8/12/2014 6:00 PM

Questions You Need to Ask Before Buying Distressed Commercial Properties

The economic downturn that began in late 2007 has taken a severe toll on all sectors of the U.S. economy, but it hit the real estate sector especially hard. Real estate research company Green Street Advisors reported in March 2011 that commercial property values were 17 percent below their peak in August 2007. CoStar Group reported that the values of the highest quality office buildings, relatively new retail and industrial properties, and apartment complexes were down 33 percent since June 2007. These large price decreases may attract investors in search of good buying opportunities. However, potential buyers should look beyond the low purchase price when they evaluate these properties. The properties' physical state, legal issues, and insurance considerations also affect whether they are smart investments.

Many of these properties were only partially completed when the financial crisis hit, so buyers must assess their economic viability and physical condition. They need to ask:

* How much of the project has been completed and how much remains to be done?

* Does any of the work need to be repaired or redone because the builder, facing financial difficulty, took shortcuts in material quality or construction?

* Do the original construction plans comply with current building codes? Are there any design errors that need correction?

* Are there any significant changes the buyer would like to make to the project?

* What liabilities (debts, lawsuits, penalties, etc.) will the buyer assume with the property?

* Who will be legally liable for any defects in the design or construction of the project?

* If the original owner and builder are responsible for the problems, can the buyer recover from them?

* What insurance covered the original project? Did one program apply to the entire project, or did each individual contractor have its own coverage?

* Will the insurance apply to construction defects?

* If a single wrap-up insurance policy covered the project, did it include a deductible or self-insured retention? If so, and the insured owner or contractor has declared bankruptcy and is unable to pay it, will the insurance still apply?

* Are there special conditions that must be met before the policy will apply when the deductible or SIR cannot be paid?

* Does the original wrap-up policy extend completed operations coverage beyond the policy's expiration date? If so, for how long?

Prospective buyers need to pay special attention to builders risk insurance on the project. If the original developer bought this coverage, the policy may have cancelled after work on the project stopped. A policy purchased by the general contractor may still be in force, but the buyer should review its terms and conditions carefully. Due to the long period of inactivity, vacancy and unoccupancy provisions may have taken effect. The buyer should also check to see if the policy covers catastrophic perils such as flood and earthquake; lost income and extra expenses resulting from delays due to covered perils such as fire or vandalism; and the extent of coverage for testing.

Regardless how low a property's price may be, it is no bargain if it comes with a host of physical and legal problems. Arranging insurance on a property with severe problems may be very difficult or even impossible. An insurance agent or broker experienced in obtaining coverage for such properties can help sift through the issues and identify appropriate policies. There is no substitute for a careful examination of a property and all that comes with it. Buyers who do their homework will uncover the profitable opportunities.

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