Five Common Deal Killers In CRE
Despite solid financials, the best of intentions, hard work and everything else commercial real estate professionals can throw at them, sometimes even the most promising of deals fall apart. From last-minute financing troubles to problems with the fine print, here’s a look at five common deal killers and how to avoid them.
1. Financing
Every step of a deal, from the letter of intent to the drafting of a lease, is ultimately leading up to one thing: money changing hands. So while it might seem like a no-brainer, it’s important for sellers to make sure up front they can come through with the funds once the papers have been drawn up. Unfortunately, it doesn’t always work out that way.
Adelaide Polsinelli, a principal at Eastern Consolidated (above with New York Historical Tours director and historian Kevin Draper), says she’s heard her fair share of horror stories about that situation. Often buyers assume they’ll be able to get the financing they need, only to find “they can’t get the debt they expected, lenders have backed off on a certain sector, interest rates have changed—there’s a lot that can go wrong.”
Like most potential deal-killers, the remedy to financing woes is straightforward: figure it out at the beginning.
“Every time I start working with a client on a deal, one of the first things I’ll do is go to my firm’s capital advisory division and ask them what’s happening in the markets right now and to suggest a few options—quotes from traditional lenders, hard money quotes, etc., whatever we might need to get it done.”
2. Changes In Local And Federal Laws
More often than not, the deciding factor that turns a barren plot of land into a major new development—or any deal from pipe dream to reality—comes down to local and federal laws and regulations. Tax abatements, zoning restrictions, height requirements and other governmental considerations exert a huge influence on a deal’s profitability, so it should come as no surprise that when they change, someone’s usually left holding the bag.
“For just one example, changes to rent stabilization laws can throw a buyer’s entire plan of action off course, if their whole plan was to buy out rent-stabilized tenants after purchasing a building,” Adelaide says. "There’s also changes to tax laws that might make the date of a sale untenable, areas can be down-zoned, tax credits can dry up, and a host of other pitfalls to watch out for.
For one recent example, look no further than New York’s 421-a tax abatement. When the program ended last January it left several big projects that’d been depending on it in the lurch, most notably Hallets Point and Astoria Cove, both of which would’ve been massive, game-changing developments if they’d gone forward as originally planned.
3. Dysfunctional Public-Private Partnerships
In theory it makes perfect sense: developers partner with a government entity to get a new project off the ground that wouldn’t have made sense for either to go it alone on. If it works out, it’ll be profitable for the developer and have a variety of positive effects for the surrounding community. In practice, the reality of public-private partnerships is much thornier.
RXR Realty EVP Seth Pinsky is working on just such a project in New Rochelle: a sweeping renovation of the city’s downtown area that’ll ultimately account for roughly 10M SF of development. While that deal worked out, Seth says there are plenty of pitfalls that can often derail similar projects.
“The first issue involves timing,” Seth says. “These projects are so complicated they often take years to plan and approve. A flaw that frequently turns fatal is when parties strike a deal that’s perfectly calibrated to a very specific economic environment that then turns out to be unworkable when, inevitably, the economy turns. Accordingly, these projects have to build in enough 'give,' so that they can remain sustainable, not just in the best of times, but in worse times, as well.”
The second issue, he says, involves the failure of public and private partners to take the other into account before it is too late. “On the public side, this means creating development plans through the political process without developer input, only to find out that what was approved and supported by the public and elected officials is not actually finance-able or buildable."
On the flip side, private developers frequently come to the table with plans that can be financed and built, but fail to take into account political realities, he adds.
4. The Devil Is In The Details
The wording of the legal documents that codify a deal are every bit as important as the broader fundamentals like the financials or regulatory considerations. Unfortunately, some in commercial real estate have to learn that the hard way.
“Over the years, fortunes have been made or lost depending on the foresight of the brokers and lawyers negotiating a lease agreement,” says CPEX Real Estate managing partner Tim King. For example, Tim says some clever tenants made major bucks in ‘90s New York by signing net-leases giving them the right to set up cellphone towers on the property, just as service providers were scrambling to one-up themselves by building more towers and increasing their coverage.
“Sometimes the profits from those towers turned out to be a better source of revenue than what the business itself was pulling in,” Tim says.
That might not prevent a deal from going through, but it could result in something even worse—money left on the table for the entire course of the lease. On the other hand, some tenants often box themselves into a corner by signing leases that restrict them to only operating a specific type of business on a given property, Tim says. If that business doesn’t work out, they’re still on the hook for the lease and could be unable to change directions or sublet the space.
Adelaide says even the wording in letters of intent can come back to blow up a deal, such as when owners agree to LOI’s with exclusivity clauses that prevent them from speaking to other buyers. If they do, the legal ramifications can often blow up the deal entirely.
5. Dealing With Professionals (Or Lack Thereof)
Real estate is a complicated business—that’s why CRE professionals spend years learning the ins and outs of minutiae most people have no idea exists, let alone how to navigate. So problems can arise when smaller buyers or sellers, say in the $5M to $20M range, assume they can cut corners by trying to put a deal together without bringing in the relevant professionals.
“I’ve seen buyers for smaller assets try to do the deal with the lawyer they used for their last divorce,” Tim says. “I’m not kidding. They might have the legal side of things down, but when they run into complications on the real estate side it becomes clear very quickly they’re in over their head.”
Tim tells us people are often much too quick to assume "these are the facts, these are the numbers, everyone’s agreed,” without taking a cold, hard look at regulations, legal loopholes and other potential deal-killers before signing on the dotted line.
