We’ve been discussing the process of assembling groups of investors for the purpose of acquiring income producing commercial real estate. As we move to getting the property into escrow so that you can verify its suitability for investment, we need to look at keeping control of the property for sufficient time to complete your investigation.
Your goal is to control the property without risking any of your money. The Seller’s goal is to extract as much money as possible from you as quickly as possible to tie you to his property. So how do you structure your purchase contract to maximize your time while minimizing your exposure? Using well structured contingencies is the answer.
As the Syndicator of group investment, you need to perform a Due Diligence investigation of the property. This is essentially a verification of the statements made by the Seller as to the condition of the property, the status of the leases, the history of income and expenses, the state of title, the existence of natural and man-made hazards, and anything else that can affect the value of the property. It is acceptable to make your purchase (and your deposit) subject to your approval of all of these conditions. Stating these conditions in your purchase contract turns them into contingencies, since your completing the purchase is contingent upon accepting the all of this information as stated by the Seller.
There are two “special” contingencies you’ll want in your purchase offer when you are creating a group investment. The first one is that you can cancel the transaction if you cannot fully subscribe your investment group in a specific period of time. Basically, if you fail to raise the money in time, the transaction is canceled and you get your deposit back.
The second is to allow you to vest the property in another name. This might be something as simple as “John Doe or assignee” in the Purchaser section of a standard real estate contract. This is very important to your “survival” as the Syndicator. It is this ability to assign your purchase rights under the contract to the LLC that gives you an opportunity for ownership in the group investment.
As a practical matter though, Sellers can get uncomfortable with lots of contingencies that have long removal periods and may wait for a faster buyer. An acceptable alternative is the use of an Option to Purchase. The Option gives the option holder (you) an irrevocable right to purchase the property in the time period specified in the option. Options also tend to be less “expensive” that escrow deposits since no one is getting tied up in purchase contract. The downside for you is that your option payment is non-refundable. If you don’t purchase the property, your option payment (called “option money”) is gone.
Options can range from a week to a year, although most fall into a 3 to 6 month period. It is also possible to pay a small amount of money for a shorter period, say a month, in what is often termed a “free look.” Why it’s called a “free” look when you’re paying a few hundred dollars for it is one of those time-honored industry oxymoron’s, but it probably relates to the relatively small amount of money for the short term option compared to the longer term ones.
Realistically, you would want to structure your option to have an extension period if you discover you want the property. Of course, you’d need to pay more money with each extension. Even when using an option, you’ll still want to have your contingencies in place when you submit the purchase contract. The difference is that you’ll have less time in which to approve of them.
So now you have the two methods in which you can control a potential investment property for sufficient time to complete your investigation and raise the money with which to purchase it. Good hunting!
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