I recently came across a blog by Camile Baptiste titled 3 Advantages of Buying Bank Owned Property (REO) (see Camile’s Blog HERE). I tweeted it out and said that it is totally false (follow me @dkblattneratty).  Maybe it isn’t totally false, but there are numerous reasons not to buy REO property.  Banks, as sellers, are extremely difficult to deal with.  Let me briefly enumerate my observations.

  1. Banks typically attach a multi-page addendum to the standard from contract used in a locale. The addendum, of course, disclaims any liability for anything that could possibly be wrong with the property. OK, “AS IS” is “AS IS”.  But the addendum changes customary contract provisions including times for inspections, responsibility for closing costs and rights regarding title.

 

The title issue can be a big one. In most areas in Florida, the buyer selects the title agent.  Banks, following foreclosure, like to control title.  In a recent REO transaction I handled for a buyer, the bank’s title company provided the title commitment and set the closing date.  However, the title commitment showed that the foreclosure was not complete and a subordinate lender was not properly foreclosed.  Therefore, the property had to be re-foreclosed.  Because we couldn’t control the process, it was difficult to first convince the title company and then the bank that re-foreclosure was required.  They wanted us to close!  Then, we had no ability to coordinate with the bank to assure that the case was progressing and the re-foreclosure took over 18 months.

  1. Banks don’t negotiate – anything. Their form is their form.  The deal is the deal.  If there is a problem later, they don’t negotiate.  During the same transaction, while waiting for the re-foreclosure, Hurricane Irma hit South Florida.  Though the contract was “AS-IS”, it also provided that seller shall maintain the property and deliver it in the same condition as of the Effective Date.  Additionally, there was a casualty/risk of loss paragraph.  Hurricanes were covered under this paragraph and seller had an obligation to spend up to 1.5% of the purchase price to repair damages, including removal of debris and trimming of trees following a casualty.  Of course, there was extensive damage and the purchase price was just under $1,000,000.  The bank did almost no clean up or repair.  The roof was severely damaged and had extensive leaks, yet the bank didn’t even put a tarp on the roof to stop the growing water and mold damage to the interior.  The pool pump became inoperable creating a green cest-pool.  A horse stable on the property was demolished and not cleared or re-built.  Fences were missing and trees uprooted.  Notwithstanding, the bank only agreed to a closing credit of only $10,000.

 

  1. Banks don’t close or make decisions as quickly as advertised. When a contract is submitted or a decision is required, the real estate agent will tell a buyer that the bank will respond immediately.  That is never the case as approval is not obtained locally.  An out of town asset manager makes the decision.  The asset manager has dozens of files on his/her desk and responds when he/she can, regardless of contractual deadline.  If buyer’s lender requires information or a signature, the asset manager doesn’t move any more quickly.  There is no “professional courtesy” afforded from the selling bank to the new lender.

 

  1. REO property is always in worse condition than advertised or than you observe. The foreclosed owner didn’t care for it and in fact, purposefully damaged it on the way out.  Bank will do the absolute minimum to maintain it while it owns it and will do nothing to repair it.  They hire local property managers or real estate agents to do these things and the local managers/agents spend as little as possible to maximize their profits under their contracts.

 

  1. Anti-flip provisions in REO sale contracts limit buyers. A large percentage of buyers of REO properties are flippers.  Many REO sale contracts restrict the buyer’s ability to flip.  These restrictions range from 60-180 days.

 

  1. Banks and asset managers are usually located out of state and therefore, unfamiliar with local law and custom. This causes additional delay and confusion.

These are but a few of the difficulties in buying REO property. Though the price is often attractive, these and other difficulties can cause a buyer time, money and lost opportunities which might offset the favorable up front pricing.  Think more than once before buying from an REO.

Many real estate and lease transactions begin with a letter of intent (LOI). An LOI is supposed to be a non-binding expression of interest between a buyer and seller of real estate or a landlord and tenant.  In a perfect world, the LOI should outline, in as much detail as possible, the salient business terms of the proposed transaction.  These would include the parties, purchase price or rent, closing date or lease term, contingencies, due diligence period, financial accommodations such as tenant improvement and who is responsible for closing and other expenses.  However, LOIs often are bare bones and leave many business points to be negotiated with the final contract or lease.  In these cases, what was the purpose of the LOI in the first place?

Sometimes, clients and brokers ask my input on preparation of LOIs. When they do, I try to make them as detailed as possible to that when I prepare the contract or lease later, I don’t have to re-negotiate.  More often, I am given a signed LOI and asked to prepare the contract or lease or worse, negotiate someone else’s document.  These LOIs regularly have missing or incomplete essential terms or ambiguities.  Therefore, we have issues that will have to be negotiated at the contract stage that the client and perhaps the broker intended to have put to rest with the execution of the LOI.

