The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. Presenting a live 90-minute webinar with interactive Q&A Structuring REIT Credit Facilities: Loan Terms, Financial Covenants, Commitment Letters, MAC Provisions and More Today’s faculty features: 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURSDAY, OCTOBER 19, 2017 Ari B. Blaut, Partner, Sullivan & Cromwell, New York Benjamin R. Weber, Partner, Sullivan & Cromwell, New York
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Structuring REIT Credit Facilities Loan Terms, Financial Covenants, Commitment Letters, MAC Provisions and More
Ari Blaut
Benjamin Weber
6
Overview
I. REITs – Brief Overview
II. Recent Market Trends – REIT Bank Loan Market
III. Credit Agreement Process and Terms
IV. Q&A
7
I. REITs – Brief Overview
8
What is a REIT?
• “REIT” – Real Estate Investment Trust
• An entity that satisfies certain requirements of the Internal Revenue Code and elects to be treated as a REIT for U.S. federal income tax purposes
• REITs own, or make loans secured by, income-producing real estate
• A REIT is expected to pay regular quarterly (or in some cases monthly) dividends
• REITs generally are not able to retain earnings due to the annual dividend requirement
• Organized in the U.S.
• Can be organized under the laws of any state; but in practice many REITs (75% or more of public REITS) are organized as Maryland corporations or as “real estate investment trusts” under Maryland law
• Governed by a board of directors (or a board of trustees)
9
Benefits of REIT Status
• “Dividends-paid” deduction enables a REIT to avoid entity-level tax
• Well-known in U.S. capital markets; REITs raise capital through:
• Issuance of public equity (and debt)
• Issuance of common and preferred OP units
• Mortgage borrowings
• Credit facilities (secured and unsecured)
• Attractive to tax-exempt and foreign investors
• Tax-exempt investors can invest in real estate without incurring tax on unrelated business taxable income (UBTI)
• Foreign investors can invest in real estate without having to pay FIRPTA (essentially capital gains tax for non-U.S. investors) upon disposition, so long as the REIT is domestically-controlled
10
Principal Tests for REIT Qualification
• Ownership tests • Must have at least 100 distinct shareholders and
• Five or fewer individuals cannot own more than 50% of the REIT’s stock during the last half of its taxable year (this requirement leads REITs to adopt a share ownership limit of 9.9% or less)
• Asset tests – tested quarterly • At least 75% of the assets must be real estate assets or cash and
• Not more than 20% of assets can be securities of taxable REIT subsidiaries (“TRS”)
• Income tests – tested annually • At least 75% of gross income must be real estate related and
• At least 95% of gross income must be passive income
• Must distribute 90% of the REIT’s taxable income for each taxable year
• Subject to tax on undistributed taxable income (for this reason, as a practical matter, most public REITs distribute 100% of taxable income)
11
REIT Qualification
• Management must be highly-focused on operating within the various requirements for REIT qualification
• REIT qualification matters must be taken into consideration when structuring a REIT credit facility
• Must ensure that loan covenants and restrictions will not interfere with REIT compliance, both before and after an event of default
• Should permit any distributions being made for REIT compliance (and to avoid federal income tax)
• Minimize the nature of any limitation on transfers of REIT stock
• If a REIT fails to qualify it must wait five years before it will again be eligible to elect REIT status
12
REIT Structures
• Common REIT structure:
• UPREIT (umbrella partnership REIT)
• REIT holds all assets through an operating partnership
• Vast majority of REITs are organized as UPREITs
• Exceptions: mortgage REITs and non-traded REITs
• Straight REIT (no operating partnership)
• Down-REIT
• Important to ensure that credit facility provisions are consistent with relevant REIT structure
• As an example, in an UPREIT structure, the OP is generally designated as the borrower, and the REIT is typically a guarantor
13
Typical REIT Structure – continued
REIT
Operating Partnership*
Property Owner
Property Owner
Property Owner
REIT Investors/Shareholders
Outside Limited Partners
TRS
Sole GP
100% 100% 100%
Assets Assets Assets Assets
JV
Outside Partner
*A straight REIT would use a similar structure, but with no operating partnership
14
OP Unit Redemption Right
• OP units typically are denominated to correspond, on an economic basis, with outstanding REIT common stock (1:1)
• OP unit holders usually have a right to redeem their units for cash (with the amount being determined based on the then-trading value of a corresponding number of REIT shares) or, at the option of the REIT, delivery of REIT shares
• REITs routinely elect to satisfy redemption requests with shares to avoid unnecessary cash outlay; as a result, the redemption feature is sometimes improperly referred to as a conversion right, but the determination of cash vs. shares rests solely with the REIT
• An UPREIT typically establishes an issuer shelf (S-3) so it can deliver registered shares when satisfying a unitholder redemption
15
Down-REIT
• Investors contribute depreciated property to a joint venture with an UPREIT (or a straight REIT) in a manner that enables the investors to defer gain
• The REIT provides day-to-day management for the joint venture
• Outside investors receive negotiated distribution rights (e.g., distributions equivalent to those paid on a corresponding amount of the REIT’s shares); terms vary greatly
