Platforms – The Flavor of the Month in Real Estate InvestingOct 25, 2017
In the old days a sponsor found a deal to buy a real estate asset and called up a financial party (either a fund or other institution). They would form a joint venture and purchase the asset and that would be that. Of course those – relatively simple – deals continue today; however, more and more we see clients entering into a more long-term relationship.
Here are some (philosophical?) perspectives on the various types of relationships that can ensue between sponsors and financial partners. Since I have been (happily) married for over thirty years -- and therefore know nothing about dating -- I thought I would relate my thoughts here to the dating process.
The first level is the one I mentioned above, i.e. the sponsor finds deals on a one-off basis and when she finds a deal goes around to money partners until one is interested. Then they form a joint venture and close. I would call this casual dating since no one is obligated to do more than the single deal at hand.
The second level is what is often called a “programmatic relationship.” This is where the sponsor and the financial partner enter into what we called a “Deal Production Agreement”, although there are other names for these types of arrangements. Basically this means that the sponsor will seek out deals and give the financial partner “first dibs” on the deals. Often the financial partner asks for exclusivity (or at least the first look) and sometimes the sponsor asks for the financial partner to pay part of its overhead or pursuit costs in return; however, these issues are typically heavily negotiated on both sides. By the way, sometimes there is no agreement at all and the parties just handshake that the sponsor will show the deals to the financial partner and they will try to work together. I would say this is like going steady (for old-timers) or being “in a relationship” (for people in the middle) or “making it Facebook official” (for the millennials).
The third level is a formal agreement to form a Newco, which is a joint venture between the Sponsor and the Financial Partner. Newco will be used to do new deals, with typically Newco forming a special purpose subsidiary for each deal. The Sponsor will pre-agree to post a certain (smaller) percentage of the capital needed for the new deals done by Newco and the Financial Partner will agree to post the rest. There are quite a number of important issues to be negotiated in these types of arrangements since the parties are really joined together. For example, are deals “crossed? Can the Sponsor do the deal without the Financial Partner if the Financial Partner disapproves the deal? How much discretion does the Sponsor have? What if the Financial Partner just doesn’t fund any deals what can the Sponsor do about it? How does the promote split work – does the Financial Partner get its pro rata share of the promote or some smaller amount; does the Financial Partner pay a promote or not?; does the Financial Partner participate in the payment of fees or receive a portion of any fees? Going back to the dating analogy, this is like moving in together, but you aren’t really married yet – with the added twist that, when you move in together, you invariably need to think about how much you want to share and how much you want to keep separate. But, at the end of the day, in a program, typically each party keeps its own business and if there is a divorce they are (moderately) easily able to go their separate ways.
The fourth – and final – level is typically called a “Platform Investment.” To start off with our analogy, this is truly getting married. In these types of deals, the Financial Partner invests directly “into” the Sponsor or, alternatively, just purchases the Sponsor whole-hog. Often the theory is that the Financial Partner will have access to everything the Sponsor does plus the ability to recapitalize existing deals plus a share of promotes and even fees. In return the Sponsor now is more credible in the market with the real backing of a major financial player. Often, these transactions are used to set the stage for an eventual IPO and/or to grow the sponsor’s business. Sometimes the goal is to have the now-recapitalized Sponsor raise a fund, using the Sponsor’s reputation and the Financial Partners financial backing, and sometimes the goal is just to do future deals as a team. These deals are very intricate and involve significant negotiation. There are numerous issues but some of the big ones are the valuation of pre-existing deals and whether and to what extent the Financial Partner participates in pre-existing promotes and future promotes, the split of fees between the Sponsor’s principals and the Financial Partner, the allocation between fees and promotes where the Financial Partner has different participation rights depending on the income stream, the nature of incentive compensation arrangements, the ability to reinvest funds into the business, the extent of future funding obligations of the Financial Partner or Sponsor, the ability of the Sponsor to raise additional capital from alternative sources, corporate loan facilities, discretion and decision-making, buy-out rights, the terms of an eventual unwind, and the degree of non-compete that the Sponsor’s principals will have to agree to.
Duval & Stachenfeld is right in the middle of all of this. And what we are seeing is a gradual gravitation from the simpler deals to the programmatic to the formation of Newco’s and all the way to the platforms. Indeed, we are seeing more platform deals than we have ever seen before. My sense – as I survey the real estate industry – is that Financial Partners are fearful of being locked out of the “good deals” if they are not right in on the ground floor with a high-quality sponsor seeking those deals. Correspondingly, the Sponsors are fearful that if they don’t have credible and real financial backing they will not be able to compete for the “good deals” as the sellers will gravitate towards buyers who have the ready cash to be able to perform.
Now for the sales pitch part of this – sorry……
At Duval & Stachenfeld, we have an entire team of lawyers that have dedicated their careers to corporate real estate transactions. Our Corporate Real Estate Group consists of over 20 lawyers and is one of the largest of such practice groups anywhere. But, unlike the corporate groups of most of our peer firms, our Corporate Real Estate Group focuses exclusively on real estate transactions, and this translates into a distinct competitive advantage for our clients in the area of corporate real estate because, put simply, we understand how real estate businesses work from top to bottom!
