Getting creative with transaction structures

Throughout much of 2023, we have been operating in a market where sellers and buyers remain some distance apart in their pricing of real estate assets. There are various factors making buyers more cautious; financing has become increasingly expensive, construction costs have inflated and void levels remain above those of 2019. Despite the market pressures, many owners are not feeling any particular pressure to sell, particularly not below the value that was set 18 months ago. The result is a flat market with buyers and sellers alike preferring to wait it out. Yet there remain deals to be done and increasingly clients are turning to more creative transaction mechanics to get the edge in a quiet market. Many of these alternatives are not new and are reliable strategies that have been used in real estate transactions many times before. Some of these structures have historically been more popular in particular sectors. For example, option agreements are very much the bread and butter for those operating in the renewable energy sector and overage provisions have been used by public and charitable bodies well before the current market downturn. The fact that such tools have been tried and tested means creative dealmakers might look to see how they can employ them in their own sector, knowing that alternative structures can be a route to market. Of course, the structuring of transactions can have significant tax implications and this article does not explore those in any detail. Conditional contracts The first option to explore is a conditional contract. It is understandable that many sellers looking for certainty would prefer not to entertain a conditional offer. However, in today’s market we are seeing increasingly creative conditions being employed as a route to market. Conditional contracts are not a novel idea and classically have included: a requirement on the seller to obtain vacant possession; the need to first receive consent from a third party (landlord or a neighbouring landowner); a requirement on the buyer to first obtain a satisfactory planning permission; and the ability for the buyer to obtain funding for the purchase. However, conditional contracts do not need to be limited to these typical scenarios. For example, if a seller is on the cusp of securing a significant tenant at the property, parties may agree to make the sale contract conditional on the lease being signed, or if the buyer wants further reports/surveys to be commissioned, then the contract could be made conditional on the surveys yielding a particular result. So long as the condition is clearly defined and drafted in a way that avoids any uncertainty as to whether it has been satisfied, a conditional contract is a tool that can be very useful. Forward purchase/contingent contract Under such arrangements, a buyer is only required to pay a proportion of the purchase price on future events occurring. It is a flexible tool that can be used to structure a transaction to ensure a sharing of risk between the buyer and seller. We have found contingent consideration particularly useful where the ability of the asset to generate a sustainable income remains untested (perhaps because the building has been recently developed or refurbished). To ensure the funds remain available, contingent payments are often held in a segregated escrow account and only released to the appropriate party on certain contractual conditions being met. It means the structure is limited if either party wants to have full use of these funds during the contingency period. However, it can be a useful way of getting a buyer comfortable with the asking price on an untested asset. Overage provisions Overage provisions provide parties with a mechanism that allows the seller to share in the increased value of a property post-sale. They are commonly associated with a scenario where the land has the potential to be redeveloped or a valuable planning permission might be obtained. Overage provisions are often used by charities and public sector bodies who are required to obtain the best consideration when selling land. However, all sellers can utilise this tool as an “anti-embarrassment” measure to ensure that they take the benefit of any increase in the land value. A poorly drafted overage clause can cause a whole range of issues further down the line as the buyer could be left with the risk of overage provisions taking effect in scenarios that were not originally envisaged. However, when drafted correctly, they can be a useful way for a developer or promoter to bring the seller to the table in exchange for a share in any potential uplift to the value of the land. Pre-emption agreements A pre-emption right gives a prospective buyer the right to be offered the opportunity to buy land before the landowner offers it to another party. Importantly, a pre-emption right does not place the landowner under any compulsion to sell. However, it does allow the buyer to retain a competitive advantage in the market should the landowner decide to sell the land during the agreed pre-emption period. One of the main points of discussion is how to determine the eventual purchase price. Often parties will agree that the buyer will be offered the opportunity to put in a bid ahead of the wider market. If the bid is rejected, the seller is then only allowed to sell on the open market at a higher price. However, other structures can also be used. For example, parties may agree to a mechanism where the property is put on the open market and the buyer is offered the opportunity, after bids have been received, to match the highest bid. Another example would be to have the purchase price determined by an independent third party with parties then able to choose whether to proceed at that price. Pre-emption agreements are commonly agreed by larger estates who want to keep their foot in the door and retain an element of control over land that has been transferred out of their wider estate. This can also be a great mechanism for a prospective buyer with a long-term strategic interest in a particular plot but currently faced with a seller not yet willing to sell. Options Call options are traditionally used by developers who, for a modest option fee, can secure a site while having full discretion over whether it will elect to buy the property in the future. Once the call option is exercised, the seller is contractually obliged to sell. While it is often granted to developers who need time to line up appropriate financing or obtain a particular planning permission, the option could be a mechanism employed by others who are keen to secure a site ahead of their competitors but unwilling to over-commit in the current market. Option agreements do not need to be limited to giving the buyer the right to call on completion. Put options can also be prepared which switch the power to the seller who, when the time is right to sell, is able to serve a notice requiring the buyer to purchase the site at a pre-agreed price. Sale-and-leaseback In a sale-and-leaseback transaction, the seller transfers the property to the buyer with the buyer granting a lease straight back to the seller, allowing them to remain at the property. If you are an owner-occupier undergoing a strategic review of your space but not looking to relocate immediately, this structure allows you a route to market and the opportunity to unlock capital with minimal operational disruption. In a market where investors are seeking out assets that will generate an income for the foreseeable future, a leaseback structure could attract some significant bidder interest. Parties might agree to an institutionally standard “full repair and insuring” leaseback at market rent which will give the buyer an income producing asset for their balance books. Alternatively, the rental payments under the lease could be deducted from the initial sale price so that only a reduced rent is payable while the seller remains in occupation. Boxing clever Having a good understanding of the various tools that are available allows you to be more creative with how you employ them. The person having a good grasp of such mechanics will find that they are well equipped to both get assets on the market and also to unblock a deal that might otherwise be on the verge of breaking down. Case studies Forward purchase: A transaction involved the sale of student accommodation in three UK cities worth approximately £100m. The properties had been recently developed so the purchase price was based on the deemed net income across the properties. However, given the assets had only recently been let out to students, the buyer wanted some protection that the income would remain at a certain level for the next three years. Therefore, parties agreed that part of the purchase price would only be payable at the end of each academic year when there was proof that the actual income had reached a certain threshold. Sale-and-leaseback: An owner-occupier considered a sale-and-leaseback structure as a viable alternative to financing and so sold its freehold estate to a ground rent investor in return for a long lease at a ground rent. The re-gearing allowed the occupier to release the cash it needed while continuing to control the asset under a long lease, albeit subject to paying on some of rental income to the new freeholder. The lease included a call option allowing a buyback of the freehold interest at a pre-determined price every five years. Peter Lewis is a senior associate at Norton Rose Fulbright LLP Image © Stocktake/imageBROKER/Shutterstock