• Outside investors receive negotiated redemption rights, which may be satisfied with cash, REIT units or stock, depending on the business agreement
• Structure allows outside investors to maintain concentration in specific property rather than the REIT’s entire portfolio
16
II. Recent Market Trends – REIT Bank Loan Market
17
Market Update
• Issuance activity
• High by historical standards, despite slight drop in 2015-2016 (Dealogic through 10/11/17)
• Increased usage of bank loans rather than bonds
• Volatility in bond markets
• Pricing has been attractive compared to bonds
• No call protection
• Improved covenant terms in bank loans
Year Domestic Global
2014 $97.8B $172.7B
2015 $88.7B $150.0B
2016 $74.3B $119.9B
2017 YTD $77.8B $103.2B
18
Market Update
• Unsecured bank loans*
• Financing option of choice for many REITs
• Even though bond market has been open in 2017
• Average facility size has increased by 19% from 2014 to 2016
• Decreased pricing
• Pricing decreased 20–50 bps from previous facilities with an average decrease of 30 bps
• Increased draws under unsecured credit lines
• Bank-borrowing exposure accounted for 17.5% of total debt as of March 31, 2017, up from 8.5% on December 31, 2010
• Though, recent data shows upsize in revolvers resulting in decreased usage ratio
• Some borrowers shifting from secured to unsecured loans
• Term loans comprise about 70% of total REIT bank borrowing as of March 31, 2017
– continued
*Trend data from Fitch
19
Market Update
• Longer dated term loans as part of capital structure
• Increasingly seeing seven-year term loans
• Takes advantage of historically low interest rates
• Protects against increased borrowing costs in a rising interest rate environment
• Have limited call protection
• Flexibility to refinance without a large prepayment premium
• Terms continue to favor borrowers
• Removal of certain financial maintenance covenants
• Loosening of restrictions on investments
• Been a continuing trend for past three years
– continued
20
III. Credit Agreement Process and Terms
21
A. Introduction
22
Key Considerations
• Ability to comply with REIT distribution requirements – including post-default
• Permit operational flexibility
• Unencumbered v. encumbered assets
• Mortgage financings
• Non-recourse carve-out guarantees
• TRS
• Industry specific
• Gaming, hospitality and leisure
• Office properties
• Telecom
• Healthcare
23
Key Differences Between Corporate and REIT Facilities
Security Typically secured Either secured or supported by a pool of unencumbered properties
Restricted payments Limited dividend payments; must meet exceptions or satisfy baskets
Can pay dividends to maintain REIT status (even post-default)
Incurrence of Indebtedness Limited debt incurrence; must meet exceptions or satisfy baskets
Generally permitted when financial maintenance covenants are met
Investments Limited investments; must meet exceptions or satisfy baskets
Generally permitted when financial maintenance covenants are met; though may contain percentage caps by investment type
Financial Maintenance Covenants May be “covenant lite” or have one to two covenants
Primary protection for lenders; often contain more than four financial maintenance covenants
*Investment grade corporate facilities are typically unsecured and generally contain more permissive covenants
24
B. Process
25
Timeline
Negotiate engagement letter
and term sheet
Sign engagement letter and begin
negotiating credit agreement
Negotiate ancillary
documents
Ongoing reporting obligations and
delivery of quarterly
compliance certificates
Due diligence process
Sign definitive documentation
and fund
t t+2 weeks t+6 weeks
26
Key Documentation: Initial Documents
• Engagement letter
• Sets forth key syndication terms
• Term sheet attached
• Can be very detailed or more general
27
Key Documentation: Initial Documents
• Fee letter
• Arranger fee
• Fee paid for arranging financing
• Accordion arranger fee also typically set (unlike corporate borrowers)
• If a committed financing, will usually have an underwriting fee
• Upfront fee
• Fee paid to market
• Typically based on lender’s commitment request (not to exceed its invited commitment) rather than the accepted commitment
• Administrative Agent fee
• Ongoing fee paid for acting as going forward agent
– continued
28
Key Documentation: Closing Deliverables
• Credit agreement
• Schedules
• Exhibits
• Guarantees
• Make sure to review guarantor organizational documents
• Notes (if requested)
• Borrowing Notice
• Officer’s certificates
• Solvency certificate
• Compliance certificate
• Secretary’s certificate
• Including board resolutions
• Opinion of counsel
29
C. Security and Guarantees
30
Security
• Investment grade REIT facilities are typically unsecured
• Credit facilities for sub-investment grade REIT borrowers are typically secured
• Collateral included pledges of equity, profits and other entitlements of the borrower and its subsidiaries
• Depending on industry may be able to obtain corporate like security package
• Trend: REITs with ratings of BBB to BB are increasingly able to obtain unsecured bank loans
31
Security
• Typically, instead of collateral, banks rely on a pool of unencumbered property comprised of select eligible property of the borrower – “Minimum Unencumbered Property Condition”
• Eligible property is typically required to be:
• Wholly owned by or ground leased to borrower, guarantor or controlled joint venture
• For investment grade borrowers, may be held by wholly-owned domestic subsidiary
• Located in the U.S.
