Are you looking for perfect place for your business? Hanny Lerner shares tips on how to make sure that you don’t screwed in your next deal, buying or selling.
Not many small businesses today could afford to buy a building for their business, considering that banks typically require the buyer to put down 35%-50% of the purchase price. But the federal government-backed loan program SBA 504 is a great option to consider, as it allows qualified buyers to obtain 90% financing.
Buying an industrial building for my business took me the entire 2013 – six months to find the right building, three months to negotiate the contract and another three months of being in contract. I learned an incredible amount during the process, a lot of which I’m going to share with you in this article, so you can learn from my experiences and avoid making my mistakes.
A. Negotiating the Contract
First rule: everything in the contract is up for negotiation. There is a long list of things to consider, including:
- how much of a deposit to put down
- how long of a due diligence period
- whether the seller will accept the contract subject to SBA financing
- the seller’s financial responsible to remedy title and/or environmental issues
My contract negotiations took as long as it did because we couldn’t agree on the deposit amount, due diligence period, mortgage contingency period, seller’s responsibility for title remediation and much more. We ended up settling on a 10% down payment, 45 days of due diligence period and 60 days mortgage contingency period with a closing date of 90 days from contract signing. I also agreed to buy the building “as is”, which means that the seller wasn’t responsible for doing any structural or cosmetic repairs.
1. Mortgage Contingency
It’s in your best interest to make the contract “mortgage contingent”, so you can back out of the deal for a full refund if you aren’t able to obtain financing within the contingency timeframe. A “non-mortgage contingency” (or “all-cash deal”) means that the you can’t back out of the deal, regardless of your ability to get financing. In my case, the seller begrudgingly agreed to an SBA mortgage contingency solely because she trusted her real estate broker who assured her that I would close. But in all fairness, I should have started the mortgage approval process way before I signed the contract to ensure that I had enough time to close; I was running against the clock from the minute I signed it.
2. Creating an Entity
To limit liability, you should buy a building under a new corporate entity, and not under one’s personal name or operating business name. If your business gets sued, you don’t want the Plaintiff to come after your building too. On the flip side, if someone trips in front of your building and sues you, you don’t want them to come after you personally or your business. I learnt this the hard way when I was 25 and got sued personally by an ex-tenant who claimed the roof fell on his head. The building was under my personal name at the time.For this new building, the Purchaser was an LLC that I formed once I received the contract.
3. Time of Essence
You never want to accept a “time is of the essence” (TOE) clause in your contract, unless you are buying the building with all cash. A TOE clause requires you to close by a certain date, whether you obtain financing or not. If you don’t close on or before that date, you are in breach of contract and you will lose your entire down payment and the building.
Sometimes you have no choice, like what happened to me. The 60-day mortgage contingency period was up and, thanks to the government shutdown and delayed tax return filings, I still hadn’t received a commitment letter from the traditional bank or SBA. At that point I had a choice: either to cancel the contract, get my down payment back and lose the building, or agree to a TOE and close within 90 days of contract signing.
I really wanted to buy this building. Being the risk-taker that I am, I agreed to convert the contract into a TOE closing, accepting the pressure of obtaining 90% financing and close within the next 30 days (or I’d lose my 10% down payment). Doing what I did is not recommended. If you decide to do a TOE closing, be positive that you will get the financing and are able to close on time. When I realized it was impossible to close within 30 days, I begged the seller to give me more time to close; she finally agreed to extend the deadline by 30 days, stating that she’s only doing it because she admires my determination to get this deal done.
I got approved by both the SBA and traditional lender barely two weeks before the new closing. As you can imagine, the pressure and stress I endured during this period was off the charts.
B. Obtaining Mortgage Financing
The SBA 504 is structured where a traditional bank (i.e. Citibank or Chase ) finances 50% of the purchase price. The SBA finances 40% of the purchase price and the buyer puts down the remaining 10% financing.
1. Traditional Bank
I wasted a lot of time trying to get financed with the large banks. I later learned (from my business banker at Citibank, no less) that they get hundreds of mortgage applications a day and are extremely selective in who they approve. They will always opt to finance a company that generates eighty million dollars in annual revenue over a young company that generates a couple million. I finally turned to smaller banks like American Community Bank, Sovereign and Celtic Bank, all of whom were eager to finance my deal.
2. SBA Financing
The SBA application process was tedious. Just to get them all the required documents took several months, as they kept asking for more and more items each week. They ended up offering me a 20-year fixed rate amortized over 20 years, which I happily accepted.
