PURCHASE AND LEASING OF REAL PROPERTY in the US

An Expert's View about Business Support Services in the United States

Posted on: 3 Jun 2010

Overview of the purchase and/or leasing of real property in the United States

PURCHASE AND LEASING OF REAL PROPERTY IN THE UNITED STATES: A SHORT GUIDE FOR INDIVIDUALS AND COMPANIES By David L. Berkey, Partner and Aaron N. Wise, Partner Gallet Dreyer & Berkey, LLP Atorneys atLaw New York City, USA A. INTRODUCTION The purchase and/or leasing of real property in the United States is governed by the laws, customs and practices of the state in which the real property is located and sometimes by local laws of the municipality or county of the state (such as zoning laws, which may limit particular uses of property, and tax laws, which may impose transfer taxes on the transaction). The purchase or leasing of federal lands is mainly governed by federal law. The general principles governing the purchase or lease of real property are fairly consistent in all jurisdictions. However, it is prudent to consult local counsel in connection with any purchase or lease transaction. The general procedure for the purchase of real property includes the negotiation of a contract of sale, the clearance of title objections and the closing of the contract of sale, when the purchase price is paid and a deed for the property is delivered by the seller to the buyer. In connection with the purchase or lease, the buyer may wish to obtain a loan, which may be secured by a mortgage upon the real property being purchased, to finance a portion of the purchase price or improvements to be made to the property. There are many types of real property that may be leased or purchased. In addition to commercial buildings, which may be stand-alone properties (such as factory buildings) or be part of a commercial development (such as a shopping center), there are residential apartment and office buildings, single family and attached homes, cooperative apartments (which are technically not real property) and condominium apartments. The procedure for leasing real property involves identification of a suitable property to be leased, the negotiation of the lease terms, including any necessary improvements to the property that must be made before the tenant takes possession and arrangements for financing of such improvements. D:\Documents and Settings\Barney\My Documents\FITA\GlobalTrade.net\Real Estate in USA. Country Neutral (00253823).DOC This Guide will discuss each of the steps involved in the purchase and lease transactions, from identifying the property sought to be purchased or leased through the closing of the sale transaction or the taking of occupancy of the leased property. B. RESIDENTIAL PROPERTY AVAILABLE FOR PURCHASE OR LEASE There are many types of residential property. Each is available for purchase or may be leased. The most common type of residence is the single family home. Ownership of that property includes ownership of the plot of land on which the structure is located as well as ownership of the house and all other structures (i.e., garage building, storage shed) located on the plot of land. In many metropolitan and vacation areas, cooperative and condominium apartments are purchased and sold for residential use. When a buyer purchases a cooperative apartment, the buyer is not purchasing real property. Instead, the buyer purchases from a seller the shares of stock in a corporation that owns an apartment building, which shares are allocated to a particular apartment within the building. The buyer, due to his ownership of the shares of stock, is entitled to receive a lease, called a ?proprietary lease?, for the apartment within the building that was occupied by the seller. The lease is for a long term of years (often more than 50 years) and is assigned by the seller to the buyer. The lease is generally extended when the original lease term expires. The rent payable is the tenant?s proportionate share of the cooperative apartment building annual expenses. The rights and obligations of the cooperative apartment owner are determined by the provisions of the proprietary lease, house rules, and the by-laws of the cooperative corporation. The real property in which the cooperative apartment is located is owned by a corporation and is managed by the board of directors of the corporation. Generally, the board of directors of a cooperative has the power to approve or disapprove the proposed sale of an apartment (stock and lease) to a new buyer. The board also has the power to approve or disapprove the subleasing of an apartment. With such powers, the board can exclude individuals who may not be strong financially or who may be incompatible in temperament with the other cooperative apartment owners. A condominium apartment (usually called a ?condominium unit?) is an interest in real property. The dimensions of the condominium unit are set forth in a document called a ?condominium declaration?. The rights and obligations of the condominium unit owner are determined by the terms of the condominium declaration, condominium by-laws and house rules. The condominium unit owners, in addition to owning their unit, collectively own the common areas of the condominium property, such as the lobby, roof, elevators. The common areas are managed by the unit owners, who are all members of a