Property Finance Jargon and Legal Documentation

Monday 14 September 2009Jonathan Lawrence, Partner, K&L Gates LLP

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UK Real Estate Finance Market – 2009 Savills research Some 22 banks currently willing to lend, out of which 10 are German and 8 are British

£20m now considered “big ticket” H1 2009:

26 deals with a value between £50m and £100m

63 between £20m and £50m 64 between £10m and £20m

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Overview

Pack documentation introduction Property finance glossary Investment loan term sheet Development loan term sheet

Loan documentation Parties Provisions

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The “Finance” in Property Finance

Equity

Debt Senior Mezzanine

Intercreditor

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Borrower(s)

Borrower Trading entity Special Purpose Vehicle (SPV) company

Single/Multiple Multiple borrowers for multiple properties

Cross-collateralisation

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Obligors or Borrower Group Obligors

Guarantees may be required from shareholders in B / other entities in B’s group

Especially relevant where B is an SPV Sponsor

Individual or entity “behind” the real estate acquisition, B and management of real estate

Not usually a party to loan documentation

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The Finance Parties

Lender Lends / Advances the funds Identity of original lender may change Lender may reduce exposure to loan through syndication or sub-participation (and, before the crisis, securitisation)

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The Finance Parties Facility Agent

Day to day administration of loan

Security Trustee Holds security on trust for all Secured Parties Controls enforcement process Intercreditor issues

Hedge Counterparty B enters into a hedge with respect to all or part of its interest rate exposure under the loan with the hedging counterparty

e.g. fixed-to-floating interest rate hedge

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Documentation

Term sheet Loan agreement Security documentation (next session) Hedging documentation Fee letters

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The Loan Agreement No standard format Long form / short form

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Purpose of the loan

Should always be set out in loan agreement

L not obliged to monitor the loan to make sure it is used for the purpose advanced

BUT Quistclose Trust established

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Interest Usually based on aggregate of:

1. Floating rate of aggregate of LIBOR/EURIBOR; 2. Margin (interest rate) agreed between L and B (fixed or variable); and

3. Any Mandatory Cost Paid on each interest payment date (end of interest period)

Interest period generally 1, 3, 6 or 12 months

Interest may be capitalised

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Representations and warranties Statements of fact made by B or Obligors about certain matters of fact relating to themselves, their status and the underlying real estate

If untrue, L may call an Event of Default Standard reps e.g. that it is solvent, that security has not been granted in favour of another party

Specific reps e.g. property specific concerns re environmental issues

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Covenants

General General obligations imposed on Obligors Additional covenants for SPV Negative pledge

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Covenants

Property Ensure that property will not fundamentally change during the term

Restrict development, granting of leases etc.

Insurance covenant Application of insurance proceeds Damage Loss of rent

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Covenants

Information Delivery of information Financial statements, annual accounts Proceedings Property reporting requirements (rental income, tenant details etc.)

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Covenants Financial: Loan to Value (LTV)

Day 1: L obtains credit sanction to lend up to a maximum percentage of the value of a property

Ongoing: Measures the ratio of current market value of a property against the then principal amount of the loan outstanding

If max % is exceeded due to fall in property prices, B will have to bring the loan into compliance by prepaying proportion of loan/disposing of property/renegotiate terms

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Covenants Financial: Interest Cover

Ratio of net rental income (gross rental income less certain deductions e.g. insurance premiums, tax) versus B’s interest payment obligations

Test measures the ability of B to comply with its interest payment obligations

B’s interest payment obligations usually serviced from rental income

Can be “look back” or “look forward”

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Covenants

Financial: Debt Service Cover (DSC) Used when loan is amortising Ratio of net rental income received versus B’s interest and principal payment obligations

Can be “look back” or “look forward” Must be more than 1 to ensure B meets interest and principal obligations under the loan

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Covenants Financial

Remedy a breach of financial covenants by B paying additional funds into blocked reserve accounts

Funds will be deemed to reduce outstanding balance of the loans (LTV) or to supplement net rental income (Interest Cover and DSC)

May be released if B complies with financial covenants or applied to prepay loan if financial covenants not complied with

Restriction on number of times can remedy a breach in this way

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Events of Default Trigger events which may mean L cancels commitments and declares all amounts owing and immediately payable - Acceleration

L under no obligation to accelerate loan following event of default – may waive/renegotiate

B often allowed grace period e.g. insolvency of obligor, non-payment of sums, misrepresentation, breach of covenant, material adverse change

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Term and Prepayment

Term = length of lifespan of loan L cannot prevent B repaying the loan prior to end of term

Prepayment not favourable for L as misses out on interest, therefore L imposes prepayment fees

L may require mandatory prepayment e.g. proceeds of sale

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Principal

Loans are interest only or amortising Interest only – B pays interest on each payment date and principal paid as bullet repayment on maturity date

Amortising – B repays specific amounts of principal on regular basis during term of loan

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Payment mechanics Property Managing Agent Gross rental income paid into segregated trust account/held on trust by Managing Agent

Managing Agent responsible for paying net rental income into Rent Account

Duty of care agreement – Managing Agent owes L direct contractual duty of care

On interest payment date funds are applied in order – “waterfall”

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Default interest Additional interest which accrues on overdue amount in event that B or Obligor fails to make a payment under the loan

Usually around 2%-3% above the interest rate usually payable on the loan

Rate must not be set too high as it may be considered a penalty and non-recoverable

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Conditions Precedent (CPs) Prior to advancing funds, L will insist on receiving certain documents and/or B satisfying other requirements Corporate documentation and authorisations

Financial information Property documentation and due diligence Legal opinions Miscellaneous

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Utilisation / Drawdown

Specific procedure for drawdown Notice to lender required Likely that initial drawdown must be made during an agreed availability period

Overall number of drawdowns likely to be limited

CPs must be satisfied prior to drawdown

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Assignment, transfer and Qualifying Lenders L usually reserves right to freely transfer its interest in the loan provided that B does not incur any tax liability on its interest/other payments due to change in status of transferee – “Qualifying Lender” concept

Crucial that L can assign interest freely if it intends to syndicate the loan

Often prohibited for B and Obligors to assign rights and obligations without written consent of Ls

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Amendments and waivers

Amendment usually allowed with written consent of Majority Lenders and Obligors

Some amendments e.g. a decrease in margin will require consent of all Ls as they fundamentally affect the loan terms

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