Anatomy of a Real Estate Transaction – Parts of the Transaction
Most people know that songs are written in a structure. Some songs have several verses, all written to the same music. For instance, the Star Spangled Banner has four verses; although most of us only know the first one. Other songs, such as God Bless the U.S.A, contain a refrain or chorus, which has both the same words and the same music, between the verses.
Although it might not be as obvious as music with words, classical music also can be written in several musical forms. The rondo form contains a recurring main section or theme, with different sections in between.
A theme and variations form has a simple theme, followed by sections in different styles all based upon that theme. This style also can be called a chaconne or passacaglia, depending upon the musical era and style variants.
Many symphonies, concertos, and sonatas are written in sonata-allegro form. This form starts with the exposition, in which the main key and themes of the piece are introduced. Next comes a development section, in which the themes are explored in different keys, rhythms, styles, or complexity.
After the development, there is a recapitulation. The recapitulation is usually in the same key as the exposition and sounds similar to the exposition but can reflect changes explored in the development. Although thousands of musical compositions might follow the same form, what makes them different are the details the composers add.
Real estate transactions are similar to musical forms. Most follow a similar pattern, but like real estate, each transaction is as different as each parcel of real estate, itself.
This is the first in a series of articles about the Anatomy of a Real Estate Transaction. This article discusses the form of a transaction – the major periods of a typical transaction and how they relate to each other. Subsequent articles will discuss in more detail what happens during each period.
Parts of a Real Estate Transaction
Most real estate transactions have six major parts:
Due diligence inspection period
Closing preparation period
In some transactions, those parts may overlap. For instance, it’s common for a buyer to start the financing process before the end of due diligence. Other times, a buyer might conduct some due diligence during the contract period. However, most transactions will have all of these periods.
The pre-contract period consists of everything that happens before the buyer and seller sign a real estate purchase contract (Contract). At a minimum, this will include negotiation of the purchase and sale terms, such as price and timing of the transactions.
In a commercial real estate transaction, the pre-contract period may be lengthy. The buyer may issue a letter of intent (LOI), which itself may be negotiated before the parties’ attorneys start work on the Contract.
In other transactions, the seller might share property information with prospective buyers hoping to streamline the Contract and due diligence periods. Or, buyers, themselves, may extensively evaluate a property before even issuing an LOI to the seller. Regardless, the pre-contract period ends when the parties sign the Contract and the buyer pays any required earnest money deposit demonstrating the buyer’s commitment to the purchase.
Due Diligence Inspection Period
In most real estate transactions, there is a buyer due diligence inspection period (the Due Diligence Period) starting after the Contract is signed. In a home purchase, the Due Diligence Period might involve little more than obtaining a home inspection. However, in a commercial real estate transaction, the Due Diligence Period usually is more complicated.
Like a home purchaser, a commercial real estate purchaser hires independent experts to inspect the property – but instead of one inspector, there may be many. These may involve structural, environmental, pest, zoning, title, survey, and maybe others depending upon the type of real estate.
A commercial real estate Contract usually requires the seller to provide the buyer with certain information about the real estate. Thousands of pages of lease, financial, maintenance, and other records may available for the buyer to review.
At the end of the due diligence inspection period, the buyer has the option to cancel the Contract. Usually, but not always, if the buyer cancels, it receives a refund of any earnest money deposit.
Although a certain amount of cash is necessary to buy real estate, most buyers obtain a mortgage loan to pay the bulk of the purchase price. Since the loan represents the lion’s share of the purchase price and may be outstanding for as long as 25 or 30 years, buyers want the most favorable loan terms they can obtain.
Although the financing period is a separate period, it frequently overlaps both the Due Diligence Period and the Closing Preparation Period. That is because it takes time to get a loan approved and documentation prepared.
For both home and commercial real estate purchases, lenders require that the buyer provide a large amount of documentation to get a loan approved. After receiving the initial documents, the lender may have questions and require more information. Plus, if the first lender doesn’t approve the loan application, they buyer needs time to go through the process again.
Once the loan is approved, with a home mortgage, the documentation may consist of non-negotiable forms. But in a commercial real estate transaction, the parties may negotiate loan documents until the closing date.
Closing Preparation Period
Closing preparation usually starts at the end of the due diligence period or whenever it is certain that the buyer will be buying the property. It ends at the closing.
The closing preparation period is when the deed is finalized. In a commercial real estate closing, possibly, other conveyance documents, such as a bill of sale or assignments of leases and contracts, might be prepared.
During the closing preparation period both buyer and seller prepare for transferring title to the real estate. The parties should coordinate transfer of utility accounts. In a home sale, the seller may move out of the house and arrange for it to be cleaned. The buyer may hire contractors to develop plans for renovations to be completed before the buyer moves into the home.
In a commercial real estate transaction, the seller may terminate its management agreement, and the buyer may hire its own management company. And the buyer and seller should collaborate so the management transition runs smoothly for any tenants.
Immediately before the closing, the closing agent will prepare a settlement statement, which allocates the transaction costs between the buyer and seller. Although those costs may be standard in a home purchase, it’s not uncommon for the settlement statement to go back and forth several times in a commercial real estate transaction.
Years ago, parties would meet in a single location, usually at the same time, for a closing with their attorneys and a notary. They would pass documents around the table with each signing documents, and the buyer would pay the seller.
In the 21st century many closings occur without the parties ever meeting. They may email documents back and forth, and original documents can be sent via overnight delivery services. Some legal documents can even be signed electronically. And instead of delivering a certified or cashier’s check to the closing, the buyer may wire funds.
But closing’s fundamental purpose is the same: the closing marks the point at which the parties exchange documents and title to the real estate passes from the buyer to the seller.
A closing on a house might not have a post-closing period. Rather, the buyer and seller may part ways after the closing.
However, due to the complexities involved in managing commercial real estate, the closing usually isn’t the end of the buyer-seller relationship. There may be utility or other bills which need to be allocated between the parties. Or, a tenant may pay its rent late, and the buyer could have to forward the payment to the seller.
Sometimes, the parties close on a transaction with other open items, such as pending repairs or litigation which require post-closing collaboration. Other times, there may be a holdback or post-closing guaranty, which keeps the parties mutually engaged for several months after the closing.
© 2019 by Elizabeth A. Whitman
Any references clients and their legal situations have been modified to protect client confidentiality
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