The economic and credit climate has meant the rise of the “exit clause” in commercial real estate deals, a fine print item that got little play before now.
Though the proliferation of deals is limited these days, the ones in the market are getting extra scrutiny from lenders, landlords, tenants, buyers and sellers. Skittish and tightfisted lenders have seized up when it comes to financing real estate transactions, whether funding renovations of office space or a new development. On the other side, developers are canceling or delaying projects to hold onto what cash and lines of credit they have on hand. It all boils down to the money.
“Finance contingencies are back in vogue,” said Fred Masters, a real estate attorney with Buchanan Ingersoll. “Anybody who is doing a deal today is going to look for a finance contingency.”
But that’s not the only kind that’s being sought. There are leasing contingencies, where a lender will require a certain percentage of an office or apartment building or retail strip be leased up or rented out before financing will be lined up for either construction or acquisition.
“In the good ol’ days people would have an agreement that wouldn’t have any of this,” Masters said. “They would have 30 to 45 days of due diligence to walk for any and no reason. It’s because financing was so common and inexpensive. In today’s market because financing is so difficult to get, people are more concerned and are looking for these types of contingencies. They’re becoming accepted. People are very worried.”
They are worried retail tenants will go dark or bankrupt. With an apartment building, they are worried renters will lose jobs and vacate a unit.
“You could buy an apartment building that has 90 percent occupancy and two to three months later you’re down to 85 percent,” Masters said. “An exit strategy is about the economic value of a property remaining the same by the time of closing.”
A landlord is worried an office tenant will downsize or cease operating. Or, in the case of VWR International Inc., the company is worried a lender won’t be able to finance a new development because of apprehension of financial institutions to lend money.
An exit clause was incorporated into a recent deal in which VWR signed a 12-year, 150,000-square-foot lease on a new headquarters with O’Neill Properties Group. The clause was an extra detail the involved broker felt “necessary” to add in.
“Based on the size of the deal, complexity and environment we’re in, we put in the exit clause,” said Scott Gabrielsen, a broker with Binswanger who represents VWR. “If certain milestones aren’t met then we’ve negotiated for our client to get out of the lease.
“We have the utmost confidence in Brian [O’Neill] to deliver. If he doesn’t, we’ve covered ourselves to go into a different direction.”
The VWR deal is a big one, especially at a time when such transactions are scarce. Under terms of the agreement, O’Neill Properties will construct a 240,000-square-foot mixed-use building at the developer’s Worthington Town Center project off routes 29 and 202 in Malvern.
Brian O’Neill, who heads the King of Prussia company, isn’t worried. “It’s not going to be used,” O’Neill said of the exit clause. He doesn’t foresee starting to initiate putting exit clauses into his deals. “I don’t do deals on contingency,” he said.
The fate of the transaction could be determined by the end of the first quarter or at the beginning of the second.
The building is expected to be completed in the third quarter of next year and in time for VWR, which supplies laboratory equipment globally, to move from its current headquarters. It now maintains operations in two buildings off Goshen Parkway in West Chester and has a lease that expires at the end of 2010. It doesn’t have much wiggle room. The company that owns the buildings wants the space back for itself.
VWR had considered relocating to Delaware but instead accepted $600,000 in economic-development incentives from Pennsylvania to keep its headquarters and 350 jobs in the state.
The company will receive the funds in the form of an opportunity grant that it doesn’t need to repay if it meets certain job retention or capital investment goals established by the company and state over a defined period of time.
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