Avoiding Deal Killers in Real Estate Sale...

Presenting a live 90‐minute webinar with interactive Q&A

Avoiding Deal Killers in Real Estate Saled P h T i and Purchase Transactions

Anticipating and Resolving Environmental Issues, Land Use Approval Problems, Encroachment Issues and More

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, JULY 17, 2013

Today’s faculty features:

Robert G. Koury, Shareholder, Lane Powell, Portland, Ore.

Walter W. McMonies, Shareholder, Lane Powell, Portland, Ore.

John C. Pinkstaff, Counsel to the Firm, Lane Powell, Portland, Ore.John C. Pinkstaff, Counsel to the Firm, Lane Powell, Portland, Ore.

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Avoiding Deal KillersAnticipating and Solving Problems Related to

Properties Being Sold or Purchased(a webinar for Strafford Webinars)(a webinar for Strafford Webinars)

July 17, 2013

Presented by:Robert Koury

Walter W. McMonies, Jr.John PinkstaffJohn Pinkstaff

Lane Powell PC601 S.W. Second Avenue, Suite 2100

Portland OR 97204

55©2013 Lane Powell PC

Portland, OR 97204503.778.2100 (T) 503.778.2200 (F)

TABLE OF CONTENTS

A. Introduction1 Contamination; Environmental Issues 1. Contamination; Environmental Issues 2. Defective or Incomplete Land Use Approval3. “As Is,” “Your Problem Not Mine” Seller4. Encroachment 5 URM or Otherwise Seismically Challenged Property5. URM or Otherwise Seismically Challenged Property6. Use, Alterations and Redevelopment of Existing Buildings7. CC& R Restrictions8. Legal Access9 Soils or Riparian Issues9. Soils or Riparian Issues10. Flood, Tsunami, Storm/Wind Vulnerability11. Prohibitive Prepayment Penalty12. Under-Performing Property13. Low Basis Seller13. Low Basis Seller14. Investor Gets “Cold Feet;” Need $$ to Close

Note: This Presentation was first given to the Portland, OR Chapter of CCIM on Wednesday April 3, 2013, next was given to a continuing education seminar sponsored by Ticor Title (Portland) on Friday, June 14, 2013, and an expanded version in a web seminar for Strafford Webinars on Wednesday, July 17, 2013 ( the l t d th titl “A idi D l Kill ”)


last under the title “Avoiding Deal Killers”).

Avoiding Deal KillersIntroduction: General ApproachSellers: Don’t hide a Property’s problem; disclose them.Buyers: Look under every rock; get appropriate contingencies; and get Reps and Warrantiescontingencies; and get Reps and Warranties.Both: Dealing with Property defects:•Find out as much as possible;R t i d lt t•Retain and consult an expert;

•Develop a plan to cure or minimize;•Ascertain the approximate cost and timetable to implement the plan; andimplement the plan; and•Implement the plan pre-closing if possible; or •Negotiate a price reduction or buyer holdback or credit against the purchase price to compensate for buying the


against the purchase price to compensate for buying the Property with the defect.

Avoiding Deal KillersAttorneys have a bad rap as “deal killers” among some brokers and principals; however there is a basis for the misconception:• Some do lose the forest for the trees, negotiating for overly protective

i i i PSA th t d ti d t ff th th tprovisions in a PSA that are destined to scare off the other party;• Some are seemingly incapable of writing a simple sentence or using

lay terminology, turning off principals and brokers alike;• Some won’t return calls of or even stoop to talk with the brokers,

lth h tt thi ll t d f t lki t th although attorneys are ethically prevented from talking to another attorney’s client without permission;

• Some treat the brokers and opposing counsel as adversaries;• Some lose professional detachment and treat the deal as their own;

d and • Some fail to estimate likely fees or keep the fees to a reasonable

amount.


