The process of buying a freehold commercial property
This blog post sets out the process involved when buying a freehold commercial property via the standard sale and purchase method, and does not cover the process involved where the property is being purchased through auction.
Each transaction is, of course, unique and distinct, however the same general process is followed in each case, with the parties attaching more emphasis to certain phases depending on their bargaining power and commercial objectives.
What are the differences between freehold and leasehold commercial property?
Since 1925, there can only be two legal estates in land, namely an estate in fee simple absolute in possession (i.e. the freehold estate) and a term of years absolute (i.e. the leasehold estate) – note that the majority of land in the UK is owned freehold. Whether the land/property in question is freehold or leasehold will be stated in the property register in the register of title.
If, for example, a landowner registered the freehold estate in a parcel of land, a registered title would be created, identifying the physical area of land which belonged to him/her. The title would also identify the estate as freehold and give him/her a title number by which to identify the land. If that landowner then grants a 999-year lease of the whole of the land to a tenant, the tenant under that lease has a registrable interest in the land and, on registration of the lease, a second and separate registered title would be created, again showing the physical extent of the land (in this example this will be identical to that shown on the freehold title), stating that the interest held is leasehold, giving brief details of the lease itself, and giving the tenant an identifying title number which is different from that used by the freehold estate.
On registration of the lease, the freehold title will be cross-referenced to show the existence of the lease. Similarly, the leasehold title will contain a reference to the freehold title. This cross-referencing system ensures that the tenant of a registered lease is able to trace his/her landlord should the need to do so arise, and that, because the existence of the lease is noted on the freehold title, a buyer of the freehold cannot buy in ignorance of the existence of the lease.
If the lease had been a lease of part, a similar process would have taken place, only the physical extent referred to in the title to the lease and cross-referenced on the freehold title would have reflected the actual extent let.
If you purchase the freehold of a commercial property, you will own it exclusively and outright. This means that you can do as you wish with the property (subject to the confines of the relevant law), you will benefit from any rise in the property’s market value, and also suffer if the property market crashes. As an owner of the freehold you would also be able to sell the property on to anyone you wish, which gives flexibility and a much wider market of prospective purchasers than if you owned the leasehold and wanted to sell the lease to another party.
A leasehold transaction involves buying a lease in relation to the property for a set period of time. For example, new long-term commercial leases are often granted for a term of 999 years. To take a more extreme example, Arthur Guinness agreed a lease of the St. James’s Gate brewery in Dublin in 1759 for a term of 9,000 years (a copy of the original lease is available to view at the brewery itself).
The owner of a lease is permitted to sell on the lease to another party and make some changes to the property, however can only take such action in accordance with the terms of the leasehold contract, which will often require obtaining the landlord’s (i.e. the owner of the freehold title) permission first.
Note finally that for VAT purposes, there is a distinction between ‘old’ and ‘new’ commercial property. A ‘new’ building is one completed within the three year period prior to the sale. If the building is more than three years old, then it is classed as an ‘old’ building for VAT purposes.
The sale of a new commercial building is standard rated for VAT purposes and the sale of an old commercial building is exempt from VAT, but subject to the option to tax.
A typical conveyancing transaction can be broken down into three distinct stages – pre-contract, post-contract/pre-completion and post-completion.
Generally, a simple conveyancing transaction will follow the structure set out below:
|Take instructions||Take instructions|
|Prepare pre-contract package|
|Produce draft sale contract||Pre-contract searches and enquiries|
|Investigate property title|
|Approve draft sale contract|
|Exchange contracts||Exchange contracts|
|Prepare transfer deed|
|Approve transfer deed|
|Prepare for completion||Prepare for completion|
|Post-completion matters||Post-completion matters|
Phase 1: Heads of terms and the pre-contract package
It is customary for heads of terms to be left to the parties and their surveyors, although commercial property solicitors may sometimes become involved at this stage depending on the parties’ wishes and attitude to costs. The heads of terms will set out all the fundamental terms of the proposed sale and purchase, and this document will form the basis of the formal legal contract between the parties.
The heads of terms are rarely intended to be legally binding, given that the formal legal contract will be. In this sense, the heads of terms are essentially simply the skeleton for the negotiations and the legally binding documents that will follow. For this reason, heads of terms are often drafted on a ‘subject to contract’ basis. However, the heads of terms document will set out what details should be included within the formal legal contract.