Another pitfall to LOIs is a negotiating strategy some people like to use. When I include a term in a draft of a document that the other side might not like, a common response is “that wasn’t in the LOI”.  These “strict constructionists” can’t honestly believe that a non-binding LOI acts as list of exclusive terms of the deal.  Similarly, if a client wants to modify or even tweak a term, the obstructionist won’t allow it because “that’s what the LOI says”.  People get too hung up on the 4 corners of the LOI, they ignore the provision that says it is non-binding or they just don’t want to make a deal.  Circumstances change between the LOI stage and the final contract.  The parties have had an opportunity to do a bit more due diligence, to talk with their partners, attorneys, bankers and other experts.  They have a more complete understanding of what needs to go in the final, binding deal.  The LOI is designed only to be a road map.  If one party gets too stuck on every word in the LOI, the deal will not get signed.

LOIs can be valuable tools, but only if they are drafted with the appropriate detail and only if the parties understand that until the contract is signed, nothing is final. If they are used otherwise, they can be costly and an obstruction to completing potentially valuable deals.

Most tenants are cost conscious. They are always looking for ways to save a buck.  And, when I am working with a tenant and their broker in negotiating a new lease, I look for ways to save money.  Operating Expenses is a good place to start.  How can we limit tenant’s exposure to Operating Expense charges and increases?  I have written on this topic before (see previous post HERE).

But what about after the lease is signed? What happens when tenant gets the reconciliation statement after the end of the year?  The tenant should be proactive and should carefully review the reconciliation statement.  A savvy, experienced tenant should be able to determine if the landlord’s reconciliation is accurate or whether there are red flags that indicate a more comprehensive review, including audit, is necessary.

 

  • The first step is to check the landlord’s math. No one is perfect. We all mistakes and everyone, including accountants, make math errors. It is not unusual to find money just by doing a simple math review. Also, make certain that tenant’s pro-rata share is accurate. This includes confirming that the building area is correctly stated.

 

  • Verify that landlord has used the correct adjustment years. Should the increase in Operating Expenses be from the 1st lease year or from the prior lease year? some leases have different bases for different categories of expenses. Is CPI a factor?

 

  • Have caps on controllable expenses been properly applied and itemized? It is important to run through the lease to make sure that all such expenses have been addressed and not inadvertently included in increases of non-capped expenses.

 

  • Assure that there are no charges for expenses which are either specifically excluded from the definition of Operating Expenses or, where possible, not specifically included in the definition of Operating Expenses. If an item can’t fit into a defined category, can it be excluded? Investigate.

A tenant can save money doing a thorough review of an Operating Expenses reconciliation statement and inquiring about questionable or incomplete charges.  Certainly, it is preferable to resolve issues at this stage rather than the time and expense of a lease audit.  Tenant’s should take the time to be familiar with their lease provisions so that the reconciliation statement is not a surprise or difficult to understand.

00184143

        Negotiation of complex real estate documents is, by its nature, adversarial. Each side has to stake out its position and fight for the points that are important to them. Attorneys and brokers, as advocates for their clients, understand this. Each will be zealous in making their arguments. While the substance of negotiation is adversarial, the process of preparing the documents, generally speaking, is not. One side prepares a draft, the other side reviews the draft and provides comments. Revisions are made. The process continues until a final draft is agreed upon.

            As technology has made life simpler, this process has evolved. The person reviewing the document now makes comments and revisions directly on the draft provided using the Track Changes feature in Microsoft Word, or some other compare write or redlining program. When the draft is returned, the preparer can accept or reject the revisions and make additional or new changes. A new Track Change or redline is generated and returned. This process makes it easy for buyers and sellers, borrowers and lenders or landlords and tenants to easily see and discuss specific revisions. Negotiations can still be heated, but the parties can trust the process and that agreed changes at each stage are being made. Technology has made it possible to negotiate documents with little to no personal contact.

             Even before we had this “fancy” computer technology, attorneys usually endeavored to assist opposing counsel in reviewing document revisions from draft to draft. When I started practicing in the 1980’s, we hand marked or redlined our documents at every draft to show clients and opposing counsel everything we changed. And our opponents did the same. We underlined every word, sentence, clause and paragraph we inserted with a red pen (thus, redlining). We put a carrot or asterisk everywhere we deleted language so that the reader could compare the new document to the prior draft. We cautioned that the redline might not be accurate so the reader should carefully review the entire document in case a change was missed. In other words, though we were adversaries, we acted as colleagues, friends, gentlemen (and women). We treated each other with respect.