Avoiding Deal KillersThe Attorney’s proper role:• Analyze the proposed deal and point out problem areas;• Draft an LOI and later a PSA which protect the client Draft an LOI and later a PSA which protect the client

from liability; clearly commit the other party to certain actions; provide reasonable reps and warranties; afford a reasonable time line; anticipate procedural issues; provides the client remedies; and is clear concise and provides the client remedies; and is clear, concise and avoids ambiguity;

• Assist in the design and conduct of due diligence; • Review and resolve title issues; • Review and resolve title issues; • Structure the transaction to maximize tax benefits; and• Draft conveyance documents and escrow instructions.


1. Contamination; Environmental Issues

Problem: Problem: • Significant environmental contamination on or directly

affecting the Property.• No state environmental agency “no further action” (NFA) letter. g y ( )Concerns: • Buyer:

– Stepping into major liability for someone else’s mess.R di i l i i d diffi l– Remediation costly, time consuming and difficult.

– Stigma of the contamination will scare off lenders and buyers.– Remediation may interfere with day to day use.

• Seller: Seller: – Buyer may mishandle or “drop ball” on remediation creating more

liability for Seller


Contamination; Environmental (cont.)Approach to Solution:Approach to Solution:• Hire an environmental consultant or environmental

attorney (one for each party or side).• Obtain any existing Phase One or other documentation

on the contamination.• If none, commission a Phase One/Phase Two ,

environmental assessment.• The parties’ consultants should agree on a scope of

work and then negotiate with state agencywork and then negotiate with state agency.• Get bids or estimates to quantify the cost of remediating

and the estimated time frame.


Contamination; Environmental/Approach (cont.)• Determine if there is any “deep pocket” third party y p p p y

liability.• Negotiate both (i) a holdback of the remediation cost out

of Seller’s closing funds and (ii) potentially an adjustment of the purchase price or (iii) a credit.

• Ensure Buyer’s lender will hold its interest rate on the new loan pending remediati, on if done pre-closing.

• Determine whether insurance may be available to Seller covering his loss.

• Consider deal terms that impose liability for pre-existing p y p gconditions on Seller and liability for new contamination occurring post-closing on Buyer, but need a baseline on the contamination [an environmental site assessment?]


Contamination; Environmental/Approach (cont.)

• Consider negotiating a pre-purchase Prospective Purchaser Agreement with state environmental agency, if allowed.

• Consider a Common Interest Agreement regarding remediation obligations to afford privileged communications among the parties if allowedcommunications among the parties, if allowed.

• If contamination is present, consider what is the best remedial action plan and the best regulatory approach.


2. Defective or Incomplete Land Use ApprovalProblem:

O t t di d ti fi d diti t • Outstanding and unsatisfied pre-conditions to the original (land use) development approval of the Project.

Concerns: • City/County could force compliance at any time;

and • It may be difficult, costly or impossible to

comply. Approach: Approach: • Identify all prior land use decisions and

conditions of approval.


Defective or Incomplete Land Use Approval/Approach (cont.)

G th i f ti d d t ti • Gather information and documentation re compliance from:– Planning staff.Planning staff.– ALTA surveys and title reports.– Zoning reports by consultants such as PZR

Reports.– City/County file review.

Hi t k ti t i l d l t fil– History, marketing materials, development files.


Defective or Incomplete Land Use Approval/Approach (cont.)( )• Evaluate materiality of outstanding/unsatisfied

condition of development approval.• Is it:

– Fatal non-compliance?Non fatal non compliance?– Non-fatal non-compliance?

• Confer with Lender’s counsel on situation.• If material and/or fatal, evaluate the feasibility of If material and/or fatal, evaluate the feasibility of

obtaining retroactive compliance pre vs. post-closing.


3. “As Is,” “Your Problem Not Mine” SellerProblem: Seller who: • Insists on selling his Property entirely on an “AS IS”

basis; basis; • Refuses to make any representations or warranties;

and • Either has inadequate files or refuses to allow Buyer

to review his files. Concerns: Seller likely suspects or knows there is a major defect in the Property.


