Good loan terms achievable through forward transactions

Banks are yet again lending money to property projects, but they pose pretty stringent requirements for the projects to be financed with a high debt to asset ratio. So-called forward transactions may, however, be adapted to the requirements of the banks, and it is thus fully possible to achieve the banks’ best loan terms in such transactions. By being conscious of the risks normally involved in a construction project, the real risk of a forward transaction may also be minimized.

The banks’ loan terms

A low interest rate level and a diminishing margin in the banks’ lending rate have generated new optimism in the property market. Greece’s enormous national debt, on the other hand, has created a degree of uncertainty in respect of the European economy and also some uncertainty as to how this may affect the Norwegian economy. With the measures now being implemented in Greece in consultation with the EU and the IMF, there is reason to believe that the Southern European problem will not have major adverse effects on the Norwegian economy. On the contrary, the problems in Southern Europe are expected to contribute to keeping the European, and consequently also the Norwegian, interest rate level low in the foreseeable future.  A continued low interest rate is clearly positive for the Norwegian property market. We are also seeing a growing competition between the banks to finance projects within business property – certainly when it comes to the good projects.

For these good projects it is possible to achieve a high debt to asset ratio and a lower interest rate margin, but the banks pose certain partly strict requirements as to what may be considered a good property project.

Forward solution

The good property projects are characterized by solid borrowers, recent constructions which do not incur great costs for maintenance and replacements, as well as long lease agreements – often on so-called “bare house” terms. For investors wishing to place capital in the property market, finding such good projects which qualify for the banks’ best loan terms may present a challenge. In precisely such situations forward transactions may be the solution.

The structure of the transactions

Forward transactions are characterized by the selling of a property company with a building under construction. The sale can be implemented at any time in the projecting or construction period. The settlement of the purchase amount as per the time of the acquisition of shares is, however, performed as if the building has been completed and the lessee already moved in and is paying the full rent. The purchase amount settlement at the time of the acquisition of shares is still temporary, and is based on a construction cost estimate.

The final purchase amount settlement is performed when the construction of the building has been completed and the final cost of construction is known.

The seller thus carries the full risk of the cost of construction, but also keeps the upside if the construction costs may be reduced in the process. Any missing rent payment in the construction period is set off by the seller paying a rent substitute to the buyer corresponding to the rent to be paid by the lessee when the building is completed, or by the buyer being awarded a price reduction corresponding to the missing rent in the construction period. The buyer’s contribution in the transaction is to provide financing of the estimated construction cost, as well as for the gain received by the seller on the acquisition of shares.

Current suitability

Forward transactions are well suited to today’s property market, precisely because these transactions can be fully adapted to the requirements posed by the banks for giving their best loan terms.

What is generally needed in order to arrange for a forward transaction is a plot in an acceptable location and a business looking for new premises to rent (premises for offices, shops, production activities, storage, etc.). Then, the terms of the lease contract may be adjusted to the requirements of the banks for duration and distribution of risk. If the lessee does not fulfil the requirements concerning capital adequacy posed by the banks, the situation may be remedied by guarantees. The lessee’s great benefit is thus finding efficient and tailor-made premises, and the requirement for long contracts is today often welcomed by potential lessees.

Instances to be emphasized as being particularly well suited to forward selling are the so-called “sale and lease back” cases.

In such cases, there is often a fairly large business seeking new premises and having already secured a plot for the purpose. The business does not, however, wish to tie up capital long term in a property investment, and it is therefore possible for professional property investors to enter the scene and take over the position as owner/lessor. Arcus-Gruppen’s construction of their new production and logistics facility (for wine and spirits) is an example of this. Other cases particularly well suited to forward transactions are cases involving the construction of buildings for government lessees.

Seller’s responsibility

The risks involved in a forward transaction are typically associated with ground conditions and public permits. These are risks for which the seller normally assumes full liability for the costs and from the point of view of the banks and the buyers this consequently becomes a matter of the seller’s ability to carry the costs if such risks materialize.

Nonetheless, such risks may be practically eliminated by the acquisition of shares not being effectuated until the building pit is established and building permission for constructions above ground has been given.

If the parties choose to effect the acquisition of shares before such risks have been minimized, it can for instance be agreed that parts of the purchase amount are withheld until the time when the erection of the building is completed and the adjustment of the purchase amount takes place. By being conscious of the way in which the risk is managed in the construction project and without including any further risks (such as implementing the forward sale without any lease agreements having been concluded), it should through forward transactions be possible to achieve the best loan terms on offer in today’s market.

Written by Ståle O. Meleng, lawyer in Wiersholm (feature article in the Norwegina Financial Daily, 27 May 2010)