Illinois Commercial Real Estate: Due Diligence to Closing, with Checklists

By R. Kymn Harp

Illinois Commercial Real Estate is a practical handbook and unique resource for investors, developers, brokers, lenders, attorneys, and others interested in commercial real estate projects in Illinois. If you are involved in commercial real estateespecially in Illinoisthis book is a must-have addition to your library. Sometimes humorous and always useful, Illinois Commercial Real Estate provides best-practice guidance gleaned from the authors lifetime of experience growing up in a real estate family and his thirty-seven-plus years as a commercial real estate attorney. It is packed with pearls of wisdom acquired by working in the trenches with creative clients actively engaged in the commercial real estate business. The authors practical approach to commercial real estate due diligence and closing and the invaluable insights and closing checklists he shares serve as benchmarks for commercial real estate transactions throughout the USA.

• Language: English
• Publisher: Xlibris US
• Release date: Aug 22, 2016
• ISBN: 9781524535087

R. Kymn Harp

R. Kymn Harp is a recognized thought leader and resourceful advocate for commercial real estate investment and development. A solutions-oriented attorney, Kymn (pronounced “Kim”) takes a practical approach to all transactions. Using the mind-set of an entrepreneur, Kymn is dedicated to overcoming obstacles and finding solutions for successful outcomes. His motto, “If the deal doesn’t close, it doesn’t count,” guides his efforts. Kymn is a working lawyer. His knowledge of commercial real estate and creative problem-solving is the result of thirty-seven-plus years in the trenches. Kymn’s passion is deal making. Through a labor of love, he works tirelessly every day to earn his clients’ business and their trust. He truly is a trusted advisor. This book reveals why. Illinois Commercial Real Estate is a unique resource for the commercial real estate industry. Author contact Robbins, Salomon & Patt Ltd. 180 N. LaSalle St., Suite 3300 Chicago, IL 60601 Phone: [phone] E-mail: [e-mail]

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Copyright © 2016 by R. Kymn Harp.

Library of Congress Control Number:   2016913654

ISBN:      Hardcover      978-1-5245-3510-0

      Softcover      978-1-5245-3509-4

      eBook         978-1-5245-3508-7

All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without permission in writing from the copyright owner.

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Rev. date: 08/16/2016

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CONTENTS

Preface

Using this Book

Part I Getting to Closing

1 Deal Flow If It Doesn’t Close, It Doesn’t Count

2 Four Keys to Closing a Commercial Real Estate Transaction

3 Ten Things Every Buyer Needs to Close a Commercial Real Estate Loan

4 Perfect Seller!

Part II Commercial Real Estate Due Diligence

5 Small Deal Due Diligence

6 Property Due Diligence Do You Know the Four Areas of Inquiry?

7 Planning the Due Diligence Investigation

8 Property Due Diligence vs. Transaction Due Diligence

9 Sources of Information for Conducting a Due Diligence Investigation

10 Due Diligence Checklists for Commercial Real Estate Transactions

Part III Commercial Real Estate Development

11 Turning Brownfields Green via Public-Private Partnerships

12 Government Money for Private Development

13 Top10 Things to Know about Commercial Real Estate Development Agreements

14 Land Development Preparing for Change

15 Air Rights Developing the Air Up There

Part IV Asset Protection in Illinois

16 Asset Protection Lessons Learned

17 Asset Protection Legitimate Endeavor or Moral Hazard?

18 Illinois LLCs: An Asset Protection Advantage Technical Analysis

Part V Section 1031 Exchanges Tax-Deferred Exchanges of Real Estate

19 Why Consider a Section 1031 Like-Kind Exchange?

20 Key Rules for Section 1031 Exchanges

21 The TIC Trap

Part VI A Few Thoughts on Commercial Real Estate Loans

22 Lending Blind What You Don’t Know Can Hurt You

23 Assignments of Rent: Lenders Beware!

24 When Wraparound Mortgages Return: The Time to Plan Is Now

Part VII Commercial Condominiums and Condominium Issues

25 Commercial Condominiums

26 Condominium Deconversion

Part VIII Commercial Leases Landlord-Tenant Issues

27 Commercial Leases

28 Rights and Remedies Arising under Commercial Leases

Part IX Choosing Commercial Real Estate Projects

29 Momentum Investing vs. Value Investing

30 Cool Projects Real Estate Projects I Love to Work On

To the dealmakers

Special thank

s to

My clients, whose passion for creative commercial development I share;