condominium association. The unit owners elect a board of managers of the condominium association that is responsible for the day to day operation of the condominium association property. The board of a condominium usually does not have the power to approve or disapprove a sale or lease of a condominium unit. Instead, the board is granted the ?right of first refusal? to purchase or lease an apartment that is {GdRealEstateUSA (GDB Client Files\09999\203\GDREUSA\00192576.DOC;1)}2 proposed to be sold or leased to a third party on the same terms and conditions offered by the third party. It is generally believed to be easier to resell a condominium apartment than a cooperative apartment because of the limited right granted to the condominium board of managers. C. PRE-CONTRACT CONSIDERATIONS 1. Due Diligence Review Prior to signing a contract of sale, the buyer must perform due diligence reviews to determine whether the property is suitable for use and if the purchase price is appropriate for the property given its location and physical condition. Many jurisdictions in the United States do not require the seller of real property to disclose any defective conditions of such property to the potential buyer (They are known as ?caveat emptor? jurisdictions, for ?buyer beware?) . Other jurisdictions do require the seller to describe known defects in the property to the buyer and may require a real property condition disclosure statement in connection with the sale. Whenever a buyer is seriously interested in a particular piece of real property, the buyer should engage an engineer or architect to examine the property for physical problems. Often serious physical problems may exist that are not evident to the casual observer. These can include problems with the roof, foundation, supporting beams, utility systems, etc. In addition, the buyer may wish to perform environmental examinations of the ground and structure to exclude the possibility of toxic substances (petroleum waste, toxic mold, radon, asbestos, etc.). The buyer should know the condition of the property before signing a contract to purchase at a particular price. If the buyer can not perform an inspection prior to signing the contract, the contract may have to be made conditional upon receiving a ?clean? inspection report. In connection with the purchase of a cooperative apartment or a condominium apartment, the buyer is also advised to review financial and other documents (by-laws, condominium declaration, proprietary lease, minutes of meetings of board of directors or board of managers) that relate to the corporation that owns the cooperative apartment building or the condominium association that manages the condominium for the benefit of the individual unit owners. These documents will explain whether the corporation or association is properly managed, whether there are outstanding claims that may increase expenses dramatically, and whether there are problems with the building or the particular apartment that the buyer wishes to purchase. The financial statements should disclose if the property is being operated at a loss, if there is any reserve fund established for contingencies, if there are mortgages on the property and if there are law suits pending against the cooperative corporation or condominium association. 2. Use of a Real Estate Broker The buyer may wish to engage a real estate broker to assist in the search for the right property. The real estate broker should provide the buyer with a list of comparable properties {GdRealEstateUSA (GDB Client Files\09999\203\GDREUSA\00192576.DOC;1)}3 and their selling prices, show the buyer any properties that are of interest and assist the buyer in the negotiation of the purchase price. Generally, a real estate broker acts as the agent for the seller and is paid a fee (commission) at the time a closing occurs by the seller. A buyer may wish to enter into an agreement with a real estate broker to act solely for the benefit of the buyer. That agreement may provide for the buyer to pay a fee to the buyer?s broker or it may require the buyer?s broker to negotiate with the seller or seller?s broker for payment of the fee. Although a seller?s real estate broker is entitled to obtain a full commission for procuring a ?ready, willing and able? buyer, the seller?s broker often shares the commission with a broker representing the buyer. Typically, one brokerage commission of 6% of the sales price is split between the seller?s and the buyer?s broker. 3. Due Diligence in Leasing Transactions Prior to signing a lease for real property, a potential tenant must also perform due diligence reviews. Important considerations will be related to the legality of landlord imposed restrictions upon the proposed use of the property, any alterations required to permit such use, whether there are other tenants of the property who may interfere with the proposed use of the leased property and whether the location, condition of the building and the particular premises within the building and services provided are suitable for the tenant?s use. An examination of the property with these issues in mind, in addition to the other issues raised above, will be required. D. NEGOTIATION OF THE CONTRACT OF SALE OR LEASE 1. Negotiation of a Contract for Purchase of Real Property Negotiation of the contract of sale may be performed