             So with this background in mind and given that technology makes it easy for everyone today to “help a fella out”, why would anyone in the real estate business today go out of their way to make it difficult to review a document? My latest story involves a client with A++ credit seeking to lease about 65% of a landlord’s class B office building as well as 100% of his vacant lot, adjacent to the building. Client will be doing all of the TI at client’s cost (about $350,000) and the lease is 10 years with 2 five year renewals. The landlord’s representative is his son-in-law. The landlord sent the lease draft in .pdf format. This is not unusual and I requested a copy in Word. We got no response back for over a week until the representative called and demanded our comments. When we again requested a copy in Word, the representative, and then the Landlord told us no such copy existed. We ran the .pdf through a .pdf converter program and I provided my revisions and comments using Track Changes. I will admit, my revisions and comments were substantial. This particular client is in high demand and is used to getting its way.

             We heard nothing for 2 weeks. When we did, the landlord’s representative sent us what we presumed to be a revised lease. Again, it was in .pdf format. There was no redlining or Track Changes.   We were told that this would be the last draft and any remaining changes had to be by addendum. When I asked for a redline or at least a Word version so that I could compare the lease to my draft I was flat out told no.   Why would the landlord do this? What is his purpose other than to be nasty? We can certainly battle it out over the terms that we don’t agree on but why make it difficult (and therefore expensive) for us to review the lease? I am now reviewing the lease line by line and finding that the landlord has made changes to provisions that I did not even comment on. Is the landlord doing this because he is angry that I marked up his original lease?

             I think what this landlord is really telling my client and me is that IF we ultimately sign this lease, we are going to have a very difficult relationship. Everything is going to be a battle. When you’re in a battle over the process of negotiating a document rather than the terms of the document and when you can’t trust the other side to be honorable in the drafting of the document, you probably can’t trust them to honorable in any dealings in the relationship.

Caucasian mid-adult businessman and woman staring at each other with hostile expressions.

        It always helps to know what your client hopes accomplish in a transaction when you begin negotiations. It also helps to know the strength of your client’s position.  Otherwise, you can get your head handed to you.  And it is much better to be the one handing your opponent his head than the other way around.

        I have been working with a client recently on the sale of some commercial real estate. My client really wants to sell this property and the assets associated with the business he operates on the property.  He is losing a lot of money in this business.  A business broker found a buyer in the same business who agreed to buy the property and the inventory of the business.  Both parties wanted to close very quickly.  However, the buyer would not be able to get financing in time and in fact, because of the size of the inventory involved, would need to tackle the inventory loan first and then wait for a few years before financing the real estate.  Not to worry.  My client was willing to consign the inventory and to purchase money financing on the real estate.

        After the terms were negotiated by the broker, I prepared a contract and it was signed. Closing was to be in less than 3 weeks.  I started right away on the loan documents.  Buyer had a law firm acting as the title company who I assumed would be his attorney as well, but I never got a response.  Nevertheless, I sent my draft loan documents out as soon as they were ready.  My client and I had discussed that the loan documents had to be as if a bank were the lender because we were financing more than 85% of the purchase price and consigning the inventory.  Because we held 2 parcels of property in 2 different entities, there were 2 different sellers.  Thus, there would be 2 different lenders and 2 different mortgagees – 2 notes and 2 mortgages.  The notes and mortgages would be cross defaulted with each other and with the consignment agreement.

        A few days before the scheduled closing date, the title company/law firm was retained to review the loan documents. They sent comments to me.  The buyer 1) did not want to enter into a consignment agreement, 2) saw no need for cross default provisions, 3) saw no need for assignments of leases and 4) thought the mortgage was too long (and thus gutted it).

        My job was then to remind buyer and his lawyer that 1) he had no cash and no ability to obtain cash, 2) this was purchase money financing of more than 85%, 3) if buyer went to a bank, not only would the mortgage be at least as long as the one I had provided (probably longer), but there would be many more documents than I provided, all very long, including assignments of leases, and 4) if he didn’t like the structure of the loans or the forms of documents we were offering, he needed to find another lender because seller isn’t going to give you his property, including the inventory for under 15% down and the handshake you’re offering.

        The moral of this story? It could be he who has the gold makes the rules, but that is tired and cliché.  Maybe it’s, before you swing for the fences, make sure you aren’t going to get knocked down by the pitch.

    Get Blog Updates

    Get news, insights, and commentary delivered straight to your inbox!
    Click Here

    About Us

    Welcome to Assouline & Berlowe’s Florida Real Estate Law and Investment Blog with news, insights, and commentary for investors, developers, and their advisors.

    Topics

    Recent Updates

    Archives

    Stay ConnectedLinkedIn

    STAY TUNED!
    Get Blog Updates
    We'll send you an email whenever we add a new post.
    Stay Updated
    Give it a try, you can unsubscribe anytime.
    close-link
    Get news, insights, and commentary delivered straight to your inbox!
    Click Here
    close-link