LexisNexis Practical Guidance®

Conditions precedent (CPs) are the pre-conditions that a lender requires to be satisfied prior to any draw taking place under a facility agreement. Many of the usual conditions precedent for a typical bilateral or syndicated facility agreement will also be applicable in the context of a real estate finance transaction, whether it be a land acquisition and/or development financing.

This guidance note outlines the additional conditions precedent which may apply in:

• •a real estate acquisition finance transaction (where the facility is required to fund the purchase of a single property or multiple properties); and
• •a real estate construction facility (where the facility is required to refurbish an existing building, or construct a new building, to be used for commercial, retail, industrial or residential purposes or for a combination of one or more of those purposes).

See Conditions precedent in real estate finance transactions and the mechanics of drawdown.

In a real estate acquisition finance transaction, covenants are designed to preserve the value of the property against which the lender is advancing the loan. The finance documents will include both positive and negative (or restrictive) covenants, which impose obligations on the borrower to keep the property in a good state of repair and to limit the borrower’s use of the property. Many of the usual covenants (also referred to as undertakings) for a typical bilateral or syndicated loan facility will also be applicable to a real estate acquisition finance transaction.

The guidance note looks at the additional covenants (including property-specific, information and financial covenants) which may apply in a real estate acquisition finance transaction.

See Covenants in real estate acquisition facilities.

In a development (or construction) facility agreement, the borrower will borrow money to develop a property (which may it may already own or lease or is acquiring). Therefore, the covenants applicable to real estate acquisition facility agreements often apply equally to a real estate development facility agreement (other than those restricting development), with additional covenants required in relation to the development aspects of the transaction.

Many of the usual covenants (also referred to as undertakings) for a typical bilateral or syndicated loan facility will also apply (in some form) to a real estate acquisition and development finance transaction.

There will also be further financial covenants (eg cost to complete and loan to cost ratio) that will apply to real estate development facilities in addition to those typically specified for acquisition facilities (usually loan to value in nature). These covenants are essential in regulating the conduct of the borrower throughout the life of the project, from both a construction and commercial standpoint and will also cover arrangements (or side deeds) with project third parties, such as builders and major tenants.

This guidance note looks at the additional development-specific covenants which may apply in a real estate development transaction and the key considerations when drafting them.

See Covenants in real estate development facilities.

In a typical real estate finance transaction, lenders rely on the income generated by the property as the primary source for repayment of the loan. The source of income may include rental income, sale proceeds and any money due to the borrower under other related agreements. Accordingly, lenders will seek to impose controls on how the borrower may deal with the income generated from the property, including:

• •requiring specific bank accounts into which cash income must be deposited;
• •imposing restrictions on the operation of each account; and
• •putting in place security arrangements over the bank accounts.

This guidance note details how each of the above matters are typically dealt with in facility documentation.

See Bank account provisions in real estate finance facility agreements.

Real estate finance facility documentation will typically include additional financial covenants in order to monitor the value of the property against the outstanding loan, and in the case of a development finance transaction, the progress and cost of the development.

This guidance note outlines:

• •the typical financial covenants contained in real estate finance facility agreements;
• •key considerations when drafting such financial covenants;
• •when and how these financial covenants may be tested; and
• •the typical consequences of breach of a financial covenant.

See Financial covenants in real estate finance.

Many of the usual representations and warranties for a typical bilateral or syndicated facility agreement will also be applicable to a real estate finance transaction. In a real estate finance transaction, the lenders will require the borrower to make additional representations in relation to the property addressing the following matters (among others):

• •title to the property;
• •no other interests which may adversely affect the use of the property or the lenders’ ability to take security over the property;
• •compliance with planning and environmental legislation;
• •condition of the property;
• •accuracy of information and reports supplied to the lender in relation to the property;
• •for a development finance facility, further representations will be included as to:
• • ◦the property development site;e
• • ◦the costs to complete the development project;
• • ◦practical completion of the project;
• • ◦the project design, plans and specifications; and
• • ◦the underlying project documents and (if any) pre-sales contracts.

This guidance note discusses these property or development project-specific representations and warranties and the key considerations when drafting them.

See Representations and warranties in real estate finance.

Many of the events of default for a typical bilateral or syndicated loan facility will also apply to real estate acquisition and development finance transactions. Real estate finance documentation will include additional events of default relating to the following categories:

• •property-related defaults, such as failure to obtain or maintain planning approvals, compulsory acquisition or appropriation of the security property, default under key property documents (sales or leases), non-compliance with environmental laws;
• •construction defaults in a construction project, such as builder default or insolvency, failure to achieve completion, abandonment, damage or destruction;
• •cash flow defaults relating to administration of project cash flows, cost overruns, payment of contractors and operation of project bank accounts;
• •control events, such as change of ownership or control; and
• •cross defaults under project documents.

This guidance note describes these property or development project-specific events of default and the key considerations when drafting them.

See Events of default in real estate finance.

Lenders in real estate finance transactions will usually look to take a full suite of security over all of the assets of the borrower, including but not limited to:

• •the land itself, including any fixtures forming part of that land and any fittings or equipment used on the land;
• •the borrower’s rights to any rental income generated from the commercial exploitation of the land;
• •the positive balance of the borrower’s key bank accounts;
• •the borrower’s rights to the proceeds of insurance claims;
• •with respect to development finance, the borrower’s rights under construction and development contracts and any takeouts (agreements to lease and/or any presale contracts);
• •any shares or units in other entities that the borrower has rights to; and
• •the personal property of the borrower.

