Real Estate Due Diligence (eBook)

Prof. Dr. Tobias Just is Managing Director at the IRE|BS Immobilienakademie and professor for Real Estate at the University of Regensburg. Tobias studied economics in Hamburg and Uppsala (Sweden). In 1997 he graduated and started to work at the University of the Federal Armed Forces Hamburg. His PhD-dissertation was awarded the university science prize in 2001. For more than ten years Tobias worked at Deutsche Bank Research, the economics research unit of Deutsche Bank. He headed the units’ sector and real estate research team and was a member of Deutsche Bank’s group wide Environmental Steering Committee. In summer 2006 Tobias was Research Fellow at the American Institute of Contemporary German Studies at the Johns Hopkins University in Washington DC. Tobias published more than 100 papers in professional and academic journals and books. Since November 2011 Tobias has been Managing Director at the IRE|BS Immobilienakademie and has a chair for Real Estate at the University of Regensburg. He is President of the German Society of Property Researchers (gif), editor of the ZIÖ – the German Journal of Real Estate Research and a member of the Executive Management Board of the German section of the Urban Land Institute. In 2013 Tobias was elected “Head of the German real estate industry” by leading real estate journalists, and in 2015 he was ranked among the leading German economists by the FAZ.Dr. Hermann Stapenhorst, MRICS is a partner of 3A, a real estate focussed nationwide consulting law firm for real estate investment and strategy. He was admitted as an attorney-at-law in 1991 and started his professional career at Sigle Loose Schmidt Diemitz, where he became a partner in 1995. In 1997, he was appointed a Civil Law Notary. After the merger into CMS Hasche Sigle in 1999, he headed the firm´s Practice Group Real Estate and Construction for 10 years until 2009. Between 2009 and 2012, Hermann Stapenhorst had been the head of the CMS Hotel Industry Business Group before he became a member of the CMS Hasche Sigle Board until 2014. He has been the president of the Pension Fund of Lawyers in Berlin since 2011. In 2015, he set up 3A.

Acknowledgements 6
Contents 7
Contributing Authors 8
Real Estate Transactions 11
1 Real Estate Transactions 11
1.1 Definition: What Makes Real Estate Different 11
1.2 Overall Transaction Volume in Germany 12
1.3 Different Transactions 13
1.3.1 Location 14
1.3.2 Asset Classes 14
1.3.3 Risk-Return 15
1.3.4 Financing 16
1.4 Due Diligence: Origin, Legal Concept, Terms 16
1.5 Functions and Objective of Due Diligence 18
1.6 Subject of Due Diligence 21
1.7 Sales Process 22
1.7.1 Investment Memorandum 22
1.7.2 Process Letter 23
1.8 Due Diligence in the Context of Real Estate Transactions 24
1.9 Legal Frame of Due Diligence 26
1.9.1 Statutory Provisions 26
Example 27
1.9.2 Contractual Provisions 28
1.10 Instruction of Advisors 28
Example 29
References 29
Legal Due Diligence 31
1 Introduction 31
1.1 Purpose and Objective of Legal Due Diligence 31
1.2 Sources of Legal Due Diligence 32
2 Vendor Legal Due Diligence 32
2.1 Preparation of the Data Room 32
Example 33
2.2 QandA Process Sequence 34
2.3 Establishing Saleability 34
Example 35
2.4 Non-Disclosure Agreement (NDA) 36
2.5 Legal Fact Book: Reliance Letter 36
Example 37
3 Buyer Red Flag Legal Due Diligence 38
Example 39
4 Initial Bid, Letter of Intent, Exclusivity 40
4.1 Initial Bid 40
4.2 Letter of Intent 40
4.3 Exclusivity Agreement 42
5 Buyer Full Due Diligence 43
5.1 Detailed Examination 43
5.1.1 Examination of Title: Land Register 43
Example 44
5.1.2 Lease Contracts 45
5.1.3 Planning and Building Law 48
Example 49
5.1.4 Further Issues Regarding Share Deals 50
5.2 Questions and Answers (QandA) 51
5.3 Due Diligence Report 53
5.4 Mark-Up SPA 55
5.5 Final Bid 56
6 Signing/Closing 57
7 Conclusion and Outlook 58
References 59
Tax Due Diligence in Real Estate Transactions 60
1 Introduction 60
2 Tax Due Diligence in Asset Deals 61
2.1 Introduction 61
2.2 VAT 62
2.2.1 VAT Treatment of the Acquisition of Real Estate 62