As Is (cont.)Approach• Some minimal Representations (“Reps”) are

expected of Seller: – Has marketable title to the Property; Has marketable title to the Property; – Seller entity authorized to sell the Property; – Knows of no substantial defects in condition of

Property or in land use approvals for its development; Property or in land use approvals for its development; – Has received no notices of non-compliance from

government , lender or insurer not cured; andC t Ok f S ll t lif t R – Caveat: Okay for Seller to qualify most Reps.

“To the actual knowledge of Seller’s principal [insert name] without inquiry.”


As Is/Approach (cont.)• AS IS language may be acceptable as long as:

d – Buyer is given access to and an opportunity to copy all Seller’s files (excepting tax returns); and

– Seller represents that the files are substantially p ycomplete and accurate.

• Presence of a strong AS IS disclaimer:Forces meticulous and thorough due diligence– Forces meticulous and thorough due diligence.

– Necessitates a longer contingency period.– Raises a concern is a hidden defect.– May be explained by status of Seller, e.g. a

trustee or creditor with little knowledge


As Is/Approach (cont.)• Terminate if Seller won’t either:

All fil – Allow file access; or– Give a Rep or Warranty that there are no substantial

undisclosed defects.The AS IS clause etc should be vetted by each party’s • The AS IS clause, etc., should be vetted by each party’s attorney. Typical components:– Buyer is a sophisticated real estate [investor,

developer, ?];developer, ______?];– Seller has afforded Buyer sufficient time for thorough

due diligence on the Property;– If the sale were not “As Is,” Buyer would necessarily , y y

charge significantly more for the Property;– [If true] Seller has only owned the Property for a short

time and/or is not involved in its management.


4. EncroachmentProblem: Project buildings or other improvements Problem: Project buildings or other improvements encroach on a Property boundary line, into a required setback or into a recorded easement way. Concern: Cloud on title and potentially a loss of use Concern: Cloud on title and potentially a loss of use and financial cost to rectify.Approach: One can cure an encroachment by:

– Moving or demolishing the improvement;– Payment to obtain a modification or to obtain a

license; or ;– Litigation successfully asserting adverse

possession or abandonment with neighbor (owner of the dominant parcel)


(owner of the dominant parcel).

Encroachment /Approach (cont.)• Don’t have to straddle the Property boundary to on t have to straddle the Property boundary to

encroach. – An improvement can encroach on an access or

utility easement or it can encroach into and utility easement or it can encroach into and thereby violate a setback.

– Whatever, need to have a land surveyor to locate, d d draw and measure.

– Encroaching into a zoning setback is a problem, but can often get a retroactive variance or gadjustment.

– A setback imposed by CC&R’s may be a bigger problem as may be multiple benefitted parties.


problem as may be multiple benefitted parties.

Encroachment/Approach (cont.)– When an encroachment is in the form of

improvements built over a utility easement, Seller may have to modify or move the improvements.

– Find out if the easement is still in use or has been – Find out if the easement is still in use or has been abandoned.

– Query, whether Seller had an “encroachment endorsement” ALTA 9.5 (Owner’s Policy, Improved Land) on his title policy when purchased?purchased?


Encroachment/ Approach (cont.)• Boundary line encroachments. Consider:

– Work with title examiner to clear up boundary line overlaps/gaps.

– Confer with County Surveyor re encroachments – Confer with County Surveyor re encroachments identified by a survey.

– Comply with County/City ordinances prohibiting recording of surveys evidencing boundary line encroachments.

– Need a property line adjustment easement – Need a property line adjustment, easement, license or boundary line agreement with adjacent property owner to resolve encroachment.


5. URM or Otherwise Seismically Challenged Property

Problem: • Where the building(s) are of unreinforced masonry

(“URM”) or other seismically deficient construction ( URM ) or other seismically deficient construction (non-ductile concrete); and/or

• Where located in a seismically vulnerable area or on yunstable soils.

Concerns: If a URM:C ’ d ddi i • Can’t get advantageous Freddie Mac, Fannie Mae and “Conduit” loans, if in a seismically vulnerable area.


