By Dale C. Eisenman
After the self-storage buyer completes the due-diligence process, the parties ready themselves and the property for the exchange. Typically, there’s a three- to four-week period from the end of due diligence to the closing of the transaction. What occurs during that time? Each situation is different, but there are some common elements. Let’s take a look at what you can expect during the closing process of a self-storage real estate transaction.
Both buyer and seller will want to investigate the conversion or transition of the software currently being used at the facility. The seller should investigate the costs and steps needed to retain the historical information so access can be gained post-closing. The buyer will want to be able to either continue with the same software or convert it to another.
There’s usually a cost associated with making the data available for conversion, including the credit card information tenants have on file. Timing is important, and the switchover usually occurs on the closing date or just before.
The seller will have informed his staff of the sale, and once due diligence has been completed, the buyer may choose to interview and hire one or more of the employees. Approaching staff during the due-diligence process about future employment is inappropriate. Most buyers understand the protocol and won’t approach the employees regarding job opportunities without coordinating with the seller.
Staff members should be informed that they’re not to contact the potential buyer until such time as both the buyer and seller agree. It’s understandable that current employees are anxious about the situation and the uncertainty it creates. However, by keeping them informed as to when and how future employment can be discussed helps the process.
All expenses and revenue must be prorated in accordance with the purchase agreement. Real estate tax, which is paid in arrears—meaning that it’s paid near the end of the current year—is a good example of an expense proration. The buyer pays for the full year even though the period of ownership is less. Therefore, he receives a credit at closing for the portion of the year the property is owned by the seller.
It was traditional to base the proration on the most recent real estate tax bill. However, it’s increasingly common to apply a percentage, say 105 percent, of the most recent tax bill for the purpose of prorations and/or to provide for a post-closing adjustment once the actual tax bill is received.
Rent prorations are commonly done on a unit-by-unit basis, with the buyer receiving a credit for each day that has been prepaid by the tenant from the date of closing and beyond. The methodology should be reviewed carefully. For example, consider a closing in which some tenants’ prepaid rent was calculated differently from others by one day because the software assigned 11:59 p.m. to some tenants and 12 a.m. to others, which resulted in a full day’s difference in prepaid rent.
Utilities, Phones, Internet
Typically, the buyer can coordinate the transfer of utilities, but often the seller must provide account information and authorization to transfer phone lines, Internet service and other utilities. It’s important the parties agree on who will do what. Either the buyer or the seller should be tasked with the responsibility to accomplish the transfers.
Integration with the appropriate website should be coordinated in advance, particularly if rent payments are received online. In some cases, the buyer will want to take over the seller’s website; or he may replace the existing website or integrate it with another.
Defeasance and Loan Payoff
As part of the transfer of ownership, the seller delivers the property free of encumbrances such as mortgages unless the buyer agrees to assume the mortgage. If the property has a commercial mortgage-backed securities loan, it often can’t be prepaid (except just before maturity) and must be assumed or defeased.
The defeasance process could be the subject of an entire article, but simply stated, it involves the purchase of government securities to take the place of the collateral and provide for the timely payments required under the loan agreement. Some loans have a yield-maintenance provision or other prepayment provision, which the seller should investigate early in the sales process.
Closings are often done by title companies who also serve as escrow agents. Prior to closing, the escrow agent will circulate a draft settlement statement reflecting credits and debits for the buyer and seller including fees and prorations. The statement details what funds are required from the buyer, what credits and debits are allocated between the buyer and seller, and how the remaining funds are disbursed. It’s common for the funds to be received and disbursed by wire transfer on the date of closing.
Possession and Ownership
Unless otherwise agreed in the purchase and sale agreement, the buyer is the new owner of the property on the day of closing as of 12:01 a.m., even if the funds are not disbursed to the seller until later in the day. Sometimes closings can be delayed, which complicates the operation of the facility during the period of such delay. Technically, until closing, the property remains with the seller. If there’s significant delay, all prorations must be recalculated to be accurate.
Accordingly, subject to the purchase agreement, the seller delivers possession of the facility to the buyer on the date of closing. The seller should have one staff member onsite on the day of closing to assist with any needed items as a courtesy to the buyer. Unexpected and sometimes very simple issues can arise and be easily addressed by the seller’s manager.
Tenants are notified in writing of the change in ownership and provided instructions and information regarding payment options. In some cases, the buyer and seller may collaborate on the notice, but often the buyer determines the content and timing.
It’s common to have last-minute, unanticipated issues arise just before or on the day of closing. This might include a water shut-off, interruption of Internet services, staffing issues, and other misunderstandings or miscommunications. There should be clear lines of communication to report and address any such issues. The goal is a smooth transition with minimum interruption to the operation of the self-storage facility.
While the items above are not intended to be an all-encompassing list or comprehensive outline of the closing of a real estate transaction, they’re meant to provide a general idea of what’s commonly involved. Knowing what to expect and your role—whether you’re the buyer or seller—will lead to a smoother transaction for all.
Dale C. Eisenman is president and broker-in-charge of Midcoast Properties Inc., as well as a licensed real estate broker in Georgia, and North and South Carolina. In addition to being a professional pilot early in his career, he has practiced law, owned and operated several small businesses, and been an active commercial real estate investor for more than 20 years. He specializes in the self-storage industry as an investor and broker. To reach him, e-mail [email protected]; visit www.midcoastproperties.com.