My partners and staff at Robbins, Salomon & Patt, Ltd., who work with me tirelessly to earn our clients’ business every day;

Catherine A. Cooke and Emily C Kaminski, attorneys at Robbins Salomon & Patt, Ltd., who provided legal research, advice, counseling, and technical editing;

James M. Mainzer, tax partner at Robbins, Salomon & Patt, Ltd., for his insights and assistance on tax matters;

The editing staff at the Illinois Institute for Continuing Legal Education, for editing early versions of chapters 11, 12, 25, 27, and 28, which were first published in IICLE Practice Handbooks; and

Dale V. Weaver, Illinois licensed surveyor, who was kind enough to convert my rough drawings into the diagrams included in chapter 25.

Personal acknowledgements to

Aunt Sophie, and the next generation, Ryan Harp and Ashley and Ken Klotz, for valuable lessons taught;

Delanie Lawrence, W.M.E., for her energy, good humor and enthusiasm;

Becca Tepper, a powerful voice by example for young women entrepreneurs; and

The dedicated volunteers at K9s for Warriors, for making a difference.

PREFACE

This book is about Illinois commercial real estate. Why? Because, Illinois is where most of my clients invest most of their money most of the time.

I am licensed to practice law in Illinois, Indiana, and New Mexico. Periodically, I handle commercial real estate transactions in other jurisdictions as well. But Illinois is my home. Illinois real estate is what I love and know best. Illinois is where most of my clients are located.

My law firm is in Chicago, where I have based my law practice my entire professional career. From downtown Chicago to the suburbs, Chicagoland is at the forefront of real estate development and investing. Chicago is the birthplace of the skyscraper. Chicago is an air rights-development pioneer city, with its entire central business district built, literally, in the air. Chicago is the principal money center of the Midwest and serves as an incubator for laws and development concepts applicable throughout the state of Illinois and beyond.

I’ve been fortunate to spend my entire thirty-seven-plus years as an attorney representing real estate investors, developers, lenders, brokers, and private businesses in Illinois real estate transactions. It’s what I wanted to do with my professional life. It’s why I became a lawyer.

As a kid growing up in southern Indiana, I was raised in a real estate family. My father and my mother were each business owners and active participants in the real estate industry. My grandfather was a business owner and real estate investor. My father’s brother, Bob, and his family were active in real estate. Real estate and real estate investing were always topics of conversation at the dinner table and family gatherings. I purchased my first rental property and became a landlord when I was sixteen years old. It’s what we did in our family. We were interested in real estate, and my family invested in real estate. It’s where I come from, and it has always informed my understanding of what’s important to my real estate investing clients.

From the time I first became a lawyer, I knew I would eventually write a book on commercial real estate. This book is actually my second. My first was an unfortunately timed book sent to the publisher in August of 2008, roughly three weeks before the collapse of Lehman Brothers, and published in February 2009, at a point when the commercial real estate industry was in a state of extreme economic collapse. The title of the book, Intent to Prosper, could have hardly been more ironic given its release date in the depths of the Great Recession.

To the few who purchased Intent to Prosper, I apologize in advance. I will confess that I have updated and repackaged some of the chapters from that book that remain useful today. I have added much more, and have left out some of the distressed property loan workout chapters I added to the second edition of Intent to Prosper to reflect the times. This book began as a third-edition edit to Intent to Prosper, but there was so much I wanted to add and change it seemed reasonable to begin anew, with a new project that became this book.

If you regularly follow my blog, www.Harp-OnThis.com, you may recognize some of the material in this book. Unlike a novelist, those of us who write to inform don’t hoard our thoughts for release in a fresh tome of knowledge. We publish as we go, which is one of several reasons a book like this will never end up on the New York Times Best Seller List. But hey, I can live with that.