In hindsight, it was a big mistake to go directly to the banks and NYBDC (SBA’s CDC) to get financed. I should have used an experienced mortgage broker who already has relationships with the banks to get the deal done. The time and energy I spent getting the mortgage (versus working on my business) was definitely not worth the 1% that I saved on the broker fee. I’ll never make that mistake again.
C. Due Diligence
The “due diligence” period is the time the buyer has to assess and research the property. The two most important reports are the title search and environmental assessment.
1. Title Search
All buyers obtaining financing must buy title insurance on the property. The title search confirms land tenure and title claims, as well ensures that there are no liens, violations, or outstanding bills on the property. Typically, the seller is responsible for clearing up any title issues, such as liens, DOB or HPD violations and outstanding debt. Double check your contract to make sure the seller assumes responsibility for removing any title issues.
In my case, the seller was responsible for up to $7500 (negotiated up from $5000) to remedy any title issues. Thankfully the building didn’t have any title issues because $7500 probably wouldn’t have sufficed if there were!
2. Environmental Phase I and II
The mortgage company conducts an Phase I environmental on the building being purchased. The environmental company inspects and researches the building to ensure that there are no underground oil/fuel tanks or contamination affecting the property. If they find anything questionable on the Phase I, the buyer is required to do a Phase II, which is a more rigorous analysis that can include drilling and excavation. If the Phase II comes back with any signs of contamination, you’re pretty much screwed. You’d have to excavate the entire ground, which can cost hundreds of thousands of dollars.
My Phase I report showed that there were two buried tanks in the building, so I was required to do a Phase II. Between missing affidavits from the Fire Department and no proof that the underground tanks were ever properly abandoned or removed, I had to hire a tank removal company to excavate the ground and properly abandon the tanks. Unfortunately, my contract didn’t include any clause for the event of any environmental issues; the seller was relieved from paying any of the remediation costs and I incurred the entire cost of excavating and removing/abandoning these tanks. I do wonder how my attorney missed adding that clause in the contract.
3. Architecture and Construction
You definitely want to bring in an architect and general contractor during your due diligence period to ensure that you’re fully aware of the costs associated to build out your space. In some cases, if the construction costs are too high, it may not make sense anymore to buy the building.
In my case, I needed to redo the roof, upgrade the electric service (so that it handled the machinery we use), and create partitions for our offices and workrooms. It was going to cost me at least $300,000 to do the renovations, which I was okay with.
D. Finding Incentives
Federal, state and city agencies offer many incentives for small businesses that purchase and renovate a building. Here are some that I researched:
ICAP : This program provides a 15 to 25-year property tax abatement when your renovation costs are at least 30% of the purchase price. This is by far the biggest incentive I’ve discovered.
New York Power Authority: NYSERDA, Con Ed
and National Grid offer rebates when installing certain energy savings equipment, such as LED lighting and efficient heating and cooling systems.
Excelsior: This program provides tax incentives if you create 10 new jobs when you move into the building you’re buying.
IBZ Relocation Tax Credit: If your building is in the IBZ zone, you receive a one-time $1000 tax credit for each employee when you move your business.
Use Tax Exemptions (IIP): You can apply for a use-tax exemption on all new manufacturing equipment/machinery that you buy for the new space.
There is also a Guide to Incentives for small businesses in NYC, which include more incentives provided by the Industrial Development Authority (IDA), Energy Cost Savings Program (ECSP), as well as the Façade Grant Easement, Non-Historic Tax Credit and more.
D. We Can’t Control Everything
Buying a building is by no means a simple undertaking. If you decide to take the plunge, know that you’ll be under a lot of stress—before, during and after you buy the building. In fact, so many things can go wrong during the process that can cause you to lose the building (along with a lot of money). For example, environmental issues may be too great for you to remedy, the seller may decide to back out of the deal or your financing may fall through. Tragically, the latter just happened to me.
My TOE closing date was set for today, 12/31/13. Just a couple of weeks before closing, my soon-to-be ex-partner put a “lis pendens” on an apartment building that I own (as part of his marital asset claim); the mortgage company and SBA needed to use that building as collateral for my new building, and dropped the deal as soon as they saw the “ lis pendens”. The building that I worked an entire year to buy was sabotaged in exactly 30 seconds flat.
While I am devastated for having lost the building and all the money I put into it, I believe that everything happens for a reason. I learned a tremendous amount in the last 12 months that will only help me with my next purchase. And if dreams do come true, maybe the seller would be willing to sell me the building again one day.
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