a copy of the lease attached • Who are the lease parties? • What is the leased space? • What is the lease term? • What is the rent? • What is the security deposit? • What are the landlord’s duties? • Are there any modifications to the lease attached? • Are there any uncured defaults? (Does the tenant owe any rent) • Are there any other disputes existing? • Have there been any non-permitted alterations? • There is no assignment or subletting allowed. • Guarantees – 3rd party basically on the hook for rent or costs. • Make sure the tenant is not in bankruptcy • Buyer can rely on these and they are true What if the tenant doesn’t want to give an estoppel certificate? Section 9.1 H says if a tenant refuses to provide an estoppel certificate then the seller should complete and execute an estoppel certificate for that tenant. The problem is that it does not mean anything down the road other than that you can sue the seller. Tenants often bargain for lower rent to provide the estoppel certificate. Agreements affecting property (in addition to leases) Agreements with the gardner, maintenance man, etc. Buyer usually wants right to terminate agreement within 30-60 days. FINANCING Financing contingency – Buyer has a certain amount of time to find a loan to fund the purchase price. Important for the buyer to put in the agreement that finding financing is a contingency to close. Types of loans: Purchase/Sale Construction Permanent Financing Who is lender? Third party lender Seller Type of loan? Term loan – Loan for a period of time Revolving loan – Re-borrow and repay forever (sometimes has a term) Borrower rights? Rates and Amounts Prepay rights Assumeability /Assignability rights Constuction/leasing rights Lender’s rights? Accelerate debt based on any type of default Accelerate debt based on transfer or sale Accelerate debt based on encumbrances Protection of collateral (owner takes care of property so value does not decrease) Borrower should comply with laws Insurance Seniority of lien If there is an encumbrance on the property (like a lien or lease) the lender will want a SNDA (subordination and non-disturbance agreement), get the lienholder or leasee to subordinate their interest. The first part of the agreement is the subordination, the non-disturbance part is a way to get the tenant to subordinate. It says if you are not in default then I will not disturb you, if you are in default then you are gone. The reason the tenant does this is that it is often required in the lease. For the lender, it makes it easier to get rid of a defaulting tenant. Open and shut case. LOAN DOCS • Promissory note/Loan Agreement (not recorded) – This creates the debt, it says you will pay this amount of dollars in this many increments. Parties are the maker (borrower) and payee (lender) • Deed of trust (recorded in the county records) or Mortgage – The mortgage is a 2 party agreement (mortgageor and mortgagee). Deed of trust has 3 parties (trustor is the borrower, trustee is a 3rd party, and beneficiary is the lender). The deed of trust includes: o Assignment of leases and rents o UCC-1 Fixture filing o Financing statement (filed at the secretary of state office): secures the debt with respect to any fixtures and personal property on the property The buyer typically has the obligation to apply for a loan in good faith. 3/7/05 Damage and Destruction & Material Change If there is damage and destruction to the property during the executory period (escrow), who bears the risk of loss. California has enacted the UVPRA, this says that if the contract does not state who bears the risk of loss, the law implies that if title or possession has not passed and there is damage to the property, then the seller can not enforce the contract. In other words, assuming the buyer is not at fault and the buyer does not have possession of the property, then the seller takes the hit. However, if the buyer has taken title or taken possession, then they take the hit, and the buyer can not cancel the agreement because of the damage. The AIR form address head on who bears the risk of loss. It says: If the damage or destruction is $10,000 or less, the seller has to repair the damage before closing. If the damage is more than $10,000, then the buyer has to be notified by the seller of the damage or destruction, and within 10 days can decide whether or not they want to remain in the agreement. If they want, they can cancel the contract and get all of their deposit back, or they can stay in the agreement without a reduction in purchase price and then they get any insurance proceeds if there are any. MATERIAL CHANGE Material change: definition in section 9(n): Change in the status of the use, occupancy, etc. The seller must give notice, and the buyer has a choice whether or not to continue with the deal. The definition is vague. Only talks about the change that occurs to the property. If a liquor store is built next door, that does not change the property itself. REPRESENTATIONS and WARRANTIES These are statements by either party