“Real estate provides the highest returns, the greatest values, and the least risk.” That is the advice self-made millionaire Armstrong Williams has for investors, and this sentiment is echoed by many who consider property investments as a cornerstone to building long-term wealth.
While it is true that commercial real estate investments can be extremely rewarding, you need to exercise caution as well.
One specific area to watch out for is the labyrinth of legal issues surrounding property acquisitions. A minor misstep or a lack of knowledge about the applicable commercial real estate regulations could have grave consequences.
In the sections that follow, we will discuss some of the key legal considerations commercial real estate investors should be aware of.
We will also outline the practical measures you can take to remain compliant with the regulatory framework applicable to property acquisitions.
Understanding the Zoning Laws and Building Codes
Violating zoning laws and building codes can lead to costly delays, penalties, and in some cases, even project cancellations.
Let us understand what zoning laws and building codes are and how they work:
Zoning Laws
- Zoning laws are established by local governing bodies such as city councils or planning commissions.
- They dictate how a property can be used. The land is typically classified as residential, commercial, industrial, or mixed-use.
- Zoning laws also place restrictions on development. The Floor Area Ratio (FAR) regulations set by the local governing body determine the maximum allowable building floor area relative to the lot size.
CRE investors must verify that a property is zoned appropriately for its intended commercial use.
Building Codes
- State and local governments regulate the construction, renovation, and maintenance of buildings.
- The primary purpose of building codes is to ensure public health and safety and to lay down the rules for compliance with federal standards pertaining to property accessibility.
- Building codes also address energy efficiency requirements.
It is essential for investors to secure the required permits before starting construction or renovation activities.
What if CRE investors fail to comply with zoning laws and building codes? A breach of the law could result in fines and penalties.
In certain instances, the local government authority responsible for enforcing the zoning and building regulations could even issue a stop-work order.
However, it is important to remember that property owners typically have the right to appeal or correct violations to lift the order.
Legal Title Review
Title due diligence is a crucial part of the investment process. Before purchasing a property, investors need to get answers to some basic questions:
- Does the seller legally own the property?
- Are there any ownership disputes?
- Is a historical record of past owners available?
- Has the property changed hands legally in the past?
- Has a licensed land surveyor physically inspected and mapped the property?
If the property title is found to be clear, the next step is to purchase title insurance. This coverage protects investors from financial loss if an undiscovered issue, like forgery or a clerical error, subsequently comes to light.
Physical Inspection
In several states, sellers are legally required to disclose the property’s condition prior to sale. Additionally, if the deal is being financed, the lender would usually require a Property Condition Assessment to be carried out.
Buyers typically engage licensed third-party professionals to inspect the property before purchase. It is also a common practice for an engineering firm to be retained to carry out a detailed check of:
- Structural components of the building
- HVAC systems
- Plumbing
- Electrical systems
- Elevators and common areas
If the building is old or showing signs of foundation cracks, it may be necessary to bring in a structural engineer to determine if repairs are needed.
It is also a good idea to hire a qualified fire protection and life safety professional or certified inspector to check the fire suppression systems, alarms, and emergency exits.
Environmental Compliance
There are multiple state and federal regulations in place regarding environmental compliance. These cover a wide range of areas, the most important of which are:
- Water management
- Conservation
- Air quality
- Land use
Non-compliance with environmental regulations can result in legal action and substantial fines. CRE investors should consider hiring specialized professionals to ensure that they comply with the applicable laws.
A consultant who works in environmental due diligence could be of great help. Based on the specifics of the deal, investors could also think about using the services of an environmental attorney or an environmental risk assessment specialist.
Tenant Rights
Property owners should take the time to understand the rights their tenants have. These rights are governed by a combination of federal, state, and local laws, as well as the terms of the lease agreement that property owners enter with their tenants.
While specific tenant rights vary by state, common protections include the following:
- Tenants have the right to occupy and use the premises without interference from the landlord if they comply with the lease terms.
- It is the property owner’s responsibility to ensure that the building complies with the applicable building codes as well as health and safety requirements.
- The property owner must also ensure compliance with the Americans with Disabilities Act (ADA). Among other rules, the Act stipulates that commercial buildings that are open to the public must have accessible entrances, parking, signage, and restrooms.
If landlords fail to uphold tenants’ rights, they could face financial and legal repercussions. A large number of states impose fines for each day or instance of violation.
Consequently, there could be a significant monetary implication for property owners who, for instance, fail to provide essential services such as electricity and water to their tenants.
Non-compliance with the ADA can have serious implications. There are civil penalties of up to $75,000 for the first violation and $150,000 for subsequent violations.
The Bottom Line
When buying commercial property, investors must familiarize themselves with the applicable laws and regulations. Non-compliance could lead to fines, legal disputes, and project delays.
If the issue is serious, the violation could even result in project cancellation. CRE investors should keep these legal considerations in mind when initiating a property acquisition.