This guidance note details how security over the assets listed above is typically structured and documented in a real estate finance transaction. It also highlights the key provisions of the security documents.

See Security in real estate finance transactions.

The development documents are key to any real estate finance transaction involving property development. They deal with the nature of the development, the development team’s relationships and responsibilities and the cost of the development. Accordingly, the lenders will typically take security over all the rights of the borrower under the key development contracts.

This guidance note outlines:

• •the key development contracts and insurances in respect of which security is typically taken; and
• •how such security may be taken.

See Taking security over development contracts.

A side deed (also commonly referred to as a “tripartite deed” or a “multiparty deed”) is an agreement that supplements or sits with the primary contract and is required to manage variations and termination of that contract. Side deeds are entered into between the lender, the relevant project counterparty (such as a builder) and the borrower and are intended to allow the lender to keep the project performing if the borrower defaults on any of its obligations under the relevant project document.

This guidance note discusses:

• •the project counterparties who will typically be required by the lender to enter into a side deed;
• •the key provisions included in side deeds; and
• •practical tips for negotiating a builder’s side deed in the context of a development finance transaction.

See Side deeds in real estate finance.

A lender in considering whether to finance a land acquisition or project needs to assess the “bankability” of the acquisition or project. Due diligence is a necessary part of understanding the risk profile of the project and the source of cash to repay the loan. Due diligence will be carried out at many different levels.

Due diligence is a critical aspect of project or real estate financing. In a land acquisition, the lender needs to determine the source of cash for repayment — whether it be through sale or refinancing or through development of the land. Given that the lender's recourse is limited to project assets (there may also be some corporate or personal credit support) and that the cashflows of the project are the primary source of repayment, it will need to understand the risks inherent in the particular project and be satisfied with how those risks are allocated and mitigated.

In other words, the lender is concerned with risk allocation inherent in the underlying contracts, the creditworthiness of the counterparties and the credit support provided in respect of those counterparties' obligations, as well as any risk to the quality or quantum or revenue streams (be it sales or leasing milestones or operating licenses).

Due diligence is the primary means by which the lender can assess and price the risks inherent in the project — particularly site and environmental risks, but also delivery risks which may affect time and cost and risks which might impact the quantum and quality of cashflows in the projects' operating phase.

This guidance note will discuss the purpose, nature and scope of real estate finance due diligence principally from a senior lender’s perspective.

See Real estate finance due diligence.

In addition to the property-related aspects of a real estate finance transaction, a lender (or its lawyers) must conduct due diligence on the legal aspects of the transaction. This guidance note details the following components of such legal due diligence:

• •the contractual framework; and
• •the legal framework.

See Legal due diligence in real estate finance transactions.

If a transaction involves the financing of the development (or construction) of a property, a lender will need to conduct additional due diligence on the following:

• •the building contract and any other development documentation;
• •consultants’ reports in relation to geotechnical, environmental, financial, legal, engineering, survey, insurance, valuation and any other matters associated with the development; and
• •the financial model (prepared by the borrower or sponsor) detailing all construction, development and financing costs and the expected market or other returns following completion of the development.

This guidance note provides detail in relation to each of the above.

See Development finance due diligence.

This guidance note discusses the most typical arrangements and points for negotiation between senior lenders and mezzanine lenders in a real estate finance transaction in relation to key provisions of a typical intercreditor agreement.

These key provisions relate to:

• •subordination and priority of payments;
• •which lender may take enforcement action;
• •the mezzanine lender’s right to cure a default under the senior loan;
• •the mezzanine lender’s right to purchase the senior loan; and
• •consent rights of the mezzanine lender.

See Senior loans, mezzanine loans, intercreditor and subordination arrangements in real estate finance.

For more information about intercreditor arrangements generally, see Priority/subordination agreements.

A lender’s security will typically become enforceable once an actual or potential default subsists under the finance documents. The lender will then have broad powers to do whatever it deems necessary or desirable in connection with the restructuring or enforcement of the real estate finance loan.

This guidance notes discusses:

• •the issues a lender may consider before enforcement (including any restructuring options available to it);
• •the ways in which security over the property may be enforced under a real property mortgage or general security deed, including:
• • ◦appointment of a receiver;
• • ◦exercising a power of sale;
• • ◦exercising rights of set off and combination; and
• • ◦obtaining foreclosure.

See Enforcement options in respect of real estate finance transactions.

Hedging is often required in a land facility or a construction project to manage interest rate exposure during the construction phase or term phase where the funding is provided at a variable interest rate. In a construction context, hedging can still be required in the construction phase, even though no revenue is produced to service interest and the interest is being capitalised. Hedging enables the interest rate to be fixed and therefore provides some certainty for project costs and budgeting purposes.

This guidance note discusses:

• •the common types of derivatives in real estate finance;
• •commercial considerations regarding the identity of the hedge counterparty, whether it be a lender or a third-party hedge provider;
• •the key documentation issues concerning hedging, including the need to ensure that the facility documentation and hedging documentation are aligned (particularly relating to defaults and circumstances where hedges or swaps can be terminated or “closed out”); and
• •intercreditor issues associated with hedging.

See Hedging issues in real estate finance transactions.