5 Tips for Buying a Commercial Short Sale or Foreclosure

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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There was a time when snatching up a commercial property through a short sale or a foreclosure involved finding a fixer-upper and then hunkering down for some serious red tape.

But with default rates for commercial real estate mortgages skyrocketing in some parts of the country, banks and other lenders are becoming more flexible in working with buyers just to get non-performing loans off their books.

“In 2006 and 2007, we dealt with virtually no commercial foreclosures,” says Adam Von Romer, director of Commercial Capital Advisors in the Fort Lauderdale area. “Now, it’s one out of every two cases we see.”

Financial hardships, brought on by changing consumption patterns, increased competition, construction delays or production shifts overseas, can lead a business to default on a commercial mortgage loan. In the end, the lender(s) can either agree to accept less than the full balance of the loan at closing (a short sale), or seize the property through an expensive and time-consuming foreclosure process.

In either scenario, an informed buyer can reap substantial savings (in some markets, high-end office condominiums are being offered at 30 cents on the dollar). Nationally, commercial foreclosure filings have jumped by more than 500%, from 3,597 in 2006 to 21,869 in 2010, according to RealtyTrac, a foreclosure listing company.

Before diving into an uncertain market, however, you’ve got to do some homework.

Become a Detective

Be ready to dig for foreclosures or other commercial properties sold through short sale. Online databases, courthouse listings and legal ads offer some insight. You may try approaching banks, mortgage companies or other financial institutions to inquire about their current listings of foreclosed commercial properties. Good customers with a demonstrated track record and contacts within the institution are generally more successful.

For added support, hire an experienced commercial real estate agent as a buyer’s agent, who can scope out properties through specialized databases. Make sure to find someone who has connections to lenders and experience working with commercial property short sales and foreclosures. Often, these properties are sold off-market, meaning that they are never formally advertised, says Michael Bull, president and founder of Bull Realty based in Atlanta. A buyer can offer a broker a reasonable fee, which can vary from less than one percent to ten percent of the purchase price, as a commission to find these hidden gems.

Do Your Due Diligence

Even the best bargain can be a flop if it doesn’t fit your business objectives.

“If you’re buying it for your business, it needs to be the right property,” advises Bull, who also hosts a national talk radio show about commercial real estate and works with nearly 300 lenders handling commercial foreclosures. “Don’t compromise on that.”

Determine what the property is worth (the bank likely won’t tell you) and its profit potential, paying special consideration to location, access, and visibility. If it’s an income-generating property, evaluate the strength of the tenants. Mortgage companies typically require an attornment clause in commercial loans, which safeguards existing tenants against having to sign new leases if a property slips into foreclosure. Avoid questionable lease arrangements, such as when a seller in default executes a 40-year lease for $3 per square foot with his brother-in-law.

“No matter what else happens, get title insurance,” urges Von Romer of Commerical Capital Advisors.

Conduct a uniform commercial code search to ensure that any equipment in the building or anything attached to the building is not subject to leases or a chattel mortgage. Check for code violations and open permits.

Even more important in a short sale is making sure that no one else can lay claim to the property, since a secondary lien may not be extinguished automatically. In foreclosure situations, get permission from the bank to conduct an inspection and require copies of any environmental assessments performed.

Show Me the Money

Before you buy, you’re going to need cash on hand or ready access to cash. “People always say location, location, location, but buying a commercial foreclosure is all about timing,” says Marcia Mueller, president of Westbrook Realty in Denver. When applying for a commercial foreclosure loan, the lender will require detailed financial records for your business, along with an appraisal, valuation, and inspection of the property. Lenders tend to prefer owner-occupied properties to those backed by investors at a distance.

In a bidding war, “lenders want to be confident that the horse they picked gets to the end of the race,” notes Bull, who recommends that buyers submit a copy of their bank statement or other proof that cash is available, and offer the largest amount of earnest money that they can afford.

Von Romer suggests avoiding bidding-up situations entirely. “Buyers need to determine their line in the sand and be prepared to walk away,” he says.

Skip the Letter of Intent

Once a property is owned by the bank, the opportunity for drawn-out negotiations may evaporate. Rather than compete with five other letters of intent buried on a banker’s desk, Bull suggests cutting to the chase and offering your best offer upfront in a purchase and sale contract drafted by a real estate attorney. Sign in blue ink and have it overnighted to those handling the transaction.

When you make an offer, know with whom you’re dealing. Small community banks worried about staying afloat may be more willing to accept lowball offers, while large, affluent banks may prefer to hold on to the property.

Consider shortening the contingency period for a more attractive offer. This will depend on the size and price of the property. The inspection period on an eight-unit apartment building might be wrapped up in three days, while it could take more than two months for a mammoth shopping center.

The timing of the offer is also important, notes Bull. Banks may be more willing to play ball at the end of a quarter.

Be Patient

In this topsy-turvy market, you may not receive a response from the lender. If the property is worth the time and energy, revisit it a few months down the road and reevaluate its potential. Then, the bank may be in a better (i.e., more desperate) position to sign on the dotted line.