## Joint Venture Calculation Issues That Must be Considered

This article will discuss five calculation issues that have arisen in real estate joint venture transactions in which the author has participated. In each case, the applicable issue came as a surprise to at least one of the parties to the transaction.

### WHAT IS THAT RATE OF RETURN?

It is common for a rate of return to be stated as an annual rate compounded over some periodic interval, e.g., a month or a quarter. For example, the rate of return might be 10% per annum, compounded monthly. What does this 10% rate mean? According to most finance textbooks, this is a nominal annual rate, but the author has been involved in a number of transactions where one of the parties thought a similarly stated rate was (or should have been) an effective annual rate.

A nominal annual rate is basically the percentage growth that would occur if a fixed amount remained fully invested for 1 year and the stated annual rate were not compounded. It has been described as a”1-year simple equivalent rate” or a “de-compounded, 1-year equivalent.” An effective annual rate, on the other hand, is the actual percentage growth that would occur if a fixed amount remained fully invested for an entire year, taking into account compounding. Thus, a 10% annual rate, compounded monthly, is sometimes called a 10% nominal annual rate that is compounded monthly and would be equivalent to an effective annual rate of approximately 10.47%. In the context of a U.S. mortgage loan, the annual percentage rate (APR) is a nominal annual rate. More generally, a number of finance textbooks indicate that the convention in real estate finance is to quote nominal annual rates. However, there does not appear to be a consensus regarding how annual internal rates of return (IRRs) are quoted, and this lack of consensus seems to have led to a number of disagreements and misunderstandings over the meaning of a rate of return. For example, many practitioners use the XIRR (a feature of MS Excel), which generates an effective annual rate rather than a nominal annual rate. What happens when the parties say they want to use the XIRR for what they call a 10% IRR hurdle (i.e., the minimum IRR that a real estate financial partner requires before paying a particular “carried interest” or “promote” touts operating partner), but the 10% rate is an annual rate that they also say is compounded monthly? They may be talking apples and oranges. If the XIRR is to be used, it would be clearer if the parties were to specify the effective annual rate. For example, if the parties intend to compound monthly a 10% nominal annual rate and to have an annual yield of approximately 10.47%, then the effective annual rate and the XIRR target would be approximately 10.47%. Another way to avoid confusion would be to state the rate per compounding period. For example, a 10% nominal annual rate, compounded monthly, would have a 5/6% monthly rate, but a 10% effective annual rate would have a monthly rate that is less than 5/6%.

Nominal Annual Rate,
Compounded Monthtly
Monthly Rate
(NAR/12)
Effective Annual Rate
(1+ [NAR/12])12-1
10.0% 0.8333% 10.47%
9.57% 0.797% 10.0%

### ARE PROFITS BEING DOUBLE-COUNTED (RECYCLED) IN THE IRR CALCULATION?

Think of a financial partner’s IRR hurdle as the positive balance, if any, of a hypothetical account that is (1) increased by (a) each capital contribution of the financial partner and (b) interest on the gross amount of each such capital contribution at the stated hurdle rate, and (2) decreased by (a) the amount of each distribution to the financial partner and (b) interest on the gross amount of each distribution to the financial partner at the stated hurdle rate. (Although IRR calculations may vary in many respects, the preceding formulation is equivalent to the manner in which the IRR is calculated in many transactions and is useful for illustration.) If this account is allowed to go negative, the negative balance will offset an equal amount of any future contributions, so that all or a portion of the future contributions may, in effect, be recouped by previous profit distributions. When this happens, it is sometimes called “recycling profits.” Sample distribution provisions that allow for recycling of profits are set forth in the Appendix to this article.

#### Example of Recycling

Assume that the financial partner has a 10% IRR hurdle (based on a 10% annual rate, compounded annually) and the financial partner’s cash flows are as follows: An initial contribution of \$100; a \$210 distribution on the first anniversary; and a \$100 contribution on the second anniversary.

After the \$100 additional contribution, the financial partner’s hurdle balance is still not positive. Therefore, if the venture makes a distribution before any further capital calls, the financial partner has still achieved its hurdle for purposes of determining how to share that distribution. In fact, the financial partner’s IRR after the first distribution is 110% per annum and the second contribution merely reduces the IRR to approximately 37% per annum.

