What is the Role of Escrow in a Commercial Real Estate Transaction?

by | Jun 9, 2024 | Article

What is the Role of Escrow in a Commercial Real Estate Transaction?

Commercial real estate transactions are often complex, involving significant sums of money, extensive documentation, and multiple parties with varying interests. One crucial component that helps streamline and safeguard these transactions is the escrow process. Escrow plays a critical role in ensuring that all conditions of the sale are met before the property changes hands.

What is Escrow?

Escrow is a legal arrangement where a third party, commonly referred to as the escrow agent, temporarily holds funds, documents, and other assets on behalf of the buyer and seller until the conditions of the sale are fulfilled. The escrow agent acts as a neutral intermediary, ensuring that neither party can access the funds or property until all contractual obligations are met.  Commonly in a commercial real estate transaction, the title company providing title insurance to the buyer and its lender will act as escrow agent, although the role may also be filled by an attorney or broker associated with the transaction.

The Role of Escrow in Commercial Real Estate

1. Holding Transaction Funds and Documents

One of the primary functions of escrow in commercial real estate transactions is to provide security and build trust between the buyer and the seller. Given the substantial financial stakes and potential risks involved, both parties need assurance that the transaction will proceed as agreed. In a commercial real estate transaction, the buyer typically deposits an earnest money deposit or deposits into escrow at the beginning of the purchase process and funds the purchase money into escrow prior to closing.  In addition, prior to closing, the buyer and seller will each deposit with the escrow agent their signed copies of any required closing documents.  The escrow agent will hold these items until all required funds and documents have been received and any required prorations have been agreed to.  Once the parties are sure that everything is in order they will instruct the escrow agent to close escrow, disburse the funds, record any documents that need to be recorded in the official records and distribute executed copies of the closing documents to the parties.

2. Document Preparation and Verification

Escrow agents play a key role in ensuring that all required documents are properly prepared, signed, and verified. This includes the purchase agreement, loan documents, the deed and any other closing documents relating to the transaction. In particular, the escrow agent can play a critical role in preparing any tax forms or similar documents required by the specific municipality in which the property is located. These documents are necessary for compliance with local tax regulations and must be correctly completed by the parties to ensure that the transaction adheres to relevant legal requirements.  Prior to closing the escrow agent will collect executed copies of all required documents from each party.

3. Calculating Prorations and Closing Costs

In commercial real estate transactions, certain costs and revenues need to be prorated between the buyer and seller to properly correspond to each party’s period of ownership of the property being sold.  These items commonly include rent payments, tenant reimbursements, tax payments, utility payments, and various other elements of income and expense.  In addition to calculating these prorations, a number of additional expenses are frequently paid by the parties out of escrow at closing.  These closing costs include payments to the various vendors engaged by the buyer and seller in connection with the transaction, payment of any brokers fees, and payment of transfer tax or other relevant expenses payable at closing.  The escrow agent calculates these expenses and prorations and prepares a settlement statement that will be reviewed and confirmed by the parties. Accurate prorations ensure that both parties only pay their fair share of these costs and the settlement statement ensures that all costs associated with the transaction are paid at closing.

4. Closing the Transaction and Disbursing Funds and Documents

Once all conditions of the sale are met, the buyer and seller will mutually instruct the escrow agent to close the transaction.  In order to effect the closing, the escrow agent will disburse the funds it is holding in accordance with the settlement statement, this typically includes paying off the seller’s existing lender, paying the various vendors to be paid out of closing, making any required tax payments, paying recording costs, paying the remainder of the purchase money to the seller and refunding any excess to the buyer.  The escrow agent will also send the deed and any other recordable closing documents to be recorded in the official records of the municipality in which the property is located and circulated fully executed and complied copies of the closing documents to the buyer and seller.

Conclusion

Escrow is a critical component of commercial real estate transactions, providing a secure and efficient means of managing the exchange of funds and documents. By acting as a neutral intermediary, the escrow agent ensures that the transaction proceeds smoothly and transparently.

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