Presenting a live 90-minute webinar with interactive Q&A Structuring REIT Credit Facilities: Loan Terms, Financial Covenants, Commitment Letters, MAC Provisions and More THURSDAY, OCTOBER 6, 2016 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Ari B. Blaut, Partner, Sullivan & Cromwell , New York Benjamin R. Weber, Partner, Sullivan & Cromwell , New York The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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Structuring REIT Credit Facilities Loan Terms, Financial Covenants, Commitment Letters, MAC Provisions and More Ari Blaut Benjamin Weber
Overview I. REITs – Brief Overview II. Recent Market Trends – REIT Bank Loan Market III. Credit Agreement Process and Terms IV. Q&A 6
I. REITs – Brief Overview 7
What is a REIT? • “REIT” – Real Estate Investment Trust • An entity that satisfies certain requirements of the Internal Revenue Code and elects to be treated as a REIT for U.S. federal income tax purposes • REITs own, or make loans secured by, income-producing real estate • A REIT is expected to pay regular quarterly (or in some cases monthly) dividends • REITs generally are not able to retain earnings due to the annual dividend requirement • Organized in the U.S. • Can be organized under the laws of any state; but in practice many REITs (75% or more of public REITS) are organized as Maryland corporations or as “real estate investment trusts” under Maryland law • Governed by a board of directors (or a board of trustees) 8
Benefits of REIT Status • “Dividends -paid ” deduction enables a REIT to avoid entity -level tax • Well-known in U.S. capital markets; REITs raise capital through: • Issuance of public equity (and debt) • Issuance of common and preferred OP units • Mortgage borrowings • Credit facilities (secured and unsecured) • Attractive to tax-exempt and foreign investors • Tax-exempt investors can invest in real estate without incurring tax on unrelated business taxable income (UBTI) • Foreign investors can invest in real estate without having to pay FIRPTA (essentially capital gains tax for non-U.S. investors) upon disposition, so long as the REIT is domestically-controlled 9
Principal Tests for REIT Qualification • Ownership tests • Must have at least 100 distinct shareholders and • Five or fewer individuals cannot own more than 50% of the REIT’s stock during the last half of its taxable year (this requirement leads REITs to adopt a share ownership limit of 9.9% or less) • Asset tests – tested quarterly • At least 75% of the assets must be real estate assets or cash and • Not more than 20% of assets can be securities of taxable REIT subsidiaries (“TRS”) • Income tests – tested annually • At least 75% of gross income must be real estate related and • At least 95% of gross income must be passive income • Must distribute 90% of the REIT’s taxable income for each taxable year • Subject to tax on undistributed taxable income (for this reason, as a practical matter, most public REITs distribute 100% of taxable income) 10
REIT Qualification • Management must be highly-focused on operating within the various requirements for REIT qualification • REIT qualification matters must be taken into consideration when structuring a REIT credit facility • Must ensure that loan covenants and restrictions will not interfere with REIT compliance, both before and after an event of default • Should permit any distributions being made for REIT compliance (and to avoid federal income tax) • Minimize the nature of any limitation on transfers of REIT stock • If a REIT fails to qualify it must wait five years before it will again be eligible to elect REIT status 11
REIT Structures • Common REIT structure: • UPREIT (umbrella partnership REIT) • REIT holds all assets through an operating partnership • Vast majority of REITs are organized as UPREITs • Exceptions: mortgage REITs and non-traded REITs • Straight REIT (no operating partnership) • Down-REIT • Important to ensure that credit facility provisions are consistent with relevant REIT structure • As an example, in an UPREIT structure, the OP is generally designated as the borrower, and the REIT is typically a guarantor 12
Typical REIT Structure – continued REIT Investors/Shareholders REIT Outside Limited Partners Sole GP Operating Partnership * Outside Partner 100% 100% 100% Property Property Property JV TRS Owner Owner Owner Assets Assets Assets Assets *A straight REIT would use a similar structure, but with no operating partnership 13
OP Unit Redemption Right • OP units typically are denominated to correspond, on an economic basis, with outstanding REIT common stock (1:1) • OP unit holders usually have a right to redeem their units for cash (with the amount being determined based on the then-trading value of a corresponding number of REIT shares) or, at the option of the REIT, delivery of REIT shares • REITs routinely elect to satisfy redemption requests with shares to avoid unnecessary cash outlay; as a result, the redemption feature is sometimes improperly referred to as a conversion right, but the determination of cash vs. shares rests solely with the REIT • An UPREIT typically establishes an issuer shelf (S-3) so it can deliver registered shares when satisfying a unitholder redemption 14
Down-REIT • Investors contribute depreciated property to a joint venture with an UPREIT (or a straight REIT) in a manner that enables the investors to defer gain • The REIT provides day-to-day management for the joint venture • Outside investors receive negotiated distribution rights (e.g., distributions equivalent to those paid on a corresponding amount of the REIT’s shares); terms vary greatly • Outside investors receive negotiated redemption rights, which may be satisfied with cash, REIT units or stock, depending on the business agreement • Structure allows outside investors to maintain concentration in specific property rather than the REIT’s entire portfolio 15
II. Recent Market Trends – REIT Bank Loan Market 16
Market Update • Issuance activity • High by historical standards, despite slight drop from 2015/2014 ( Dealogic through 9/12) • 2014 – $79.7B • 2014 FY – $172.7B • 2015 – $83.7B • 2015 FY – $150.0B • 2016 – $71.9B • 2016 LTM – $125B • Increased usage of bank loans rather than bonds • Volatility in bond markets • Pricing has been attractive compared to bonds • No call protection • Improved covenant terms in bank loans 17
Market Update – continued • Unsecured bank loans* • Financing option of choice for many REITs • Average facility size has increased by 19% from 2014 to 2016 • Decreased pricing • Pricing decreased 20 – 50 bps from previous facilities with an average decrease of 30 bps • Increased draws under unsecured credit lines • Borrowers increasing percentage of drawn revolvers • Some borrowers shifting from secured to unsecured loans *Trend data from Fitch 18
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