Time Hurdle Balance Approximate
(Positive) IRR
0 (before C) 0 None
(after C) 100 None
1 (before D) 110 None
(after D) 100 110%
2 (before C) 110 110%
(after C) 10 37%
C = contribution; D = distribution

#### Double-Counting Problem; Expanded Example of Recycling

Recycling of profits may change the contemplated sharing of profit distributions.

Assume the same facts as above. Also assume that the financial partner had formed a partnership with an operating partner and agreed to contribute 100% of the capital and give the operating partner a 50% profit distribution (a so-called “promote” distribution) after the financial partner’s 10% IRR hurdle. To keep the same financial partner cash flows as provided above, assume the contributions and distributions for the partnership were as follows: \$100 initial contribution by the financial partner; \$310 distribution to the partners(\$110 to the hurdle and \$200 split 50-50) on the first anniversary; and \$100 contribution by the financial partner on the second anniversary. Suppose that the parties intended a 50-50 sharing of all non-hurdle distributions (i.e., all distributions that are not applied to the hurdle)

The \$100 distribution to the financial partner at the 50-50 level has in effect been double-counted, first as a non-hurdle distribution and subsequently as a hurdle distribution. In effect, it loses its character as a non-hurdle distribution when the additional contribution is made, at which point the financial partner has 0% of the non-hurdle distributions.

To avoid recycling profits, the hurdle balance should not be allowed to go negative. In other words, in the above example, the 50-50 distributions should not be counted in the hurdle calculation. (Note that it’s not necessarily wrong to recycle profits, but if the parties do not intend to recycle profits, the documents should reflect that intent.)

### ARE THE IRR HURDLES OUT OF ORDER

A common criticism of the internal rate of return is that the same set of cash flows can generate more than one positive IRR. For example, a set of cash flows can result in both a 10% and 20% IRR at the same time. It is therefore possible, in the context of A joint venture, to have two hurdles (e.g., a 10% hurdle and a 20% hurdle) achieved at the same time, although this is very unlikely. This problem is symptomatic of a larger problem with IRR hurdles: When the hurdle balances go negative, the order of the balances can shift.

#### Example of Order Reversal With Multiple Hurdles

Assume there are 10% and 20% IRR hurdles (based on annual rates, compounded annually) and an initial \$10 million investment followed by a \$30 million distribution 1 year later and a \$21 million contribution 2 years later. Note that after 1 year, the hurdle balances are \$11 million and \$12 million, respectively, before the distribution, and that immediately after the distribution, the hurdle balances are -\$19 million and -\$18 million, respectively. At this point in time, the 10% hurdle balance is still less than the 20% hurdle balance: -19 < -18. But after another year, the order of the balances will have switched, as indicated in the following chart:

Time Investor’s
Cash Flows
Hurdle Balance
10%
hurdle
20%
hurdle
0 10
contribution
0 = 0 (immediately before
contribution)
10 = 10 (immediately after
contribution)
1 30
contribution
11 < 12 (immediately before
distribution)
(19) < (18) (immediately after
distribution
2 21
contribution
(20.9) > (21.6) (immediately before
contribution)
0.1 > (0.6) (immediately after
contribution)

After the \$21 million contribution, there is a positive 10% hurdle balance and a negative 20% hurdle balance. If the only other cash flow were a liquidating distribution, some or all of it would be required to satisfy the 10% hurdle before distributing promote, but the 20% hurdle would already be satisfied. By not recycling profits, this reversal does not occur.

### BUY-SELL, DRAG-ALONG, AND TAG-ALONG CONUNDRUMS

First, assume that a sale of the property at its then current value would generate roughly \$1.5 million of distributable net sale proceeds. If the subordinated partner names a buy-sell project price that would generate \$2 million of distributable net sale proceeds, the preferred partner may have a Hobson’s choice: either sell for \$1 million or overpay (\$1 million for a \$0.5 million interest). Similarly, if the preferred partner names a buy-sell project price that would generate \$1 million of distributable net sale proceeds, the subordinated partner may have a Hobson’s choice: either buy for \$1 million or sell (a \$0.5 million interest) for nothing.