• Though some facilities provide for a sublimit of non-U.S. properties
• No asset level debt
• Aggregate pool value equal to or greater than the facility size
• Direct and indirect owners of the properties in the pool guarantee the facilities
• Typically required to have a certain minimum number of unencumbered pool properties
• Can range from three to ten
– continued
32
Guarantees
• Investment grade – typically no guarantee requirement
• Sub-investment grade – guarantees are typically required
33
Guarantees
• Guarantors typically include:
• Parent entity in an UPREIT structure
• Each wholly owned subsidiary liable in respect of unsecured debt
• Each direct and indirect owner of an unencumbered pool property
• Sometimes may include “material subsidiaries”
• Based on a percentage of guarantor’s asset value
– continued
34
Transition to Investment Grade
• Non-investment grade borrowers who expect to transition to investment grade status during the life of their credit facility may build in transition terms
• Release of subsidiary guarantors owning unencumbered pool property
• Often requires prior notice and delivery of an officer’s certificate
• Ability to opt-in to a more favorable ratings-based pricing grid
• Fall-away of certain financial maintenances covenants
35
D. Interest Rates
36
Borrowing Rate
• Investment grade borrowers: ratings-based grid
• Negotiated provision for pricing in split-ratings circumstances
• First three fiscal quarters of each year only (typically)
• Compliance Certificate
• Concurrently with delivery of annual and quarterly financial statements
• Forecasts of consolidated balance sheet, income statement and cash flow projection
46
Other Reporting Obligations
• Notices of certain material events, including:
• Defaults
• Matters that have or would reasonably be expected to have a “material adverse effect”
• Announcement by Moody’s or S&P of change or possible change in rating
47
REIT-Specific Affirmative Covenants
• Maintenance of REIT status
• Procedures for adding unencumbered pool properties
• Notification and information to the Administrative Agent
• Add direct and indirect owners as guarantors (if required)
• Procedures for adding guarantors
• If a subsidiary becomes:
• A direct or indirect owner of unencumbered pool property
• Exception: if after an investment grade release
• A borrower or guarantor of unsecured indebtedness
• Exception: guarantees of nonrecourse indebtedness, which guarantees generally are limited to a customary recourse exclusion
• Must then execute a joinder agreement to the credit agreement
48
H. Negative Covenants
49
Negative Covenants
• “Thou shall not” covenants
• Prohibit the borrower and other loan parties from engaging in certain activities
• Customary negative covenants include restrictions on:
• Incurring indebtedness
• Fundamental changes or dispositions
• Making restricted payments
• Changing the nature of the business
• Transacting with affiliates
• Entering into burdensome agreements
• Changing accounting policies and practices
50
Restricted Payments
• Ability to make “Restricted Payments” is generally not limited when no event of default occurred and is continuing
• “Restricted Payments”: dividends, distributions or repurchases of equity interests
• Alternatively, may be constrained by a cap or limitation (e.g., up to 95% of funds from operations)
51
Restricted Payments
• During an event of default, carve-outs allow the following Restricted Payments to be made:
• Amounts sufficient to avoid payment of federal and state income or excise tax
• Amounts sufficient to maintain REIT status
• Some facilities limit restricted payments upon bankruptcy or payment event of default
