Acquiring an operating shopping center can be tricky business in any economic climate. In today’s market, more of our clients are finding great opportunities at attractive prices. But these days, extra caution and focus — during due diligence and beyond — is essential to be sure that your latest bargain won’t become your next headache.
Recognizing that these transactions are often quite complex (and that all potential issues cannot be addressed in a short article), we thought that it might nevertheless be helpful to highlight just a few of the issues that merit special attention when purchasing an existing shopping center.
Know the REA:
It is critical to carefully review any Reciprocal Easement Agreements (REAs) that may be in place at the site. Check the REA for use restrictions, no-build areas, parking ratios, operating covenants, and other restrictions that may affect your interests, which may very well include future development opportunities. Identify no-build or permissible build areas, as well as those uses that are prohibited under the REA.
Understand the parking allocations under the REA, considering how parking may be restricted by spaces reserved for other shopping center uses. Be sure to look for any access or other easement rights in favor of abutting uses or property owners that may negatively impact your use or future development. If necessary, how easy or difficult will it be to amend the REA down the road, and how many parties will need to consent? Focus on the reimbursement structure under the REA for CAM, taxes, and other costs – and watch for exceptions to other parties’ reimbursement obligations.
Protect your audit rights:
Under the purchase agreement, be sure that you have continued access to the seller’s books and records for a defined period of time after closing (and check the audit provisions in the individual space leases to determine that time period). This is important for CAM obligations and possible audits. Ensure that the purchase agreement requires the parties to reconcile applicable charges, if necessary, post-closing. The seller should stay on the hook for any overcharging of CAM, taxes, and other charges that are paid by tenants during seller’s ownership of the property (together with the audit costs if applicable under the lease(s)).
Know thy leases:
Be sure to carefully review all tenant leases in the shopping center and check for all of the typical “pitfalls,” such as exclusive use clauses and other prohibited uses that restrict re-tenanting, and conflicting use provisions that point to potential violations at the site. Do the leases contain site plan controls, and if they do, then how do they impact future development? Are there co-tenancy requirements that, if violated, allow individual tenants to reduce rent payments, or cease paying rent altogether?
Check to see if individual tenants have any purchase rights, such as a right of first refusal, that need to be waived. Review the tax and CAM apportionments and calculations to be sure that they make sense and will work economically going forward.
Wherever possible, ensure that the seller provides originals of all operative documents at closing. Pay particular attention to obtaining fully executed original leases (together with any assignments and/or amendments). In some jurisdictions, a landlord will need to go through evidentiary hurdles to bring an enforcement action against the tenant if the landlord does not have the original of the lease. Having a fully-executed copy of the lease, together with all associated amendments and assignments, certified by the tenant in an estoppel certificate may be helpful “insurance” as well.
Estoppels, estoppels, estoppels:
Be sure to obtain estoppel certificates for leases, REAs, and other critical documents. In drafting the estoppels, avoid a “one size fits all” approach. Carefully review each applicable document to identify points of ambiguity, concern or exposure, and craft your estoppel certifications accordingly. And, when reviewing response drafts from the certifying party, be sure to watch for edits like knowledge qualifiers that can take the teeth out of estoppel protections. Finally, be sure that the estoppel states that it can be relied upon by your successors, assigns, and lenders.
Review zoning and future development plans:
Be sure to analyze the property’s existing compliance with applicable zoning requirements, and identify any areas of non-compliance. Is any non-compliance subject to “grandfathering” protection and, if so, what restrictions might apply to future alteration, expansion, or reconstruction? If future development is part of your strategy for this asset, then carefully review the zoning code to determine whether it would restrict any such development and, if so, how such restrictions may be overcome (whether by obtaining zoning relief or otherwise). If floor area ratio (FAR) and other similar zoning restrictions apply, consider whether future development by other property owners in the shopping center could “eat up” all remaining FAR and effectively preclude your further development of the site.
Read your title:
In conjunction with your title company, carefully review your title commitment and exception documents to evaluate title, and look for any critical easement documents that may have been missing from your due diligence materials (or any “surprise” occupancy agreements). Be prepared for your list of required estoppels to expand based upon this review. Review the manner in which your seller received title to the property and look for any potential issues or defects. This is especially important if your seller acquired the center in connection with a bankruptcy or foreclosure.
Don’t mess with taxes:
Transfer, recording, and/or mortgage taxes can have a substantial economic impact on your transaction. The applicability and amount of these taxes varies depending on the jurisdiction. Also, be sure that your real estate tax proration clause works as intended if you happen to be buying a center in a jurisdiction where real estate taxes are paid in arrears. For the above and many other reasons (including ensuring an accurate pro forma for the purchase), these issues should be vetted as early in the transaction as possible.
Each transaction certainly is unique and presents its own challenges, but, with careful diligence and thoughtful attention to possible areas of risk, your next acquisition can be a reliable and profitable investment for years to come.