by attorneys or in residential transactions by real estate brokers, depending upon the jurisdiction in which the property is located. In cases where a contract for sale of a house, cooperative or condominium is prepared by a real estate broker, the buyer?s attorney should carefully review the contract before it is signed by the buyer. Contracts for the purchase of commercial properties are often much more complex documents and are almost always drafted and negotiated by attorneys. Usually, the seller?s attorney will prepare the first draft of a contract of sale. In connection with many residential sales, the type of contract used is usually a commonly accepted form document with a ?rider? attached containing any specific issues not addressed in the form document. The buyer?s attorney is expected to comment upon the contract and negotiate changes that may be required due to the buyer?s particular needs. 2. Items For Negotiation There are a multitude of items that may be negotiated in connection with the purchase of real estate. Below are a checklist of items that the buyer?s attorney must consider. {GdRealEstateUSA (GDB Client Files\09999\203\GDREUSA\00192576.DOC;1)}4 a. Purchase Price - usually negotiated by brokers, depends upon the market and condition of the property. b. Downpayment - usually 10% of the purchase price; may be less on very large deals. c. Mortgage - sometimes the seller finances a portion of the purchase price by providing a purchase money mortgage; other times the buyer obtains a loan from a third party and the contract must be made conditional upon the issuance of a mortgage commitment or the closing of the mortgage loan. If there is an existing mortgage, the buyer may wish to have it assigned to his new lender or to take the property subject to the existing mortgage to avoid payment of mortgage recording tax. d. Personal Property - often personal property is included in or exempted from the sale; these items must be specified and an allocation may be made so that a portion of the sales price is attributed to the personal property. Note that real property transfer taxes may be reduced as a result but sales taxes may have to be paid. e. Acceptable Title and Title Insurance - most buyers require marketable title (that the property is resalable), not just insurable title. Exceptions from the title report must be cleared so that they can be omitted as exceptions from the final title insurance policy. A title insurance policy protects the new owner against third parties who claim an interest in the property. f. Municipal Violations/Certificate of Occupancy - the buyer should require the seller to cure any violations of record up to the closing date; the seller may require the buyer to take the property subject to existing violations. The buyer should require a current certificate of occupancy from the seller showing that the proposed use of the property is permitted by law. g. Closing Date - the date set for closing is not a firm date; the seller is given an opportunity to cure title defects and may adjourn the closing to do so; the buyer may also obtain a reasonable extension of the closing. The parties can require that the closing be on a firm date by declaring ?time of the essence?; this is usually not done unless there is inordinate delay. h. Risk of Loss - generally, the seller bears the risk of loss to the property, such as damage by fire, until title is transferred at closing. {GdRealEstateUSA (GDB Client Files\09999\203\GDREUSA\00192576.DOC;1)}5 However, sometimes the buyer wishes to take occupancy before the closing; then the risk of loss is shifted to the buyer commencing upon the date of occupancy. i. New Construction - if the seller is building the house for the buyer, then the plans and specifications must be detailed, provisions made for pre-closing inspection and delay of closing until substantial completion occurs (with possible credits to the buyer if the seller delays completion), warranties negotiated for work performed, appliances and systems installed. It is recommended that the buyer?s architect review the plans and specifications. j. Tenanted Property - if there are existing tenants in the property, the parties need to agree upon delivery of vacant possession or possession subject to the tenancies; if the latter, leases must be examined, tenant security deposits transferred to the buyer, and tenants notified to pay rent to buyer. k. Cooperatives or Condominiums - the buyer wants the seller to represent that any work that was performed in the unit was in accordance with all applicable laws and with the rules and regulations of the cooperative or condominium. l. Damages - usually, the seller is only able to retain the downpayment if the buyer defaults; the buyer may be able to obtain specific performance of the contract if the seller wilfully defaults, which requires the seller to convey the property to the buyer in accordance with the contract. E. PRE-CLOSING CONSIDERATIONS - PURCHASE OF REAL ESTATE 1. Clearing Title Objections Prior to the closing the buyer?s attorney obtains a title report from a title insurance company that will be insuring the buyer?s title after the closing. The title report lists ?exceptions? to title which, if not omitted prior to closing, will not be insured by the title insurance company. An example of an exception is an