What is a Due-on-sale Clause and Why Does it Matter to Investors?

Many investors have asked me a variety of questions concerning a clause that is common in mortgages and promissory notes called a “due-on-sale clause”. A due-on-sale clause is a clause in a mortgage and/or promissory note that provides that a default may be declared and the loan may be called due (repaid in full) upon sale or transfer of ownership of the property secured by the mortgage without the bank’s consent. In other words, the bank has the right to demand full payment of the note if the property is transferred without the bank’s permission (this does not include a traditional closing where the bank is paid off and the lien released at closing).

…you may need to transfer your investments… into a limited liability company (or companies).

Edward Schenkel

Why should a real estate investor understand be aware of the due-on-sale clause in a mortgage? For several reasons. First, as an investor, you will want to make sure you are protected by keeping the property in a limited liability company so you are shielded individually if there is a lawsuit. This means that you may need to transfer your investments, which are currently held in your name, into a limited liability company (or companies). If there is a due-on-sale clause, such transfer may technically violate the clause. Accordingly, you should be aware that if you transfer the properties in a company without the bank’s consent, there is a risk the bank could declare that this is an act of default and call the loan. However, this is low risk since the bank’s primary concern is receiving the monthly mortgage payment and that the property is not wasting away. Also, if the bank did complain, you could transfer it back. Still, to be safe, it is recommended you either purchase the property in a corporate entity or that you obtain the bank’s consent before transferring the property to your company, even if it is a sole member limited liability company where you are the sole member.

This means that you will have more bargaining power to discuss the terms you want in and out of the loan documents.

Edward Schenkel

Second, a good reason to understand the due-on-sale clause is so you can negotiate it out of future deals, or at least negotiate room to transfer to companies where you own an interest. As an investor progresses in his or her career, he or she may find a good deal that involves seller or alternative financing. This means that you will have more bargaining power to discuss the terms you want in and out of the loan documents. Being aware of this clause means that you can either take it out, allowing you to freely transfer the Property to your companies or partners, or draft a due-on-sale provision that is more flexible and suitable to your needs.

Five Commercial Real Estate Contract Provisions that Every Commercial Real Estate Investor Should Know

Commercial Real Estate can be a great investment. However, commercial deals are often more complicated than residential. Everything from the due diligence to the contracts are more involved. That is why any investor who is contemplating a commercial investment should understand all the nuances of these types of deal before getting started. This post will talk about some of the different types of real estate contact provisions in commercial deals that every investor should understand before getting started.

Due Diligence Clause

The clause must be carefully drafted… so it is important to consult with counsel before signing.

Edward Schenkel

Due Diligence is important in any real estate acquisition, residential or commercial. However, in commercial, due diligence encompasses many more things and is more complicated. Accordingly, it is essential that the due diligence provision in commercial contracts is drafted broadly to allow the investor to inspect more than just the physical condition of the property. An investor should be entitled to conduct due diligence on zoning, environmental (including phase 1 and phase 2 testing), tenant leases, owner contracts, and the financials of the property. The clause must be carefully drafted to allow you to get out of the deal if any of one these are not satisfactory so it is important to consult with counsel before signing.

Permitting Contingency Clause

…it is essential to have a contingency clause in the contract…

Edward Schenkel

Unlike residential acquisitions, you may have plans to add an addition to the commercial property, construct a new building on the parcel, or move a new anchor tenant to the property soon after the closing. These plans may require some sort of zoning permit from the City or Town for your plan to legally materialize. Accordingly, it is important to determine if such a permit is needed. If important to your investment, it is essential to have a contingency clause in the contract that makes it clear that the closing is contingent on obtaining the permit. If you do not include this clause, you may be obligated to purchase a property without the ability to bring your vision to reality.

Financing Contingency Clause

…it is imperative to describe all financing sources in the contingency…

Edwards Schenkel

As with a residential deal, Commercial real estate contracts should have a financing contingency provision if financing will be used. However, financing contingency provisions in commercial deals may be more involved as there is creative and nontraditional financing often utilized in commercial deals that are not typically used in residential transactions. Therefore, it is important that the financing contingency in commercial deals is carefully drafted to reflect the particular financing that is being used. For example, if there is a combination of two private lenders combined with owner financing, it is imperative to describe all financing sources in the contingency so that the deal is expressly contingency on obtaining all of the necessary financing.

Estoppel Certificates

…a provision that entitles the buyer to estoppel certificates is imperative.

Edward Schenkel

A commercial deal will often involve the sale of the property with tenants in place. Accordingly, it is essential for the Buyer to confirm that the leases are in full force and effect; that there is no default on the lease payments; and that both the tenant and current owner are in compliance with the lease and there are no violations. Estoppel Certificates will allow the Buyer to close with an assurance that the tenants are not behind on the rent. Accordingly, a provision that entitles the Buyer to estoppel certificates is imperative.

Seller Representations

The seller representation should be clear…

Edward Schenkel

Seller representations and warranties are important in any real estate transaction, but particularly in commercial because there are different issues involved such as potential environmental concerns and different zoning issues. The Seller representations should be clear, and specifically note whether they are to the best of Seller’s knowledge and which representations survive closing. Common Seller representations and warranties include that the property is in compliance with the zoning and building regulations; that there are is no environmental contamination; that the leases, contracts, and financials provided to the Buyer are complete and accurate; and that the Seller (if a company) has the authority to enter into the contract.

In summary, commercial real estate can be a great investment but it is important to know all of the different issues before signing a contract for a commercial deal. Please ask any questions you here about commercial real estate contracts.