Fire at an 18-unit complex I'm set to purchase in 3 weeks, help!

[Tony S.]

There was a fire yesterday evening in one unit with injuries at an 18-unit property I’m under contract to purchase 3 weeks from now. How should I proceed?

My diligence period ends this Saturday, though Seller has already agreed to extend the diligence period to allow us all to react to this new development.

There are substantial tax considerations to close on this property by year end from both the seller’s and my perspective. Almost all of the tenants are month-to-month, this is a big value-add project ($20,000 renovations for each unit) and I’m getting these properties at an attractive price with great seller-finance terms. I was going to strip these units down to the studs anyways to fully rehab them, but it appears the fire has damaged some of the trusses in this unit.

I’ve never dealt with a fire before. The tenant was found unconscious by the fire department at the property (suspected smoke inhalation), was conscious on the way to the hospital in an ambulance, though was subsequently put into an induced coma due to soot in lungs. I’m unsure of the tenant’s condition now.

The fire department is saying it’s a stove fire, though admittedly they have a lot of questions since the properties still have some knob and tube wiring, and this is the second fire originating from a stove at this complex this year. Out of the 15 years the seller has owned the complex, there has never been a fire incident under their ownership until this year.

I was planning to upgrade all the electrical anyways in each of these units, but how should I approach handling this fire incident in light of closing? Because this is the second fire this year, I think maybe this property now has the city’s attention (not in a good way), so the risk profile may have increased for me now.

Questions:

1. Should I forget about closing this year? Or can I still make it happen?
2. How do handle processing this with the seller’s insurance if we close next month? Can the seller assign the insurance claim to me as the buyer?
3. The purchase contract states that the seller will indemnify me as the buyer for any claims arising from anything that happened before closing. Should I be worried abiout anything from a liability perspective?
4. If I estimate about $40,000 in damage and the unit being offline for a couple of months, how much of a purchase price reduction should I request.
5. Any other considerations I should be thinking about?

Any help or advice from anyone that has gone through this or has any experience would be greatly appreciated! I’m set to have a conversation with the seller about this issue tomorrow and want to have thought through everything ahead of time.

[Charles Seaman]

@Tony S.  I bought a property with an open fire claim earlier this year.  My replies to your questions are below in Italics.

1. 1. Should I forget about closing this year? Or can I still make it happen?  It's possible that you can still close this year.  Are you obtaining traditional financing to acquire the property or is the seller financing the sole source of debt?  If you are using traditional financing, then it might make it tougher, but it's still possible.
2. 2. How do handle processing this with the seller’s insurance if we close next month? Can the seller assign the insurance claim to me as the buyer?  The seller can assign the insurance claim to you, however it'll likely be easier just having them keep the proceeds from the claim and giving you a credit to the purchase price now.
3. 3. The purchase contract states that the seller will indemnify me as the buyer for any claims arising from anything that happened before closing. Should I be worried abiout anything from a liability perspective?  Your best bet is to speak with your insurance broker or attorney about this.  If the seller has already filed the claim or will file it prior to closing, then your liability should be limited.  While indemnification provisions are good in theory, there are times where it can be tough to enforce them in practicality.
4. 4. If I estimate about $40,000 in damage and the unit being offline for a couple of months, how much of a purchase price reduction should I request.  $40,000 + whatever lost rent you'll incur.  Keep in mind that your insurance premium will also most likely increase if you provide your insurance broker or carrier with updated loss runs that reflect this claim, so you'll want to include a further reduction to reflect that.
   5. Any other considerations I should be thinking about?  If you haven't already done so, then you probably want to have an electrician and a structural engineer inspect the property to evaluate any further issues that you might encounter.  If you're getting the deal at an attractive price and you're planning to bring the units down to the studs, then you'll likely be fine.

[Christopher Alan Rush]

Commercial contractor here, our company did the repair work for a warehouse fire that was probably in flames for less than 5 minutes. 

1st of all, does the current owners insurance not cover anything? 

2nd: the repair costs will be based partly on what 1) the engineer will require to be comfortable signing off on the repairs and 2) what the city or AHJ may require. Insurance often tries to pay out only for “matching the original condition”, rarely will you be allowed to actually reconstruct it that way. For reference i think there was ~60 trusses in that roof, with 7 or 8 having visible burn signs, and we had to replace all the trusses… which means all of the ceiling Sheetrock , attic insulation , sheathing , finish roofing, fascia and soffits… also isn’t there water damage from a fire truck? That would be more water damaged materials to replace. 
if your closing in 3 weeks… we’ve worked with a few different insurers. 1 is great. But the majority (especially residential insurers) will most likely take 2-3 months of wanting to go back and forth, get additional estimates, etc before authorizing a contractor to begin or paying the claim.
it would most likely be to your financial benefit to extend the closing date until after insurer-paid repairs are completed. 

[Tony S.]

Quote from @Charles Seaman:

@Tony S.  I bought a property with an open fire claim earlier this year.  My replies to your questions are below in Italics.