• Can create issues for both lenders and borrower in bankruptcy
– continued
52
Restrictions on Debt Incurrence
• Some facilities restrict the incurrence of indebtedness by categorizing debt into baskets and constraining each basket with a cap or limitation
• Hedging arrangements
• Capital leases
• General basket
• However, there is a trend to allow the incurrence of additional indebtedness as long as the borrower is in compliance with its financial maintenance covenants
53
Restrictions on Debt Incurrence
• Indebtedness is often defined broadly
• Includes:
• Borrowed money, notes, bonds or debentures
• Capital leases
• Net payments in respect of swaps
• Deferred purchase price of property or services
• Excludes:
• Guarantees of non-recourse indebtedness
• Recourse typically limited to “customary recourse exceptions”
• Trade liabilities
• Security deposits
– continued
54
Restrictions on Investments
• Limits ability of borrower and restricted subsidiaries to make “investments”
• “Investments” typically defined as including:
• Purchase of equity interests or securities
• Loans or extensions of credit
• Purchase of business units
• Purchase or investment in real property
55
Restrictions on Investments
• Often caps different baskets of investments, individually and in the aggregate
• May see baskets for investments in:
• Unconsolidated affiliates/JVs (e.g., 10% of total asset value)
• Assets under development (e.g., 15% of total asset value)
• Mortgage receivables (e.g., 5%–10% of total asset value)
• Unimproved land (e.g., 5% of total asset value)
• Aggregate of all investments (e.g., 25%–35% of total asset value)
• Cap could be a dollar value or percentage of total asset value
• Alternative formulation: generally permit investments so long as no event of default occurred and is continuing
• Lenders protected by financial maintenance covenants and minimum unencumbered property condition
– continued
56
I. Financial Maintenance Covenants
57
Financial Maintenance Covenants
• Key limitation on taking actions
• Not unusual to have four to eight
• Typical menu of financial maintenance covenants include:
• Fixed charge coverage
• Tangible net worth
• Total assets covenants
• Unencumbered NOI
• Unsecured debt yield
• Total leverage
• Secured leverage
• Secured recourse leverage
• Unsecured leverage
• Unencumbered interest coverage
58
Key Financial Definitions
• Capitalization Rate
• Rate of return on real estate investment property
• Used in the calculations of Total Asset Value and Unencumbered Pool Value
• Rates may differ for specific property categories (e.g., office, retail, multifamily) and/or geographic location of the properties
• EBITDA – earnings before interest, taxes, depreciation and amortization
• Proxy for earning potential
• Net Operating Income (NOI)
• Proxy for income production of real estate
• Equal to revenue from the property minus all reasonably necessary operating expenses
• Negotiations over included v. excluded operating expenses
• Unencumbered NOI • Net Operating Income of the unencumbered pool properties
ri Blaut is a partner in the firm’s Corporate and Finance Group. Mr. Blaut maintains a broad corporate practice advising clients on a wide range of financing transactions, including bank financings, high yield bond issuances, “PIPE” transactions, debt restructurings, liability management, creditor representations and joint ventures. Mr. Blaut has particular expertise in leveraged finance and acquisition finance transactions. Mr. Blaut regularly acts for clients in connection with arranging committed debt financing (both bank and bond).
