As Canada steels itself in the face of a second wave of COVID-19 and the economy continues to navigate the related downturn, the commercial real estate industry, like many others, finds itself faced with significant challenges and uncertainty. Indeed the ongoing pandemic has introduced to deal making and completion an array of novel risks for buy and sell side market participants to assess, manage, and mitigate. These include asset evaluation and pricing considerations, structuring of due diligence and other conditional periods, risk sharing with respect to tenancies and tenant defaults, unique closing conditions and considerations relating to financing, to name a few. How best to negotiate these challenges has undoubtedly been on the mind of all market participants, and was the topic of a recent Miller Thomson-led webinar, “Adjusting to the New Normal: Transacting & Managing Commercial Real Estate amid COVID-19”, moderated by Chris Newbert of the firm’s Real Estate Transactions and Leasing team. Discussion centred around the adaptations required to successfully navigate the “new normal,” with panelist Savvas Kotsopoulos, Leader of Miller Thomson’s Real Estate Transactions and Leasing group. Chetan Baweja of BentallGreenOak and Scott Chandler of Colliers International anchored the panel, lending their expertise and insight from the perspective of an investor/asset manager and broker, respectively.
All three panelists noted that, despite significant challenges, investor sentiment remains generally positive, asset pricing remains strong, and appreciable market opportunities still exist across all major asset classes. With that said, both buy and sell side players have been forced to adapt quickly to changing market conditions and to navigate new risks. From an acquisition perspective, the pandemic has introduced significant roadblocks to due diligence, with purchasers being forced to adapt their typical processes (and to rely on the resourcefulness of their brokers) in order to assess value and evaluate opportunity amidst restricted ability to access assets for purposes of site tours and completing environmental, building condition, and other physical or on-site investigations. In this environment, it is critical that vendors are flexible with the logistics of a purchaser’s due diligence investigations and cooperate in good faith to facilitate a purchaser’s diligence.
Another significant issue faced by transacting parties is their reduced ability to rely on the stability of real property assets (tenant leases, in particular) over time, even the relatively short time period that would comprise most customary due diligence and pre-closing periods. Indeed, as Ontario continues to oscillate between varying degrees of economic closure, the significantly increased risk of tenant default occasioned by the pandemic may, in some deals, significantly alter purchaser comfort with the target asset. In addition to direct valuation implications, in many instances, this challenge has resulted in parties rethinking customary risk allocation mechanisms and closing conditions contained in agreements of purchase and sale, and has highlighted the need for transactional flexibility during the “new normal”. This may be as simple as vendors agreeing to novel or “off-market” (in the pre-pandemic sense) representations and warranties or purchasers making peace with modifications to the standard treatment of tenant leases and estoppel certificates to accommodate COVID-19-related carve-outs or modified rental arrangements. On the other hand, more elaborate risk-sharing (and deal-saving) mechanisms such as rent guarantees or purchase price abatements with detailed thresholds and triggers may ultimately be necessary in order to facilitate a deal.
With respect to acquisition financing, the pandemic has highlighted the critical importance of establishing and maintaining strong relationships with lenders to ensure deal certainty. Purchasers should be transparent about a transaction’s pandemic-related considerations and ensure that they and their lenders are on the same page. There should be agreement as to how any foreseeable or discrete risks will be handled by the purchaser and interpreted by the lender pursuant to material adverse change and other similar provisions of the loan documents. Indeed loan documents, often prepared on the lender’s standard form with little modification, should reflect the parties’ expectations in this regard, even if via a side letter or similar written comfort. Where market conditions and/or deal specifics might make it challenging for a purchaser to secure conventional financing on closing, vendors may consider increasing marketability by offering vendor take-back financing.
Finally, the importance of reconsidering what may typically be thought of as “boilerplate” clauses in transaction documents should not be underestimated, as the pandemic has thrust oft-forgotten (or at least infrequently tweaked) transactional provisions (as well as those which were not drafted with the perils of a pandemic in mind) such as force majeure and “material adverse change” into the spotlight and under the judicial microscope. Market participants should follow developments coming out of the Courts in relation to these issues as the jurisprudence will play a significant role in shaping the risk-sharing landscape in areas where parties’ contracts have not done so adequately, For the transacting parties in particular, the most prudent course of action is to steer well clear of the expense and uncertainty of the courtroom by ensuring that deal documents clearly set out the expectations and obligations of the parties in respect of pandemic-related circumstances, risks and eventualities.
During this time of continued uncertainty, transacting parties would be well advised to bring all available resources to bear in addressing the risks and challenges presented by COVID-19. While risk allocation is a cornerstone of any contractual agreement, understanding, mitigating and allocating the new and significant risks brought about by the pandemic will be critical to ensuring the success of commercial real estate transactions in the “new normal”. Miller Thomson’s Real Estate Transactions and Leasing group has been at the forefront of assisting clients with identifying, assessing and navigating these risks, and remains poised to assist market participants with evolving challenges in all areas of the commercial real estate space.