.

URM/Concerns (cont.)• What loans are available (often from Banks) will:

– have a lower LTV ratio and higher DSC; – higher interest rate;

shorter rate fixed period;– shorter rate-fixed period;– shorter amortization; and – will require personal guarantees.q p g

• Earthquake insurance, if available:– Will be surplus lines only (less regulated);

H hi h d d tibl – Have higher deductibles; – Have less breadth of coverage; and – Will be more expensive.


Will be more expensive.

URM /Concerns (cont.)• Building inspector might force a major seismic

upgrade if it is determined: – a dangerous building;

substantial work being done; or – substantial work being done; or – there is a “change of use.”

• Building potentially dangerous to tenants Building potentially dangerous to tenants, – discouraging occupancy; and – creating possible tort liability for the owner for g p y

wrongful death, as occurred in Paso Robles during Dec. 2003 San Luis Obispo EQ (M 6.5)


URM (cont.)Comment:Comment:• It is technically feasible to seismically

upgrade most URMs and seismically pg ydeficient buildings.

• Financial feasibility is a reflection of both the t f th i i d d th t l cost of the seismic upgrade and the rental

value of the renovated space. – San Francisco has high rents and high – San Francisco has high rents and high

seismic risk vs. (say) Boise, Idaho with lower rents and lower risk.


URM (cont.)Approach:

D t i if th b ildi i URM th i • Determine if the building is a URM or otherwise seismically challenged. – Some cities have inventoried URMs.Some cities have inventoried URMs.

• Determine whether the building is in a seismic risk area.– Most of California and the Oregon Coast are in

Seismic Zone 4. Consult the state’s geologist to learn of any – Consult the state s geologist to learn of any nearby faults and unstable soils.


URM/Approach (cont.)• If the Building is a URM or inadequately reinforced,

consider having an engineer perform an ASCE 31 or an ASCE 41 analysis and get a “PML” (Probable Max Loss) calculation.Loss) calculation.

• If the Building is of historic quality, significant tax incentives may apply, e.g. – A historic property tax assessment freeze; – The Federal 20% historic tax credit; and

A h it bl f d d ti– A charitable façade donation.


URM/Approach (cont.)• To determine if seismic upgrading is financially pg g y

feasible: – Obtain upgrade design from an engineer and

preliminary bids from several masonry preliminary bids from several masonry contractors.

– Project the post construction income and j pexpense of the Building.

• Result: Reduce purchase price to reflect th k i k d d t earthquake risk and upgrade cost.


6. Use, Alterations and Redevelopment of Existing Buildings

Concerns: • Before committing to acquire a Property, perform

due diligence regarding building permits, proposed g g g g p , p puse, alterations, change of use or redevelopment of the building.

Approach:Approach:• Check all permits in the Building Department’s file

and consult with City/County Planning Dept.C i f b ildi it f l P– Copies of building permits, formal Pre-Application Conference, informal assistance, written report from City/County planning staff.


Use, Redevelopment (cont.)– If Work appears to have been performed after

original construction, check to be sure it was g ,permitted.

– If not permitted, retain a competent engineer or architect to negotiate with the Building Department to get the work permitted.

– Uniform Building Code violations, problems:o Plumbing, electrical or structural work done g,

without a permit, may be defective, dangerous and could result in Building being “red tagged” at any time;

o Lender may refuse to loan until situation rectified; and

o Casualty insurer may refuse to insure.


Use, Redevelopment/ Approach (cont.)– Illegal Units Illegal Units

o Apartment complex has unpermitted (“illegal”) units (e.g. common area converted to units), b t S ll thi k th ill l it th th but Seller thinks the illegal units are worth the same as legal ones.

o Consult an architect and/or City/County o Consult an architect and/or City/County planning departments regarding legality of units and what is needed legalize units.

i f h ill l i h ld b di d o Price of the illegal units should be discounted to reflect the time, money and risk won’t be able to make them legal.


g

Use, Redevelopment (cont.)– Exactions

oGoverning Law: Whether condition of development

(e g dedication of land) is an (e.g. dedication of land) is an unconstitutional “taking” under U.S. Constitution based on Nolan/Dolan analysis requiring that the condition analysis, requiring that the condition have the requisite “nexus” (condition serves same purpose as regulation) and “proportionality” (roughly equal) and proportionality (roughly equal) to impact from development.