existing mortgage on the property. The buyer?s attorney sends a copy of the title report to the seller?s attorney so that the exceptions can be removed. The buyer also obtains municipal searches, which he provides to the seller?s attorney so that any violations of record can be removed prior to the closing. Any issues regarding the certificate of occupancy should also be resolved prior to the closing. {GdRealEstateUSA (GDB Client Files\09999\203\GDREUSA\00192576.DOC;1)}6 2. Obtaining Financing If the buyer requires a loan to finance the purchase, then between the time of the contract signing and closing the buyer must apply for and obtain a mortgage commitment. Generally, banks lend up to 80% of the value of the property to be purchased, depending upon the income, assets and credit worthiness of the buyer. Sometimes the buyer must negotiate the terms of a mortgage commitment letter with the lender. 3. Seller Arranges for Payment of Existing Mortgages and Liens The seller must make arrangements with its existing mortgage lender to have its mortgage satisfied (or assigned to the buyer?s lender) and to remove any liens of record which are exceptions to title. 4. Seller Performs all Conditions of Closing The seller must perform all conditions required by the contract that must be met for closing, such as removing any existing tenants, performing any required work, curing any existing violations and clearing title exceptions. 5. Calculation of Adjustments Shortly prior to closing, the seller?s attorney and buyer?s attorney contact each other to confirm the closing date and calculate any adjustments to the contract price that may be required. For example, if the seller has prepaid property taxes for a period that includes dates that extend beyond the closing date, the seller would be entitled to a credit for the prepaid property taxes. F. CLOSING THE CONTRACT OF SALE OF REAL PROPERTY The real property closing is the date when the seller delivers the deed to the buyer, the buyer pays the balance of the purchase price to the seller, the representative of the title company assures the buyer that proper title is being delivered and the brokers are paid their commissions due on the sale. The buyer performs an inspection of the property to assure that it is in proper condition for closing the day prior or the morning of the closing. If all is in order, the buyer and his lender attend the closing so the proper purchase price can be paid. The seller?s lender attends in person or by agent to release any existing mortgage liens and to collect any amounts due to it on its outstanding loan to the seller. The seller attends to deliver the appropriate deed (or in a cooperative apartment sale the shares of stock and lease for the apartment) and keys for the property to the buyer. All parties complete the required real property transfer tax forms for the sale. Utility companies should be notified to start providing utility service to the buyer. The buyer should also obtain liability and property insurance for the new property. {GdRealEstateUSA (GDB Client Files\09999\203\GDREUSA\00192576.DOC;1)}7 G. NEGOTIATION AND EXECUTION OF A LEASE FOR REAL PROPERTY The negotiations of a lease for real property generally center upon the following provisions. 1. Rent payable - although the price is commonly expressed as an amount per square foot per year, such as $100 per square foot, the lease contains the amount payable per year and per month. 2. Landlord Concession - the number of months of ?free rent?, when the tenant can occupy the premises without making payments to the landlord. 3. Landlord Work - the scope and type of work that the landlord is willing to do to prepare the premises for occupancy. This can vary from no work to substantial build-outs of the space to tailor it for the tenant?s needs. 4. Escalations - the landlord will seek to have the tenant pay increases in base rent each year based upon a formula such as increases in the consumer price index; in addition, the landlord will seek to have the tenant pay its proportionate share of any increases in real estate taxes on the building and increases in building expenses and/or wages paid to employees who perform services at the building. 5. Lease Term and Renewals - the length of the term (e.g., 1 year, 3 years, 5 years, 10 years) and whether the tenant will have the right to renew the lease at the same or different rental (such as fair market value) after the expiration of the initial lease term for additional periods of time. 6. Sublease or Assignment Rights - the tenant will seek the right to sublease a portion or all of the space should its business needs require and may seek the right to assign the lease to a third party during the term of the lease; landlords often refuse to permit any sublease or assignment. 7. Alterations - the tenant will want the right to perform alterations to the leased premises prior to commencing occupancy and during the lease term to alter the space to suit changing business needs. 8. Signage - the tenant will want listings in a building lobby or the right to place signs on the leased property for advertising purposes. Landords often reserve the right to approve all such signs. 