Navigating Portfolio Transactions

By Michael Scheinberg, Partner, Pircher, Nichols & Meeks LLP

With increased capital being deployed in the real estate space, multi-property portfolio transactions are ever more common, as investors are growing and seeking scale. Parties to these transactions face a variety of unique issues. Considering them ahead of time can help avoid headaches and lead to an efficient and timely closing. Issues to be considered include:

• Kick-Out of Properties: Portfolio transactions are typically structured as “all or nothing,” which protects sellers from being stuck with the “dogs” after giving up the more desirable properties. However, a buyer may demand the right to kick out a property if certain issues arise, rather than killing the entire transaction. Such issues could be a major tenant default, casualty/condemnation or even a breached seller representation or interim covenant. In turn, the seller may require a termination right if a certain property is removed or if its value exceeds a specified threshold.
• Estoppel Conditions: A seller may insist on a portfolio-wide estoppel condition, while a buyer might negotiate for tests among property groups, such as those located in a particular region. A buyer also may call for tests on significant individual properties, in which case the issue remains whether the transaction should be terminated or the subject properties removed.
• Efficient Due Diligence: Responsible underwriting of a portfolio on a cost-effective basis within the transaction timeline can be a challenge. A seller can increase the likelihood of closing with thorough advance organization and updates of due diligence materials. Buyer staffing also should be ready, including third-party consultants for required reports which can be critical path items, such as physical, environmental and zoning reports and surveys. The buyer might consider limiting its title and survey review. For example, if the seller is an institutional heavyweight, the buyer may choose to rely upon the seller’s underwriting and focus only on select matters such as mechanic’s liens, delinquent taxes, judgment liens and purchase options. However, the need for third-party estoppels should not be ignored, such as under an REA or CC&Rs. If not required for financing, updated surveys might be skipped, though existing surveys should be reviewed to determine if they are current, whether they contain ALTA/ACSM certifications and whether they reveal any major encroachments. The buyer might also piggyback on the seller’s title policies for title endorsements.
• Purchase Price Allocation; Joint versus Several Liability: Allocating the purchase price among the portfolio properties can have advantages for both the seller and the buyer, though their interests may not be aligned. The allocation may be helpful in minimizing transfer taxes, title insurance premiums and even ongoing real estate taxes.  The allocation also may be relevant if an asset gets kicked out of the deal or if the seller holds title in multiple entities and is able to negotiate for several liability. Of course, the buyer will push for joint and several liability among the seller entities.
• Financing: Loan documents for a multi-property deal typically contain partial release provisions, with standard conditions for the remaining collateral, financial tests and independence from released property. Borrowers seek “release prices” with a small premium, such as 110 percent of the allocated loan amount rather than 120 percent, and especially avoid the requirement to pay 100 percent of net sale proceeds. A borrower also will want to avoid a full loan default for circumstances limited to one property—such as casualty, major tenant default or a new environmental condition—possibly negotiating for a “softer” remedy, such as an increased interest rate until the default is cured or even ignoring the default for minor assets. Partial release provisions can help here, allowing the borrower to sell the problem asset or advance funds to secure the release. Some borrowers are able to negotiate for property-by-property cash management waterfalls.
• Post-Closing Matters: Multiple properties present an increased likelihood of a need to allocate responsibility for ongoing matters, such as leasing commissions, tenant improvements and other work, as well as litigation.

For a successful closing, the parties to a portfolio transaction should consider these issues and others. Some are unique business issues to be negotiated, and others suggest mindful planning and staffing for both due diligence and the closing process.

Michael Scheinberg is a partner with Pircher, Nichols & Meeks LLP, a real estate law firm with offices in Los Angeles and Chicago.