Workouts for Underperforming Communities

In an increasingly common scenario in today’s deplorable market conditions, multifamily owners and asset managers are struggling with under-performing rental communities – the communities have declining occupancy levels, are unable to make debt service payments or required capital repairs and are facing the maturity of their existing debt, with no meaningful refinancing prospects on the horizon.

What steps should owners and asset managers consider taking in the near term to preserve their assets and, if necessary, successfully take them through a “workout” transaction?

While any program for an under-performing asset must be tailored to the specific factors affecting that particular asset, the starting point in most situations is to try to identify the objectives that the existing lender will have for the community. For example, some lenders are working extensively with borrowers to maintain the relationships and enable their borrowers to retain their assets. Other banks are accelerating their loans on the first sign of default with the objective of reducing their exposure (especially as market values continue to decline). Loans that have been securitized will likely provide the fewest opportunities for consensual “workout” deals, because the loan servicers that manage these types of loans have little discretion and limited options to modify the terms of the governing loan documents with a view toward helping the troubled borrowers.

Another variable to consider is whether the owner, asset manager or its principals are exposed to any personal liability under guaranties or other loan documents securing the existing financing. In particular, if a guaranty contains a “springing recourse” provision, the guarantors will typically face full recourse liability for the repayment of the entire loan if the owner or one of its affiliates voluntarily files a bankruptcy petition or fails to contest an involuntary bankruptcy filing. Such “springing recourse” provisions significantly limit the options available to the owner of a troubled asset to rely on the bankruptcy laws to “reorganize” the asset since few borrowers will want to risk triggering a guarantor’s personal obligation to repay the entire loan.

Owners and asset managers should review the terms of the existing loan and associated documents to evaluate whether there are any favorable provisions that might assist them in negotiating a workout with their lenders. If the loan documents require any “clean up” (i.e., they contain ambiguities or other provisions that might offer an advantage in the workout negotiations), the owner or asset manager may have greater leverage to achieve a loan extension or forbearance agreement from the existing lender. This approach may provide the owner or asset manager with sufficient time to weather current market conditions and find a take out loan, avoiding a more costly foreclosure for the lender, especially if the collateral securing the loan has materially declined in value.

It is difficult to predict whether a lender will want to pursue foreclosures in the current economic environment. The fact there have been few real estate bankruptcies filed affecting multifamily rental communities in the last year suggests either that most lenders are willing to work with their borrowers or that the most recent changes to the Bankruptcy Code have generally rendered single asset real estate bankruptcy filings to be futile (or maybe some combination of both). On the other hand, if the values of communities continue to drop, lenders may elect to become more aggressive in dealing with under-performing assets.

(This entry posted by Pamela V. Rothenberg, a member of Womble Carlyle's Real Estate Development group, and Jeffrey Tarkenton, a member of Womble Carlyle's Bankruptcy and Creditors' Rights group)

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Naming Issues

Apartment owners and managers should vigilantly protect the brand and goodwill that they create in each of the submarkets in which they own and operate their apartment communities. The branding of a single apartment community, a multi-property portfolio or even an asset or property management company itself and the creation of the associated goodwill occurs through the consistent use by the owner and its property manager of their trade names, logos and other proprietary names and marks (i.e., their “Intellectual Property”) over an extended period of time.

The need to protect Intellectual Property does not end when an owner moves into a “disposition” mode for a single community or a portfolio of properties. In fact, to the contrary, the Intellectual Property of the owner and the property manager should be expressly excluded from the assets being sold.

However, what happens during the transition period immediately following a sale? It is simply not realistic to expect a purchaser to immediately discontinue the use of the Intellectual Property starting on day one of its ownership of a community. One practical way to address this issue is for the parties to enter into a “name license agreement” that survives for a short period following the closing on the sale of the community or portfolio.

Through a name license agreement, the seller can grant to the purchaser a non-exclusive, revocable and limited license to use the Intellectual Property for a specific period of time, typically not more than ninety (90) days, following the closing of the sale. The sole purpose of the name license agreement (which should be stated in the agreement) is to facilitate the transition of ownership to the purchaser and the agreement should prohibit the purchaser from using the Intellectual Property in conjunction with any other property or in any other respect.

The agreement should also state that the seller is not warranting any of its rights in the Intellectual Property and that the purchaser is using the same at its own risk. The seller should have the right to immediately terminate the name license agreement if the purchaser fails to comply with its terms in any respect (hence the need to state that the license is “revocable”). Finally, the agreement should prohibit the purchaser from assigning its license to use the Intellectual Property so that these rights are personal only to the purchaser.

