I wrote a story before finishing law school. I don’t know how I found the time. It was an “actioner” with subplots, derring-do, a bit of blood, and what I hope was a satisfying conclusion. I won’t speak to how good that story was, but I will say that being involved with PEG’s efforts to purchase transient lodging facilities across the country and turn them into workforce housing—what I’ll call the “Conversion Strategy”—is perhaps the closest I’ve come to the complexity and detail I struggled through while trying to piece that story together.
In the same way I felt that story helped me learn to compose narrative fiction, I feel the Conversion Strategy, with its complexity, detail, and potential for deal-merge—but no blood so far as I know—is rife with opportunities to for me to glean new insights. When I think about these lessons, I tend to place them into three groups: (i) critical-though-minute contract provisions, (ii) unique local practices, and (iii) loan-related considerations. While I’ll try to keep this post as focused as possible, feel free to reach out to me at firstname.lastname@example.org if you’re looking for some additional context.
- Major Minutiae
Within the Conversion Strategy, perhaps my most important role is to draft and negotiate the purchase and sale agreement related to each asset. While I don’t do this alone, I spend a lot of time with my head in the contracts and, though I work to avoid quibbling over unimportant deal points, I find that the contractual minutiae are what end up saving the proverbial day. The following contractual provisions are only some of the terms which have been shown to be critical to PEG successfully closing on assets within the Conversion Strategy:
- Seller Prorations. Ensuring Seller is required to timely produce its estimation of allocations and prorations in advance of the agreed-upon closing date has been critical to being able to close each deal. Too often, PEG has seen Sellers, especially less sophisticated Sellers, fail to timely provide their proposed allocations and prorations, often requiring long hours from and unnecessary stress to all involved to ensure a closing date is met. As a result, each purchase agreement negotiated by PEG seeks to (i) impose on Seller to provide any and all prorations well in advance of closing and (ii) to create a one-to-one extension of the closing date for each day the Seller delays in providing that necessary information.
- Property Access and Seller Representations. The assets PEG is purchasing through the Conversion Strategy are most often in operation, with guests occupying some rooms and staff working around the clock to meet the needs of those guests. This creates a tension between Seller’s obligations to guests and staff and PEG’s obligation to thoroughly inspect each property before acquisition; a tension our purchase agreement attempts to alleviate by giving the Seller a simple choice. Either the Seller can provide PEG with unfettered access to each and every space on each property, from mechanical closets to guest bathrooms, or Seller can provide extensive representations and warranties regarding the physical and economic condition of the asset. I should note two things here. First, PEG will always argue for both unfettered access to each and every room, in the same way any party would while engaging in the purchase of a multi-family asset, and extensive representations and warranties to fill in the gaps regarding unknowable information. Second, PEG accepts the reticence of sellers to provide the such representations and is usually willing to limit representations and warranties to “the best of seller’s knowledge” or similar. However, in the presence of such limited representations, PEG should not and cannot accept anything less than the complete access to the property.
- Clean Rooms. It might seem obvious that rooms should be clean and in good condition at closing, thereby alleviating the buyer’s costs of bringing the acquisition in line with its standards. Unfortunately, most sellers push back strongly against any such language, refusing to ensure anything other than that they will make “reasonable efforts” to provide the property in clean and good condition. While I understand sellers are shutting down their operations, laying off staff, and terminating contracts, this does not absolve them of their responsibilities to preserve the condition of the property. As such, PEG demands each acquired asset is “rent ready,” not merely “okay,” and that a seller’s failure to provide the property in that condition results in a monetary penalty calculated based on the foreseeable cost of cleaning and repairs to the property, usually based on the number of rooms requiring remediation.
- Local Rules of Engagement
Thus far, PEG has done deals in more than twenty States and two Canadian Provinces. Unsurprisingly, nearly every one of those jurisdictions has different standards, laws, practices, and customs. By way of example, (i) title agents in Florida are commonly attorneys barred in the State, (ii) title policy fees in Georgia are not split between the parties—with seller paying for the standard policy and buyer paying any extended coverage—but paid exclusively by the buyer, (iii) New York transactions require unique language be included in the deed, and (iv) zoning changes in Scottsdale, Arizona simply don’t get done unless a potential buyer hires a local land use attorney. As a result of these variations, PEG regularly engages local counsel for zoning issues and works closely with local title agents and companies in order to ensure each asset is adequately protected, recorded, and entitled.
- Loans (and Lenders) Lead
The ability to leverage a property is wonderful—as in “it fills me full of wonder”—and the Conversion Strategy is dictated in no small way by the availability of and covenants imposed by debt financing. Not to put too fine a point on this, but loans and lending make or break the bottom line on any project. Accordingly, the group of us driving the Conversion Strategy has learned a few loan-related lessons noted below, though in no particular order:
- The Simultaneous Close. A “simultaneous close,” closing on the land and on the debt at the same time, is usually the rule and not the exception in the Conversion Strategy. This is driven by a few factors, including, but not limited to, (i) an interest in keeping the available equity of the Conversion Strategy as liquid as possible, and (ii) the need to move on any construction as soon as possible and, thus, needing to avoid unnecessary lien waivers prior to funding. At the same time, those of us who work on the Conversion Strategy much prefer to stagger the closings where possible, thereby avoiding, among many other possibilities and hazards, the chaos and delay that can result from a single third-party document being produced late.
- Loan Type. While ignoring the many contract provisions which are critical to successfully negotiating loan documents, I would point out a single, major consideration that must be addressed even before executing a term sheet: determining what type of loan will finance each asset within the Conversion Strategy. Each of these assets we acquire requires renovation. However, we have found that a standard construction loan, as opposed to a value-add or similar loan type, is appropriately structured for these assets. With a construction loan, we can ask that the first “draw” cover the actual land acquisition, pre-closing soft costs, and even the property management fee that will be required to ensure the asset is sufficiently cash-flowing during renovations.
- Sophistication. Each deal, just like each seller, each asset, and each lender, is unique and requires a unique approach, despite the seeming sameness of the assets we look at in the Conversion Strategy. Accordingly, we must consider the complexity of the deal before engaging any lender. More complex deals require more sophisticated lenders. Accordingly, on a particularly complex deal, we may be willing to trade more lenient loan covenants or loan oversight for a lender who will be more proactive, more communicative, and more demanding. Luckily for me, balancing these competing interests usually falls to someone else.
- Managing the Action
The forgoing terms, issues, and considerations are only some of the many such items that come into play on each deal that comes to PEG under the Conversion Strategy. Unlike some deals that we work on at PEG, the Conversion Strategy is fast-moving. For instance, in the course of sixty days or so stretching through the Holidays that closed out 2020, the team working on the Conversion Strategy closed on four properties. Three of those properties were simultaneous closes.
To manage this process, PEG focuses on two main ideas: (i) delegation and (ii) communication. Each deal is staffed with no less than five people, representing PEG Companies, Inc. and at least three of its subsidiaries. Each employee is delegated certain duties during due diligence—mine being mostly associated with insurance and title—which fall within their specific skill set. PEG also holds weekly meetings between these departments where each team member will review their due diligence findings and break-down site visits. This communication is critical to keeping each employee accountable, ensuring issues are brought forward for discussion, and documenting each deal. Without the delegation of duties and steady communication about these, none of the lessons-learned listed above would have been realized.
I anticipate additional insights and improvements as I continue to work with the Conversion Strategy. But more, I expect the continued teamwork at PEG to make learning these lessons much easier than that one time I wrote an “actioner.”