Second, assume that a sale of the property at its then current value would generate less than \$1 million of distributable net sale proceeds. If the preferred partner names a buy-sell project price that would generate \$1 million of distributable net sale proceeds, the subordinated partner may have a Hobson’s choice: either sell for nothing or buy for more than the preferred partner’s interest is worth. If a partner were allowed to name any buy-sell price under these facts, the preferred partner might be tempted to try to force out the subordinated partner for nothing at time when the subordinated partner’s interest is valueless. If the property were generating sufficient cash flow to pay debt service, this could be particularly painful because the subordinated partner could be deprived of any chance to share in a future recovery.

Notice that, in the first example above, the preferred partner gets the same \$1 million for all project values generating distributable net sale proceeds between \$1 million and \$2 million while the subordinated partner may get anywhere from \$0 to \$1 million. What happens if the preferred partner receives a \$1 million offer and wants to exercise a drag-along right or the subordinated partner wants to exercise a tag-along right? Similarly, in the second example above, the subordinated partner gets the same zero amount for all project values generating distributable net sale proceeds of not more than \$1 million while the preferred partner may get anywhere from \$0 to \$1 million. What happens if the subordinated partner receives an offer of zero and wants to exercise its drag-along right?

### SQUEEZE-DOWN FORMULA SURPRISES

Most squeeze-down formulas are capital-based (admittedly for good reason, i.e., to keep things simple and expedient), but the partners’ shares of capital (whether gross or net) may not track the values of their interests. In fact, there may be a substantial discrepancy, and when there is, squeeze-down formula results can be surprising (whether or not there is a penalty factor). Such discrepancies may easily arise from an increase or decline in value (i.e., appreciation or loss). (Discrepancies may also arise in other ways, e.g. , (1) a distribution that reduces equity value but not the capital taken into account in the squeeze down formula, (2) a contribution to pay operating deficits that increases capital but not value, or (3) a bargain purchase price, which reflects built-in appreciation over cost so that the venture starts with an imbalance.)

#### Value Exceeds Capital: Appreciation

Assume that there has been appreciation so that each \$1 of capital represents more than \$1 of equity value. If additional capital is invested when there is more equity value than capital, each \$1 of capital will still represent more than \$1 of equity value (although the surplus value over capital cost will be somewhat diluted on a dollar-to-dollar basis). A prorate squeeze down gives the contributing member a greater share of the capital and a greater share of the excess value over the amount of capital.

#### Capital Exceeds Value: Loss

Similarly, assume that there has been a loss so that each \$1 of capital represents less than \$1 of equity value. If additional capital is invested when there is less equity value than capital, then each \$1 of capital will still represent less than \$1 of equity value (although the deficiency will be somewhat diluted on a dollar-to-dollar basis). A pro-rata squeeze-down gives the contributing member a greater share of the capital and a greater share of that loss.

#### Example of Formula Being Under-Effective

Assume for simplicity that dilution is pro-rata with no additional penalty so that partnership interests are always proportionate to gross capital contributions. Also assume that the deal is 50-50; that there is a total \$20 million capital requirement for two \$10 million investments; and that each partner funds its \$5 million share of the first investment, which is a success and sold all cash for a large profit before the second investment is made. What happens if one of the partners refuses to fund its share of the second investment? Surely it was not intended that the defaulting partner could get 25% of the second investment without spending a dime for it?

In the example above, all capital had been recouped immediately before the additional contribution. Would the problem be solved by using a dilution formula based on unrecouped (i.e., net) capital?

#### Example of Formula Being Over-Effective

Assume that the dilution formula provides that partnership interests are always proportionate to net (i.e., unrecouped) capital contributions; that the deal is 50-50; and that all capital is refinanced out, but each partner still has millions of dollars of equity. What happens if, due to liquidity and timing issues, a partner fails to contribute its share of a \$5,000 amount? Surely it was not intended that the defaulting partner could lose millions of dollars for failing to contribute a few thousand dollars?