that the other party can rely on as being true. There are agreements where there are not representations and warranties, those are called “as is” sale. Just because you have an “as is” clause does not exempt you from having to disclose known material defects. As a buyer, you are really looking for the seller to make representations and warranties about things that are very difficult for you to find out. What are some of these things? Noise or crime in the area, notices of violation, pending litigation, unrecorded covenants (expand this and ask that all the agreements with respect to the property have been delivered), is the seller facing bankruptcy, has there been any construction done on the property (there may be a lien placed on the property after you buy it if the seller did not pay the constructors). They can limit it to the seller’s knowledge, “to the seller’s knowledge there are no notices of violation.” CLOSING New York closing – all the parties come into a room and swap papers and do the closing. West Coast closing – Everyone stays in their own offices or homes and send in the documents to the one escrow company. When the escrow has all the documents and all the instructions, they execute and close. What are the necessary documents: Seller: • The Deed o General Warranty Deed: provides all 6 warranties of title o Special Warranty Deed (aka: Grant Deed): This is what is used in CA, it only says that the grantor has not transferred any interest in the property. This is why title insurance is so important, the insurance company covers the 6 warranties. o Quit Claim Deed: This does not have any warranty at all in it. It basically says that I transfer to you any ownership interest I have (does not guarantee that the person even owns it). • Bill of sale – Transfers any personal property involved in the deal • Assignment and assumption of contracts – Seller assigns all contracts that have to do with the property • Assignment and assumption of leases • Estoppel Certificate • Fees and Prorations – Seller pays for the owner’s title insurance policy, splits the escrow fees, pays the transfer taxes, and the brokers commission. Buyer: • Money (also comes from the lenders) • Assumption of contracts • Assumption of leases • PCOR – Preliminary change of ownership report: This document is sent to the tax assessor’s office describing the property and purchase price and used to determine the value for tax purposes. • Fees and prorations – If there are rents paid on the first, but the buyer closes on the 15th, he is entitled to half those months rent. Aside from rents there are taxes. Property taxes are done in a weird way, the first bill is for the “first half” (July 1 to Dec 31). The second bill is for the “second half” (Jan1 to June 30). In CA property value for tax purposes can only change if there is a transfer or construction. On march 1st the assessor will look at your value and give that info to the auditor/controller, the auditor sends a bill to you which the first installment is due on Nov 1st (delinquent after Dec 10th). The second half is due Feb 1 (delinquent after April 10th). As far as fees, typically the buyer and seller split the escrow fees. The buyer pays for the lenders title insurance. If the seller is a foreign entity, then escrow will be instructed to with-hold some money of the buyer’s to pay for taxes. This is avoided by getting affidavits from the seller that they are not a foreign person (FIRPTA). The Closing Date If there is a “Time is of the Essence clause” then it must be closed on the exact date. If not, then the court will impose some sort of reasonableness standard. 3/21/05 Hypo’s Due Dilligence 1. Standard form says he has a right to get this info and if he likes it he can go along with the deal, if he does not like, it he can get out. The first question is when did he get the info? If the buyer is objecting after April 10 then he is out of luck, the due diligence period is over. The real important issue is to get this info to the lender and insurance agent to find out what your cost is going to be. With a standard AIR the seller has a right to cure. Not really able to cure zones, but can brace the water heater if it is not. 2. Seller has a right to cure this, so buyer is stuck. 3. The first question is, “when are they doing their phase I.” If it is before April 10th, they can ask the permission of the property owner to do a phase II. Under superfund, the owner would be liable so it would be a problem. If the phase II comes back positive then talk about it with the seller. Tell them that the only way the buyer will approve is if the seller gets it cleaned. The problem is that the issue is offsite. The seller can not cure anything because it is not on the seller’s property, it is on the north. The buyer may have to bite the bullet. 