Real Estate Acquisition Tips

The Eleventh Commandment

by Marvin Levin

In this new millennium, with a proliferation of neighborhood, regional and state-wide development protest groups, a good rule to follow is: never, never, never, never, never close escrow to purchase development property until full entitlements have been granted. In some cases, this might simply mean that you cannot buy the property to be developed because the seller will not sit still long enough for that to happen.

Depending upon the seller’s motivation and needs, he/she is not necessarily unreasonable in demanding a quick closing before entitlements can be granted. However, that is not necessarily good judgment. I have in mind several cases of a seller demanding a six-month close, and granting a series of six-month conditional escrows. In one case, a series of six six-month escrows were granted, and none of the buyers were able to satisfy entitlement conditions within the six months. As a result, three years went by and the seller still did not have a closing.

Well, here is one compromise position: Seller gives to buyer a six-month conditional escrow, with the agreement that the buyer will employ consultants and launch a full-court press to move the entitlement process along. Then, at the end of six months, the buyer has a choice. If the entitlement process does not look hopeful, the buyer can simply terminate the escrow and recover his refundable deposit. Or, the buyer can elect to continue to extend the escrow for a designated amount of time by either paying to the seller out of escrow non-refundable option money or depositing into escrow non-refundable money. (The problem is that this sets up all sorts of legal questions about whether the seller is entitled to obtain that money by forfeiture without the consent of the buyer, etc.)

From the buyer’s point of view, you might pick apart certain elements of this approach, however, almost anyone would agree that it is a better approach than closing quickly and taking the entitlement gamble.

In Contra Costa County (located east of San Francisco, California), there are two dramatic examples worth mentioning. One is the case of the Orinda Theater building in Orinda. After acquisition, a local group entitled “Save the Orinda Theater” was formed to preserve the theater building because it was a splendid example of art nouveau architecture. It took approximately seven years for the developer to obtain entitlements, but the entitlements required that the original theater be preserved. It was a major financial disaster. The difficulty might have been mitigated if the developer had an entitlement condition in his escrow. Or, possibly the developer could have leased the property with an option to purchase. When it became obvious early in the game that entitlements would not be easily granted, the developer might have suffered a relatively small loss on the lease, but then could have eliminated further loss by turning the property back to the lessor. (To do that effectively, a non-recourse provision must be part of the lease.)

A second example is the Gateway project, which is located a mile or so away from the Orinda Theater. Two previous owners had been unsuccessful in developing the property, and the third owner is close to obtaining a subdivision map for approximately 100 lots. When acquired by the first owner, the belief was that it could be developed into 300 lots. Although I am not familiar with the precise economics of the project, I suspect that the first owner would have been prudent to make the approval of the Tentative Subdivision Map a condition to close of escrow.

I am not suggesting that there is never an occasion to close quickly and take your chances. Certainly, there are situations where the purchase price is attractive based on existing use of the property so that if entitlement for a more valuable use is denied you will not necessarily be the loser. However, it is a different situation if certain entitlements are required in order to justify your price, and that is really the point of this real estate tip.

There are smart ways to seek entitlements, and there are not-so-smart ways to seek entitlements. So, if you know of a property that faces an entitlement battle, please put me on your list of people to contact.