Asian real estate assets still attract interest even in times of distress

In times of economic stress, the value of real estate – like other asset classes – can come under pressure. In 2020, COVID-19 has caused severe distress in real estate-intensive sectors like hospitality and retail. And it has raised questions about long-term demand in office and other commercial property sectors.

However, equity and debt investors are actively monitoring real estate opportunities, to identify potential for distressed or opportunistic acquisitions, while owners may be looking for ways to dispose of or lever their real estate portfolios to meet their liquidity needs. Lenders with existing exposure to real estate may be interested in how to protect and enforce their rights if things take a turn for the worse.

This article looks at some transaction types we expect to see involving distressed real estate assets in a stressed market, with a particular focus on Asia.

Distressed acquisition opportunities

Distress in real estate-intensive sectors may present opportunities for investors to make acquisitions from distressed sellers. Some clients in the investment sector in Asia, for instance, tell us that they would consider well-placed hospitality assets located in leading regional urban centres.

Nonetheless, in these times of economic uncertainty caused by COVID-19, it can be difficult to reach agreement on asset valuation, and it’s also difficult to perform due diligence and execute transactions, given travel restrictions and other measures introduced to control the pandemic.

The acquisition of real estate – or any other asset – from a financially distressed seller can raise certain legal issues. Typically, these issues focus on the need to understand and mitigate the risk of the transaction being unwound under insolvency laws, potentially causing loss to the buyer if the seller enters insolvency in the period after completion of the sale. The greatest concerns in this context typically relate to undervalue transaction laws. In Hong Kong, in certain circumstances the law allows the unwinding of transactions where a company disposes of an asset in return for no consideration or for consideration worth significantly less than the value of the asset. There are similar laws in other jurisdictions, although how they are formulated varies considerably.

Such concerns do not necessarily prevent buyers from completing acquisitions of distressed assets, provided buyers are properly advised and appropriate mitigation steps are taken. Mitigation may include taking steps to verify the market value of the property, seeking independent valuation where prudent to do so, and confirming that the seller has undertaken a thorough marketing process. Other safe harbours may be available under applicable law; for instance, in Hong Kong, a transaction will not be set aside if it was entered into by the seller in good faith and for the purposes of carrying on its business, and if there were reasonable grounds for believing that the transaction would benefit the company.

Other questions may arise where the asset is being sold not by the seller company and its management, but by an officer such as a liquidator or receiver who has been appointed over the asset or the selling company. Such officers will typically give no, or very few, representations or warranties as to the asset, and certainly much fewer than would typically be given by a commercial seller. Buyers can try to mitigate this with due diligence, although liquidators and receivers often favour quick sales processes (and cash bids). In practice, buyers use price as a means to address risk concerns; buyers familiar with the asset (such as former owners, tenants, joint venture partners) may be at an advantage in this type of sale process.

Levering assets

In a distressed economic climate, corporate borrowers may find it more difficult to roll over, or refinance, debt raised in the bank or bond markets as it approaches maturity. Furthermore, in times of market stress, many borrowers may face working capital shortfalls that may need to be addressed by additional borrowing.

To meet these borrowing needs at a time when their overall credit profile may be deteriorating, borrowers will frequently offer real estate assets as additional collateral to attract lenders. This may be particularly effective where the value of the real estate asset is perceived as independent, to a greater or lesser extent, from the prospects and performance of the borrower’s business; for instance, because it is a development site or a building suitable for multiple types of use.

There have been a number of these transactions in the Asian market in recent years. Often this type of transaction is of interest to debt funds focusing on private credit and special situations. Funds in this sector are typically attracted to the independent property collateral and are willing to consider innovative or less standardised financing structures.

Creditors’ rights over real estate – enforcement

Finally, it is worth considering the position of lenders who find themselves exposed to distressed corporates who own real estate assets.

The rights and options of such creditors will depend on whether they hold security over the real estate assets in question.

If they do, a real estate mortgage (whatever jurisdiction’s laws it is governed by) is likely to confer the power to sell the property to repay the secured debt. Depending on the jurisdiction whose laws govern the security package (which is likely to mean the jurisdiction in which the real estate is located), a court order may be required to effect the sale, or a specific sale process (such as a public auction) may be specified, potentially restricting the options available to a secured creditor as to the timing and manner of sale.

However, common law jurisdictions, such as Hong Kong, tend to be more flexible and grant secured creditors more power and time to control and manage assets. In particular, in many such jurisdictions, the relevant finance documentation will typically grant the secured lender the right to appoint a receiver over the property concerned (or over the shares of the company that owns it, which confers management power over that company and its assets). As well as being ultimately empowered to sell the asset, the receiver is also empowered to manage it, all in the interests of the secured creditor. However, under the terms of the security documents, the receiver will typically act as the agent of the company, which reduces the risk to the creditor of going “into possession” of the asset.

By taking effective control of a real estate asset through the use of a receiver, secured lenders can potentially manage that asset for a long period until the right moment comes to sell. And they can manage the asset in the meantime, including fixing any physical or other defects in the asset or its management to keep tenants happy and maximise sale value to potential buyers who will be looking to buy a tenanted building or site with reliable, existing rent flows and happy tenants.

For unsecured creditors whose borrowers hold real estate assets, the options are different. Such creditors can, if unpaid, petition for the appointment of a liquidator or, subject to certain conditions, a provisional liquidator of the relevant debtor company, depending on its jurisdiction of incorporation. In some jurisdictions, such as the UK, they may be able to seek the appointment of an administrator. However, as a general rule, unsecured creditors will have less control over the monetisation of the specific asset and will be more exposed to the decisions of the company or (if appointed) a liquidator, whose decisions will be made for the benefit of the creditors generally, or to the company, which (depending on jurisdiction) may choose to promote its own restructuring plan.