In both examples above, immediately before the additional contribution, the partners had no capital left in the transaction, but in the first case the fair market value was zero while the partners were credited with millions of gross capital, and in the second case, the fair market value was equal to millions while the partners were credited with zero net capital.

### SAMPLE PROVISIONS

This Appendix sets forth sample (rather than model) alternative distribution provisions using a preferred return (and return of capital) hurdle or an IRR hurdle that either (a) allow for recycling of profits or (b) do not allow for recycling of profits.

#### Assumed Facts

Assume the following facts: (1) Investor and operator form a joint venture; (2) Investor agrees to provide 100% of the capital; and (3) each distribution is to be made in accordance with the following provisions:

Section 5. Distributions. Each distribution of Distributable Cash will be made as follows:

5.1. First, 100% to Investor until Investor has received all its money back and a 10% annual return compounded annually; and

5.2. Second, 50% to Investor and 50% to Operator.

### PREFERRED RETURN FORMULATIONS

The wording for a preferred return (PR) (and return of capital) formulation that does NOT recycle profits is as follows:

5.1. First, Investor receives 100% until it has received from distributions under this subsection A 10% annual preferred return compounded annually and all of its capital (where all distributions under this first level are applied first to pay Investor’s preferred return and then to recoup Investor’s capital).

The wording for a preferred return (PR) (and return of capital) formulation that DOES recycle profits is as follows:

5.1. First, Investor receives 100% until it has received from distributions under this Section a 10% annual preferred return compounded annually and all of its capital (where all distributions under this first level are applied first to pay Investor’s preferred return and then to recoup Investor’s capital

### IRR FORMULATIONS: FIRST VERSION

Sample provisions using an IRR formulation are set forth below.

#### IRR Example: Not Recycling Profits

The first distribution level may be worded as follows:

5.1. First, Investor receives 100% until it has received the amount, if any, of distributions under this subsection then required to achieve at least a 10% annual IRR. An “lRR” as of a particular time is defined to be an annual rate that makes (x), the present value of all contributions made by Investor to the Venture at or before such time, equal (y), the present value (as of the date of this Agreement) of all distributions under this subsection received by Investor at or before such time.

#### IRR Example: Recycling Profits

The first distribution level may be worded as follows:

5.1. First, Investor receives 100% until it has received the amount, if any, of distributions under this Section then required to achieve at least a 10% annual IRR. An “IRR” as of a particular time is defined to be an annual rate that makes (x), the present value of all contributions made by Investor at or before such time, equal(y), the present value of all distributions under Section 5 received by Investor at or before such time.

### IRR FORMULATIONS: SECOND VERSION

Sample provisions using an IRR formulation are set forth below. In both cases, the first distribution level is worded as follows:

5.1. First, Investor receives 100% until it has received the then IRR Hurdle Deficiency.

#### IRR Example: Recycling Profits

The following definitions might be used for an IRR hurdle when profits are intended to be recycled.

“IRR Contributions” means all contributions made by Investor to the Venture.
“IRR Distributions” means all distributions made by the Venture to Investor.
“IRR Hurdle Deficiency” as of any particular time means the amount by which (1) the future value (as of such time) at the IRR Rate of all IRRContributions made at or before such time exceeds(2) the future value (as of such time) at theIRR Rate of all IRR Distributions made before such time.

#### IRR Example: Not Recycling Profits

The only change required to avoid recycling in the above example is to the definition of IRR Distributions (the underscoring indicates additional language):

“IRR Distributions” means all distributions made by the Venture to Investor under subsection 5.1.

If there are multiple IRR hurdles, the definitions require more changes.

## Due Diligence in Real Estate Acquisitions

The primary purpose of due diligence is to obtain information, and the extent and type of due diligence that purchaser’s counsel may undertake will depend on, among other factors: (i) the risk profile and business objectives of the purchaser; (ii) the type of real estate asset involved; (iii) the time frame for completion of the transaction; (iv) the cost of conducting due diligence; and (v) whether the purchaser will obtain third party financing either pre-transaction or post-transaction closing. As a prelude to commencing legal due diligence, purchaser’s counsel first must negotiate effective due diligence provisions in the purchase and sale agreement. Following execution of the purchase and sale agreement, purchaser’s counsel typically undertakes a review and analysis of the title commitment applicable to the property, the underlying title documents referenced in the title commitment, and the property survey. Depending on the property type, the due diligence process may include obtaining and reviewing property leases, ground leases and other property related documents, some of which may be prepared by outside consultants.

