New Jersey Law Journal: Pacing Yourself in Today's Real Estate Market: "Hurry Up and Close" vs. "Wait and See"
Real estate acquisitions and sales are on the fast-track, even in this pandemic environment. After a bit of uncertainty at the very beginning of the pandemic last year, deal volume not only resumed, but increased substantially. More than that, the speed at which clients want to sign and close deals has increased, with the time to draft, negotiate and finalize contracts becoming shorter as 2021 progressed. Contrast acquisitions and sales with commercial lease transactions, which have not only taken longer to rebound in terms of volume—but are also taking longer to negotiate and finalize. Let’s explore the factors influencing these vastly differing tempos.
Acquisitions and sales are driven by a variety of market factors, not the least of which is product type. With the great increase in internet sales that resulted from the lockdown, the need for warehouse space and last mile delivery facilities has put these types of facilities at a premium. Also, multi-family housing has been strong, locally and elsewhere. Office and hotel properties may be more opportunity-driven for buyers who want to repurpose those facilities or have plans for upgrades and remarketing. As in any real estate market, in-demand properties may sell at a premium, with greater demand resulting in more competition.
Properties that are less in demand may still trade with some urgency as buyers look for both opportunities and properties that can be purchased with Section 1031 tax-free exchange funds that only retain their tax benefit for a short time. In addition to the tax-free exchange driven purchases, favorable interest rates and availability of financing are part of the fuel for this increase in transactions. As we move toward the end of 2021, with possible changes in the availability of tax-free exchanges and the Federal Reserve signaling that higher interest rates may be coming, the need in the last three months of the year to sign contracts and expedite closings may result in an even faster pace.
With some exceptions for properties in high demand, leasing activity for commercial and retail properties is sometimes moving at a glacial speed. Since early in the pandemic, both tenants and landlords are taking time at all phases of leasing deals.
Tenants in particular have been following a wait-and-see approach for certain product types. There are also a significant number of uncertainties that prevent some tenants from adequately predicting future space needs. For retail, future possible shutdown concerns, competition from e-commerce and worker shortages may cause expansion or lease renewals to be difficult commitments at this point. For food and beverage venues, dining habits have changed and outdoor seating has become a factor. For office users, the previous 18 months have shown that many types of business can prosper remotely, making it difficult to commit to new space or renewals of existing space that may not be needed if employees continue to work from home, or if the company broadens its hiring criteria to allow new hires to work completely outside of an office environment.
Delay in consummating lease deals is not only a tenant issue. Office and retail lease deals often require landlords to commit to significant property improvements, plus offer landlord’s work and tenant concession packages that, taken together with brokerage commissions, result in significant costs to the landlord. With rents flat in some product types and in some areas, landlords do not seem to be in a hurry to sign leases that lock in high costs and low rents, when a better deal might be just around the corner as parties look to the normalization post-pandemic. The exception in commercial leasing is in the industrial sector, where high-demand warehouse space is generally seeing that rising rents and costs for the deal may not be as high (on a per-square-foot basis) as other product types.
Concerns related to construction and completion of leasehold improvements have further expanded the timeline for lease negotiations. Favorable interest rates have spurred construction work across all sectors of real estate, and landlords and tenants are finding contractors reluctant to commit to pricing or scheduling a project until firm dates for work commencement and scope of work are established. Compounding the construction-related issues are long lead times for certain building materials, and in some cases, longer than usual periods in obtaining municipal approval for building permits. Due to the foregoing, completion dates for leasehold improvements and the costs of construction have become moving targets. Consequently, in the midst of lease negotiations, the parties are revisiting construction schedules and budgets. Estimates for key dates provided in good faith in the initial term sheet are abandoned as landlords reassess the delivery dates and exposure to late delivery penalties, and tenants consider how revised delivery dates impact their timing for occupying new space. During these periods, lease negotiations are often suspended to allow the parties time to evaluate revisions to the initially proposed timeline for performance under the lease, the leasehold improvement scope and the resulting costs.
What is the role of a real estate attorney in managing these very different aspects of the practice? Here are some practice suggestions to consider:
- Flexibility. Practitioners should not rely on what has been the usual pace for real estate deals. Market conditions have required the real estate practitioner be nimble and prepared to adapt his or her pace to accommodate external factors such as favorable interest rates, construction-related concerns and the ongoing and residual impact of the pandemic on services which rely on availability of personnel or labor.
- Creativity. With uncertainty in various sectors of the commercial real estate market and urgency to close deals on attractive product-type, drafting and negotiation strategies may require a certain level of creativity rather than strict adherence to what may have been practice in prior years. Appreciating that current market conditions may influence the bargaining power of one party over another in a purchase/sale transaction or lease, real estate attorneys may need to blend what had been traditional negotiation or drafting strategies with novel treatment of certain deal terms. Clients may be willing (or may need) to entertain alternative provisions to make a deal work.
- Organization. With real estate deals being rushed to closing, or as may be the case with leases, sudden urgency to paper the lease after business issues have been resolved, enlisting tools such as document checklists, critical date timelines, calendar reminders, and other productivity tools, become essential. In a hectic deal environment, such tools provide easily accessible reminders and summaries of where a transaction stands and helps avoid missteps.
- Proper Deal Staffing. As real estate practitioners, the importance of having the right person working on a deal is not lost on anyone. However, ensuring the right person is available when needed can be elusive. Having a plan in place which allocates attorney, paralegal and legal assistant time, and respective responsibilities, can help ensure that the right person is available when needed.
- Manage Client Expectations. This sounds much easier than it is since real estate attorneys wear many hats for clients over the span of a transaction—from drafting and negotiating documents, to managing receipt of property information and responding to third-party inquiries. It is nevertheless important to be mindful of not over-promising. Consider that when a closing is occurring or there is a tight deadline on turning a document, it is likely you cannot “take a quick look” at a document. Rather, you are better serving the client by being realistic on when you can turn your attention to their request.
- Responsiveness. No matter the size of the deal, clients get concerned when they do not hear from counsel for a period of time. It is good practice to reserve time to update clients on status, even if there is nothing to report.
- Communication. Especially when a deal is moving at a fast pace, there is great value in communicating with all parties attached to the deal. The moving parts in many transactions involve third parties that are not always copied on emails and documents. Consider that lenders, brokers, title agents, surveyors, consultants, etc., may not “be in the loop” on certain details, and ensuring such parties are informed of status can avoid troublesome delays when the transaction is ready to close. Additionally, communicating and inquiring with opposing counsel on status of document preparation and review is important to keep the process moving.
- Civility. In transactions where there is an urgency to close or there are timing pressures of any nature, or perhaps a deal appears to be taking too long, the client, the business people and the lawyers will naturally be under stress. Although a level of frustration is understandable, compounding stress by being unpleasant or even hostile, does not facilitate closing. Remaining professional and civil at all times is a good practice strategy for both normal and high-stress situations.
- Take Care of Yourself. The stress and demands of practicing real estate law can be unrelenting. Mentally stepping away from work is important. The brain needs to rest, and spending time with family and friends, and carving time out of your day to relax has incalculable benefits.
Reprinted with permission from the October 13, 2021 issue of the New Jersey Law Journal. © 2021. ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
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