4. When did they find out? If before April 10, then ask the buyer to get a geophysical inspection. Looking for metal under ground. If you go forward you would need to get the dates extended as well. 5. When was it found? The problem with methane is that it is flammable. Being on a methane zone is not itself a problem. But you would want to make sure that it is build according to code to make sure that the methane does not become a problem. This is a combo physical and environmental inspection. 6. When finding out about this? The first scenario conditionally allows apartments. In this case you would ask for a CUP (conditional use permit). To get this, you need to apply, give notice to people around you, they can object, and you have an appeal right. It will take at least 60 days. If you want to get a CUP, you need to extend the closing date and the due diligence date at least with respect to the governmental approvals. The second scenario is where the ordinance is silent or actively prohibits apartments. Then you can try to get a rezoning which is tough to get, or you can get a variance for your building. This is hard to get as well. All of the options take a long time. 7. This tells us that the person selling us the property is not the owner. Here you want to amend the agreement to change the name. You want Seller LLC to assign all right in the agreement to Seller Office Properties, and have Seller Office Properties assume all rights and responsibilities. 8. a. Find out where the easement is and find out what rights the easement holder has. To find this you do a survey. The surveyor does a map with all the easements. b. This will probably be a larger easement than the first one. This could be a problem. Ask the same questions. c. Can approve on the contingency that they pay off the lien, can have escrow instructed to pay off liens at closing. d. The ones that are unconstitutional don’t really matter. The other questions are, how old are they? Have they expired by their own terms? What are the likelihood of enforcement? e. Get a tenant estoppel certificate. Generally you need to see if there are any surface rights of entry. Read the lease. Usually there are not and if there are not, who cares? Usually the oil leases are for 500 feet and below. f. Look at the terms of the lease, and get an estoppel certificate. 9. Look for an easement. Also beware of adverse possession. Maybe you demand that the seller gets rid of the encroachment. 10. Seller can complete the estoppel certificates himself. That makes the seller liable. 11. Can subordinate the lease. Look at subordination analysis above. SNDA agreement. 12. If the property is $10,000 or less, then the seller has to repair, no negotiation allowed. If the damage is above $50,000 then the buyer can back out of the deal, or can go ahead of the deal and then they get any insurance proceeds. 13. This is an agreement that does not exist at the time the contract for sale is entered into. The AIR says that the seller is not allowed to enter new agreements affecting the property unless approved by the buyer. The agreement of the buyer shall not be withheld unreasonably. 14. If the buyer remains silent past the due diligence date, that is a tacit approval. 15. Under the AIR section 8.8 it says that the closing shall occur on the expected closing date. If it does not close on the date then it is automatically terminated. He has this weird reading of the provision. REAL RULE – If it does not close on the closing date, then it can close as soon as escrow is ready. Party not in default can give written notice to the other party that closing must occur within 5 days. As a seller you do not want this, so scratch this and put in a time is of the essence clause. CONSTRUCTION What is being constructed? • Either new construction or remodeling/renovations. Who are the parties involved? • Owner • General Contractor • Sub Contractors • Architect – Draws the plans and estimates costs. They also get the permits. They review the bills that are sent by the contractor each month. They generally get between 10%-15% of construction costs. Copyright protection is generally given to the architects plans. • Engineers • Lender • Inspectors – These are city inspectors. They make sure everything is done per code. • General/Project Manager When is construction going to begin and when is it going to end? • Have to own the property • Plans have to be approved • General Contractor must be there • Seasonal concerns How much is construction going to cost? How is the building going to be built? (5 different ways) • Owner – Builder: No general contractor involved, they higher all the subs themselves • General Contractor: Owner hires a general contractor and he hires subs • General/Project Manager: Owner is not directly involved, the project manager is the owner’s representative. Very often this is the architect. • Design – Build: One group does the whole thing. They design and build the whole thing. Not a different architect and general contractor. • Turnkey: The owner does not take possession or does not pay for the work until it is completely done. The owner does not finance the project themselves, they just pay for the final thing. 