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Eversheds Sutherland property column: July 2020

  • United Kingdom
  • Corporate Real estate - Real estate briefing
  • Real estate

10-07-2020

Five things to consider when investing in a distressed real estate market

With a whole raft of new investors having entered into the real estate market since 2012, there will be many with little or no experience of acquiring commercial property from insolvency practitioners and many legal practitioners for whom this is an unfamiliar area. Below are five key points to consider when investing (or acting for an investor) in a distressed real estate market, which may have renewed relevance following the current COVID-19 pandemic.

Understand who your seller is and why the property is being sold

The acquisition will frequently be from somebody who is not listed on the legal title documentation as the registered proprietor, whether it be a Law of Property Act (LPA) receiver, administrator or liquidator. The different types of insolvency practitioner have different primary concerns, but will usually all favour a quick sale. There are legal implications to the identity of the seller in this type of acquisition, ranging from ensuring that the right Land Registry documentation is used (for example a TR2 transfer form for any lender disposing of property under a power of sale), to ensuring that the right people sign (authorised under a power of attorney or appointment of administrators for example).

Limit your expectations

A distressed real estate market often means limited ability for a buyer to obtain the extensive information normally provided on acquisition of real estate, so expectations for full due diligence and a significantly negotiated contract should be limited from the start of a transaction. Insolvency practitioners will include extensive protective drafting in contracts and transfers, and this is to be expected and will have to be accepted. It is worth remembering that the other effect of a distressed market is a reduction in purchase prices and provided that they are well advised and aware of the limitations, pragmatic and hardworking purchasers will often see such transactions as opportunities to seize, rather than unacceptably risky.

Limited information available through due diligence can have direct financial consequences. For example, a buyer will usually take on the obligation to pay back rent deposits to the tenants of a building, regardless of whether the money has been collected from the seller on completion of the purchase. A buyer should try hard to discover the existence and amounts of any rent deposits, in order to ensure that the purchase price is adjusted to reflect the same where the deposit monies are not available to be transferred to the buyer on completion.

Ensure a careful review of the indemnities required of the buyer

Despite the pragmatic approach recommended above, a well-advised buyer will require a careful review of the indemnities included in any contract for sale of distressed property, including those which may be buried in the interpretation provisions. It is not unusual on purchase from an insolvency practitioner to see wide drafting requiring the buyer to indemnify the seller for losses or liabilities, sometimes even including those arising as a result of the seller’s own negligence. While this extreme position may be more common on insolvency sales than any other, a properly advised buyer will likely push back on contractual drafting along these lines.

Consider timings

Many of the risks of purchasing real estate in a distressed market can be mitigated by simultaneous exchange and completion. This deals with the concerns a buyer may have around the continued asset management (or lack of it) after exchange, and the fact that in this sort of transaction deposits expressed to be non-refundable are common. In a contract with split exchange and completion, contractual provisions making time of the essence in relation to completion and removing the usual drafting around service of notices to complete are common when buying from an insolvency practitioner. So in a worst-case scenario for a buyer, it will have paid a deposit, but a delay in transferring the completion funds by a 1.00 pm deadline on the completion date would allow the seller to rescind the contract and retain the deposit.

Where external funding is required for the transaction it is vital to ensure that this is secured quickly to avoid losing the purchase, which will include identifying at the outset a lender that is willing to proceed with a reduced level of due diligence.

Be prepared for post-completion surprises

The limited ability to carry out detailed due diligence in advance of completion makes uncovering asset management skeletons post-completion all the more likely in relation to distressed assets. There is real benefit in taking the time to undertake more detailed due diligence after the transaction has completed so that any underlying issues can be identified and either remedied or mitigated against (possibly even through insurance). The issue can be particularly acute where the asset includes established tenants. In addition to the potential problem with rent deposits noted above, common issues include ongoing but undisclosed service charge disputes, rent arrears and other breaches of lease covenants. Even where the property is empty, there may be undisclosed neighbourly issues such as disputes over boundaries, rights or restrictive covenants.

If time did not permit in advance of the purchase, any searches (such as local authority or utilities searches) should also be undertaken to provide more information about the property. If possible, discussions with the previous managing agents and even a series of site visits and/or discussions with tenants and neighbours could help to uncover any hidden issues.

Conclusion

In summary, there are a number of additional and different considerations for a purchaser when dealing with acquisition of property in a distressed market, but such a market can provide keen pricing and quick deals. This means that a range of investors, provided that they are well advised, aware of the limitations and willing to put work into the management of their assets, will see this type of market as a great opportunity.