## Contract Negotiations

The purchase and sale agreement contains fve important provisions relating to property due diligence:
(i) the representations and warranties;
(ii) the due diligence deliveries section;
(iii) the provisions describing the duration of the due diligence period and the purchaser’s inspection rights during the due diligence period,
(iv) those contract provisions relating to the seller’s obligation to provide consents and/or estoppel letters from certain third parties; and
(v) the confidentiality provision.

As with due diligence itself, the primary purpose of contract representations and warranties is to provide the purchaser with information regarding the seller and the property. Purchaser’s counsel should strive to include as many property related representations and warranties in the contract as is practicable under the circumstances.1 Property related representations and warranties are particularly useful in circumstances where a seller must expand or modify a ‘‘standard’’ representation and warranty (e.g., a representation and warranty that the seller has not received knowledge of any building code violations) in order to provide information that identifies issues of particular concern to the purchaser (i.e., in the example above, the actual existence of a building code violation). If a representation and warranty deviates from the standard ‘‘no problems’’ language, then purchaser’s counsel should request additional information from the seller during the due diligence review period regarding both the ‘‘problem’’ and the legal consequences of the existence of that problem.2

The contract should contain a detailed list of all due diligence delivery items,3 as well as a schedule for the delivery of copies of the due diligence materials to the purchaser and its counsel (or, in the alternative, the date on which the items will be made available for review at the property or another location). Many sellers currently use online due diligence ‘‘rooms’’ where the necessary due diligence documents are made available to the purchaser and its counsel immediately following contract execution.

The contract must provide the purchaser with a specific period within which to complete its due diligence and raise any objections with the seller. The commencement and length of this ‘‘due diligence period’’ or ‘‘review period’’ often is the subject of much negotiation, as the seller typically desires to have the due diligence period commence upon contract signing (or earlier, if the seller has provided the purchaser with due diligence information during any letter of intent negotiations) and be as short as possible. Depending on the complexity of the transaction and the volume of due diligence information, the parties may negotiate “phased” due diligence periods whereby the purchaser will have to comment on title and survey by one date, and other due diligence matters by one or more other dates.4

Depending on the asset type and transaction structure, counsel for the purchaser may need to add a provision to the contract describing the seller’s obligations to obtain third party consents and/or estoppels. Third party consents may be necessary in situations where the purchaser is assuming existing mortgage or bond financing in connection with the acquisition, while estoppel requirements are customary in purchase transactions involving office buildings, industrial facilities and shopping centers (i.e., transactions where there are significant tenant leases, ground leases, reciprocal easement agreements (‘‘REAs’’), declarations of covenants, conditions and restrictions (‘‘CCRs’’), commercial condominium, or other documents that affect the use or operation of the subject property). Counsel should carefully review all due diligence documents to determine if those documents expressly obligate the parties thereto to furnish estoppel letters upon request.

Finally, the contract usually contains provisions requiring that the purchaser keep all of the due diligence information regarding the property confidential, irrespective of whether the information is furnished to the purchaser by the seller or independently obtained by the purchaser from its consultants. The purchaser’s counsel must make sure that the confidentiality provisions permit the purchaser (i) to meet with and interview any necessary third parties (e.g., tenants, representatives of governmental authorities, ground lessors) and conduct any appropriate on site physical inspections and testing during the due diligence period, and (ii) to share due diligence information with the purchaser’s lenders, accountants, insurers, attorneys, consultants and other relevant advisors.