1) Owner/Architect – Programmatic stage. The owner tells the architect what he wants 2) Architect – Concept Plan. One step further, visual 3) Architect – Schematic phase. More detail 4) Architect – Estimate costs 5) Architectural Plans 6) Architect hires engineers and takes the architectural plans to the engineers 7) Architect goes to the city and the city starts doing plan checks (takes 4-6 weeks) 8) Construction plan 9) Bids/Form 10) Construction K 11) Begin THE ACTUAL CONSTRUCTION 1. Demolition 2. Grading aka. soil work. 3. Excavation 4. Laying the foundation 5. The building, framing 6. The roof 7. Rough Utilities 8. Outer walls and floors 9. Finish work 10.Cleaning up and polishing up CONSTRUCTION K PROCESS 1. Signing the contract 2. Construction commencement aka. breaking ground 3. Substantial completion 4. Punch List (list of to do items, things that weren’t done properly, or things that need to be finished). 5. Final completion 6. Certificate of occupancy for residential or Certificate of use for commercial 7. Final payment Substantial v. Final Completion • Basically finished, but not yet good enough to get certificate of occupancy/use. 3 Types of Construction Contracts 1. Stipulated Sum K. GC and owner decide on the sum that will be the sum of the construction. If the cost goes higher the GC eats those costs. If the GC can perform the work for less, they keep the profit. A. Problems: encourages over estimation, and encourages spotty work. 2. Cost of work plus fee. Owner pays the cost of work plus the contractor’s fee (usually 10%-15%). A. Problems: open ended, lenders don’t like it because there is no maximum price. 3. Guaranteed Maximum Price Contract (GMAX) – It is kind of like the stipulated sum in that there is a max. Difference is that up until that guaranteed maximum price the owner pays cost of work plus fee. ISSUES: Look at Contract Sum and Contract Time. The contract sum and time can change. The owner gives notice to the contractor of changes with something called a change order (wants the bathroom to be bigger, etc.). These change orders can change the contract sum and time. Contractors like this because it gives them a chance to legally raise the price or delay the time. Sometimes change orders come from architects. For a change order to be effective you need the items to be changed, the change in time that will result, and the change in cost that will result. All parties must sign. How do you ensure that things are done on time? Have a liquidated damages clause that says “if you don’t substantially complete the project by this date, then every day after that will result in a penalty of X amount of dollars. Courts think of this as a liquidated damages clause and they require it to be reasonably related to the costs of the delay. A lot of contractors don’t like this because it is a penalty for being slow, what about the bonus for doing it faster. You can put incentives in for doing the work faster. What can change the contract time? Change orders, weather, terrorist attack or threat. The test is whether the delay was reasonably foreseeable. Things that are not reasonably foreseeable extend the contract time and things that are reasonably foreseeable do not extend the contract time. You should put in the contract that the contractor needs to mitigate damages if there is a delay. How does construction progress? By Money. Generally this is done with progress payments. On most projects this is done once a month. 1. GC sends to architect an application for payment. 2. Certificate for payment is issued by the architect. 3. Owner/Lender will release the funds to GC. What is in the application for payment? • % of work completed and description • What materials were incorporated • Conditional release: when you pay money, you want to make sure the GC and the subcontractors releases you from the obligation of paying that money ever again. • Unconditional release: deals with last payment made. Get release from last payment made to make sure that you as make payments to the GC and SC that you get released from any lien rights they have against you up to that point. • Copies of all contracts • Inspection reports • Updated following documents o Project schedule – Keeps you up to date on the project, tells about delays, about % of work completed at each pay period. o Schedule of costs – This is most important in the cost of work plus fee contract o Schedule of anticipated future disbursements – estimate of the future applications for payment Mechanics Lien • Anyone who provides labor/services to a project can attach a lien to the project property, enabling them to foreclose on the property if they are not paid. 1. Work Performed or materials supplied 2. Preliminary notice 3. Lien recorded at the county recorder’s office – Can be recorded within 90 days of the completion of the work. 4. The owner can record a “notice of completion” that basically says the project is done, this has the effect decreasing the period where a lien can be filed, it becomes 60 days from the notice of completion. 