• Use, Redevelopment (cont.)– Exactions (cont.)

Koontz v. St. Johns River Water Management 570 US slip op Management, 570 US ____, slip op (6/25/2013) USS Court held that “nexus” and “roughly proportionality” requirements apply to “monetary exactions” requiring a developer to pay or spend money for offsite environmental spend money for offsite environmental mitigation as a precondition before government will issue permit or approval.


Use, Redevelopment (cont.)– Legal lot determinationLegal lot determination

o Governing LawCity or County or governmental jurisdiction (borough,

parish etc ) code provides criteria (did the lot meet parish, etc.) code provides criteria (did the lot meet standards of ordinance in effect at time of creation?).

o Legal lot and permitted use distinguishedLot may be legally created but proposed use may not be Lot may be legally created but proposed use may not be

permitted use under current code.

o EstablishmentCit C t t d id li ti f l l l t City or County, etc. code provides application for legal lot

determination or makes finding as part of another land use application process.


Use, Redevelopment (cont.)Ch f U– Change of Use

o Governing lawCity or County code provides what constitutes a change y y p g

of use as distinguished from similar use, minor or major variance, modification of conditions.

o EstablishmentCity or County code provides specific type of

applications, requirements regarding pre-application conferences, type of decision, decision authority (City Manager, Hearing Officer, Planning Commission, City or Town Council) and appeals.


Use, Redevelopment (cont.)– Nonconforming Use (NCU)Nonconforming Use (NCU)

o Use or structure lawfully existed before enactment of zoning code and may be continued after enactment or ordinance although does not comply enactment or ordinance although does not comply with current use restrictions.

o Governing Law – state statute and City and County, etc. Code requirements.

o Vested Rights distinguished: commenced but not completed NCU – allowed to be completed based p pon factors showing investment-backed expectations.


Use, Redevelopment (cont.)– Nonconforming Use (NCU)(cont.)

o Code may provide application for recognition of NCUof NCU.

o Possible criteria:Lawfully existed at time of zoning code.y gNature and extent of use.Use not discontinued or abandoned.Use not altered or alterations comply.


Use, Redevelopment (cont.)Nonconforming Development– Nonconforming Development

o Governing Lawo Nonconforming Development and NCU

di ti i h d U i ll d b t i ti distinguished. Use is allowed but existing development does not meet current development standards.E t bli h t d So Establishment and ScopeDevelopment standards include ADA, setbacks,

buffers, height, density, parking, site design review, fire code and FAR (floor area ratio)fire code, and FAR (floor area ratio).

Planning staff advice regarding which upgrades are required.


Use, Redevelopment/ Approach (cont.)– Outdoor Signs/Cell Towers/Roof AntennaOutdoor Signs/Cell Towers/Roof Antenna

o Value of lease vs. limitations on future use.o Review lease terms (assignment, renewal,

removal, replacement, termination to avoid renewal or buy-out).

o Preferable to Owner: if not an easement; if o Preferable to Owner: if not an easement; if terminable annually w/o cause or anytime for cause; if Lessee has affirmative obligations;

d if t i b t ti land if rent is substantialo Negotiate termination of lease if necessary.


7. CC& R Restrictions(Covenants, Conditions and Restrictions)

Problem: Problem: • Title clouded by 70 years or older (pre-WW II)

CC&R’s imposing: – Ethic, religious and/or racial restrictions on

ownership or occupancy (generally unenforceable) as well asunenforceable) as well as,

– Density and/or height limitations, minimum square footage of improvements, minimum lot q g psize, stringent setbacks, design review and/or limited approved uses (generally enforceable).


