CRE Opinion

11 Common Mistakes Made in Commercial Real Estate Deals

Industry veteran Eliza Solender shares the repeat offenders she see's over the past three decades in the business.

I’ve been thinking a lot about the real estate mistakes I’ve seen since I started my company 30 years ago. It is a topic I cover extensively in the Nonprofit Real Estate 101 class that I teach for The Real Estate Council.  As an “anniversary present,” I thought I would share some of the major mistakes I’ve seen and, in some cases, unsuccessfully tried to prevent.

1. Falling in “Love” With Real Estate

Falling in love with real estate generally happens in two different situations.  The first occurs when I take a client to see a property that is for sale or lease and, no matter how hard I have tried to caution them in advance, the client begins gushing about how the property is absolutely perfect—in front of the owner or the owner’s broker. Prices or rates harden, and negotiations become much more difficult because the owner knows they have the upper hand.

The second example is where a client owns a piece of property that has substantially increased in value but will not sell when it should because the client has a “vision” that can only be met with this singular piece of real estate.

A nonprofit purchased a tract of land but didn’t have the money to build its new building. Eventually, the developer who had acquired the remaining three-quarters of the block offered to purchase the land. The initial offer was 15 times what the nonprofit had paid for the land. The owner wouldn’t sell for any price because the organization had a vision for that specific tract of land. It was not the highest and best use of the land. The developer built a high-rise office building next to the land on the remainder of the block. The lot by itself is not large enough to build a high-rise office building. The nonprofit could have sold the land and made enough to purchase less valuable land somewhere else and had the funds to build their new building.  But the owner was in love with its real estate and lost out on an opportunity.

2. Talking About a Deal Before it is Under Contract or a Lease is Signed

The propaganda poster from World War II, “Loose Lips Sink Ships,” is advice we give our clients. The meaning is to avoid careless talk that can result in a disaster. Unfortunately, many excited prospective tenants or buyers talk about a deal before a lease is signed or the property is under contract. This careless talk can attract the attention of another potential tenant or buyer who makes a better or faster offer and gets the deal.

3. Closing Before Zoning is Approved

Getting an owner to extend closing until a change in zoning or a specific use permit is approved can be challenging. Frequently, it requires the buyer to agree to pay non-refundable extension fees. However, the risk of closing before zoning approval is granted might be even more costly.

Unfortunately, we had a school client who had assumed the neighborhood wouldn’t object to a school and purchased the property (not while we represented them). When they did not obtain the necessary zoning, they retained us to sell the property, which wasn’t easy. They had to pay property taxes for many years and eventually sold the property at a loss. As we advise, up-front work will save you in the long run.

4. Not Knowing a Client has Weak Financials

One of the biggest time wasters is a client that does not have the funds to purchase or lease the property.  With our nonprofit clients, financial information is usually easy to obtain since they must provide financial information to the IRS, prospective donors, and government agencies.

It is the smaller, privately-held businesses that can be the most reluctant to share financial information with their broker in advance. While probing prospective clients about their financial condition isn’t fun, it is an important part of the due diligence process that brokers must tackle before spending a lot of time with a new client.

5. Unrealistic Proformas

 I encourage our clients to purchase or lease space that allows for future growth. However, I caution against purchasing or constructing a building with substantial unused space with the expectation that they can lease the space and use the income to cover debt and operating costs. If they are relying on this income in their proforma, it is a very risky plan. Most of our clients have little expertise in being a landlord and do not understand the risks and expenses involved in leasing office space.

6. No Existing Banking Relationships

There are plenty of potential lenders for acquiring real estate. They all have different requirements and target clients. The market for good bank loans is very competitive, and there are many items to negotiate beyond just rate, term, and required equity.

As a director of Origin Bank, I have seen countless loans approved and rejected. I have observed that for most banks it is all about relationships. It is so much easier if the buyer has an established bank relationship prior to beginning the loan application process. Their banker can assist in budgeting for the potential transaction, setting realistic goals, and shepherding their loan through the approval process.

7. Being Insulted by a Low-Ball Offer

It is always interesting when a client wants to make a “low-ball” offer for a property and then is surprised when the seller chooses not to respond. However, when they are selling a property, they become insulted when someone makes a very low offer. In either case, I recommend responding, even if both parties are far apart. Most of the time, I find that the low offer is just initial posturing, and the parties can easily move on to a reasonable negotiation process.

8. Not Hiring an Attorney Experienced in Real Estate

I can certainly make a case for the importance of retaining a real estate broker. However, just as important is hiring an attorney with real estate experience. It is amazing how many buyers and sellers don’t want to hire an attorney.

So often, they expect their broker (assuming they have one) to draft a contract using either the Texas Association of Realtors or the North Texas Commercial Association of Realtors forms to avoid paying legal fees. What they really want is their broker to act as their attorney. The forms are fine and can save on legal fees, but, in my experience, it is not a good idea for the broker to attempt to serve in this capacity.  A good attorney, working in partnership with the broker, can save their client money, time, and future legal issues.

9. Not Prepared to Pay the Costs of Proper Due Diligence

Failing to hire experts to do thorough due diligence is another major mistake.  Getting a property condition report and environmental assessment will help the buyer or tenant understand the potential repair and remediation costs associated with the property and budget accordingly. A superficial inspection almost guarantees unpleasant and costly surprises later.

10. Using a Residential Title Company Closer for a Commercial Transaction

Over the years, I have learned that good commercial title company closers make a big difference. They understand the complexities of a commercial transaction and the expectations of the various parties. They are accustomed to working with attorneys and following the instructions in a closing letter. Residential closers work in an entirely different universe. The title policy fees are regulated by the state of Texas, so there are no savings by using a closer whose expertise is in residential transactions.

11. Neglecting to Plan for Delays

Buyers and tenants need to have timelines that reflect the inevitable delays that occur (even prior to the pandemic). They include items such as uncertain permitting processes, shortages of labor and materials, lengthy zoning procedures, and financing approvals.  Hiring experts can significantly mitigate delays and assist in creating realistic deadlines. Even so, the unexpected can happen, and having a backup plan or cushion in the timeline can be very important.

Most of these mistakes are ones that experienced brokers have encountered and despite our best efforts, they still happen. I know there are many more I could have included. Feel free to share this list with your clients, and contribute an expanded list in the comments.  It may save everyone from a lot of costly mistakes and headaches.

Eliza Solender is the president of Solender/Hall, Inc. and serves on the board of directors of Origin Bancorp.

 

Newsletter

Sign up now to get breaking commercial real estate news and industry reports from the D CEO editors, plus on-the-ground insights from nearly 100 contributing editors across all sectors.

Comments