5. Foreclosure – This must be a judicial action. (the other way to foreclose is something called power of sale). The mechanics liens relate back. Let’s say your construction starts on Jan 1. It is completed on June 31. You record your lien on July 15. The lien that was recorded on July 15 relates back and has priority as of the date construction visibly commenced. Here it would be Jan 1. If there are a bunch of people that record mechanics liens, they all share equally. To avoid dealing with the mechanics lien as an owner is first off to make checks payable jointly to the GC and SC. You can also buy a performance bond: If no payment from GC then they look to the bond for payment, not owner. Problem is that this is expensive, most often used with public buildings because can not put a mechanics lien on a public building. FINAL PAYMENT – application will have normal info contained in all other applications for payment, but also include 1. Affidavit from the GC stating that the work is done in compliance with all laws, in compliance with permits and industry standard 2. Copy of certificate of occupancy 3. GC will assign all warranties to the owner 4. Final payment – every time there is an application for payment the owner generally holds back about 10% from each payment. All of those accumulated adds up to the final payment. 4/4/05 Project schedule – This says at this time you will have done this amount of work. Schedule of costs – What materials you are receiving and the costs Schedule of future anticipated disbursements – This is how much you will need to come up with next time K time • Can be set in stone (exact date) • Can be tied to an event happening • Can change (such as the sum can change) Just like the change in sum, the change in time can be due to change orders. Change orders are a request for GC to change part of project (add, modify, limit). Generally change orders increase the time and cost of a project • Can also change the time and delay things if there is some event that comes about that did not come from either party. The general AIA rule is this, if there is an abnormal event that is unforeseeable then the contractor is entitled to a delay. If the event was foreseeable, then the contractor is not entitled to a delay. • Can use a carrot and stick approach to regular time, say if the construction is done early you get a bonus, if it is done late there is a penalty. The penalty must be tied in to a reasonable amount, like liquidated damages. Termination or Suspension • Once get schedules showing delay in construction process, owner can issue a warning giving GC X amount of time to fix the problem to complete the project on time You can terminate a construction contract. Generally you can terminate without cause at anytime as long as you pay the GC his or her expectation (profit). If you are terminating for cause you must only pay them for the work they have done. This is obviously more difficult. Insurance Owner is responsible for insurance on the premises with respect to general liability. Anything dealing with the construction operations, the contractor is responsible for. GC must get workers comp, auto, construction, completion of construction and explosion insurance. Environmental Issues In the AIA form, if the GC finds any type of environmental condition, they must inform the owner/primary contact and must comply with all laws and the owner must remediate Issue: owner not in best position to do remediation because problem is due to current work being done. Best is to put in K for GC to handle remediation process. Representation and warranties If you are a buyer in a buyer’s market you can ask for whatever you want. In a seller’s market you need to pick your battles. The standard thing is that you want to get a warranty that they are insured, that they are experienced, that they are licensed (but you can confirm this stuff on your own). The important ones are that you want a warranty that there is not litigation, nor bankruptcy pending against the GC. You want to know that the plans and permits that have been provided are sufficient for the contractor to do the work. LEASING Do you want to buy or lease? Lease: exclusive right of possession. Different from a license in that a license gives right to non-exclusive entry to property. Residential leasing is extremely implied by law (the terms that is) Commercial leasing is different, the law implies very few terms. Space Lease – An office in a building Ground Lease – Lease the land Building Lease – Leasing the entire building including ground – Problem is that it is illegal in California to transfer a parcel of property that is not approved pursuant to the subdivision map act. The problem arises when you build multiple buildings on one parcel of land. If so then you can not lease out the building as a building lease because then you would be leasing the ground that the building is on and that is not a separate parcel. Must do it with a space lease (lease the space inside the building). Types of Leases 1. Gross lease – Takes all the fees and rolls it into one payment. 