1. 1. Should I forget about closing this year? Or can I still make it happen?  It's possible that you can still close this year.  Are you obtaining traditional financing to acquire the property or is the seller financing the sole source of debt?  If you are using traditional financing, then it might make it tougher, but it's still possible.
2. 2. How do handle processing this with the seller’s insurance if we close next month? Can the seller assign the insurance claim to me as the buyer?  The seller can assign the insurance claim to you, however it'll likely be easier just having them keep the proceeds from the claim and giving you a credit to the purchase price now.
3. 3. The purchase contract states that the seller will indemnify me as the buyer for any claims arising from anything that happened before closing. Should I be worried abiout anything from a liability perspective?  Your best bet is to speak with your insurance broker or attorney about this.  If the seller has already filed the claim or will file it prior to closing, then your liability should be limited.  While indemnification provisions are good in theory, there are times where it can be tough to enforce them in practicality.
4. 4. If I estimate about $40,000 in damage and the unit being offline for a couple of months, how much of a purchase price reduction should I request.  $40,000 + whatever lost rent you'll incur.  Keep in mind that your insurance premium will also most likely increase if you provide your insurance broker or carrier with updated loss runs that reflect this claim, so you'll want to include a further reduction to reflect that.
   5. Any other considerations I should be thinking about?  If you haven't already done so, then you probably want to have an electrician and a structural engineer inspect the property to evaluate any further issues that you might encounter.  If you're getting the deal at an attractive price and you're planning to bring the units down to the studs, then you'll likely be fine.

 Thanks, Charles! I appreciate the sage advice and guidance, I feel a lot better about going through with this.

[Charles Seaman]

@Tony S.You're welcome.

[Percy N.]

@Tony S., a few years ago we were under contract to purchase a 124 unit complex when there was a fire while we were under the DD period and 12 units were damaged to varying degrees.

We still went ahead and closed and it turned out OK though had its headaches as well.

Couple key things to consider:

- Will the seller's insurance company let him assign the claim to you? Many will not, so you may need to negotiate an escrow with the seller to cover the repairs as they get reimbursed from the insurance.

- Will the construction be done in time and units leased with loss of rent coverage?

- Does the policy have code upgrade coverage?

- Insurance will claim some amount of depreciation that is not covered, etc so make sure you are getting all your costs covered from the seller.

- Permitting and COs can take longer than expected so who will cover that expense?

- Get multiple quotes from GCs and Public adjusters and go with the higher ones to be on the safe side. 

- You have the leverage to walk now, so negotiate what you want, all the seller can do is say no and you have the deal you currently have. 

- Don't let the tax tail wag the dog - make sure it is a good deal first, tax benefits will be secondary. 

[Matt Devincenzo]

I always look at issues like this as a "what can I do that is different to achieve a deal where other's wouldn't". I'd be telling the seller I absolutely want to close still, and we just need to figure out how we do it correctly so we're both protected. The seller already knows that his asset just took a nose dive after this, so help him figure out a solution. 

1. I'd absolutely try closing still, as long as you can sort out the other details.

2. I don't have experience with this, but I believe you can. Also I'd talk to an attorney re: a private agreement for what happens if the claim is assigned to you and there are unforeseen issues with insurance. You and the seller can agree to continue to work out this issue until it is 100% resolved, and an attorney can help ensure your agreement is legal and covers other possibilities you're not aware of. 

4. Maybe there's no PP reduction. If you get the insurance assigned and it repairs the damage, then were you actually negatively impacted by this loss? Especially considering that there is likely at least some overlap in scope of work you planned vs. what just became a loss? The details will really dictate what the best approach is here. 

[Jason Bott]

@Tony S. In regards to #2, it will be difficult to cleanly get the claim assigned to you.  The insurance carrier by law needs to pay the "Named Insured" on the policy at the time of the loss.

Our client had to give a credit at closing with funds tied up in escrow until the claim payout was settled 90 days later.

[John Mocker]

Tony,

Have you lined up insurance on the property.  I see multiple issues that would make suggest you speak to your agent:

1. Knob & Tube wiring.  

2. tenant occupied during reno (sounds like your are doing it unit by unit so that may not be an issue)

3. Active claim.  (many companies will not write the coverage until the claim is closed)

[Tony S.]

Quote from @Jason Bott:

@Tony S. In regards to #2, it will be difficult to cleanly get the claim assigned to you.  The insurance carrier by law needs to pay the "Named Insured" on the policy at the time of the loss.

Our client had to give a credit at closing with funds tied up in escrow until the claim payout was settled 90 days later.

Jason,

Why establish an escrow account?  Was it because the claim was to be paid to the seller by the insurance company and the buyer just wanted to ensure that the buyer would get paid?  Why not guaranty the credit to the buyer (whether or not seller gets paid by insurance), since this loss was incurred by the seller during seller's ownership?

Thanks,
Tony

[Jason Bott]

@Tony S. Sorry if I wasn't clear on it.  Please keep in mind this is second hand from my client, I didn't set up the structure.

The credit to the seller was in escrow.  I think it was about $100k which was a conservative estimate.  As the funds were paid to the seller by the insurance carrier, those credited funds in escrow were distributed to the buyer.

In the end, I think the seller got $25k back from escrow.