Producing and advising on a well-considered heads of terms document at the outset of a commercial property transaction can save time and money in the long-term as it will ensure that both parties agree to the principal terms of the proposed transaction and the heads of terms will provide the solicitors involved with clear instructions/information pertaining to how the parties envisage the transaction working and what the legal contract should include.
Having taken instructions, the seller’s solicitor must then prepare the pre-contract package for the buyer. This comprises:
- the draft sale contract (detailed further below), showing what land the seller is selling and on what terms he/she is prepared to sell it;
- evidence of the seller’s legal title to the property, to prove that he/she does own and is entitled to sell the land; and
- sometimes, the results of pre-contract searches which the seller has made and other information about the property.
When the buyer’s solicitor receives the pre-contract package from the seller’s solicitor, he/she will check all the documents supplied very carefully to ensure that the terms of the contract accord with his/her instructions and do not reveal any problems which might make the property an unsuitable purchase for his/her client.
Although the seller has a limited duty to disclose defects in his/her legal title (but not physical defects), the caveat emptor principle (‘buyer beware’) applies to conveyancing, so that it is the buyer’s responsibility to find out all the information which he/she needs to know about the property before committing to the purchase.
It is important to note that at this stage, the parties have not entered into any legally-binding relationships with each other, and either of them can walk away from the transaction at any point up until exchange of contracts (following exchange the parties will be committed to completion).
Phase 2: Pre-contract searches and investigation of title
It is the application of the caveat emptor principle which makes pre-contract searches necessary.
These searches, many of them made with public bodies such as the local authority or Land Registry, will reveal a large amount of information about the property, all of which will help the buyer to make up his/her mind whether or not to proceed with the purchase.
As indicated above, in some instances, the seller’s solicitor will submit the search applications and pass their results to the buyer’s solicitor as part of the pre-contract package. If this has happened, the buyer’s solicitor still needs to check that the correct searches have been made and that their results are satisfactory.
In the majority of cases, however, the buyer’s solicitor will be responsible for making the search applications. In this situation the search applications should be sent to the relevant/applicable authorities as soon as firm instructions to proceed have been obtained from the buyer, otherwise the time taken to receive search replies may cause an unnecessary delay in the transaction.
The National Land Information Service (“NLIS”) provides an internet-based ‘one-stop shop’, enabling information kept by a variety of public and other bodies to be accessed more efficiently and speedily than by requesting the information separately from each individual body.
There are two main purposes behind the seller’s investigation of title. First, it is the seller’s solicitor’s responsibility to draft the contract for the sale of the property. The seller’s solicitor will therefore need to carry out a thorough investigation of title in order to be able to embody the detail of this accurately within the sale contract.
Secondly, investigation of title will enable the seller’s solicitor, at an early stage, to anticipate and, if possible, deal with any problems that might be revealed by the title, and this can help smooth the passage of the transaction as a whole.
Although the seller’s reasons for investigating title are different from those of the buyer, the method that he/she will use to do so will be identical to that undertaken by a buyer’s solicitor.
Once the seller has supplied the buyer with evidence of his title, the buyer’s task will be to ensure that the seller is able to transfer what he/she has contracted to sell, and also to identify whether there are any defects in, or problems raised by, the title which could adversely affect the interests of the buyer. Any matters which are unclear or unsatisfactory on the face of the documentary evidence supplied by the seller may be raised as queries (known as ‘requisitions’) with the seller.
Modern practice is for title to be deduced and investigated before exchange of contracts, and for any issues that arise from this process to be resolved before that point. If this is the case, as the buyer will have already had his/her opportunity to raise any requisitions and will have entered into the sale contract with full knowledge of what the title contains, it is usual to find that the contract will contain a provision preventing the buyer raising requisitions on some or all aspects of the title once exchange has taken place. If, exceptionally, title is deduced after exchange, the contract will usually contain a timetable for the raising of, and responding to, requisitions.
The searches listed below are regarded as ‘usual’ in every transaction:
- search of the local land charges register;
- enquiries of the local authority and, if appropriate, additional enquiries;
- pre-contract enquiries of the seller;
- water and drainage enquiries;
- environmental search; and
- personal inspection.