2. Modified Gross/Modified Net – Pay flat fee + at least one of landlord’s costs (this can be CAM (common area maintenance), insurance, taxes 3. Net lease aka. Triple Net lease – Pay flat fee + all 3 of landlord’s main costs. The tenant does not necessarily pay all, they pay their % share. 4. Bond Lease – Tenant pays every cost associated with the property except paying the mortgage. PREMISES • Measurement of premises o Care because if % share rent then care how much you are leasing measured in square feet. Also because rent for premises is quoted in square footage. o If you rent an entire floor, you are renting the entire floor, the columns and elevator shafts and all. That is called the rentable/leaseable area. The useable area is the actual area that you can use. The ratio is called the loss factor. • Site plan o This lets the landlord and tenant know exactly what area is being leased out to whom. Hypos – Construction 1. Now she wants to get bids from contractors. Generally she should specify what kind of contract she wants because the bids will be different. She should include any additional terms she wants included. If she is closing on May 15 and has a lease starting on Jan 1, then she cannot start construction until May 15 so she will be finished on Dec 15. She wants to have some good clauses in the contract that make the Dec 15 date pretty important. 2. I would tell her to get a stip sum, or guaranteed max price contract. She should get a schedule of construction, make sure final completion is by Dec 15. Have a liquidated damages clause to make sure the final completion is done by Dec 15. 3. Tell the contractor that they have to get back on track and you have some days to get back on track. If you do not get back on track by the allotted time then I will terminate the agreement. If terminate for cause, then have to pay for any work done (materials + labor + profit) up to that point, but no more. 4. Carl submits the application for payment to Mary and Aaron. Next they review it and check receipts. Then there is a certificate for payment issued by Aaron. This will be given to Mary or the lender (whoever has the money) and they will make the payment. From the payment a certain percentage is held back (withholding/retainage). 5. Want: 1) % of work completed; 2) Materials incorporated in project; 3) Actual work completed; 4) Conditional release (this looks forward to the payment they are asking for, once you pay me this amount I will release); 5) Unconditional release (looks backward to the last conditional release and says I now unconditionally release you from the last stuff); you want the release from the G.C. and the Subs; 6) also want copies of K’s with Subs and inspection reports; 7) Update of schedules (project schedule, cost schedule, anticipated future dispursements). 6. 1) Draft a change order detailing the work that needs to be done, costs of work, and how long it will take. The GC then needs to get a signed change order from the Owner. a. Arbitration clause: Owner and GC both pick appraisers to independently determine the costs to implement the change order. Often they agree. If not, the 2 appraisers together picks a 3rd appraiser to make final determination of cost. The 3rd appraiser will choose the number of the other two appraisers that is closest to the actual cost. 7. Something FX will not allow delay in the project, meaning the contractor will bear the costs. If not FX then the contractor will not have to bear the burden, but he does have to try to mitigate damages. 8. Submit an application for payment. Owner will be covered if they have received conditional and unconditional releases from both GC and Subs. 9. Is there a problem? Is it a K requiring substantial or final completion of the project? What stage is the project at? If not substantially completed, then there is a problem. If the project is not up to date the owner should withhold payments, and look to the liquidated damages clause. 10. Final payment v. payment of retainage. The final payment that you make is not the final progress payment, it is the final payment of all the withholdings. LEASING • Rents are quoted on a square foot basis • Leasable v. Useable square footage: RENT • Base rent: fixed rental payment made by tenant to landlord periodically (typically monthly). If the term of the lease is long-term, then there may be rent escalation provisions, increasing the rent over time. The amount of increase can be tied to an objective inflation standard (CPI) or an actual amount. • Reimbursement of Operating Expenses: see AIR handout. o CAM (common area maintenance) Maintenance Repairs Security Signage Water Gas Electric Trash Fire (smoke alarms, etc) Property Management Parking Reserves Capital expenditures o Insurance Commercial Liability Casualty Liability Loss of Rent o Property Taxes Percentage Share: % of the property leased to tenant as compared to total premises. That % is what tenant will pay of the costs listed above. Sometimes it is calculated as the % of