Old CC & R’s/Approach: Concern: Uncertainty whether enforceable.• Constitutionally unenforceable restrictions • Constitutionally unenforceable restrictions

against ownership or occupancy by individuals of various racial and ethnic groups NOT THE ISSUE.

• Other restrictions are likely enforceable: • Other restrictions are likely enforceable: – Limiting uses allowed beyond applicable

zoning; I i l t b k th li bl – Imposing larger set-backs than applicable zoning;

– Imposing minimum lot and house/ building size; – Specifying construction materials and design;

or– Imposing design review.


p g g

Old CC & R’s/Approach (cont.)• Some restrictions can be waived: Some restrictions can be waived:

– If benefitted parties consent in writing; or – If the benefitted parties have tacitly or formally p y y

waived their rights by allowing non-conforming improvements, etc.

• Consult an attorney or title company to determine • Consult an attorney or title company to determine benefitted owners.

• Get any consent in writing, notarized if possible, y g, p ,ready for recording.


8. Legal Access. Problem:• Project lacks adequate legal access to an

arterial street (an authorized “curb cut”), or extent of current access diminished due to extent of current access diminished due to state, county or city policies or permit conditions.

Concerns: • Bad access diminishes building value; no

li i t laccess eliminates value.• Can be difficult and expensive to negotiate

access if you don’t have it


access if you don t have it.

Legal Access (cont.)Approach:pp• Consult a land use attorney and a traffic

consultant/engineer if necessary. If l k l l Q did h S ll h • If lack legal access, Query: did the Seller have an access endorsement (ALTA 17.1-06 or ALTA 17-06) on the Owner’s title policy received at purchase?p y p

• Consult with appropriate road jurisdictions.– City streets or County roads. Talk with City or

County Transportation Dept. about Transportation Plan and policies and access permits.


p

Legal Access/Approach (cont.)– State highways. Talk with State Department of

T t ti (DOT) DOT itTransportation (DOT) re DOT access permit.o DOT may require combining driveway cuts for

adjoining parcels with same owner.j g po DOT may eliminate street parking and loading

zones. o Check state statutes and regulations affecting

state highway access re access based on objective standards re access based on objective standards

and access management rules, measures and spacing and mobility standards.


Legal Access/Approach (cont.)DOT Access Rules may address the following: y gAccess based on economic development

needs; Safety based on Standards; Change of Use based on spacing,

channelization and site distance channelization, and site distance standards; Who has burden of proving problems?; andApproval with deviations from spacing,

channelization and sight distance.


9. Soils or Riparian IssuesConcerns: • The Property has soils issues, e.g.

– The Property or immediate uphill neighbor’s Property is on an unstable slope prone to p y p plandslides; or

– Building is built on an old creek bed predisposed to liquefying in an earthquake; and/or to liquefying in an earthquake; and/or

– The creek is still active, periodically flooding the Building’s basement.

• Or, there are apparent wetlands or riparian areas.• Any of these soils issues may be difficult or

expensive to solve.


p

Soils or Riparian Issues (cont.)Approach:

C l l / h l d • Consult a soils/geotechnical engineer and test. • If a limited but important area has unstable soils,

one has options, including the installation of “mini p , gpilings” or infusing the sub soil with very liquid concrete.

• Any suspected riparian area should be inspected by Any suspected riparian area should be inspected by a biologist or other riparian specialist.

• In some situations, a compromised riparian area may be eliminated in exchange for mitigation in the may be eliminated in exchange for mitigation in the form of riparian credits acquired from another property.


10. Flood, Tsunami, Storm/Wind VulnerabilityProblem: Some structures on the Property are: • In the 100 year floodplain; • In a tsunami/hurricane evacuation/ impact zone; or • Are surrounded by large, diseased or surface rooted

trees making them vulnerable to windstorm “blow trees, making them vulnerable to windstorm blow down.”