Depending on the circumstances of the transaction, the following search results and reports may also need to be obtained:
- chancel repair search;
- Index Map search, if dealing with unregistered land;
- a Land Charges Department search against the seller’s name (for insolvency), and in unregistered land also against other previous owners of the land;
- company search;
- flood search;
- any location specific searches which may be applicable in the circumstances (for example, coal mining and brine search, enquiries made of the Canal & River Trust, highways search etc.); and
- survey reports.
Phase 3: Sale contract
Ordinarily, it is the seller’s solicitor that will be responsible for producing the first draft of the sale contract for the commercial property. There will then usually be some back and forth between the parties’ solicitors to negotiate and eventually finalise and approve the sale contract before moving onto the next phase.
The sale contract will, among other things, detail the extent of the land to be sold and will set out the terms on which the seller is prepared to sell the property, including specifying when the day of completion is to be. Although the title to the property is technically transferred in the transfer deed on completion of the transaction, it is important to understand that the terms of the transfer deed are fixed by the terms of the sale contract itself.
As above, it is the seller’s solicitor that drafts the contract, since the seller will know precisely what he/she is prepared to sell and on what terms. Although it is the seller’s prerogative to dictate the terms on which he/she is prepared to sell, this does not necessarily mean that the sale contract is drafted entirely in his/her own favour.
The contract terms are open to negotiation with the buyer, and unless the bargaining power of the seller is particularly strong, the seller must be prepared to concede points in favour of the buyer. For example, if the buyer has a survey carried out in relation to the property which reveals structural weaknesses, it is likely the buyer would want to renegotiate the purchase price to reflect this. If the seller is not willing to renegotiate, then it is likely in such circumstances that the buyer would simply walk away from the deal.
The solicitors acting for the seller will therefore have to ensure that the sale contract adequately protects their client’s interests, but at the same time provides a sufficiently attractive package so as to persuade the buyer to proceed with the purchase.
When the buyer’s solicitor is satisfied with his/her search results, with the proof of the seller’s ownership (title) of the property and with the terms of the draft contract (he/she may have negotiated some amendments to the contract with the seller’s solicitor), he/she will be ready to return the draft contract to the seller’s solicitor, telling him/her that the buyer has approved the terms and is now ready to enter into the contract.
The sale contract will then be prepared for the clients’ signatures. Two copies of the contract, incorporating any agreed amendments, are printed off; the seller signs one, the buyer the other. The contract comes into existence by ‘exchange of contracts’ (i.e. the buyer receives the copy of the contract signed by the seller and the seller receives the copy signed by the buyer). However, prior to physical exchange, which is commonly effected through the post, it is usual for the parties to agree over the telephone that the contract should come into existence at the moment of the telephone call (this is often referred to as ‘telephonic exchange’).
Phase 4: Exchange of contracts and completion
The exchange of contracts marks the stage in the transaction at which a binding contract comes into existence. Until exchange, no contract exists between buyer and seller, and either is free to change his/her mind about the transaction and withdraw from it.
Once exchange has occurred, a binding contract will exist and usually neither party can withdraw without subsequently incurring liability for breach of contract.
On exchange, the buyer will normally pay a deposit. This was customarily 10% of the purchase price and will be held by the seller’s solicitor (to the buyer’s order) until completion. This deposit serves as a statement of intent by the buyer that he/she is serious about the transaction and intends to fulfil his/her contractual obligations. If the buyer fails to complete, the seller can usually forfeit the deposit and retain the money.
Following exchange of contracts, the first step will usually be for the buyer to ‘raise requisitions’ with the seller. Given that proof of title is invariably a pre-contract issue, requisitions are more likely to be directed at the resolution of procedural queries relating to the mechanics of completion itself. For example, the buyer will need to know precisely how much money is required from him/her to complete the transaction, where completion is to take place and who holds the keys to the property. These queries are usually raised on a standard form which is sent to the seller’s solicitor for his/her replies.
