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Legal Update

Corporate Real Estate in the Credit Crunch Environment

17 October 2008
Mayer Brown JSM Legal Update
Real estate forms an integral part of many corporate businesses and as such needs to be considered in the implementation of any properly formulated strategy in the current economic environment. This Client Alert highlights some of the issues which users and owners of real estate should be considering in the unprecedented financial landscape in which we now find ourselves.

Full Update
Landlord and Tenant
Exit Strategies - a change in your real estate strategy may reduce costs. Here are a number of factors to consider in this context :
  • Intergroup transfer and sharing - a possible solution for redundant space. Provided the lease permits group sharing, expenses can be saved and the tenant's outgoings can be defrayed amongst other members of the group without the burden of taking third party space and incurring additional expense. 
  • Assignment or underletting to a third party or exercising break clauses - a means of reducing or terminating liabilities. However, this must be exercised carefully and correctly to avoid breach or disputes arising with a landlord.  Awareness of the strict conditions, and adopting a proactive approach towards meeting those conditions within time frames set out in the relevant documentation, are important.
  • Conditional contracts - it may be possible to rescind or walk away from conditional contracts for letting of property where conditions have yet to be satisfied. Careful scrutiny of such contracts may offer a potential exit route.
Restructuring - Negotiation can be conducted for changes to some existing leases in order to address cash flow and liquidity issues. The benefits to a tenant are obvious, but the landlord can also benefit from varied terms that potentially increase the value of its asset in the longer term and ensure a continued income stream from its tenant. Examples are :
  • Reduction of rent and an increase in term - reducing the rent can free up cash for a tenant and an increase in the term will allow the landlord to recover the reduction at a later date.
  • Fixed renewal rent rather than open market rent - this will provide certainty in relation to renewal rents. However in the short term this may be an expensive change for a tenant in an environment where rents are falling and open market rent reviews are generally seeing no upturn.
Property Owner
Structured Transactions - owners of corporate real estate can unlock additional funds from the value in their real estate or implement structures to promote more favourable terms for debt financing. For example :
  • Sale and leaseback - the attractions of a sale and leaseback include the freeing up of capital to fund activities elsewhere in your business whilst maintaining day-to-day operational control of the property; tax benefits include the ability to offset lease costs as an operating expense; improvement of your balance sheet through exchange of fixed assets, often carried at a below market value, for cash and transferring property value risk to a third party on a fully transparent basis.
  • Restructuring - restructuring a property portfolio using an opco/propco structure in which the propco owns the properties and the opco owns and operates the business carried on at the properties under a lease, can enable a borrower to raise additional funds compared to traditional financing by giving a lender a property asset to lend against by way of term loan and an operating business to lend against through a working capital facility. In these circumstances, banks may be prepared to lend more and at more competitive rates than normal lending. The creation of a separate property holding structure to ring fence real estate liabilities may also be desirable.
  • Portfolio sales - when planning a sale of a number of packaged properties consider carefully the types of property to be included and the opportunities that a portfolio sale may provide to tailor your lease terms (in the case of sale and leasebacks) with the operational requirements of your business. Consider adding properties to the portfolio that are located in different countries in order to avoid being aligned to a single economy.
Abortive Transactions - the global credit crisis is expected to have a knock-on effect on the property market. Purchasers who have entered into agreements for sale and purchase of properties may be unable or unwilling to complete the purchase due to failure to obtain sufficient funds or for other reasons connected with the market condition.
  • Purchaser's default - where the purchaser fails to complete the purchase of a first-hand property from a developer, the developer when determining the agreement should take care to follow the termination mechanism and issue the relevant notices to the purchaser in accordance with the provisions of the agreement for sale and purchase. A vendor of a second-hand property should also scrutinise the provisions of the sale and purchase contract carefully before exercising his rights against a defaulting purchaser.
  • Conditional contracts - it may be possible to rescind or walk away from conditional contracts for the sale and purchase of property where conditions have yet to be satisfied. Again, careful scrutiny of the subject contract is important.
Risk Management
Bank Insolvency - insolvency in the banking sector may mean that review of existing arrangements and consideration of ways to manage and mitigate against such risks are necessary.
  • Funding arrangements - consider the treatment of undrawn funds and other obligations on the part of funders which remain to be performed. This could be of particular concern in the context of development funding where projects are in the course of construction. At the first sign of a possible insolvency, it is important to be aware of the range of remedies available and to act quickly. Consider appropriate protection in any new banking documentation currently being negotiated and consider the impact on the project where implementation is likely to be delayed.
  • Stakeholder account - in a sale of units in an uncompleted development in Hong Kong, all purchasers' payments in respect of the purchase price need to be paid into a stakeholder account opened with a licensed bank and designated for the development. Even though the Government has guaranteed bank deposits for two years, care should be taken in choosing the relevant bank for placing such funds in view of possible bank insolvency.
Special Provisions - before entering into a real estate transaction, take into account factors which would normally not be too much of a concern in a stable economic environment, e.g. difficulties in raising finance for completion. Be prepared and consider building into the relevant agreements or documentation special provisions to cater for contingencies.
Tax Implications
In relation to all forms of structuring and variation, efficient tax planning is important. To ensure the most effective outcome, carefully consider the tax implications in your real estate strategy and plan early. You should seek specific advice on tax and other legal issues concerning individual situations and in carrying out any of the above strategies.
For further information, please contact:
Ellen Tsao ( )
Connie H.Y. Yu ( )
Learn more about our Hong Kong office and Real Estate practice.

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