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Los Angeles Business & Commercial Law Blog

The importance of due diligence in commercial real estate

Before proceeding with the purchase of commercial real estate, California buyers should complete due diligence on the property to make certain that it is what has been represented to them and that it is worth the asking price. Conducting due diligence may take weeks or months. Sellers often want to negotiate shorter periods so that they can complete the transactions faster.

Buyers will need enough time to review the property's zoning and compliance, structural integrity, conduct title research and inspect the books. They will want to find out if the amount of money that the seller claims comes in every month really does. Finding out the actual occupancy and vacancy rates is also important to make certain that the property will provide the desired cash flow.

Commercial real estate investors see values at their peak

The value of commercial real estate varies greatly throughout California, and investors appear to be growing cautious according to the NREI/Marcus & Millichap Investor Sentiment Survey for the third quarter of 2017. A majority of respondents, 71 percent, believed that the price cycle for commercial properties had reached a peak.

Despite concerns that property values have crested, 49 percent of those surveyed possessed confidence that construction levels would increase. They believed that the Trump administration would have a positive effect. Confidence, however, has declined since the fourth quarter of 2016 when 56 percent of surveyed investors expected more construction.

The 2028 Olympics and commercial real estate

With the 2028 Olympics coming to Los Angeles, the city is poised to increase its rank among world cities. Global cities are those cities that lead the way economically and culturally. Business and innovation boom in these centers. Already, Los Angeles has a thriving real estate market, and this will only increase the health of it.

As cities climb the ranks among global centers, businesses are more likely to invest and locate their hubs in those places. More people move to the cities because there are more jobs. Hosting the Olympics also means money coming into the city in the form of overseas contracts, sales, licensing, broadcast rights and tourism.

Dollar threshold for appraisal requirement may increase

Banks in California may not be required to obtain a certified appraisal to approve loans for commercial properties valued at or under $400,000 if a new rule is approved. Currently, financial institutions that provide loans must have a certified appraisal for properties valued at more than $250,000. This increase could make it easier for commercial real estate buyers to be approved for loans. Federal banking agencies came together to propose the rule change since it would alleviate some of the regulatory burden placed on them under the current rule.

In 1989, banks became legally obligated to standardize their rules for appraisal internally. In 1992, an amendment to the law allowed federal banking agencies to set a dollar amount as the value at or above which properties must be evaluated by a professional appraiser in order to approve a loan. Two years later, federal banking agencies chose $250,000 as the minimum value. If the proposal goes through in 2017, the new minimum value for a property that would require a certified appraisal to be approved for a loan will be $400,000.

Uncertainty may be cooling the CRE market

Economic and political uncertainties are continuing to suppress commercial real estate values in California and around the country according to a growing number of industry experts. Commercial property prices dropped by 0.3 percent in June, and falls were observed in all five core property segments. The decline marks the second consecutive month that values on the online real estate company Ten-X's pricing index have fallen. However, commercial property prices remain near record highs and have more than doubled since 2010 according to Real Capital Analytics.

Industry analysts say that investors seeking solid and secure returns are turning to alternative assets like medical facilities and student housing, and projects in smaller markets such as Nashville and Atlanta are also gaining in popularity. Secondary and tertiary cities have been overlooked in recent years as developers focused their energies on major gateway markets, and this has sometimes led to severe supply shortages and fierce demand for space. However, many investors are still reluctant to act because of continuing doubts about the economy and the political climate in the nation's capital.

Performing due diligence before buying commercial property

Prospective purchasers of California commercial real estate most likely do not look forward to performing due diligence, but they make the effort because they know that taking shortcuts in this area can cast a long shadow. Poring over documents may not provide much in the way of excitement, but the information this kind of research can yield about the legal, financial and physical condition of a property could be crucial.

The information uncovered during due diligence can protect commercial property sellers as well as buyers. While the process provides buyers with what they need to make more prudent decisions, sellers are less likely to be sued over undisclosed defects or misrepresentation. The due diligence process generally begins in earnest when an initial offer is made, and buyers often have 30 days or less to gather the required financial and legal documents and have the property physically inspected.

CRE refinancing growing more complex

California commercial real estate developers may already have felt the impact of credit constraints and Dodd-Frank regulations on their ability to refinance their projects. Hesitant lenders, a scarcity of loan funds and growing piles of required paperwork have made it a difficult, time-consuming process to refinance commercial real estate.

The Dodd-Frank Wall Street Reform and Consumer Protection Act made banks subject to more restrictive lending rules, including a requirement that lenders retain more capital in loan loss reserves. The managing director of JLL Finance Group said the amount lenders are able to lend has decreased by around 10 percentage points on a loan-to-value basis. Where banks might previously have lent a commercial property owner 75 to 80 percent of the property value, they are now lending 65 to 70 percent.

Commercial property loans up, despite higher interest rates

Those who are thinking about purchasing commercial real estate in California may be encouraged to learn that commercial real estate lending activity is strong amidst growing interest rates. In fact, commercial lending is growing faster than other types of loans, such as retail and unsecured loans.

According to reports, the rate of loan growth in U.S. banks during the first months of 2017 was down, mainly because of higher interest rates. Less enterprises and individuals want to take on new debt at these higher rates. However, as of May 2017, about 22 percent of lending was for commercial real estate, while credit card loans accounted for only about 8 percent. Retail loans at 7 percent include student loans, vehicle loans and various other types of secured consumer loans, and credit card loans consist of unsecured consumer loans.

Sales figures suggest that CRE markets are cooling

The commercial real estate markets in major California cities like Los Angeles, San Diego and San Francisco have been extremely active in recent years, but property sales data for the first quarter of 2017 suggests that investor enthusiasm is waning. First-quarter property sales in New York City were down by 58 percent compared with the same period a year ago, according to data released by the brokerage firm Cushman & Wakefield. Analysts say that overbuilding and political uncertainty may be to blame.

The business community generally reacted positively when Donald Trump was elected president, but many top executives are now expressing doubts. Some business leaders feel that Trump will be unable to pass the tax cuts he has promised, and others worry that the reduced taxes and increased spending the president is championing could lead to higher inflation, soaring interest rates and slower growth. These fears are particularly pronounced in sectors like real estate that are heavily reliant on financing and debt.

Breach of fiduciary duty 401(k) lawsuit moves forward

A lawsuit against Starwood Hotels is moving forward in a California federal court. In a ruling on May 1, a judge moved forward the claim that Starwood's record-keeping and administrative fees were so excessive as to breach the company's fiduciary duty to 401(k) plan participants.

The judge noted in his opinion that the plaintiffs in the case have not yet specifically alleged exactly how Starwood's fiduciary duty was breached. However, the facts that they have so far brought forward were sufficient in order for the case to continue.

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