Commercial foreclosure properties can present attractive opportunities for investors looking to acquire real estate below market value. A distressed office building, retail property, warehouse, multifamily property, or industrial site may appear to offer significant upside—particularly when the property’s foreclosure price is substantially below its estimated market value.
But a low purchase price does not necessarily mean a good investment.
In Pennsylvania, purchasing a property through a foreclosure or judicial sale can involve complicated issues involving liens, title, taxes, municipal claims, environmental conditions, tenants, zoning, building violations, and the condition of the property itself. An investor who focuses only on the winning bid may discover later that the true cost of the acquisition is considerably higher. Before bidding on a Pennsylvania commercial foreclosure property, investors should conduct careful legal and financial due diligence.
What Is a Commercial Foreclosure Property?
A commercial foreclosure generally involves real estate securing a commercial loan or other obligation that has gone into default. Depending on the circumstances, the property may ultimately be sold through a sheriff’s sale, judicial sale, upset tax sale, or another foreclosure-related process. The sale process matters.
Investors should not assume that every “foreclosure sale” operates the same way or that a foreclosure automatically delivers the same type of title in every circumstance. Pennsylvania law contains different rules governing mortgage foreclosures, execution sales, municipal claims, and tax sales.
For example, Pennsylvania law generally provides that a judicial or other sale does not automatically eliminate a prior mortgage lien in every circumstance. Whether a lien is discharged can depend on the priority of the lien and the nature of the proceeding.
That is one reason why an investor should understand what type of sale is being conducted and what interests the sale is intended to discharge before submitting a bid.
Red Flag #1: Assuming the Property Is Being Sold “Free and Clear”
One of the most common mistakes is assuming that a foreclosure sale automatically eliminates every problem affecting title. It does not.
Pennsylvania law contains specific priority rules for mortgages, municipal claims, taxes, condominium assessments, and other liens. Municipal claims and municipal liens, for example, can have priority in the proceeds of a judicial sale. Similarly, Pennsylvania’s tax-sale statutes contain detailed rules concerning which liens are discharged and which may remain. An upset tax sale, for example, does not necessarily have the same effect on title as a judicial tax sale.
A title search and review by counsel before bidding can help identify which interests may survive the sale and which may be discharged.
Red Flag #2: Delinquent Taxes and Municipal Claims
Commercial properties in foreclosure frequently have more financial problems than the mortgage default that triggered the foreclosure. An investor may discover substantial unpaid taxes, municipal claims, water and sewer changes and other property related charges.
Pennsylvania law gives certain municipal claims and taxes significant priority. In some circumstances, these amounts can be paid from judicial-sale proceeds before other claims.
The important question for an investor is not simply, “How much does the property owe?” – the better question is: “Which obligations will be discharged by the sale, which will survive, and which may become my responsibility after closing?”
Red Flag #3: Environmental Contamination
Environmental liability can turn an attractive commercial acquisition into an expensive problem.
This is particularly important when evaluating industrial facilities, manufacturing properties. gas stations, auto repair facilities, warehouses, properties with underground storage tanks or previously used for chemical storage and former industrial sites
Pennsylvania and Federal Law establish a framework for environmental remediation and provides certain forms of cleanup liability protection when statutory requirements are satisfied. Conducting an environmental assessment or transaction screen, by itself, does not create liability protection.
An investor should therefore consider whether the property’s history warrants an environmental assessment before acquiring the property. A foreclosure sale does not make environmental concerns disappear.
Red Flag #4: The Building May Be in Worse Condition Than It Appears
Foreclosure properties are often sold with limited information and limited opportunity for traditional buyer inspections. Even before defaulting on mortgage and tax obligations, the owner who is experiencing financial distress will often try to conserve resources by neglecting or deferring routine maintenance and repairs.
A commercial building that looks like a bargain may have roof problems, structural defects, water intrusion, electrical and plumbing issues,, among other problems.
Red Flag #5: Existing Tenants and Occupants
A commercial property may not be vacant simply because the owner is in foreclosure.
The property could have long-term, month to month or commercial tenants with renewal rights, unrecorded leases, leases containing purchase options, occupants refusing to leave or who have left personal property at the property.
The investor should determine what leases exist, whether they are enforceable, whether they survive the foreclosure, and whether the investor may become responsible for honoring existing tenancy rights.
Evicting an owner who refuses to leave after a foreclosure sale can be a costly and time-consuming process. If a foreclosed tenant refuses to leave, it will be necessary to commence an action in ejectment. If the owner or tenant files for bankruptcy, further delay and additional expense can ensue.
Red Flag #6: Zoning and Permitting Problems
The property’s current use may not necessarily be the use you want to make of it.
Before bidding, investors should investigate the property’s current zoning classification, permitted and nonconforming uses, variance, parking requirements, building permits, certificates of occupancy, pending enforcement proceedings and any restrictions on re-development. A warehouse that appears perfect for conversion to another commercial use may require zoning relief or substantial additional investment before the proposed use is legally permitted.
Red Flag #7: Vacant or Abandoned Property Issues
Vacant commercial properties can create additional risks, including vandalism, deterioration, code violations, trespassing, and municipal enforcement.
Pennsylvania has enacted statutory provisions specifically addressing vacant and abandoned mortgaged real estate and the consequences of vacancy and abandonment in the foreclosure context.
Investors should investigate whether the property has been formally designated as vacant or abandoned and whether there are outstanding municipal orders or other proceedings involving the property. A property that has been sitting vacant for months—or years—may require substantially more work than its photographs suggest.
Red Flag #8: The Foreclosure Case Itself
The underlying foreclosure proceedings can provide important information about the mortgage, the amount owed, the borrower, other lienholders, stays or challenges to the
A careful review of the court docket and sale documents can therefore be an important part of the due-diligence process.
Red Flag #9: Bankruptcy
A foreclosure involving a financially distressed property owner can intersect with bankruptcy proceedings. A bankruptcy filing can affect the timing and enforceability of collection and foreclosure activity and may create additional issues concerning the property, the debtor, leases, assets, and creditors.
Investors should determine whether the owner or other relevant parties have filed for bankruptcy and whether any bankruptcy proceeding could affect the proposed sale.
Red Flag #10: The Numbers Do Not Work Without a Large Margin of Safety
Perhaps the biggest red flag is an investment that only works if everything goes perfectly.
Commercial foreclosure investing involves uncertainty. Investors should account for the purchase price, closing costs, title work, legal fees, environmental investigation and mediation, insurance, utilities, property management fees, unexpected repairs and related carrying costs. The investment should still make economic sense after realistic contingencies are included.
Call (610) 397-1820 to schedule an appointment with the experienced commercial foreclosure team at Max L. Lieberman & Associates to discuss the issues related to your investment in a commercial foreclosure property.
