In an interview with PropertyEU, Volker Zerr, Germany real estate partner at law firm CMS, highlights the main findings from the firm's annual CMS European Real Estate Deal Point Study.
PropertyEU: How would you judge the health of the European real estate industry?
Volker Zerr: Overall, the Covid-19-related decline in investment volume did not turn out as severe as expected and the property market seems to have got off relatively lightly. Investment volumes remain at a high level. This is due to the ongoing good credit terms and lack of alternative investment options. Nevertheless, the Covid-19 pandemic will continue to impact the market in 2021.
PropertyEU: Which asset class or type of deal are you busiest with?
VZ: In 2020, buyers focused primarily on properties with stable income and those only minimally affected by the pandemic. Logistics and residential properties were especially popular. Office real estate remained the strongest asset class in Europe, but its share of the market fell to a record low of 30%. Demand for retail properties remained at a consistently low level (15%).
PropertyEU: To what extent is it a seller’s market and how much of a swing has there been to the buyer?
VZ: In recent years, we have observed a trend towards increasingly seller-friendly regulations. Especially with regard to the contractual risk allocation, sellers have increasingly been able to assert themselves. This has been reflected, for example, in an increase in de minimis, basket and cap clauses, but also in the agreement of ever shorter limitation periods.
In 2020, this trend has been somewhat curbed. Buyers were able to strengthen their position in 2020 regarding risk allocation in contracts and succeeded more often in obtaining favourable contract terms than in previous years. Overall, however, the real estate investment market remains a sellers’ market. Good credit conditions and a lack of alternative investment opportunities continue to create excess demand in the real estate investment market.
PropertyEU: What factors are dictating the balance of power in negotiations?
VZ: First, in a low interest rate environment, there is usually high demand with little supply at the same time. This strengthens the position of sellers. Second, a decisive factor is, of course, the property itself. The better the location and the amenities – ESG criteria are also playing an increasingly important role in this regard – the more prospective buyers there are and the stronger the negotiating power of the seller. In addition, it depends on the individual circumstances of the selling company – how much pressure is behind the sale of the property, how urgent is the sale for the company. The same applies to the buyer side.
PropertyEU: Generally speaking, how is this reflected in real estate purchase agreements when it comes to key terms?
VZ: The strong position of the sellers is particularly evident in the contractual risk allocation. In our CMS European deal point study, developments in this regard can be found in the section “warranty and guarantees”. In general, it is common practice to exclude (mostly buyer-friendly) statutory warranties as far as is legally permitted and replace them with individual agreements on the seller’s liability, e.g. guarantees. In 2020 in particular, we have seen an increase in the willingness to compromise, and most contracts contained balanced provisions in this respect. This again underlines the somewhat stronger negotiating power of buyers in 2020 compared to previous years. Also, the length of the agreed limitation period and the existence of further liability limitation such as de minimis, basket and cap clauses can indicate the balance of power.
PropertyEU: In particular, what is the latest trend for de minimis, basket thresholds and cap clauses?
VZ: The proportion of deals with seller-friendly limits on liability, such as de minimis and basket clauses and caps, dropped slightly below the prior-year level in 2020. The upward trend seen over many years in agreements aimed at limiting liability has thus been curbed somewhat, while buyers were able to negotiate more favourable contract terms more often than before.
PropertyEU: To what extent are Statutory Warranty Provisions being excluded? What does this tell us about the market?
VZ: It was common practice in the evaluated transactions to exclude the statutory warranty and replace it with individual agreements on the seller’s liability, e.g. by guarantees.
The proportion of transactions with liability arrangements of this type was around 80% on average in the period covered by the study. The peaks were reached in 2015 (89%) and in 2016 and 2017 (both 88%). Following a significant decline to 70% in 2018, the share of deals with individual liability provisions rose again to 75% in 2020.
PropertyEU: What can you tell us about the use of Exclusion of Liability?
VZ: In 2020, it was agreed in roughly half (52%) of the deals examined that the seller would not be liable if the buyer had knowledge of the relevant circumstance when the agreement was signed. In 24% of cases, liability was also excluded in the event of grossly negligent ignorance of facts on the buyer’s part, i.e. in cases where the buyer should have been aware of the circumstances if it had exercised due care. In 45% of agreements, the buyer’s liability was excluded in the event that the circumstance had already been disclosed in the data room.
In such cases the buyer was thus obliged to examine the information available in the data room with due care and raise the matter in the negotiations, since subsequent warranty claims referring to these circumstances would be precluded by this provision. In 25% of transactions, it was agreed that exclusion of liability also applies with regard to circumstances disclosed in the agreement itself or in a disclosure letter. In contrast, 41% of all agreements did not include exclusion of liability in the event of knowledge.
PropertyEU: Forward funding/forward purchases seem to be more prolific. How are parties dealing with pricing/valuation if there remain some uncertainties that affect it?
VZ: In the case of forward purchases, a number of factors relevant to the purchase price are not yet determined at the time of signing. This uncertainty is countered by agreeing a variable purchase price instead of a fixed purchase price. The variable purchase price is subsequently adjusted, for example, depending on the later actual lettable area, the net rent income etc.
PropertyEU: Is it possible to say which country or countries are the most buyer-friendly as evidenced by sale purchase terms and which are the least?
VZ: Switzerland is the most seller-friendly market but besides that no further qualification is possible.
PropertyEU: Of course, Covid-19 has led to many issues for tenants, landlords, and lenders. Are there any areas that merit special attention because they have kept CMS busy on the advisory side?
VZ: The past year has, of course, been marked by the pandemic and has raised some, as yet unresolved, legal questions. In commercial leases, the main question was, and still is, to what extent the tenant can reduce the rent due to the closures associated with the pandemic. Landlords and tenants are continually in consultation regarding any lease adjustments to cushion the economic consequences of the business closures on both sides, and in doing so must always be prepared for new official regulations.
In addition, ESG is becoming an increasingly important issue. Efficient, environmentally friendly and sustainable spaces are becoming increasingly important aspects for occupants and are thus also a decisive factor in real estate investment decisions.
PropertyEU: Upon the first wave of lockdowns and other restrictions from last March, did you see arguments stemming from sellers or buyers looking to pull out of an agreement and what was the solution? Have negotiations taken place about a break fee and have escrow accounts been useful to protect either party?
VZ: The pandemic often brought uncertainty around the market value of a property. This was reflected in a reduced purchase price, or attempts by buyers to renegotiate a purchase price already agreed in the LOI. Sellers, on the other hand, were often uncertain about the buyer’s solvency going forward. The proportion of transactions in which steps were taken to ensure the buyer met its financial obligations rose to a record high of 64%. In previous years, security was agreed in less than 50% of all transactions. As a means of providing security, both bank guarantees (17%) and a notary’s escrow account (10%) became less popular. In many cases, in contrast, the buyer made an advance payment (29%). In 9% of transactions, use was made of submission to immediate enforcement.
PropertyEU: What would you say is the single most important legal aspect to real estate transactions currently and in the predictable future?
VZ: Currently we see a significant increase in W&I insurance to exclude the seller’s liability as far as possible. In the near future the requirements for a share deal, for example, will be tightened in Germany, so that this popular structure for avoiding land transfer tax (up to 6.5 % of the purchase price) will be significantly more difficult.
Highlights from the CMS Real Estate Deal Point Study
- Buyers were able to strengthen their position in 2020 regarding risk allocation in contracts and succeeded more often in obtaining favourable contract terms than in previous years
- The proportion of transactions in which steps were taken to ensure the buyer met its financial obligations rose to a record high of 64%
- W&I insurance has increased significantly to exclude the seller’s liability as far as possible