Real estate financing: what are financiers looking at today and what options are available?

One of the consequences of the financial crisis is that obtaining real estate financing from banks has become significantly more difficult. For example, nowadays the bank imposes stricter conditions on the financing itself and on the corporate structure in which financing is provided. More conditions are also imposed on the documentation to be submitted by the borrower to the financier. This does not mean that there are no(s) to negotiate for the borrower, especially now that the crisis has also had positive consequences. For example, many more parties than before are offering real estate financing. This offers opportunities.

In this article, I will discuss the most common terms that are or may be required by a lender in real estate financing today, in addition to standard collateral such as a mortgage lien on the property and a lien on the borrower's rental income, insurance and bank accounts.

Whether these conditions are all met is a matter of negotiation, where it pays for the borrower to also look for alternatives if the conditions seem too strict to him.

Special Purpose Vehicle

Financiers prefer the real estate they finance to be owned by a special purpose vehicle, called a Special Purpose Vehicle (SPV).

A first advantage for the lender is that this SPV does not contain old debts. A second advantage for the funder is that this SPV only performs services or work related to the financed property.

The foregoing means that there are only a limited number of creditors, making the risk of SPV bankruptcy very small.

An additional advantage is that a lender cannot be forced, in the event of the borrower's bankruptcy, to extract the property at a time that is not convenient for him. He can choose to claim the loan only at a time convenient to him, allowing the property to be sold (in all likelihood) at a better price.

Ringfencing

Financiers often want to contractually establish some prohibitions. For example, the loan documentation will typically include a prohibition on the borrower from i) incurring new debt ii) providing guarantees or collateral to anyone other than the lender and/or iii) engaging in activities other than the operation of the property.

The entirety of these contractual arrangements is called ringfencing.

Fiscal unit

In a fiscal unity, all companies within the unity are jointly and severally liable to the tax authorities for each other's sales tax or corporate tax liabilities. Financiers want only companies that are debtors under the financing to enter into a fiscal unity. This is because otherwise there is a risk that the company being financed will be held liable by the tax authorities for debts of another company. This is undesirable because it creates a great risk for the financier.

Therefore, a lender will usually require that a tax entity be formed only by companies that are debtors under the financing.

Pledge of shares

In addition to usual collateral, lenders today often require a lien on the shares of the financed company.

A primary advantage is that the shares can be transferred going concern and the underlying property does not have to be extracted. This can yield a higher return for the lender and - provided the lienholder/borrower cooperates - can also be done relatively inexpensively and quickly.

A second advantage is that transfer tax can be saved this way, at least if the shares are sold to four unaffiliated persons who each become owners of less than 33.3% of the property.

Skin in the game shareholders

Financiers find it important that shareholders also have "skin in the game." This preferably means that shareholders strengthen a company's equity or make a share premium payment or that their loans are subordinated to the real estate financier's loans. The same applies to claims by other creditors.

This ensures that the lender is paid before other creditors.

Alternative financiers

The crisis has not only had a negative impact on the borrower. One positive of the crisis is that today there are more parties willing to finance real estate. For example, banks have faced competition from private equity parties, family businesses and institutional investors such as pension funds and insurance companies.

Thus, the advantage for the borrower is that there is much more to choose from and therefore more to negotiate. The room for negotiation depends, among other things, on the commercial interests of both parties and the financing requirements and preferences of the specific financier. For example, institutional investors, as a rule, attach great value to (repayment-free) loans with long maturities and fixed interest rates, while banks generally prefer short-term loans with variable interest rates on which repayments are made periodically.

Conclusion

Due to the crisis, stricter conditions are generally imposed by financiers, both on the financing itself and on the corporate structure. However, this does not mean that there is no room for negotiation for the borrower. Such room does exist, especially now that there are more parties willing to finance real estate these days. Whether and exactly what opportunities there are depends mainly on the commercial position of the parties and the financing requirements and preferences of the specific financier.