9. Heat, air conditioning, electricity, water, etc. - the tenant will want to assure itself uninterrupted supplies of heat, air conditioning, electricity, water, elevator service, security services during periods that it occupies the building. Negotiations may occur over special needs for such services after business hours {GdRealEstateUSA (GDB Client Files\09999\203\GDREUSA\00192576.DOC;1)}8 or on weekends or holidays. 10. Security deposit - the tenant will attempt to have a minimal lease security deposit or use of a letter of credit in place of a cash security deposit. The landlord will seek a substantial security deposit or letter of credit and may also request personal guarantees of performance if the tenant has limited assets or a limited business track record. 11. Possession date - the tenant wishes to obtain possession on a date certain, while the landlord may have an existing tenant in the premises who may or may not vacate timely. The tenant should consider having a lease termination clause if the landlord can not deliver possession timely; rent will not be payable during the period prior to delivery of actual possession. 12. Destruction of the premises - the tenant will want to have the right to terminate the lease if a substantial portion of the premises is damaged or access to the premises is blocked. The landlord will seek an opportunity to repair any damage and may abate the rent payable by the tenant during the period of repair. 13. Special needs - the tenant will have to negotiate with the landlord to provide special services required by the tenant?s business, such as telecommunications or data services, satellite access or storage inside or outside the premises. Should the tenant wish to preclude competition from similar businesses in the premises, an ?exclusive use? clause should be negotiated. 14. Default clause - tenants should pay close attention to lease default clauses to obtain written notice of a default and adequate time periods within which to cure any lease default. 15. Insurance clause - tenants should review their own liability and property insurance coverage to be sure it meets the requirements of the lease and should determine whether the landlord also carries sufficient insurance to protect the tenant in case of damage or destruction of the leased premises. 16. Government compliance - landlords seek to pass all costs of compliance with local building codes and laws upon the tenant. The tenant should have the landlord represent that it is presently in compliance with all applicable laws regarding the building so the tenant will not have to be responsible to cure violations of local laws resulting from the landlord?s or a prior tenant?s actions. 17. Mortgage of Leasehold - the landlord usually has the right to mortgage the building which is leased and in such context will require the tenant to provide subordination agreements to a mortgage lender, in which the tenant?s lease is made subordinate to the mortgage. The tenant should confirm that the mortgage {GdRealEstateUSA (GDB Client Files\09999\203\GDREUSA\00192576.DOC;1)}9 does not prohibit the tenant?s use and request that it receive an ?attornment and nondisturbance agreement? from the lender. Such agreement protects the tenant?s leasehold interest in the event of a foreclosure of the mortgage, provided the tenant recognizes the lender as its new landlord. The tenant may also wish to obtain a leasehold mortgage and should obtain the landlord?s consent to a pledge of the tenant?s interest in the lease as security for a loan. After the lease terms are negotiated and reduced to writing, the parties execute multiple copies of the lease. The tenant may wish to record a memorandum of the lease in the real property records of the locality in which the leased property is situated to provide the public with notice that the lease exists. F. TAX AND LIABILITY CONSIDERATIONS Among other issues, consideration should be given whether it makes sense to form a U.S. legal entity to own the real estate that it purchases, and the type of entity. There may or may not be tax and other benefits to doing that, depending on the particular situation. The use of a U.S. legal entity may shield the individual from liability resulting from the ownership, use and rental to a third party or parties of that real estate. Additionally, under certain circumstances, there can be inheritance benefits to using a U.S. legal entity to own the real estate. F. COMMON PROBLEMS ARISING IN PRACTICE; DO?S AND DON?TS In our experience from representing parties in connection with US real estate transactions, difficulties that have arisen are: 1. over reliance on and misplaced trust in U.S. real estate brokers. 2. not understanding the importance of reading legal documents; 3. not arranging in sufficient time for the transfer and availability of the moneys that will be needed to consummate the transaction; 4. not understanding the various things that need to be done to finalize the transaction. 5. underestimating the difficulties in negotiating the transaction, to the point of final agreement. * * * * * * * * * * * David L. Berkey, Esq. and Aaron N. Wise, Partners Gallet Dreyer & Berkey, LLP th 845 Third Avenue - 8 Floor New York, NY 10022-6601 United Staes of America Tel. (212) 935-3131 Fax. (212) 935-4514 dlb@gdblaw.com Firm url: http://www.gdblaw.com {GdRealEstateUSA (GDB Client Files\09999\203\GDREUSA\00192576.DOC;1)}10
Posted: 03 June 2010

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