LMA Webinar Introduction to Real Estate Finance Simon Roberts, Partner Allen & Overy LLP
Introduction to Real Estate Finance This is what we will cover Assumptions behind LMA Real Estate Finance ( REF ) multiproperty investment facility agreement Core principles of real estate financing How the LMA REF facility addresses those principles Common areas of negotiation 2
Assumptions The LMA REF facility builds upon the other LMA facility agreements to present a starting point for a common real estate financing structure consistent with syndicated LMA facility agreements where possible caters for acquisition or refinancing of: multiple real estate assets in England/Wales investment properties with FRI leases SPV/limited recourse English obligor companies secured on real estate and shares no other debt financing 3
Assumptions Structure of a typical REF transaction Shareholder Equity Subordinated debt Guarantee of loans Company Downstreaming of equity and subordinated debt to Borrowers Lenders Loan to each Borrower Borrower 1 Borrower 2 Borrower 3 Acquisition Acquisition Acquisition Property 1 Property 2 Property 3 Key Finance Documents: (a) Loan agreement (b) Security documents: (c) (i) (ii) security over all of the assets of each Borrower and the Company security over all the shares in the Company (iii) security over any subordinated debt provided to the Company Subordination agreement 4
Core principles The recourse of the Finance Parties is limited to the value and income from the real estate assets: SPV financing, no other means of debt support preserve the security value of the real estate assets capture the income for debt service due diligence and property monitoring These principles drive the additional features found in the LMA REF facility 5
SPV financing The obligors should have no other liabilities which could reduce value/income from the real estate assets no other business no other acquisitions/investments no subsidiaries tight restrictive covenants tax liabilities/vat group But subordinated shareholder debt and interest rate hedging is permitted 6
SPV financing Shareholder debt must be fully subordinated permitted payments are usually regulated security assignment over shareholder debt usually required to facilitate share sale free of shareholder obligations 7
SPV financing Interest rate hedging is often required, to match fixed rental income flows with floating rate interest some deals are fixed rate, not IBOR based often, hedging is by way of a cap more complex if using an interest rate swap: security/ranking/voting for counterparty limited rights of swap termination 8
Security value Tight controls are placed on activities that might impact on recovery value of real estate assets repair and maintenance environmental compliance no alterations/development major damage/compulsory purchase/forfeiture defaults Property protection loans are emergency funding for asset preservation 9
Security value Insurance for the property is key full reinstatement and loss of rent co-insured, first loss payee due diligence and broker s letter mandatory prepayment 10
Security value Usually security cover is measured through a loan to value financial covenant professional revaluations of property quarterly testing and compliance certificate Initial drawdown amount may be limited to a lower LTV 11
Security value Comprehensive security package expected from SPV obligors registered legal mortgage security over property fixed and floating charges over all assets share security, to give alternative enforcement option Enforcement analysis needed Method, timing, cost 12
Income protection Rental income is the only source of debt service controls over leasing FRI leases upwards only rent reviews tenant deductions, headlease payments quarterly rental payments collected for quarterly interest payment dates 13
Income protection Interest cover is measured through a specific financial covenant net rental income to interest (or debt service) quarterly testing on IPD back 3 months and/or forward 12 months assumptions on future rental 14
Income protection Tight controls are usually placed on rent collection use of managing agent trust account duty of care agreement pay into secured accounts structure signing rights often given to security agent 15
Income protection LMA REF Facility Accounts Structure Cash Sources Blocked Accounts Unblocked Accounts Cash Uses Net Rental Income (other than Lease Prepayment Proceeds) Amounts under Hedging Agreements (other than Hedging Prepayment Proceeds) Rent Account Cash Sweep Fees, accrued interest, hedging payments, principal Surplus General Account Payment to Finance Parties Use for any purpose Hedging Prepayment Proceeds Lease Prepayment Proceeds Insurance Prepayment Proceeds Compensation Prepayment Proceeds Recovery Prepayment Proceeds Deposit Account Mandatory Prepayment Disposal Proceeds Disposals Account Mandatory Prepayment (Unless held in a trust account in the Managing Agent s name) Tenant Contributions Any other amounts received 16
Due diligence Conditions precedent focus on the real estate assets title diligence usually covered by certificate of title land registry searches, etc. initial valuation other reports? eg. survey, environmental insurance broker s letter discharge of existing security tax report? In addition, quarterly property monitoring report 17
Negotiation points The LMA REF facility is a starting point, there is usually plenty to negotiate. Common points are: cure rights for financial covenants disposals and substitution for a portfolio flexibility on leasing cash traps/sweeps permitted payments to borrowers or sponsors capex requirements syndication/exit options 18
Structural variations In addition, the LMA REF facility can form the base for variations in structure: asset holding entities foreign partnerships single assets (note, major tenant default) different asset class, for example hotel data centre residential mezzanine financing structures see LMA intercreditor For development financing, there is a separate LMA precedent 19