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Real Estate Risk Management Evolves with Developers

May 23, 2019
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Real estate developers are a unique breed. It takes a special Developer to identify successful development or acquisition opportunities, conduct due diligence, arrange financing, raise capital from investors, work with local government, design, build, lease, and successfully manage a project.

Deals are complex, with an overwhelming amount of daily decisions that need to be made to keep the project moving forward.

We have identified a few non-traditional risks that which owners need to consider as part of their overall risk management strategy.

Opportunity Zones

The opportunity zones incentive is a community investment tool established by Congress in the Tax Cuts and Jobs Act of 2017 to encourage long-term investments in low-income urban and rural communities nationwide. They provide a tax incentive for investors to re-invest their unrealized capital gains into dedicated opportunity funds.

Investing in a project or business in an opportunity zone can allow investors to reduce or defer federal taxes on capital gains if they stay in a project for 10 years.

According to the Brookings Institute, about 57 percent of U.S. neighborhoods qualify to be designated as an Opportunity Zone.

While opportunity zones have the real estate community excited about another compelling benefit to invest in real estate; there is still a tremendous amount of complexity as well as open issues with this new regulation.

According to Jeff Wild at Benesch, opportunity zones contain several structuring issues that must be carefully considered, such as capital infusions, capital structure, use of OZ portfolio companies vs. direct investment, to name a few.

The Takeaway
Partner with the right attorney and accountant to help you navigate the representations that you make to your investors and business partners. You may also want to review your professional and management liability policy forms.

“Bad Boy Carve Outs”

Most non-recourse loans include carve backs that convert the loan into a full-recourse liability to the borrower and the guarantor when certain “bad boy” behaviors take place.

Many commercial loan transactions include a ‘bad boy guaranty’ which imposes personal liability against the borrower and principals when ‘bad acts’ are committed. If triggered, converts a non-recourse loan into a full recourse against the borrow or guarantor.

While developers obviously want to steer clear of “bad boy” behavior, lenders that find themselves with REO property may become motivated to find recourse. Another scenario may be a simple mis-interpretation of loan provisions, leaving an owner to be out of compliance. This can bring forward litigation. Owners and guarantors can be left to defend themselves, even based upon improper acts of third parties outside of their control.

The Takeaway
While intentional acts are not covered under any insurance policy, those owners who operate with the best of intentions and care, can still find themselves in a precarious situation. Take the time to understand how your current policy may, or may not provide you defense cost protection.

Misrepresentations

At every phase of a project, owners are making representations to their investors, joint venture partners, lenders, contractors, and buyers and sellers of real estate. The accurate representation of financial, operational and legal/physical condition information in a commercial real estate deal seems obvious, but that isn’t always the case. Sometimes, misrepresentations can simply be a result of internal miscommunication, or lack of documentation.

The risk of misrepresenting information can not only lead to damage to your reputation, but also significant financial loss.

Consider the example of a Midwest based restaurant management company that wanted to expand into the Scottsdale, Arizona market. The company entered into a lease agreement for space in a high-end retail center paying $600,000 per month plus operating expenses.

Upon opening its doors, the restaurant was off to a terrible start, losing $100,000 a month. They ended up wanting out of their lease, but not without paying the developer millions in penalties to do so.

After retaining a lawyer and reviewing all correspondence with the developer and leasing company, the restaurant company found an email where it said it had concerns about entering into a lease due to the soft economic conditions (September 2008) and that before signing they wanted to see current sales volumes of the other restaurants in the center.

The leasing agent shared the sales volumes and it showed the other outlets were doing a $1,000 a sq. ft. per year – a gold standard in the restaurant industry. Based on that information they signed the lease.

When they questioned the leasing agent further about the numbers, the agent refused to share any additional sales volume information. Ultimately, the leasing company and developer reached a confidential settlement and the restaurant was released from the lease.

The Takeaway
Real estate developers move hard and fast, and information you share in order to get a deal done or move the project forward could be costly in the future. Take the time to communicate the importance of this to your staff. Consult with a real estate insurance specialist to understand the right policy term that may step in to cover your defense costs.

The Oswald Solution

Commercial real estate development and investment is a process that involves multiple layers of risk. Understanding the custom solutions that exist in the marketplace specifically for real estate developers can make all the difference.

Oswald’s Real Estate Practice consists of 20 staff with various areas of expertise to maximize and protect our clients’ NOI. We operate in 45 of the 48 contiguous United States, and insure 210M sq. ft. of commercial space, and 230,000 units.


For more information, contact:
John Mark Tichar
Vice President
216.679.7380

Note: This communication is for informational purposes only. Although every reasonable effort is made to present current and accurate information, Oswald makes no guarantees of any kind and cannot be held liable for any outdated or incorrect information. View our communications policy.

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