When acquiring commercial real estate, its vitally important to engage in detailed due diligence investigation to limit the possibility of post-closing surprises. Failing to dig into the hidden details of a property can doom the financial merits of an otherwise profitable deal, turning the transaction into a costly mistake. One very important step in the due diligence process is obtaining estoppel certificates from tenants in the property.
An estoppel certificate is a signed statement by an existing tenant certifying for the purchaser’s benefit, that certain facts are correct. A tenant’s delivery of this statement estops the tenant from later claiming a different state of facts. Why would a prospective purchaser care about leases on the property? The reason is that you will be bound by the lease terms after the closing, and you cannot simply undo or change the leases to your liking.
A Tenant Owns and Interest in the Property
A lease conveys to the tenant the right to the exclusive possession and use of the real estate for a definite period of time. A lease partakes of the elements of both a conveyance and a contract. It is a conveyance by the landlord to the tenant of the right to occupy the land for the specified time in the lease. It contains a contract by the tenant to pay rent to the landlord, in addition, to numerous other promises and undertakings by both landlord and tenant. The legal interest of the tenant in the land is called a leasehold estate and consists of the right to the exclusive use and occupancy of the estate.
Because the tenant has an interest in the property, a prospective purchaser takes title to the property subject to the rights of the tenant as set forth in the lease.
Cautionary Tale of One Real Estate Investor
Consider the unhappy surprise this investor had post-closing. He purchased a four unit building and did not review the tenant leases in advance nor did he request tenant estoppels. He did realize that the rental rates were relatively low and post-closing was looking to raise rates from existing tenants. Not only did he not realize that he was unable to simply modify the leases at will, but he also discovered that the prior owner gave one tenant a lifetime right to occupy the property at a fixed rate that could not be increased. Ever. Had the purchaser taken the very simple step of obtaining estoppel certificates prior to the closing, this problem lease could have been discovered and the financial terms of the deal modified accordingly.
What is the Purpose of the Estoppel Certificate?
The prospective purchaser of a commercial property has a keen interest in obtaining estoppel certificates from as many tenants as possible. The purposes of an estoppel certificate include:
to give a prospective purchaser or lender information about the lease and the leased premises;
that there are no defaults in the lease or delinquency in performance by the tenants;
that the tenants have not raised claims against the landlord that the prospective purchaser might have to deal with post-closing;
that there are no special agreements or concessions given by the landlord to the tenants that do not appear in the lease. These might include agreements to pay for tenant improvements to the leased premises or rent abatements; and
to give assurance to the purchaser and their lender that the tenant at a later date will not make claims that are inconsistent with the statements contained in the estoppel.
Depending on the size of the target property, a 100 percent response rate from tenants may not be feasible, but a purchaser should insist on estoppel certificates from all tenants whose tenancies are a key component of a property’s cash flow. As part of its due diligence, a purchaser will rely upon tenant estoppel certificates in determining the offering price for the shopping center, and whether the price ultimately paid is reasonable, given the property’s income-generating capacity.
If you’re purchasing commercial property, whether it’s a two-unit rental or a multi-story apartment building or office building, the experienced real estate attorneys at Fiffik Law Group can help you make the acquisition a success. We are experienced in all phases of commercial contract negotiation, due diligence and closing the deal.