## Due Diligence

Immediately following contract execution and prior to commencing due diligence, the purchaser and its counsel should allocate between themselves responsibility for performing the various due diligence tasks. Depending on the purchaser’s organizational resources, the purchaser usually will take responsibility for reviewing all financial information (including capital expenditure requirements), physical condition information (i.e., property condition and environmental reports), appraisals, and similar items, while purchaser’s counsel will undertake the review of the title commitment, underlying title documents, survey, leases and other legal documents.5 The purchaser’s counsel also should discuss with the purchaser the need for any third party reports or searches of a legal nature, such as a title commitment and current survey (if the purchaser is responsible for those items), zoning reports, UCC searches, and building code violation searches in order to make sure that those items are ordered and received in sufficient time for review prior to the expiration of the due diligence period. Unless otherwise instructed by the purchaser, purchaser’s counsel should prepare written summaries or abstracts of all due diligence documents reviewed by counsel. These summaries should be as detailed or brief as the client and/or the nature of the transaction require, but the summaries will be a very useful resource both during the due diligence review period and after transaction closing.

## Title Review

Counsel for the purchaser should analyze the title commitment and underlying title documents (including any REAs and CCRs) in the context of the client’s current and anticipated use of the property. For example, if the client is purchasing an apartment project with a view to converting the project to condominiums, then counsel must confirm whether the title documents allow, prohibit or otherwise condition the use of the project as condominiums. Also, counsel must review all easements and other agreements that affect the property in order to (i) understand the rights, if any, of the purchaser under the documents and, to the extent possible, make sure that those rights are insured by the title insurance company under the owner’s title insurance policy issued at closing, (ii) identify any obligations under those documents that will bind the purchaser after closing (e.g., common area maintenance and expense obligations in connection with the ownership of a shopping center), and (iii) determine whether any additional easements or other agreements of record, or the modification of any existing agreements of record, will be necessary in connection with the purchaser’s ownership and intended operation of the property postclosing.

On rare occasions, provisions in the underlying title documents may impact the purchaser’s proposed ownership structure. For instance, the terms of the CCRs may prohibit fractional ownership of real estate. Such a restriction, unless modified, may prevent a tenant-in-common sponsor/syndicator from purchasing an asset.

During the title review, counsel also should determine as soon as possible whether any third party consents are required under the various title documents, as well as decide which parties to the documents should provide estoppel letters in favor of purchaser (and purchaser’s lender, if any) in connection with the acquisition transaction. Based on these determinations, counsel should prepare and forward to the seller’s counsel any required third party consents and estoppels.

If the purchaser is going to finance its acquisition of the property, then purchaser’s counsel also must review title in the context of identifying and resolving issues that the lender may have regarding the underlying title documents. Such issues may be as simple as making sure that all estoppel letters are addressed to both the purchaser and the lender, or as complex as requiring that the seller amend existing REAs, CCRs or ground leases to provide more lender protections in those documents. If the purchaser is assuming an existing loan as part of the acquisition transaction, then counsel to the purchaser must review both the loan documents of record and all other loan documents to make sure that both the seller and the purchaser are complying with the loan assumption requirements. In addition, counsel should identify any provisions of the loan documents that require modification to conform to the purchaser’s requirements, e.g., transfer and insurance provisions.

In situations where a municipality has ongoing involvement in the development and/or operation of a property (e.g., where the purchaser is purchasing a (i) leasehold interest in a property owned by a governmental body, or (ii) property where the current owner has outstanding performance obligations to a governmental body, such as unremedied building code violations), purchaser’s counsel must review all relevant documents (recorded and unrecorded) in order to identify those obligations that will survive the purchaser’s acquisition of the property and become the purchaser’s responsibility. These obligations may include obtaining a replacement or new letter of credit or surety bond or providing a guaranty as security for unfinished obligations to be performed by the property owner, or negotiating with the appropriate governmental authorities the terms of any additional development to occur on the property or the timetable for curing outstanding building code violations post-acquisition closing.

Finally, prior to the expiration of the due diligence review period purchaser’s counsel should (i) inform the seller’s counsel and the title insurance company in writing of any required revisions to the title insurance commitment, (ii) ascertain the availability and cost of any endorsements to the final title insurance policy that the purchaser will require as a condition to closing, and (iii) notify the title insurance company of any co-insurance and/or reinsurance requirements.