At the same time as sending the requisitions, the buyer’s solicitor sends the draft transfer deed to the seller’s solicitor for approval (again, there may be some back and forth between the parties’ solicitors at this stage in relation to the transfer deed). Although customarily it is the buyer’s solicitor who prepares the transfer deed, it is becoming increasingly common for the contract to provide that the seller will draft the transfer. This will then be provided to the buyer at the same time as the draft contract, which can help prevent unnecessary delays between exchange and completion.
Essentially, the transfer deed activates the terms of the sale contract and it must therefore be drafted to reflect the terms of that contract (meaning that no new terms can be introduced at this stage). The seller’s solicitor will carefully check the draft deed to ensure that the buyer’s solicitor has done the job properly (presuming the buyer’s solicitor has prepared it).
The seller’s solicitor’s approval of the draft transfer deed is normally notified to the buyer’s solicitor at the stage when the seller’s solicitor replies to the buyer’s solicitor’s requisitions.
The transfer deed can then be ‘engrossed’, i.e. a copy is prepared containing any agreed amendments; this will be the copy that is signed by the parties.
The seller must always sign the transfer deed, otherwise the legal estate in the land will not pass. Usually the buyer also signs, but there are circumstances in which it is not necessary for him/her to do so.
Phase 5: Preparation for completion
A few days before completion the buyer’s solicitor makes his/her pre-completion searches to ensure that no last-minute problems have occurred with the title to the property.
Such pre-completion searches may include a search against the property’s title number at the Land Registry, a company search against a corporate seller and a physical inspection (or re-inspection) of the property.
Phase 6: Completion
Although traditionally completion took place at a physical meeting with all parties present, it is now more common for the parties to agree to complete via post.
On the day of completion, the first priority is for the buyer’s solicitor to transmit to the seller’s solicitor (from one firm’s client account to another) the purchase price/consideration required to complete the transaction.
Once the seller’s solicitor’s bank receives the funds from the buyer’s solicitor’s bank, the bank should notify the seller’s solicitor that the funds have arrived, so that the seller’s solicitor can proceed with completion.
The deeds will then need to be checked over on behalf of the buyer’s solicitor, the transfer deed dated, the estate agent informed that completion has taken place (so that the keys to the property can be released to the buyer) and the deeds themselves will then be sent by first-class post to the buyer’s solicitor. The seller’s solicitor will then telephone the buyer’s solicitor to inform him/her of the safe arrival of the money and that completion has taken place in accordance with his/her instructions.
Neither the buyer nor the seller need to attend completion but should be informed by telephone immediately after completion that it has taken place: the seller will be told that they are now in funds with the proceeds of sale and the buyer is told that he/she now owns, and can take possession of, his/her new property.
Phase 7: Post-completion
Post-completion, the seller’s solicitor will account to the seller for the proceeds of sale and, if not already done, prepare and submit a bill of costs.
The buyer’s solicitor must deal with the payment of stamp duty land tax (“SDLT”). On non-residential (i.e. commercial) property, the rates of SDLT are as follows:
- For the portion of the consideration/purchase price up to the value of £150,000, there is no SDLT payable;
- For the portion of the consideration/purchase price from values £150,001 to £250,000, SDLT is payable at a rate of 2%; and
- For the portion of the consideration/purchase price above the value of £250,000, SDLT is payable at a rate of 5%.
For example, a buyer of freehold commercial property for £275,000 will pay total SDLT of £3,250 (i.e. 0% on the first £150,000, 2% on the next £100,000 and 5% on the final £25,000).
Where SDLT is payable, it must usually be paid within 30 days of completion, failure to pay within this time attracts fines and penalties.
Particulars of the transaction (i.e. who has sold what to whom and at what price) must be delivered to HMRC after completion in the form of a land transaction return. A certificate is then issued by HMRC as proof that these requirements have been complied with. Without this certificate it is not possible to register the transaction at Land Registry. Without registration the buyer will not acquire legal ownership to the property.
After these formalities have been completed, the buyer’s solicitor must apply to the Land Registry for the buyer’s title to be registered. Land Registry will provide the buyer with a Title Information Document (“TID”) which contains a copy of the register showing the buyer as the new registered proprietor as confirmation of his/her ownership. When the buyer’s solicitor has checked that the details contained in the TID are correct, the buyer’s solicitor should forward the TID, together with any other relevant documents, to the buyer for safe-keeping.