Top Ten Commercial Considerations

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10. Buying the Land or the Business?

It is essential to be clear on exactly what you are buying – are you simply buying the land and buildings on which a business is operating or are you buying the business itself? More often than not, a commercial real estate purchase involves buying some element of the former business such as the customer list, equipment or goodwill. A number of issues need to be addressed in the purchase agreement for a business purchase including the tax implications, transfer of any business names, telephone numbers, assets and allocation of liability.

Best Practice: Consult with your lawyer about your intended purchase and have an agreement prepared specifically setting out what you are buying and deals with the many unique issues that apply to a commercial real estate transaction. Commercial real estate is substantially different from residential real estate, and your lawyer, accountant, and realtor need to work together to ensure the deal is properly structured to accomplish your goals.

9. Asset Purchase or Share Purchase?

If you are buying commercial real estate as part of an ongoing business, there are two main ways the deal can be structured. An Asset Purchase takes place when you are buying the land, buildings and business assets such as customer lists, equipment, inventory and goodwill from the prior owner. A Share Purchase occurs when you buy the company that owns the land and/or the business. Often, a share purchase is preferred by a seller, whereas an asset purchase is preferred by a buyer.

Best Practice: There are important tax and liability considerations involved with each of these structures. Consultation with your lawyer and accountant is the best way to ensure that your intended goal is accomplished.

8. HST:

Commercial real estate will generally be subject to HST so careful consideration must be given to how HST will affect the purchase price. HST may be “included in” the purchase price, i.e., the price indicated is the total being paid. In this instance the seller will receive the selling price less the 13% HST. Alternatively, HST may be “in addition to” the purchase price, i.e., the buyer will have to pay the purchase price plus an additional 13% HST. This can make a substantial difference in the purchase price and the sale proceeds received. If both the buyer and the seller are HST registrants in their own businesses, a purchase agreement can specify that a joint election will be filed to self-assess HST.

Best Practice: Be clear on how HST will be treated in the transaction and determine whether you need to become registered for HST purposes before closing.

7. Price Allocation:

Different assets are treated differently for tax purposes. Some items, like buildings and equipment, are depreciable, while land is not. When negotiating an agreement to buy commercial property, the agreement of purchase and sale should include a “price allocation clause” in which the buyer and the seller agree upon the portion of the purchase price to be allocated to each of the assets being purchased such as land, buildings, chattels/equipment, and goodwill. It is important that these terms be negotiated in advance and that both parties agree to report the transaction on their tax returns in the manner specified in the agreement. Otherwise, CRA may review the transaction and determine an allocation that results in a surprise tax bill to one party or the other.

Best Practice: The buyer and the seller’s interests will often differ when determining how much value to allocate to each item, weighing the tax treatment of depreciation against capital gains. This is a complex area that requires advice from your accountant to determine an allocation that will receive the best tax treatment within the range of valuations that CRA will accept as reasonable.

6. Financing:

Most purchase agreements for commercial real estate will be conditional on securing financing. The commercial financing process is often more difficult and lengthy than for residential mortgages. Consult early with the commercial lending department of your financial institution to determine the list of requirements you will have to fulfill before your bank will make a firm financing commitment. You will also want to understand the security that the bank will require – is there sufficient equity in the land being purchased or will they require collateral security on your other assets?

Best Practice: Leave plenty of time to obtain financing, and review the proposed terms of the financing with your lawyer and accountant before committing to a transaction.

5. Due Diligence:

Commercial real estate transactions generally involve a period where the offer is conditional not only on financing, but also to allow a purchaser to conduct a variety of searches on the property and assets being purchased. This process is called doing “due diligence” and it involves a series of inquiries and searches to ensure that the assets and land will be free and clear of debts on closing, that there are no outstanding work orders, that zoning laws have been complied with, and that there are no claims outstanding against the property. An agreement should require the seller to produce any and all surveys, site plan agreements, storm water management plans and other documents relating to the property to assist the buyer with this process.

Best Practice: Allow a period of several weeks for your lawyer to conduct due diligence on the property being purchased and do not waive conditions on the deal until the results of these searches are known. If substantial defects or problems are discovered, you may need to negotiate an abatement or an adjustment to the agreement to deal with the issue or terminate the transaction altogether.

4. Property Inspections – Fire, Building, Condition on Closing

It is recommended to have a series of inspections completed on the commercial property before and after waiving conditions. Some of these are for your own benefit and some of these inspections are required by financing. Common inspections include a Fire Compliance inspection, Building Inspection and any inspections required by municipal building officials or engineers if there are any outstanding work orders. You will also generally want to provide for an inspection prior to closing to ensure that the condition of the property has not changed and that all unwanted items and debris have been removed.

Best Practice: Make a list of the property inspections that will be require, and when each of these will need to occur. Set out these inspections in the purchase agreement and be clear about the consequences if an inspection reveals a defect in the property.

3. Environmental Issues:

Commercial financing will almost always require an investigation into any potential environmental issues or contamination that may be present on the property. Environmental issues can substantially diminish the value of the property or disqualify you from financing altogether. Many lenders require the buyer to complete an Environmental Questionnaire about the activities and any spills that may have occurred on the property in the past. As the buyer often does not know this information, the agreement should provide that the seller must supply the information necessary to answer these questions and warrant and represent that these answers are true. If early inquiries reveal any potential problems, lending institutions may require more substantial environmental inquiries or even full assessments, all at the would-be buyer’s cost.

Best Practice: Ask about the former uses and activities that took place on the commercial property and ensure that information is available to you in order to satisfy a lender that the property is free from environmental contamination.

2. Insurance:

Like property inspections and other due diligence items, an agreement to buy commercial property should also be conditional on securing insurance. Insurance is required for financing and the type of insurance you require may also be affected by the terms of any lease agreements you intend to assume on closing. The results of a due diligence search may also affect the type and quantity of insurance you may require.

Best Practice: Consult with a broker who has expertise in commercial real estate and leave time to get any inspections that may be required by the insurance company in order to issue coverage. A written insurance commitment should be in place before financing can be secured, and before conditions are waived.

1. Leasing:

Many commercial properties are subject to one or more leases to tenants. Before making an offer, you should ask your realtor whether the building or property is subject to any lease agreements and ask to review the terms of these agreements. If there are tenants on a property, steps must be taken to assign the leases to the new owner or to terminate the leases and provide vacant possession to the buyer on closing. If leases cannot be terminated and you are buying the property subject to an existing lease, then the property may not be available for your intended use for a period or months or years. However, if you are buying the property as an investment, then good tenants with solid written lease agreements may increase the value of the property.

Best Practice: When considering a purchase, ask about the status of any tenants and have all lease documents reviewed with your lawyer to determine whether the leases can be assigned or terminated, depending on your plans. Enter into properly prepared written lease agreements or renewal agreements with any tenants you keep or take on after closing.

The foregoing is meant to provide information only and does not constitute legal advice. You should always consult with a lawyer prior to signing any contract.