the total occupied area. This makes sure the landlord does not have to eat costs. Can be done by comparing the rent one tenant pays as compared to the total rent collected. For this course we will do it based on either total occupied area, or total area in the building. Some landlords have a floor of the total costs, so if the landlord can save costs he gets the extra money. Percentage Rent: % of tenants gross receipts • Generally done in shopping center leases • Saks example • This is usually in addition to rent Sometimes landlords give free rent for a couple months in bad markets. Or they will do this to make the rent for the other months higher (makes the building look more valuable). Tennant Improvement (TI) allowance. If you lease this space for x amount of years, I will give you a credit of x amount of dollars to build out your own space. Built to Suit/Turnkey • Landlord will build the space out he way the tenant wants it as an incentive for the tenant to sign a big lease. Equity kicker • Equity in building given to tenant as incentive to sign a big lease. 4/18/05 Leasing Continued The lease commencement date: when the lease actually begins and the tenant gets exclusive possession of the premises Term of the lease • Original/Initial/Commencement term • Extension term/Additional term If you have extension options generally the rent is recalculated for each extension period. Reps and warranties – These are negotiable The 2 that are in the AIR and are pretty much standard are: 1. The landlord warrants that the premise and everything inside is in good working condition and that the structure does not have any material defects 2. The landlord warrants that the premise complies with applicable laws (at the time the building was built it was up to code) For residential leases, the law implies most provisions. For commercial leases, the law implies very little, it must be in the 4 corners of the lease. The landlord usually does not warrant that the premise will be suitable for the particular purpose that the tenant wants it for. The landlord does not know if the property will be good as a bookstore. ALTERATIONS For commercial uses, things can get changed dramatically. There are two types of alterations: 1. Required by law a. Required by the tenant actual use – The tenant pays for these i. Tenant wants to have a restaurant so there needs to be a certain number of bathrooms b. Required for the actual building – This is broken up between the tenants and the landlord (negotiation) 2. Elected or Desired a. Desired by the Tenant – Usually paid for by the tenant i. Usually need to get landlord permission ii. When landlord leaves, the improvement usually becomes property of the landlord b. Desired by the Landlord – Becomes part of CAM, gets amortized over 12 years based on the tenants total share of the premises (but can be negotiated) Landlord must keep common area in good maintenance and repair, must provide right to quiet enjoyment, and must give to tenant in good condition. DAMAGE and DESTRUCTION AIR lease forms divide destruction into partial, or total destruction. Partial – Something that requires 3 months or less to repair and no more than 6 months of base rent (base rent of the tenants affected by damage) The next question becomes: Is it insured or is it not insured? If it is insured then the landlord must repair it. If it is not insured then the landlord can repair it if it wants, and if it does not want to then the tenant can terminate. Total Destruction – More than 3 months to repair or more than 6 months of base rent to repair The lease terminates under these conditions. If the premises is under repair, the rent is abated meaning that the tenant does not need to pay rent for the premises that are unusable. If more than one tenant’s space is effected, one tenant’s space could be totally destroyed and the other partially destroyed. Look at each tenant space affected. CONDEMNATION If more than 10% of the premises are condemned then the tenant can terminate the lease. If part of the premises are condemned but it is less than 10% then the tenant does not have the option to terminate the lease, but I think the portion that is condemned is prorated out. If that part that is condemned is the most important part, you can make the argument that you can not “quietly enjoy” the premises so you should be released. ASSIGNMENT AND SUBLEASING Assignment is when you assign over your entire lease. All the time and area involved in your lease. If any part of your lease is not assigned then it is called a sublease. Generally landlords do not allow assignment/subleasing without the prior written consent of the landlord. Landlord should say that they have sole discretion to approve subleases otherwise the standard is reasonableness. Sometimes the landlord will put in the lease that if there is a profit made on a sublease then the tenant has to disgorge the profit. What happens if XYZ, Inc. is bought by ABC, Inc. Is that considered an assignment of the lease? Is there a new tenant? This can