My hope is that you will find the information in this book informative and useful. Better yet, I hope you will find in the pages of this book at least a few practical ideas or concepts that will help you succeed in achieving your specific objectives in commercial real estate.

The goal of all investors and stakeholders in commercial real estate is to make money. Achieving that goal takes teamwork, insight and a developer’s vision.

I love what I do, and find the creative challenge of working with visionary developers exhilarating. New clients with new ideas and cool projects can be as much fun as the clients I have represented for years. I am an attorney for hire and stand ready, willing and able to provide legal assistance to any creative client with a real estate project on the drawing board and money to pay my fees.

Regarding attorney’s fees, let me make one final comment as a lead-in to this book.

My clients are typically private individuals and family-owned businesses and entrepreneurs who are investing their own money, or the money of a close-knit group of friends, private investment partners, or colleagues. They are not typically large real estate investment trusts (REITs), private equity funds, or other big-money interests. To my clients, every dollar spent is a dollar that matters. Because of this reality, my clients are cost-conscious and measure value by bottom-line results.

I understand why REITs, private equity fund managers, and other big-money interests who are investing other people’s money are quick to hire megasized national and international law firms that make up Big Law. In their shoes, I might do likewise. Not because I believe the actual legal work performed by Big Law lawyers justifies fees that are roughly twice my hourly rate, but because for real estate deals in excess of $100 million, where an institutional investor is using other people’s money, hiring Big Law and paying Big Law fees is like buying insurance.

But understand this: the insurance being bought is not against potential legal or tactical mistakes being made by the lawyer handling the transaction. Sophisticated commercial real estate transactions may be time consuming, but for any experienced commercial real estate attorney, they are not overwhelmingly difficult or risky to handle. Some would have you believe otherwise, but the legal and transactional risks dealt with by attorneys in commercial real estate transactions are manageable by any experienced and knowledgeable commercial real estate attorney.

Most commercial real estate transactions can be handled by one or two attorneys and a paralegal. Even in a particularly large transaction on a tight time frame, a very small team of attorneys and paralegals can usually get the job done without difficulty. It does not take a team of ten to fifteen lawyers charging Big Law rates.

The insurance value of hiring Big Law for a commercial real estate transaction arises only in the sense that if a transaction fails, the project developer or promoter can deflect blame by asserting that he or she did everything possible to make sure the project succeeded. I hired one of the biggest law firms in the world with the highest-priced lawyers in town—what more could I have done? The insurance is against the perception risk, so that the promoter doesn’t face the question from investors as to whether, maybe, the transaction would not have failed if more expensive Big Law lawyers had been hired.

On a huge transaction, where paying attorney fees to multiple attorneys at rates of $750, $850, $950, or more per hour can be easily absorbed, it may be worth it to the promoter to be able to point to Big Law and say to its investors, It’s not my fault. Especially when Big Law is being paid with the investors’ money rather than the promoter’s.

When private commercial real estate investors, developers, and business owners are spending their own money, the value of having Big Law to point a finger at if something goes wrong may not be so important—especially if it means paying double (or more) the attorneys’ fees that might otherwise be charged. In fact, except in the case of deal killer lawyers I occasionally mention in this book, when a deal goes bad, it seldom has anything to do with what a lawyer did or did not do. What typically goes wrong with a transaction, on those occasions when something does go wrong, is much more likely to be a failure of financing, a physical failure of the property to adequately accommodate an envisioned use, a failure to obtain a necessary lease or end-user, a failure to obtain necessary zoning or other local government entitlements, or a failure of some other uncontrollable third-party requirement to be fulfilled for the transaction to proceed.

Lawyers in commercial real estate transactions are, or at least should be, facilitators and problem solvers. Their skill-set is centered on knowing the law, assessing the facts, and understanding and managing the process from deal inception to closing, with a view toward making sure the client gets what it bargained for, and that the project has the legal framework to function as envisioned after closing. A qualified commercial real estate lawyer will have a well-honed skill-set that can be invaluable in moving a transaction forward, and in finding solutions and opportunities that may not be obvious to others. Still, there are some obstacles no lawyer can overcome. They cannot, for instance, turn a 10,000-square-foot parcel into a 40,000-square-foot parcel if that’s what a project truly needs (unless the expansion can be solved by going up through creative use of air rights development opportunities as discussed in chapter 15).

