SAN FRANCISCO—Pat Stanton is a partner in the Baker Botts San Francisco office and section chair of the firm's real estate group. Stanton represents owners and developers of commercial real estate projects around the world, including sponsors in the formation of real estate funds and developers in nearly every aspect of commercial real estate development. She recently shared some views about the real estate market and how deals should be structured for a possible downturn in this GlobeSt.com exclusive.
GlobeSt.com: We are fairly insulated in the Bay Area. What is happening in the rest of the country? Is the boom really slowing down?
Pat Stanton: There is a lot of uncertainty in the market right now. Since the election of Donald Trump as the next president, interest rates have increased and there is much speculation on how high the rates will go. Significantly higher interest rates would obviously have an impact on the market generally.
There has been a slowdown in sales and leasing activity in some markets and industry segments, but this has not yet impacted high-quality assets with solid cash flows. There is still significant development activity in some of the core US markets but there has been less activity in the Southern US due to the continuing downturn in the energy market.
We are hearing reports about rising loan defaults in the commercial sector, however, many of these loans were bad loans made as the result of poor lending decisions before the financial crisis in 2006 and 2007. And the new Dodd-Frank regulatory requirements that will go into effect at the end of this year will make refinancing of these bad loans more difficult.
GlobeSt.com: What should investors be looking with regard to projects moving forward? How should deals be structured for a downturn in a sliding economy?
Stanton: If a downturn in the market becomes a reality, then lenders and investors will require significant preleasing in the commercial office market or pre-sales in the residential market before investing money in new developments. There will always be a market for quality assets with solid cash flows.
From the developer or investor perspective, when structuring a deal in an uncertain or sliding economy it is important to approach the deal terms recognizing that the hold period for the asset might be longer. If the hold period is longer, the economic deal between the partners needs to take that into account and the property owner will want to negotiate more flexible terms with investors and lenders to be able to deal with changes in the market.
Issues to consider:
1. Make sure the economics are structured to take into account the long-term hold. Developers may want the returns to be based on equity multiples instead of IRRs in order to take the time value of the money out of the equation.
2. Venture documents need to be clear on capital funding requirements and the remedies available to a funding partner if its partner fails to contribute capital. The funding partner should be rewarded for providing necessary capital to carry or stabilize an asset during a downturn and the failing partner should be penalized financially for not meeting its capital contribution obligations and should be removed from decision-making roles.
3. The property owner would like the flexibility to obtain subordinate debt or to pledge its indirect interests in the property owner to secure additional financing to cover periods of unanticipated declines in cash flow.
4. Property owners need flexibility to transfer direct and indirect interests in the property owner without the consent of the lender to meet the liquidity needs of its investors and to admit new investors if additional capital is needed to carry or stabilize the investment.
5. Long-term debt may be more attractive in order to avoid having to refinance the asset during the downturn. Of course if the downturn does not materialize and sale of the asset is desired or if the property owner needs to sell or refinance the asset to avoid foreclosure, prepayment penalties can make sale or refinancing in the short term prohibitive. The property owner should obtain the right for a buyer of the property to assume the debt so that the property can sell the asset without paying a significant prepayment penalty.
Some of the types of transactions in which Stanton represents owners and developers include land acquisition, negotiation of debt and equity financing, negotiation of tenant leases (including build-to-suit tenant leases), construction contracts and management agreements, and negotiation of reciprocal easements, covenants and development agreements. Typical projects include office buildings, hotels, condominiums, retail centers and mixed-use properties.
SAN FRANCISCO—Pat Stanton is a partner in the
GlobeSt.com: We are fairly insulated in the Bay Area. What is happening in the rest of the country? Is the boom really slowing down?
Pat Stanton: There is a lot of uncertainty in the market right now. Since the election of Donald Trump as the next president, interest rates have increased and there is much speculation on how high the rates will go. Significantly higher interest rates would obviously have an impact on the market generally.
There has been a slowdown in sales and leasing activity in some markets and industry segments, but this has not yet impacted high-quality assets with solid cash flows. There is still significant development activity in some of the core US markets but there has been less activity in the Southern US due to the continuing downturn in the energy market.
We are hearing reports about rising loan defaults in the commercial sector, however, many of these loans were bad loans made as the result of poor lending decisions before the financial crisis in 2006 and 2007. And the new Dodd-Frank regulatory requirements that will go into effect at the end of this year will make refinancing of these bad loans more difficult.
GlobeSt.com: What should investors be looking with regard to projects moving forward? How should deals be structured for a downturn in a sliding economy?
Stanton: If a downturn in the market becomes a reality, then lenders and investors will require significant preleasing in the commercial office market or pre-sales in the residential market before investing money in new developments. There will always be a market for quality assets with solid cash flows.
From the developer or investor perspective, when structuring a deal in an uncertain or sliding economy it is important to approach the deal terms recognizing that the hold period for the asset might be longer. If the hold period is longer, the economic deal between the partners needs to take that into account and the property owner will want to negotiate more flexible terms with investors and lenders to be able to deal with changes in the market.
Issues to consider:
1. Make sure the economics are structured to take into account the long-term hold. Developers may want the returns to be based on equity multiples instead of IRRs in order to take the time value of the money out of the equation.
2. Venture documents need to be clear on capital funding requirements and the remedies available to a funding partner if its partner fails to contribute capital. The funding partner should be rewarded for providing necessary capital to carry or stabilize an asset during a downturn and the failing partner should be penalized financially for not meeting its capital contribution obligations and should be removed from decision-making roles.
3. The property owner would like the flexibility to obtain subordinate debt or to pledge its indirect interests in the property owner to secure additional financing to cover periods of unanticipated declines in cash flow.
4. Property owners need flexibility to transfer direct and indirect interests in the property owner without the consent of the lender to meet the liquidity needs of its investors and to admit new investors if additional capital is needed to carry or stabilize the investment.
5. Long-term debt may be more attractive in order to avoid having to refinance the asset during the downturn. Of course if the downturn does not materialize and sale of the asset is desired or if the property owner needs to sell or refinance the asset to avoid foreclosure, prepayment penalties can make sale or refinancing in the short term prohibitive. The property owner should obtain the right for a buyer of the property to assume the debt so that the property can sell the asset without paying a significant prepayment penalty.
Some of the types of transactions in which Stanton represents owners and developers include land acquisition, negotiation of debt and equity financing, negotiation of tenant leases (including build-to-suit tenant leases), construction contracts and management agreements, and negotiation of reciprocal easements, covenants and development agreements. Typical projects include office buildings, hotels, condominiums, retail centers and mixed-use properties.
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