## Survey Review

The survey may represent the only “view” (albeit a two dimensional view) that purchaser’s counsel will have of the property prior to closing. Counsel must carefully review the survey in order to confirm (i) that the legal description contained in the title report is the same as that contained in the survey; (ii) the location of the various easements and other exceptions to title (to the extent those exceptions can be depicted on a survey) on the property, and (iii) the availability of a survey or similar endorsement for inclusion on the owner’s title insurance policy.

Wherever possible, in connection with the acquisition of improved property the purchaser should obtain an ALTA/ACSM ‘‘as-built’’ survey prepared in accordance with the most recent ‘‘Minimum Standard Detail Requirements’’6 and dated not earlier than 30 days prior to the last day of the due diligence period. ALTA/ ACSM surveys are typical in most sophisticated transactions, and the ALTA/ACSM survey format costs more than states tandard surveys and requires that the surveyor provide more detailed information about the property than most state-specific survey standards. Purchaser’s counsel should discuss with his client what additional matters (in the form of the so-called “Table A” items) should be included on the survey. Table A items include matters such as zoning information, food zone information, calculation of building area and any wetlands designation. Purchaser’s counsel also should, in consultation with his client, identify the parties that will be the addressees of the survey (i.e., the parties that are entitled to rely on the survey) and determine the need for any specialized survey certification language that the purchaser or its lender will require from the surveyor.7 In making these decisions the purchaser and its counsel must balance the need for obtaining the additional information that Table A or a non-standard survey certification form may provide, against the additional cost of obtaining those items.

The second appendix to this article contains a sample checklist that purchaser’s counsel may use as a guideline to reviewing a survey.

## Zoning Reports

In some circumstances, certificates of occupancy for the property may not be readily available and/or for due diligence purposes the purchaser may desire a letter from the applicable municipality confirming the zoning classification of the property and that the current property use complies with applicable zoning laws. In those cases, purchaser’s counsel should engage a zoning services company to work with the municipality to obtain copies of the certificates of occupancy (or confirmation that no such certificates exist) and a signed zoning letter. In particular, the zoning letter will provide additional support to the title insurance company if the purchaser wants a zoning endorsement to its owner’s title insurance policy, and in jurisdictions where zoning endorsements are not available (e.g., Texas) the zoning letter will serve as a very useful substitute.

## UCC and Other Searches

Purchaser’s counsel should consider ordering UCC, tax lien and other searches of the seller in order to make sure that any liens and encumbrances against the real property or personal property being acquired by the purchaser in the transaction are identified and released at closing (to the extent the purchaser has not agreed to assume certain liens and/or encumbrances as part of the deal). UCC searches are particularly useful in identifying encumbrances affecting personal property that are not identified by the title insurance company as part of the title search process. These searches also can help confirm the accuracy of the title insurance company searches of the real property. Finally, judgment and tax lien searches can confirm (or take the place of) corresponding contract representations and warranties by the seller on those matters.

Building code violation searches are useful to supplement the purchaser’s physical due diligence on the property, especially in situations where the purchaser plans to undertake renovations of the property after acquisition.

## Other Due Diligence Documents

Depending on the purchaser’s needs and the type of property being acquired, as part of the due diligence process purchaser’s counsel may be asked to review and summarize critical terms of leases, ground leases and property financing documents. As with other due diligence document reviews, the goals should be to:
(i) ascertain that the documents allow the purchaser to operate and/or modify the property consistent with the purchaser’s business objectives;
(ii) identify the purchaser’s post-closing rights and obligations under those documents;
(iii) confirm the financial provisions (e.g., rent, expense reimbursements, landlord payment obligations) of the documents; and
(iv) determine whether a lender will require any modifications to the documents as a condition of providing mortgage financing for the property.

## Property Transfer Requirements

Some jurisdictions have specific requirements that must be satisfied as a condition to transferring title to real property. For example, the City of Chicago requires that the water meter at the property be read and the water bill be paid prior to recording the deed. Other municipalities require an inspection of the property as a condition of title transfer. Purchaser’s counsel should identify any such legal requirements and make sure that the seller or the purchaser, as applicable, is complying with those requirements.

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