Back to Basics | Corporate Wrapped Real Estate

Published in March 2023

This Back to Basics note follows our first briefing on the key matters investors and managers should keep in mind when considering how to hold real estate (available here: CMS Funds Group | Back to Basics briefings). This briefing looks at the key aspects of a corporate-wrapped (or "indirect") real estate transaction, and touches on how it will differ from a direct property acquisition. An indirect transaction may also be referred to as a special purpose vehicle (SPV) sale.

Whilst acquiring a structure is a process that requires input from a wider range of advisors when compared to a direct acquisition of the real estate, the nature of investment holding structures mean that this is a well- trodden path allowing counterparties to benefit from all the advantages that we previously outlined in relation to structures.

With regard to different types of structures, the issues that present themselves during the transaction itself are similar whether the transactions involve companies or unincorporated vehicles, such as Jersey property unit trusts. This briefing is intended to introduce some of these considerations and provide an outline of the key events in the deal timeline.

PREPARATION

The better prepared a seller is for sale, the more orderly the transaction is likely to be. In the context of an indirect real estate transaction, the seller will need to have (a) all the information and reports available that would be expected for a direct real estate transaction and (b) all the financial, corporate, operational and tax information for the relevant vehicle(s) being sold, using the information obtained on acquisition and updating the records throughout the life of the investment. This will then form the basis of a sale data room that the buyer will diligence.

HEADS OF TERMS

Heads of terms act as the baseline understanding for the transaction that will assist to frame discussions as the deal progresses. Although evidence of serious intent, they do not legally compel the parties to conclude the deal on those terms.

In addition to fundamental items such as the property price, the heads of terms will typically provide an indicative transaction timetable and note whether there are any conditions before the transaction can complete, such as regulatory consents and/or financing requirements. The parties should also establish the extent to which a seller’s liability will be limited. This will allow the buyer to consider whether or not to obtain warranty and indemnity insurance, a subject we will dedicate to the third and final briefing in this series.

Though heads of terms are only statements of intent, it is common for the heads of terms to include legally binding exclusivity and confidentiality obligations, allowing the parties to commit resources and undertake due diligence in the knowledge that both buyer and seller are focused on concluding a deal with each other as efficiently as possible.

DUE DILIGENCE

Due diligence is the key stage that will dictate the duration, complexity and terms of a transaction. It is a catch-all phase covering the work undertaken by the buyer and its advisory team from the outset, to review and test the information provided by the seller about the asset and the structure.

Due diligence covers more aspects on a “corporate wrapped” transaction than on a direct asset sale because the buyer will inherit the obligations of the holding vehicles, as well as those relating to the property itself. It is therefore important for a buyer to understand whether acquiring the holding structure has any practical or value implications to its original assumptions to ensure there are no surprises in the future and to determine if any issues need to be addressed before entering into the sale contract.

A seller should provide a well-populated data room containing the information about the underlying property and the structure available to the buyer. The buyer will then review and raise due diligence enquiries which will include legal due diligence for the property itself, the SPV holding structure and its legal obligations generally as well as tax and financial due diligence. For example, any guarantees given or change of control provisions in material contracts, including finance, will be considered.

The seller should assist the buyer and its advisory teams with their enquiries as this will enable the buy- side to report on their findings to the buyer, any funders and, if applicable, any W&I insurer.

SALE AND PURCHASE AGREEMENT

The principal transaction document in a corporate-wrapped real estate transaction is the sale and purchase agreement (SPA). Unlike the sale contract on a direct acquisition of real estate, there are no standard terms, meaning the complexity of the SPA will vary depending on the nature and circumstances of the transaction.

Broadly, the key parts of an SPA on a structured real estate transaction are as follows:

Front-End

This section has similarities across deals and will govern the obligations to sell and purchase, the price and other negotiated items, as well as the boilerplate terms required in a document of this type. The specific terms will also reflect the nature of the underlying entity being acquired and determine whether, for example, there are any specific local law requirements that need to be included.

Though not the norm in a structured deal, where there is a gap between exchange and completion (which will be the case if completion is contingent on certain matters, such as financing, taking place), the SPA may require a deposit and provisions restricting the seller’s management of the structure in the period between exchange and completion. In return, the legal risk for the asset and the structure will usually pass from the seller to the buyer, thereby mirroring the position on a direct deal.

Seller’s Warranties

Seller’s warranties are informational statements made in the SPA regarding the status, affairs, assets and liabilities of the structure being acquired.

As with any corporate transaction, the seller is expected to give these to provide the buyer with legal recourse in the event that it has relied on the accuracy of those statements on entering into the SPA when, in fact, they were untrue and the buyer did not and should not have known this was the case. A tax covenant is often included in addition to tax warranties allowing the buyer to claim for certain tax matters not provided for as part of the transaction.

The warranties will be subject to agreed limitations as to liability and time limits for claims, with separate periods for the general and tax warranties. Where W&I insurance is being obtained, a seller’s liability for some or all of the warranties is often capped at £1, with recourse for a claim against the warranties then made under the insurance policy instead of against the seller. W&I insurance will be covered in more detail in the third part of this series.

Completion Statement

The completion statement and the accompanying schedule determine how the final price payable by the buyer is reached. Using the agreed headline value of the property, it is usual in the context of a corporate- wrapped real estate transaction relating to an investment asset for the consideration to be subject to a post- completion adjustment by reference to the net asset value (NAV) of the holding vehicles at completion.

The process usually dictates that the seller’s accounting team will estimate the NAV at completion, on the basis that within an agreed period of time, the seller will then update the estimate with the actual figures once known. The buyer will pay the consideration on completion based on the estimated position, with the parties agreeing that a balancing payment will be due to the other should it be demonstrated that the NAV was higher or lower than estimated.

The importance of this aspect of the SPA is that it governs how the parties will apportion the benefit of rental income and expenses up to the moment of completion, whilst also allowing matters such as third party debt, shareholder loans, VAT, debtors and tenant incentives to be factored into the consideration payable. The completion statement is therefore again influenced by the due diligence as costs revealed in the course of the process can be included as adjustments to reduce the consideration payable.

Deliverables

A feature of a structured real estate transaction when compared to direct asset sales is that there are usually more documents required which the parties are required to deliver to each other at completion of the SPA. Principal among these is the disclosure letter, which is linked to the warranties given in the SPA, and allows the seller to detail matters of fact that qualify those statements made by the seller in the SPA. The seller will usually also deliver a copy of the data room so the parties have an agreed list of information and materials shared in the course of the transaction.

The other key documents will be deal specific but often one of the key workstreams in due diligence is identifying obligations that could extend past completion and so completion is the moment in time where the buyer may require the seller to terminate any arrangements it does not wish to inherit. Likewise, if there is third party debt in place, then the seller will usually need to deliver documentation evidencing the release of any security on completion unless the debt is also being transferred to the buyer.

The balance of the deliverables will be the suite of corporate approvals demonstrating that the parties have authorised the terms of the transaction. Related to this, if any of the parties are registered overseas, then legal opinions from local legal advisers may be given in support of that party’s capacity to enter into the documents as well.

KEY DIFFERENCES BETWEEN DIRECT AND INDIRECT PROPERTY DEALS

To conclude, below is a brief comparison of some of the key differences between direct and indirect property deals.