Flood, Tsunami, Storm/Wind Vulnerability (cont.)Approach:

Obt i fl d i d ti f FEMA • Obtain flood inundation maps from FEMA. – Engage an engineer, if within a Flood Hazard

Area, to consider:Area, to consider:Federal, State, County, City permits;FEMA Elevation Certificate;“No Net Rise” Certificate; and“Balanced cut & fill.”


Flood/Approach (cont.)• Obtain tsunami/hurricane evacuation maps from p

state agency and/or NOAA, FEMA. – If the Property is below 15 feet (40 feet in a

tsunami one) above sea level on the Coast risk tsunami zone) above sea level on the Coast, risk high.

• Check with the National Weather Service on records for high winds. – Wind risk compounded by overhanging trees. If

ibl t d ff di tpossible, cut down or prune offending trees.


Flood/Approach (cont.)• Obtain flood, tsunami, earth movement or wind

storm casualty insurance often in the form of a storm casualty insurance, often in the form of a “DIC” policy (Difference in Condition). – Often this type of coverage is limited in scope,

has high deductibles and has a fairly low maximum payout.

– Sometimes deductible must be exhausted before any payment due.

– Written on a “surplus lines basis,” meaning that the insurer deals in high risk policies and is not the insurer deals in high risk policies and is not regulated by the state (either as to rates charged or risk taken).


11. Prohibitive Prepayment PenaltyProblem:• Seller has a prohibitively large prepayment penalty

on his existing mortgage loan.Often a “yield maintenance” formula applies but • Often a “yield maintenance” formula applies, but should be called “yield enhancement” as assumes lender can only reinvest the repayment proceeds at same term T-Bill or similar low rates – Ignores the 200 basis point or larger spread

above the index available with a new loanabove the index available with a new loan.


Prohibitive Prepayment Penalty (cont.)Questions:• Does Seller have a right of “defeasance” of the Does Seller have a right of defeasance of the

existing mortgage loan? – i.e. the right to replace the Property as collateral

with a basket of T-Bills paying the same income with a basket of T Bills paying the same income stream?

• If not, does the Seller have a right of “assumption,” i.e. to sell the Property and have the Buyer assume p y ythe existing financing?

• Assumption made unattractive when (i) the Lender is unwilling to release the Seller or when (ii) the g ( )existing mortgage loan is (say) only a 50% LTV such that Buyer will need secondary financing.


Prohibitive Prepayment Penalty (cont.)Approach:• Get an estimate of the actual prepayment penalty at

a target closing date and assuming a certain market interest rate Have your accountant check the interest rate. Have your accountant check the calculation.

• Will Lender forgive some or all of the penalty if the Buyer, rather than assuming the existing loan, obtains a new acquisition loan from Lender?

• Does the Seller have any leverage to avoid the • Does the Seller have any leverage to avoid the prepayment penalties because Lender has misrepresented something or misbehaved?


Prohibitive Prepayment Penalty/Approach (cont.)• If defeasance is an option, how costly? p , y• If defeasance is cost effective, retain a defeasance

consultant and an attorney experienced with defeasance (as legal opinions typically required) defeasance (as legal opinions typically required).

• Beware: It is likely a default to bypass the Lender with “wraparound” financing. with wraparound financing.


12. Under-Performing PropertyProblem:• The Property has been poorly managed and has

below market rents, substandard tenants, a high vacancy rate and much deferred maintenance.vacancy rate and much deferred maintenance.

• The Property’s current net operating income (“NOI”) is too low to allow a 65% to 70% loan, especially

ith l d i d i i P t with lender-imposed repair reserves, i.e. Property will not meet the required “debt service coverage” ratio (say) 1.35 to 1.( y)


Under Performing Property (cont.)Solution: • Negotiate a Master Lease/Option to Purchase the • Negotiate a Master Lease/Option to Purchase the

Property from Seller.– Stated Term (say) 5 years, but in reality Buyer

intends to exercise the option within a yearintends to exercise the option within a year.– Seller will want a large option payment (say 10-

25% of the sale price) but Buyer is protected as all applies to the purchase price and has a all applies to the purchase price and has a recorded lease option.