And don’t make the mistake of accepting the tired slogan You get what you pay for. Merely being charged twice as much does not mean you are getting twice as much.

Many highly competent lawyers have made a strategic decision to work with small- to medium-sized law firms rather than work at Big Law. There are many reasons to do so that have nothing to do with quality of work. In my case, I moved to my current law firm in 2008, from a firm that was five times larger. Although I do not consider my prior law firm a part of Big Law either, it suffered from many of the same inefficiencies and built-in legacy costs that plague Big Law and drive up hourly rates.

Upon deciding to switch law firms, I was fortunate to have had plenty of choices on where to land. I had often worked in transactions with Big Law on the other side, and had developed strong relationships with many colleagues from Big Law. One in particular was the managing partner of the Chicago office of a Big Law firm among the top 100 largest in the world. He was also the real estate practice group chair for the entire law firm. We had worked together on a number of complex and high-profile real estate transactions over the previous twenty-five years. Because my skill-set would be valuable to his firm and its clients, he offered to hire me on the spot. He noted, however, that within eighteen months, I would be expected to nearly double my hourly rate charged to clients. The reason, he explained, had more to do with his firm’s fixed infrastructure costs and legacy costs than anything else. They had offices throughout the United States, London, Brazil, Vietnam, Singapore, China, and beyond, and the technology and support staff to connect them all. The question he suggested I ask myself was this: Do my real estate investment and development clients, and privately owned businesses need a law firm with offices in Vietnam, Brazil, London, China, and beyond? Because they will be paying for these worldwide offices, whether they need them or not.

Of course, the answer was obvious. My clients do not need a global law firm. The maxim that all real estate is local is certainly applicable to my clients’ projects, which are primarily in Illinois. When they occasionally get involved in transactions in far-flung jurisdictions, I can selectively associate with local counsel in those locations when and as needed. But most of the time, it would make no sense to ask my clients to pay Big Law overhead for offices and support staff they will never use.

Instead of Big Law, I chose to move to my current firm of roughly forty lawyers, where I was able to cut my hourly rate by 20 percent instead of doubling it. A forty-lawyer firm based in downtown Chicago is more than capable of handling all the commercial real estate, business, tax, litigation, and other legal needs of my Illinois-based clients, and is able to do so at a fraction of Big Law cost. Do you really think I somehow got 50 percent to 70 percent dumber and less experienced just because I decided to practice at a medium-sized law firm instead?

I’m not criticizing Big Law. There is a place for Big Law. It makes sense for some big-money interests who are spending other people’s money to hire Big Law under some circumstances. Big Law has a role to play in sophisticated international transactions and in transactions involving esoteric areas of law. But for commercial real estate? Especially Illinois commercial real estate, where we have a plethora of competent commercial real estate lawyers at much smaller law firms who are more than capable of providing high-quality representation at a fraction of the cost? Will an office in Vietnam or in San Paulo, Brazil, help you close, finance, or develop your project in Illinois?

The market for investment-grade real estate may be global, but all real estate projects are necessarily local. Local laws govern. Local rules and regulations apply. Local governments are directly involved in the entitlement process, zoning approvals, and project permitting. Whatever lawyers you choose, make sure they know the law and the process in the jurisdiction where your project is located.

Who to hire as project counsel and how to spend your money is a business decision. Ultimately, it’s up to you to decide which lawyer or law firm to hire for your commercial real estate project. All I’m suggesting is that you make that decision based upon genuine business considerations rather than some notion that does not reflect reality.

Having said my piece, let’s begin.

Enjoy!

USING THIS BOOK

This book is organized into nine parts with a total of thirty chapters for convenience of reference. It does not necessarily need to be read in order from front to back. Some basic concepts are addressed in the early chapters that may be helpful in understanding later chapters, but many other concepts more or less stand alone.

Feel free to jump around to the chapters that interest you. If concepts are discussed that seem to rely on an understanding of concepts addressed in an earlier chapter, you can always go back. It is your book. Use it however it best serves your needs.