Recent Selected Transactions
Corporate
Harris Corporation in $3.4 billion of debt financing (bank and bond) for its acquisition of Exelis
AT&T in vendor financing provided in its $2.5 billion acquisition of Iusacell
Underwriters in Alibaba Group’s $8 billion bond issuance
Impax Laboratories in $600 million of debt financing for its acquisition of pharmaceutical products from Teva and Allergan
CIM Commercial Trust in $1.2 billion of term loan and revolving bank financing
Forest City in $900 million of bank financing in connection with its conversion to a real estate investment trust
Unisys Corporation, American Casino & Entertainment Properties, and Wasserman Media Group in other recent financing transactions
Private Equity
Ontario Teachers’ Pension Plan Board (OTPPB) in $710 million of first lien, second lien and revolving facilities for its acquisition of PODS
Rhône Capital in $535 million of first lien, second lien and revolving debt financing for its acquisition of Ranpak Holdings
A
70
Biographies
Private Equity, continued
Ares Management in debt financing related to its acquisition of a large minority stake in ATD Corporation from TPG
Tinicum Capital in debt financing for its acquisition of Ashby Street outdoor holdings
Versa Capital in the dividend recapitalization of its portfolio company Avenue Stores
Rhône Capital in $1 billion of multi-jurisdictional asset-based revolving and term loan facilities for its acquisition of CSM NV’s bakery business
Ares Management and OTPPB in $1 billion of debt financing (term loans, asset based revolver and bonds) for their acquisition of CPG International
Castle Management, a joint venture of Highgate Hotels and Trilantic Capital Partners, in its debt recapitalization
Special Situations
Ad hoc committee of Key Energy’s unsecured notes, led by Platinum Equity, in connection with Key’s prepared Chapter 11
Anchorage Capital, O-Cap and Corbin Capital in their debt, preferred stock and warrant investment in Cubic Energy and the subsequent prepackaged Chapter 11
AT&T in arrangements with holders of NextWave Wireless notes (senior secured, subordinated and third lien) as part of its distressed acquisition of NextWave Wireless
Eastman Kodak for its $950 million debtor-in-possession facility, $848 million junior debtor-in-possession facilities and $895 million exit financing facilities
Versa Capital in the exit financing for its 363 acquisition of Avenue Stores
Ares Management as unsecured note holder in the restructuring of Sbarro
71
Biographies
Direct Lending
Owl Rock and GS BDC as joint-lead arrangers and second lien lenders to Roland Foods
Crescent Capital as mezzanine finance provider in connection with acquisitions by TPG, Advent and GTCR
Delaware Life and Guggenheim Life as lead arrangers in direct lending transactions for Associations Inc. and Mammoth Mountain
Publications
“Structuring Considerations for Minority Investments”, Deal Lawyers (2016) (co-author)
“Borrower Favorable Trends in REIT Credit Facilities”, Law360 (2016) (co-author)
Professional Activities
Mr. Blaut is a member of the New York City Bar Association Committee on Commercial Law and Uniform State Laws
72
Biographies
enjamin Weber has experience in a broad range of commercial real estate, corporate
finance and private and public securities transactions, including acquisitions and
dispositions, corporate and partnership restructurings, securitizations, financings, private
equity investments and public and private offerings of debt and equity.
with its sale to Cole Capital Properties Trust III
(thereafter known as Cole Real Estate
Investments)
Jujamcyn Theaters in various matters,
including the $115 million refinancing of its
Broadway theater business
Verde Realty in its merger with a fund
sponsored by Brookfield Asset Management
Lazard Alternative Investments in various
acquisitions and financings and in the
disposition of its Atria senior living business to
Ventas, Inc. and subsequent sale of the Atria
senior living management business to a group
of its senior employees
GF Investments in various real estate
investments, including its purchase of an
interest in the MS Rialto land development
business and its purchase of interests in
several other residential development projects
Ontario Teachers Pension Plan in various
real estate investments, including the
extension of its lease with the Port Authority of
New York and New Jersey (PANYNJ) for the
New York Container Terminal on Staten
Island and the development of a related toll
rebate program at that property and a sale and
related lease transaction with the PANYNJ for
the Global Container Terminal in
Hoboken/Jersey City
73
Biographies
Recent Representations, continued
AIG and certain affiliates in the sale of a portfolio of approximately $40 billion of RMBs and other securities to The Federal Reserve Bank of New York
Vornado Realty Trust in connection with various transactions, including its sale of Broadway Mall on Long Island to an affiliate of KKR, its ongoing investment in the Suffolk Downs racetrack in Boston and its purchases of various office, retail and other commercial properties and related businesses from sellers including a consortium of Chinese investors, The Mendik Company, Kennedy family entities, Commonwealth Atlantic Properties, Inc., Charles E. Smith Limited Partnership and the Kaempfer companies
Rankings and Recognitions
BTI Consulting Group (2016) – recognized as a law firm Client Service All-Star
New York Super Lawyers (2007–2015) – recognized as a Super Lawyer in Real Estate Law
The Best Lawyers in America (2013–2016) – recognized in Real Estate Law and Mergers & Acquisitions Law
The Legal 500 United States (2014) – recognized in Real Estate Law
The issuer or the underwriters in a variety of securities offerings by public real estate companies, including the initial public offerings of Morgans Hotel Group, U-Store-It Trust, General Growth Properties, Inc. and Crown American Realty Trust and shelf offerings of debt and equity by MFA Mortgage Investments, Vornado Realty Trust and Forest City Enterprises
Various lenders and borrowers in connection with loans secured by shopping centers, office buildings, hotels, apartment buildings, assisted living facilities, Broadway theaters, warehouses, manufacturing facilities and other commercial properties throughout the United States