Regardless of whether you’re buying a home or a piece of investment property, there will always be risks involved. Your goal should be to lessen these risks as much as you can. Examples of potential problems that oftentimes lead to legal disputes include:
- Defects in title
- Debt service and lender requirements
- Mechanics liens
- Zoning and land use problems
- Market fluctuations
- Hazardous waste and environmental contamination
Real property interests are usually conveyed by a deed. In order to track how property changes hands, every state has a public record system where real property deeds are recorded, becoming a part of the public record system for everyone to see. In theory, this is a great system for keeping track of who owns what, but deeds are sometimes not recorded. Sometimes people sell or transfer partial interests in property. Lenders make loans against properties and record mortgages or deeds of trust that become liens that are of public record. Easements given to cross over or use property may or may not be of record. A judgment against a person can be recorded and become a lien against any real property that person owns, even without his consent. All these things can become a lien against title. You may not be buying everything you though you were buying, because someone else may have a prior claim that you didn’t know about.
If you’re borrowing money to acquire a piece of real property, the lender is no doubt going to want security for the loan. While a personal guarantee may work if your net worth is substantial, a lender will usually want a mortgage or deed of trust against the property. This will give the lender the right to foreclose if you fail to comply with the terms and conditions of the loan. Beyond the repayment requirements, these terms and conditions can give rise to other concerns that could become a problem. For example, some lenders prohibit borrowers from taking out more loans on their property, which could stop you from getting more financing that your business may need down the road.
Often times, a commercial loan will also require that a business maintain a certain “net equity.” Pre-payment penalties are also common on real property loans. Also, many lenders on a big commercial real estate deal require that their legal fees and costs be paid by the borrower(s).
In a business context, contractors who do work on real property have a process called a “mechanics lien” that they can use to make sure that they get paid. This is a statutory lien that contractors, laborers and materialmen place on property when they’ve performed work or furnished materials in the erection or repair of a building or an improvement. They must generally give advance notice that they’re going to file the lien, and must then take action to enforce the lien within strict timelines if they aren’t paid. Ultimately a mechanic’s lien could be used to foreclose on property, so it can be a very powerful tool for a contractor, a laborer or a materialman.
A big concern for a business is to make sure not only that property used in the business is properly zoned, but also that the zoning of nearby or adjacent properties is not going to be a problem. Believe it or not, many people fail in new businesses because they don’t investigate the land use and zoning issues carefully enough. Even if you do your homework, issues can come up down the road if governmental agencies or neighbors try to change the zoning on your property to limit your use of it.
If you’re in the real estate business, changes in property values and other market fluctuations can have a profound effect on your operations. Rents can go up or down; tenancy rates can increase and decrease. Changing property values and market fluctuations can also affect any other type of business that owns property. With retail space, for example, a company that owns rather than leases a store location may decide to change locations to follow their customer base, only to find out that they can’t afford to move because of property values having dropped to the point that their business premises can’t be sold at the price they need. (In contrast, a lease may provide more flexibility because, at the end of the term, the business could simply pack up and move without having to worry about selling the premises.)
The biggest potential concerns to owning business property, though, are hazardous waste or environmental cleanup problems. Property owners are the ones who have primary responsibility for fixing such problems, even if the current property owner didn’t cause them. These problems may not be obvious or apparent to the naked eye, and could arise from anything ranging from an underground storage tank to an old garbage dump. If you’re in the chain of title to contaminated property (meaning that a some point you held an ownership interest in that property), you’re potentially responsible for paying for the clean up. The costs for an environmental cleanup operation can run into the millions of dollars.