Part I

Getting to Closing

1

Deal Flow

If It Doesn’t Close, It Doesn’t Count

Attend any gathering of commercial real estate professionals, and sooner or later, you will hear them talk about deal flow. Commercial real estate professionals love deal flow. It’s what we live for. Deal flow is addictive. We always need more.

If you google the term deal flow, or look it up in Wikipedia, you are likely to come up with a definition used in the M&A world by finance professionals such as venture capitalists, angel investors, private equity investors, and bankers. To them, deal flow refers merely to the rate at which they receive business proposals or investment offers to consider. That may be great for them, but real estate professionals are looking for much more than mere proposals and investment offers to consider.

In the world of commercial real estate, deal flow refers to closings. If it doesn’t close, it doesn’t count. It’s that simple.

At any given time, there are countless numbers of potential commercial real estate transactions being spun up for consideration. Almost everything is on the table. It may be a new ground-up development or redevelopment of an outdated project, a new leasing opportunity, or new or replacement financing for an existing project, or an investor could be considering a tax-advantaged exchange of real property, or simply adding another qualified project to an investor’s project portfolio. Whatever it is, the bottom line in commercial real estate is this: The deal has to close. If it doesn’t close, it doesn’t count.

Fortunes can be spent pursuing deals that never close, often for reasons that have more to do with the potential buyer, lender, or end-user than with the property or project itself. Sometimes deals fail to close because a key party—be it the buyer, seller, or lender—is unprepared to close, legally, financially, or even emotionally. Other times, obstacles to closing can be municipal governments, neighboring property owners, environmental concerns, zoning or private land use controls, or changes in economic circumstances, to name a few. There are almost as many reasons for a failure to close as there are grains of sand on the beach. But one thing is certain: in commercial real estate, if the deal doesn’t close, it doesn’t count—for anyone. Time is wasted. Money is lost. And the key parties are unhappy.

There are people—including, worst of all, some attorneys—who get in over their heads, become overwhelmed, and sometimes act in a way that kills a deal that becomes too complex for them to handle. These people are generally referred to as deal killers. They fear being exposed for their lack of skill and dread revealing their incompetence. In my world, this is inexcusable. There are plenty of legitimate reasons for a deal to fail, but incompetence and fear of failure are not among them. Surround yourself with competent people.

Worse than deal killers, however, are the fantasy players. These are people who identify themselves as buyers, but who bite off more than they can chew and simply do not have the resources available to move forward. This is tragically common. I say tragic because it is a complete waste of time and money for everyone. You have to wonder what alternate universe these people live in that impels them to go into projects and transactions where they objectively have no possible chance of succeeding. Typically, these people have some grandiose delusion that if they spin up a deal on paper that looks fantastically profitable, some private equity group or other moneyed interest will find it irresistible and be satisfied to make a marginally attractive return, while the fantasy player makes a financial killing. In truth: it doesn’t happen. Not in the real world of commercial real estate.

People and private equity groups with large sums of money did not accumulate great wealth by being naïve or stupid. Cash is king. The investment marketplace is global. Moneyed interests (except, occasionally, doctors and third-generation business owners) don’t invest in pipe dreams structured to make other people rich while they take the primary financial risk. Deal promoters who know a guy who will provide the big money to close a transaction while he/she middles the deal to siphon off the real money are time wasters. They have no respect for you or your time or resources, and will waste your money. They will always want you to take your share on the come. They will promise you the world, because they have nothing to lose. The dollars and returns they cite are almost always huge, and imaginary. As with virtually all things in commercial real estate, if the deal doesn’t close, your return will not materialize. It may have all the trappings of a real deal, but without verifiable access to money, it has no realistic chance of closing.

Assess your transaction counterparts to determine their capacity to close. Learn to recognize fantasy players and the signs of deal jeopardy early, and take appropriate steps to overcome closing obstacles. Avoid time wasters and incompetents.

Make a sign to hang on your wall. Put it on your computer screensaver. Repeat it as your daily mantra: If the deal doesn’t close, it doesn’t count. If the deal doesn’t close,