– Rent, on a “triple net” basis, the monthly rent payment to be approximately equivalent to a payment to be approximately equivalent to a mortgage payment for the remainder of the sale price (after deduction the option payment).


Under Performing Property/Solution (cont.)– Option to purchase that expires in (say) 9-12

months.– Buyer/Lessee given authority to:

renovate the property; • renovate the property; • cure deferred maintenance;• evict unsatisfactory tenants at end of leases evict unsatisfactory tenants at end of leases,

for cause or w/o cause assuming on month-to-month rental;

• raise tenant rents as allowed; and • tighten financial controls on Property’s

operation


operation.

Under Performing Property/Solution (cont.)– Goal: in 9 to 12 months, to increase the NOI and ,

the appraised value so that Buyer will be able to get 65-75% of sale price loan at a favorable interest rate interest rate.

– Note: Seller cannot have a right to compel purchase or else he will risk being a “deemed sale” in eyes of IRS on lease execution.

– An advantage: Seller has 9-12 extra months to find a Section 1031 exchange “replacement” find a Section 1031 exchange replacement property.


13. Low Basis SellerProblem:• Seller has a low tax basis in the Property which will

result in a large taxable gain to him on the sale.Approach:pp• Make the sale contingent on Seller’s being able to

accomplish a IRC Section 1031 tax deferred exchange.

• “Replacement” properties need to be sufficient in cost to allow equivalent debt and need to require an equity payment sufficient to absorb all Seller’s cash

d f th l proceeds from the sale. • An additional wrinkle: Seller may need a large non-

refundable earnest money deposit to tie up his replacement Property


replacement Property.

Low Basis Seller (cont.)Specific Steps: p p• If an exchange, defer gain recognition. • To qualify need:

T l h d t – To employ an exchange accommodator (“Qualified Exchange Intermediary”);

– To take no proceeds, all going to the p , g gaccommodator;

– To identify replacement properties within 45 days of sale and close within 180 days or sooner; and of sale and close within 180 days or sooner; and

– To have adequate funds to tie up the replacement property.


Low Basis Seller/Specific Steps (cont.)• Structure the PSA for the sale of the “relinquished” q

property so that accommodator receives from Buyer a large non-refundable earnest money deposit which the accommodator can in turn deposit which the accommodator can in turn deposit in the escrow as an earnest money deposit on the “replacement” property.

• Draft the PSA for the replacement property with an exchange contingency so that the deposit is refundable if Seller’s (the tax payer) sale fails.refundable if Seller s (the tax payer) sale fails.


14. Investor Gets “Cold Feet”; Need $$ to Close Problems: Problems: • Buyer’s major investor, intending to contribute (say)

50% of the equity capital for the purchase, gets “cold feet,” such that Buyer needs either a replacement investor or else needs subordinated/ mezzanine debt to provide the needed cash to pclose.

• Also, Lender must bless the new investor or b di t d d bt L dsubordinated debt Lender.


Investor gets Cold Feet (cont.)Options for Buyer: • Terminate the transaction without forfeiture if have • Terminate the transaction without forfeiture if have

broadly phrased “financing” contingency; • Terminate the transaction, but forfeit the earnest

money deposit if no suitable and un-waived money deposit if no suitable and un-waived contingency applies;

• Get an extension from Seller and attempt to find a substitute investor by if necessary providing the substitute investor by, if necessary, providing the investor a preferred return [Note: securities law issues];

• Obtain subordinated financing from a mezzanine or Obtain subordinated financing from a mezzanine or “hard money” lender, assuming your 1st mortgage lender approves; or

• Flip the deal to a new buyer if PSA assignable.


Flip the deal to a new buyer if PSA assignable.

Date post:	28-Aug-2018
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Avoiding Deal Killers in Real Estate Sale...

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