August 07, 2009
In today's economy, with financial meltdown news dominating the headlines, one may wonder: Is there any money available to complete a deal?
Of course there is. After all, institutions that are in the business of providing loans still needed to move money. That's their business.
There's not a hotter real estate issue today than the funding and collateralization of loans. Before we analyze from a legal perspective, we need to talk briefly about the business environment. After all, law is driven by business. Business doesn't drive law.
The current business environment is obviously very tough. Credit standards are now extremely high, and regulators are looking at every aspect of every lending institution very closely.
In other works, today is not the day to declare yourself a real estate developer if you've never developed anything. It's too difficult to borrow money even if you're an experienced developer. (Actually, today is not the day to start any kind of business where you have no experience.)
While banks are still lending money, the risks are more calculated. Banks are making sure the money is being loaned to the right person. Underwriting standards have become much more stringent.
When approving a loan, lenders are requiring that management not only have an established track record, but have additional equity in a project. The lender may also insist that a project boast different layers of funding, rather than all of the funds coming from one central source. Personal guarantees from the developers borrowing money are often required, as are letters of credit.
Temporarily gone are the fancy strategies of a few years ago. Second liens are pretty much gone. Banks are very tight on covenants now.
All of these documentations, guarantees and reporting procedures are in place so banks can know as early as possible of any potential problems. That way, the banks can get their rescue plan going and solve the problem as quickly as possible in the most cost effective manner.
The more convoluted real estate deals, such as health care - where the operator is of paramount importance - or niche properties, are even more conservative than the general kinds of real estate properties. Still, despite the turmoil in the market, commercial real estate is holding its own. Everyday, strop malls are apartment deals are getting done, especially if they're conservative. Other deals getting done are the everyday kind of real estate where loans become due, or someone wants to re-negotiate a higher interest rate or a change in ownership.
Developments of an environmental nature may also be a temporary casualty of today's conservative banking arena. We're seeing lenders being more cautious with projects with potential environmental problems. The last thing lenders want in today's credit environment is a project with environmental concerns. Any project that poses a potential problem is anathema to the lender.
Yes, green development is good, and green construction will continue to be at the forefront of real estate development. But developers work on a project based on financial incentives, and until we see more tax incentives for green development, we may see a slowdown on these properties. There may be a slowdown but not a halting; green projects are here to stay. Look to the next presidential administration to see how wide-ranging those green changes will be.
The busy day of a real estate lawyer
With all of these red flags dotting every loan request, how is the real estate lawyer doing these days? While there aren't as many new deals to negotiate, the real estate legal community is keeping busy with drafting amendments, re-structuring and re-writing loans. The work-out people are as busy as the bankruptcy people.
We're witnessing a lot of tough negotiations on the leasing side. Because the troubled economy has spilled over into the retail sector, we're seeing tenants struggling with old lease terms, and not being able to pay current rents. The tenants business is down, so they're looking to save costs wherever they can. Because one of a company's biggest costs is real estate, we're seeing a tremendous amount of lease re-negotiations.
Transaction lawyers are staying active too. While they're not trailblazing new developments these days, they are heavily involved in re-working existing developments. Complicated legal issues are raised because with the tougher credit environment, lenders are looking at all the fine print - and accompanying documentation - much closer.
Fees remain reasonable competitive. When there's a good, strong project, all the banks want to be a part of it. Because there are only so many good projects these days, fees are still regularly competitive.
The securitization market has really dried up. Most developers now book their loans and keep their own loans on the books. It will be a long time before the securitization market comes back.
Until the money flows back and new construction loans get approved, there's enough restructuring work to keep the legal real estate industry active for some time to come.
Michael D. Weiss is a partner in the Chicago office of Barnes & Thornburg LLP and a member of the firm's Business Department. He focuses his practice on real estate and corporate transactions. He has represented real estate clients in development, leasing, acquisition and disposition, tax-free exchanges, financing and workout matters. He can be reached at [email protected]