A name license agreement is really a “win win” document for both a seller and a purchaser. It permits the parties to address in a pragmatic way the unavoidable transition issues relating to the Intellectual Property rights associated with the assets being sold and puts a seller in a better position to protect its brand and associated goodwill.

(This entry posted by Pamela V. Rothenberg, a member of the Real Estate Development group.)

Permalink: http://womblemultifamilyandmixeduse.blogspot.com/2008/04/naming-issues.html

Fair Housing Act Accessibility: Examples of Covered Multi-Family Dwellings

As litigation over Fair Housing Act (FHA) design and construction accessibility requirements continues to increase around the country, we are getting more and more questions about what kinds of multi-family housing are, in fact, subject to these requirements.

To start with, the accessibility design and construction requirements apply to all buildings built for first occupancy after March 13, 1991, that fall under the definition of "covered multifamily dwellings (CMFDs)". CMFDs are:

1. all dwelling units inside buildings that have one or more elevators if there are at least four dwelling units in the building, and

2. all ground floor dwelling units in buildings without an elevator that have at least four dwelling units.

If a dwelling unit falls into one of the above two categories, it is a CMFD. This is true regardless of whether it is an apartment, condominium, townhouse, vacation timeshare unit or college dormitory.

Continuing care retirement facilities (CCRCs) (a fast-growing sector in our aging society) are covered even if they include health care facilities, providing that the CCRC has at least one building with four or more dwelling units ---- but there is a nuance here. To be a "dwelling" under the FHA, the unit must be intended to be used as a residence for more than a brief period of time. It is possible, therefore, for some units in a CCRC to be deemed CMFDs while others are not. While this nuance might be useful to a CCRC encountering an accessibility challenge, certainly the safest approach would be to design and construct each unit about which there could be a question as if it were a CMFD.

(This entry posted by Karen Estelle Carey, a member of the Real Estate and Construction practice.)

Permalink: http://womblemultifamilyandmixeduse.blogspot.com/2008/04/fair-housing-act-accessibility-examples.html

Transfer of Interests in Real Property Entities Soon to be Subject to Tax in Maryland

For decades, owners of real property located in Maryland have been able to avoid transfer and recordation taxes on the property's sale by selling interests in the entity that owned the real property, rather than directly selling the real property itself. But the Maryland legislature, by enacting into law the Maryland Tax Reform Act of 2007, will be closing that loophole shortly.

The act revises Title 12 and 13 of the Maryland Property Tax Code to impose transfer and recordation taxes on each transfer of a "controlling interest" in a "real property entity," as if the real property were conveyed by deed. The new transfer and recordation taxes apply to all transfers of controlling interests completed after June 30, 2008. Unless exempt, the real property entity is required to pay the tax to the Maryland State Department of Assessments and Taxation within 30 days of the transfer of a controlling interest.

Transfer of a "controlling interest" entails the sale of more than 80% of the total value of all classes of stock of a corporation, the beneficial interest of a trust, or the total interest in capital and profits of any other entity (such as a limited partnership or limited liability company) to the extent that the applicable corporation, trust or other entity constitutes a "real property entity."

A "real property entity" is any entity that beneficially owns real property located in Maryland if the Maryland real property constitutes at least 80% of the value of the entity’s assets, and the aggregate value of the Maryland real property is equal to or exceeds $1,000,000. When valuing the real property, no reduction is given for the amount of any mortgage, deed of trust, lien or other encumbrance.

There are a handful of notable exemptions to the new transfer and recordation taxes. Transfer and recordation taxes are not imposed on the transfer of a controlling interest in a real property entity if (a) the transfer would otherwise be exempt from recordation tax if the real property were transferred between the parties by deed, (b) the transferee and the transferor are owned by the same persons and in the same proportions, (c) the transfer of a controlling interest is completed in stages over a period of more than 12 months, or (d) the transfer of a controlling interest, though it may take place in stages over a period of less than twelve months, is not effected pursuant to an intentional plan or contract to do so. In addition, although the parameters are not entirely clear, the act exempts transfers of controlling interests in real property entities between certain commonly controlled entities, though the availability and applicability of this exemption may be somewhat limited.

If an entity does not quality for an exemption, then the entity itself (not the transferor or transferee) is liable for the transfer and recordation tax. The tax liability is calculated as a percentage (ranging from 1.16% to 3.00%, depending upon the county) of the "consideration payable" for the transfer of the controlling interest. In calculating the consideration payable, the entity must add to the amount of actual consideration paid by the transferee(s) all debts owed by the real property entity, including all mortgages, deeds of trust, or other liens against its real property. It may subtract the amount of all assets of the entity other than its Maryland real property.

(This entry published by Chris Iavarone and Kevin Pigott, members of the Real Estate Development group)

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