Notably, over the last five years, our Corporate Real Estate Group has spearheaded some of the most high profile transactions in this space including the formation of several up-and-coming emerging manager and operator platforms, the recapitalizations of several name-brand existing platforms, the launch of new business-lines by marquis managers through the formation of multi-tier joint venture or other arrangements for the establishment of new programs, and a host of other transactions (the list of which is too long to summarize).
Finally, there is one additional piece of information that is crucial to why the Corporate Real Estate Group at Duval & Stachenfeld is different from similar groups at our peer firms. The practice– and in particular the practice in the specialty area of programmatic and platform arrangements – fits seamlessly with our core business model -- which is “to help our clients build their businesses.” Put simply, if you are considering any of the above transactions it is great to call us for two reasons:
First – of course we know how to do the necessary legal work – as it is our core specialty
But second – we have a wealth of counterparties – Sponsors and Financial Partners – many of whom are looking for high-quality counterparties to team up with through casual dating, going steady, moving in together or even getting married.
So if you are planning to team up with someone in the real estate world, please feel free to reach out to our Corporate Real Estate Group.
Not so fast! Significant tax reform may be further away than you think.
Tax reform once again dominates the headlines, as the nation awaits draft legislation from Congress. The debate heated up in mid-September, when the Trump Administration released its proposed framework for tax reform. While that plan was light on specifics, it grabbed attention with significant changes such as cutting the number of tax brackets for individuals from seven to three (12%, 25%, and 35%), reducing the maximum corporate tax rate to 20%, limiting the maximum tax rate on income from certain types of passthrough entities to 25%, and eliminating the deduction for state and local taxes.
Given Republican control of the White House and both houses of Congress, it may be tempting to start planning around these proposals. However, there are good reasons to remain cautious, especially in the short-term:
1. A lot (and we mean a lot) of details still need to be worked out.
Reforming the tax code is a tremendously complex undertaking that will eat up months of time and will include endless proposals, amendments, public debates, and back-room agreements. The released framework was only nine pages long, but any actual legislation will be hundreds of pages. Once a draft text is released, every affected interest group will spring into action to protect its interests. Plenty of work needs to happen before a final text can be agreed, if agreement can happen at all.
2. The Senate has no margin for error.
As the recent healthcare debate demonstrated, Senate Republicans must be nearly 100% unified if they want to have any hope of passing tax reform without Democratic support. Congress is expected to pass a budget resolution this week that will pave the way for Republicans to use the reconciliation process to push through tax reform with a simple majority. However, they can still only lose two Senators before they will be unable to pass their package with 51 votes. This would be a reach for any group, but it will be particularly difficult for Senate Republicans given some of the disparate views within the party. While the Trump Administration has made some overtures to red-state Democrats, it is not yet clear that this will buy much breathing room.
3. Some of the current proposals are unpopular (even among Republicans).
Without any revenue generating solutions to help pay for the reduced rates, tax reform will substantially increase the deficit. The elimination of the state and local tax (SALT) deduction is one of those solutions. However, a large number of House Republicans come from high-tax states such as New York and California, and thus have constituents who depend on the SALT deduction. These Republicans are unlikely to agree to any proposal that will directly harm their voters, but at the same time, preserving the SALT deduction increases the pressure on the deficit and puts at risk the votes of the deficit-hawks within the Republican Party.
Notably, the headline features of the Trump proposals are mostly revenue losers. New provisions that are added to replace lost revenue will erode support for the proposals among affected interest groups. Recent suggestions to raise revenue by cutting back the tax benefits for retirement plan contributions, or by preserving a higher tax bracket for the rich, have their proponents—but also their detractors. Crafting the final reform package (if there ever is one) will be a long and tedious process, not for the faint of heart!
4. Tick tock.
The congressional calendar represents a constantly dwindling opportunity for tax reform in 2017. Less than 30 days remain on the 2017 legislative calendar during which both the House and Senate are scheduled to be in Washington at the same time. Tax reform is also not the only thing on the agenda for the next few weeks. The schedule is currently packed with potential votes on disaster relief, healthcare and the deficit ceiling. Although there is strong political pressure—some of it self-inflicted—to get a bill passed quickly, there may simply not be enough time to get to a vote on tax reform this year.
These potential roadblocks are well known to the Trump Administration and Congress. Notwithstanding some bold statements about rapid action, senior White House Officials and GOP Leaders have been scaling back their expectations on passing tax reform this year. Soon, attention will shift to the Congressional races, where all of the representatives and 33 of the senators will be up for reelection. Since 25 of those 33 Senate seats are currently held by Democrats, the Republicans have an opportunity to build their majority, which is an unusual circumstance in mid-term elections for the party in power.
The current tax reform framework is best viewed as a means for the Trump Administration to shape the political dialog in the coming year, as it seeks to bolster its Republican majorities in both houses of Congress, and where possible to fill those seats with members who are loyal to the Administration’s agenda. In the meantime, there is likely still a long way to go before significant tax reform can be actually accomplished. The last major tax reform effort was during the Reagan administration, and that took three years to get over the finish line, even with bipartisan support.
Have more questions? D&S is here to help!
The D&S Tax Practice Group is closely monitoring these developments. If you have any questions about the current state of tax reform, please reach out to a member of our Tax Practice Group.