In the myriad M&A transactions, for the technology company, hospital chain, pharmaceutical company or consulting firm, the M&A professional’s thoughts turn to supply contracts, union and pension obligations, intellectual property, key executives, debt levels and, of course, earnings. And then someone will pipe in with a “what about the real estate?
Well, what about the real estate? Other than in the transaction in which the real estate is a key asset (for example, in a transaction relating to shopping malls, a restaurant chain or a hotel portfolio), real estate issues are often an afterthought in most corporate acquisitions or mergers. But even the company with foreign suppliers and outsourced distribution usually has a physical office somewhere.
Although real estate does not drive the vast majority of M&A transactions, inattention to real estate issues can lead to delays in closings, increased costs and, maybe most unnecessarily, stress and annoyance. Following are a list of five real estate issues for the acquirer to consider in any M&A transaction (and for the target to consider so that it can anticipate issues that may be brought up by the acquirer):
1. Involving Real Estate Lawyers in the Early Stages
Real estate issues should not be the tail wagging the dog – involve real estate professionals or attorneys early in the due diligence process to avoid unpleasant surprises later on. Consider whether the target’s locations or offices are leased or owned. Different concerns based on the type of real estate interests held may potentially drive some aspects of transaction structure, particularly in an asset deal.
For example, does the target in an asset (as opposed to stock) deal have mortgage debt on owned property which might be separate and apart from corporate level financing? If so, might the debt be assumed, or should it be wrapped into acquisition financing?
In addition, sometimes the seller or its affiliates lease property to the target under sweetheart deals (for the seller or affiliate landlord). If that is the case, a new lease or amendment to the existing one may need to be negotiated to make it appropriate for an arm’s-length transaction.
2. Leases and Change of Control
Chances are that the target is going to occupy or use leased property – be it office space, a distribution center or a manufacturing facility.
There are many reasons to analyze the leased property of the target – to check expiration dates, rent step-ups, renewal terms, whether the landlord has any lien on collateral – but perhaps the most significant issue arising when the target leases property is whether the assignment of the lease in an asset purchase, or acquisition of the target in a stock or equity acquisition, requires the landlord’s consent pursuant to the terms of the lease. A straight lease assignment will often require consent of a landlord. There may be certain requirements regarding the transferee, such as that the transferee have a good reputation in the business community or that it have a specified minimum net worth. In addition, even in a merger or stock acquisition, a lease may deem a “change in control” of the tenant to constitute an assignment that requires the landlord’s consent.
Based on the language of a particular lease, and the importance of the property involved to the target’s business, there may be a need to structure around a landlord consent requirement (perhaps with a sublease from the seller) to avoid a default under a lease in the case where there are doubts about the ability to obtain (timely or at all) landlord’s consent.
At the very least, analyzing the provisions in the leases early allow time to address any potential issues.
3. Environmental Liability
This item deserves its own stand-alone article, and is not likely to be overlooked when the target is an energy company or industrial manufacturer, but environmental issues may lurk even in a transaction where it might not seem apparent. As a general rule, environmental site assessment reports are recommended for all properties save space in office buildings. If there have not been recent reports prepared, it makes sense to order new reports early, as they may take several weeks or more to obtain.
Both federal and state regulatory frameworks may come into play. Many states require seller disclosure to the purchaser or a governmental agency when a property with environmental contamination and/or historical or present uses of hazardous materials are involved.
4. Transfer Taxes
Transfer taxes are not issues in every transaction, but state, county or local transfer taxes on the conveyance of real property may add costs to a transaction that are not always accounted for in pricing the deal. This is especially an issue in high transfer tax rate jurisdictions such as New York City and Philadelphia.
In addition, real estate transfer taxes may apply even when owned property is not being conveyed by deed. Some jurisdictions tax a transfer of a controlling interest in real estate (often defined as 50 percent or more of the interests in the property owner). If transfer taxes are triggered by a transaction, the obligation for payment can be negotiated between buyers and sellers.
5. Real Estate as Collateral/Title and Survey
To the extent that financing is being used in connection with the acquisition (or even with an all-cash closing, if one contemplates eventual financing), the lender will often seek additional liens on real property assets (as well as inventory), particularly when there might be heavy equipment that constitutes fixtures. Part of thorough diligence will include review of existing title insurance policies (or other title work) and surveys of the target’s properties. Again, review of the state of title and survey, in addition to yielding information for the acquirer, may highlight items such as violations, possible zoning issues, easements or restrictions affecting the use of the property.
Where a lender desires to take a lien on assets or inventory at a leased location, it may require landlord waivers of lien. If that can be anticipated, the acquirer may consider insisting in the transaction documents that the waivers be a closing condition, or at least that the target cooperates in seeking these waivers from its landlord.
In addition, title reports (and ultimately title policies, if required), surveys (if unavailable or stale) and zoning analyses or reports (if needed based on the type of property or transaction) can be fairly significant lead-time items and may add unanticipated costs to a transaction. Also significantly, whether the acquirer or target is obligated to pay for title reports, policies, updated surveys and the like, is often not discussed at the deal stage of a transaction, which may lead to disputes as these costs add up.
In sum, inattention to the real estate issues, although normally unlikely to torpedo a transaction, can lead to unexpected expenses and headaches, both prior to closing and beyond.