be considered an assignment by operation of law. This is when the makeup of the tenant changes. Sharing the profits on a sublease is another way to do it, this is good for the tenant and the landlord. MEMO of LEASE and SUBORDINATION Good idea to record a memo of lease to put the world on notice that you are leasing the space. Landlord on behalf of new lender will ask tenant to sign a subordination and non-disturbance agreement. The AIR form says that the tenant must sign this if asked. A good lawyer will actually attach the SNDA that must be signed. There can be an option to purchase or an option to re-lease the space, or a tenant can have the first right of refusal on other offers to purchase. Generally options are recorded to give the world notice of the option right. This way if someone buys the property your option won’t be dead. Some landlords restrict the use of the property. Sometimes they will say it can be used for any legal use. Tenants sometimes want the exclusive right to sell something. Tenants also may want a co-tenancy provision. This says that if a certain amount of tenants move out, they want the right to move out as well. Can be a particular tenant moving out, can be a % of tenants moving out or whatever. Relocation rights. A tenant really wants to move to the corner spot or whatever. They may say that if that tenant leaves then I will get the option of moving in there. Sometimes the landlord has relocation rights and can move the tenant if needed. Continuous use. In an office building the landlord doesn’t care if you come into the office or not. In the shopping center context the landlord cares more about your rent, they want your store to be open. They can have rules about continuous use and when they can be closed. Radius clauses. Some landlords want to make sure that stores that are successful don’t open nearby. If you have a Gucci in my shopping center then I don’t want you opening another one a mile away. Must be reasonable, watch for anti-trust laws. Holdover provision. When the tenant goes past the termination date. As an incentive to get them to leave, the AIR says that if they do stay they have to pay 150% of the rent and the landlord does not waive any rights to kick them out. 4/25/05 Leasing Hypos 1. Walk the property, make sure the premises is sufficient for her use. She should measure the premises. 2. Gross lease you just pay one fee. Here it will be $3000 a month. 3. Under the NNN lease pay base rent + CAM, INS, and TAXES Insurance is 1,000, tax is 1500, and CAM is 1500 + 500. The total is 4500 a month for the whole building. The total sq ft of the building is 10,000. Her share can be calculated as the amount she occupies/total sq ft. or amount she occupies/sq ft occupied. If we do it based on total sq ft it will be 1000/10000. Her share is 1/10, $450. Total she will pay is 2000 base + 450= 2450. 4. In a typical commercial lease situation the tenant pays for their own build outs. He can possibly give first month free to give her incentive, the landlord can actually do the work for Tara, the landlord can also give a tenant improvement allowance (if she did the work, he would pay for x amount). 5. 1.2 million in capital improvements, under NNN AIR lease the landlord gets to pass this on to the tenants. Her share is 1/10 of it so 120,000. This is amortized over 12 years so 120/144 months. 6. She can enter into a long term lease with right to expand into a contiguous space, or right of first refusal to change space. She can ask for extension options on the lease. 7. This is required by law only for her use so she is stuck with the cost. 8. This is considered partial damage/destruction. The next question is whether it is insured or not. It is insured so the landlord has to do the work. The rule in the AIR form is the rent is abaited to the extent that you can’t use the premises. So her rent will be abaited here, but how much, if this destroyed her total use then you have to ask if she can get out of the entire lease. 9. In this instance it is considered total destruction so the lease is terminated. 10. She should get the right to assign or sublease. When bigbucks coffee buys the company this could result in an assignment by operation of law. Under the AIR form the landlord has the right to approve the assignment. There is no standard written in the AIR form so in CA it is assumed that there is a reasonable standard. Look at the use, the financials of the owner, etc. 11. Tara can negotiate for exclusive right to sell coffee. 12. SNDA must be given to the landlord if the landlord asks for it. 13. She can ask for a provision to be able to leave if the magazine rack closes (co-tenancy agreement). Can also ask for an option to run the magazine rack if it closes. 14. Here more than 10% of the premises is condemned, so she has a right to terminate the lease if she wants. The rent will be abaited for whatever the condemned premises is. EXAM will be 2 hours. Probably 1 hour multiple choice and 1 hour of essay. Closed book, but you can be a calculator.