Buying Risk: Top Title Issues for Buyers in Commercial Real Estate
The commercial real estate market in Northern Virginia continues to grow, driven by ongoing population growth, a still-booming economy, explosive data center expansion and very high per capita income, which is driving demand for goods and services produced, sold or moved through commercial properties. The continued growth makes commercial real estate an attractive business investment option for buyers, experienced and brand new alike. As with any business venture, buying commercial real estate involves a variety of risks, many of which are common to other businesses. One unusual risk even the experienced buyer may not fully understand is the danger of title issues – those defects in the title to the property that can reduce its value, prevent its intended use, make it impossible to resell or result in the buyer losing their entire investment.
In Virginia, the buyer chooses the title company, which is ultimately responsible for “clearing” any title issues before closing. The title company, however, cannot give legal advice and is not able to advise a buyer whether a title issue could be an ongoing problem for the buyer, aside from whether it must be fixed before the deal can close. Buyers should retain their own counsel to advise them on title risks and ensure they don’t close the deal only to realize a title problem will be harmful or even ruin their investment in commercial real estate. What type of risks does a buyer face, both from title issues that would stay on the property after closing or from potential mistakes by the title company missing something?
1. Access to the Property
Most title companies will see and flag almost all access issues, especially if a survey is completed that clearly discloses access–or lack thereof–to all parties. Title companies generally would refuse to close without vehicular access. Still, the fact that a property doesn’t have adoesn’t necessarily become apparent until after the contract is signed and the parties are moving toward closing. One relatively common issue is that a new survey reveals that a driveway that has been in use by the property for a decade is actually on the neighboring property. The property may still have road frontage for a new driveway after county approval, and the neighbor may be willing to allow an easement to be created for access. Still, both developments could take weeks or months to resolve, derailing buyer financing and development timelines.
2. Boundary Issues and Encroachments
Getting a commercial survey can be time-consuming, expensive and even delay closing, so should a buyer still get one? Yes! The property could be changing its use, or hasn’t been altered in a long time, or it’s been changed since the recording of a blurry subdivision plat map that doesn’t provide detail. Even when a buyer obtains title insurance, the policy typically excludes matters that a survey would reveal. Without a survey, the buyer may remain unaware of potential issues until they surface unexpectedly.
3. Opaque Seller Entity
The title company will collect basic information from sellers of a commercial property if they are an entity, including confirmation the selling entity—LLC or Corporation in most cases—exists and is in good standing with the state. The seller usually must sign an affidavit promising that the person signing on behalf of the seller entity does indeed have the authority to do so. The title company may even require the seller to provide a copy of their operating agreement or bylaws proving the person signing has authority. Beyond a certain point however, a seller entity is a black box, and what is inside is often opaque by design. If the purchase of commercial real estate is part of a larger M&A transaction, due diligence can lessen the risk level for a buyer. In a quick turnaround deal, deals where the seller is in financial distress or other circumstances that raise suspicions, the buyer must be wary of the person signing for the seller exceeding their authority or acting behind the back of other entity members or shareholders, leading to possible lawsuits and problems down the road for the buyer.
4. Zoning and Land Use Dangers
The title company, as part of its process, ensures the property is transferred effectively to the buyer, but the ultimate use of the property is usually outside its purview. There may be restrictive covenants, declarations created at the time of subdivision or changes in the zoning since the time of initial purchase that could adversely affect the buyer and their intended use of the property. A buyer can obtain a zoning report or other due diligence to significantly reduce risk and ensure their plans for the property are not frustrated. Oftentimes, even if a particular use of the property may be “grandfathered” in and allowed to continue as a non-conforming use, it may have unacceptable strings attached, such as maintaining the same building footprint. If the buyer plans to change the property’s use or use it more intensively, they should conduct appropriate due diligence into its zoning characteristics.
5. Unpaid Mechanics and Materialmen
Unpaid contractors are a significant concern for buyers and for the title company seeking to close a property sale. The risk is elevated in part because contractors are allowed to file a lien up to 90 days after their last performance or supply of materials. If the property is being refurbished, updated or otherwise worked on immediately before the buyer’s purchase, during which contractors could file a lien, that period runs well into the period after the buyer has closed and taken possession of the property. The title company will, as a matter of course, require the seller, in all transactions, to sign an affidavit promising that all their contractors have been properly paid and indemnifying the buyer should any claims arise. As a practical matter, though, the buyer should remain alert, especially when the seller is in financial distress or is disposing of only a partially completed construction project. Given the increased likelihood of a lien arising after closing, buyers should structure their timeline to account for the time, expense and disruption associated with pursuing indemnification.
6. Undesirable Easements
A significant risk for a buyer of commercial real estate is easements: either lacking one vital to their use of the property or discovering one that interferes with their use and wasn’t known before closing. An easement could affect a buyer’s property in a way that is very harmful to the buyer’s plans, without interfering in any way with the title company’s ability to close the deal. For example, the buyer plans to expand the building footprint of the existing property, which could be blocked by a powerline easement over what is presently open ground on the land. There are additional risks to easements that the title company doesn’t see or doesn’t recognize because they missed them in their review of the land records.
Conclusion: Considerations From 10,000 Feet
While there is great success and profit to be had in Northern Virginia commercial real estate, buyers should carefully weigh the risks and take appropriate precautions. A wise buyer would do well to carefully choose an experienced title company to underwrite and close their transaction, a knowledgeable attorney dedicated to looking out specifically for the buyer’s interests, and a skilled team of surveyors and other due diligence experts to ensure all necessary information about the facts on the ground is available.