2.2.1.1 Background: ``Transfer of a Going Concern´´ or Transfer of a Single Asset 62
2.2.1.2 Practical Relevance for the Buyer 63
Input-VAT-Adjustment Obligations 63
Example 64
VAT Treatment of the Sale of Moveable Assets 65
Example 65
2.2.1.3 Aspects to Be Reviewed in the Course of the Tax Due Diligence 66
2.2.2 VAT Status and Treatment of Existing Lease Agreements 67
2.2.2.1 Background 67
Example 67
2.2.2.2 Documents to Be Reviewed 68
2.2.3 Assumption of Input VAT-Adjustment Obligations (§ 15a UStG) 69
2.2.3.1 Background 69
Example 69
2.2.3.2 Practical Relevance for the Buyer 70
2.2.3.3 Aspects to Be Reviewed in a Tax Due Diligence 70
2.3 Trade Tax 71
2.3.1 Background 71
2.3.2 Documents and Information to be Reviewed 72
2.4 Secondary Tax Liability of the Buyer for Taxes of the Seller 73
2.4.1 Potential Tax Liability of the Buyer Pursuant to § 75 AO 73
2.4.1.1 Background 73
2.4.1.2 Aspects to be Reviewed in a Tax Due Diligence 74
Tax Status Certificates (Bescheinigung in Steuersachen) 74
Example 74
Construction Withholding Tax 75
2.4.2 Liability for Unpaid Land Tax 76
2.5 Other Aspects 76
2.5.1 Real Estate Transfer Tax 76
2.5.1.1 Background 76
2.5.1.2 Relevance for the Due Diligence 76
Note 77
2.5.1.3 Documents to Be Reviewed in a Tax Due Diligence 78
2.5.2 Land Tax 78
2.5.2.1 Background 78
Example 78
2.5.2.2 Relevance of Land Tax in a Tax Due Diligence 79
2.5.2.3 Documents to Be Reviewed 79
3 Tax Due Diligence in Share Deals 79
3.1 Introduction 79
3.2 Analysis of the Current Tax Status 80
3.2.1 Status of Tax Filings and Tax Assessments 80
3.2.2 Tax Audits 81
3.2.3 Pending Appeals, Proceedings, Etc. 81
3.3 Typical Potential Tax Issues to Be Reviewed 82
3.3.1 Allocation of the Purchase Price to the Land and the Building 82
3.3.2 Tax Depreciation 82
3.3.3 Tax Losses 83
3.3.3.1 Background 83
Change-of-Control in a Corporate Entity 84
Example 84
Change-of-Control in a Partnership 84
Forfeiture of Losses in Case of Certain Reorganisations 85
Consequences for a Tax Due Diligence 85
3.3.4 Deductibility of Interest Expenses 85
3.3.4.1 Background 85
3.3.4.2 Consequences for a Tax Due Diligence 87
3.3.5 Trade Tax Aspects 87
3.3.5.1 Trade Tax Aspects of Non-German Target Companies 87
3.3.5.2 Extended Trade Tax Exemption for Real Estate Companies 88
Limitation of Business Activities to Long-Term Investments 88
Property Trading 89
Lease of Business Fixtures 89
Harmful Use by the Shareholder: Operational Company Split 89
3.3.6 Transfer Pricing and Constructive Dividends 90
3.3.6.1 Background 90
3.3.6.2 Consequences for the Tax Due Diligence 90
3.3.7 Real Estate Transfer Tax 91
Example 92
3.3.8 Other Aspects 93
3.4 Specific Tax Aspects of Partnerships 93
3.4.1 German Trade Tax Aspects 94
3.4.2 German Real Estate Transfer Tax Aspects 94
3.4.2.1 Change of Control Within a 5-Year Period 94
Example 95
3.4.2.2 Retroactive Denial of Previously Applied RETT-Exemptions 95
Example 96
4 Consequences of a Tax Due Diligence for the Investor 96
References 97
Financial Due Diligence 98
1 Introduction 98
1.1 Goals of Financial Due Diligence 99
1.1.1 Reduction of Information Asymmetry 99
1.1.2 Supporting the Valuation 100
1.1.3 Reduction of Risks for Decision Makers 101
1.1.4 Identify Adequate Risk Mitigation 101
1.1.5 Supporting the Strategic Rationale of the Buyer 103
1.2 Changing Approaches to Financial Due Diligence 103
1.2.1 Changing Approaches to Conducting Due Diligence 104
1.2.2 Phased Reporting in Financial Due Diligence 104
1.3 Understand the Transaction 106
1.3.1 General Understanding of the Transaction 106
1.3.2 Understanding of the Equity Story 107
2 Scope of the Financial Due Diligence 109
2.1 Analysis of the Quality of Financials 109
2.1.1 Purpose of the Analysis of Quality of Financials 109
2.1.2 Key Hypotheses and Resulting Analysis 109
2.1.3 Accounting Policies 110
2.1.4 Audit of Financial Statements and Management Letters 111
2.1.5 Quality of Management Reporting 111
2.1.6 Historical Budgeting Accuracy 112
2.1.7 Budgeting and Forecasting Process 112
2.1.8 Internal Processes 113
2.2 Analysis of the Quality of Earnings 114
2.2.1 Purpose of the Analysis of Quality of Earnings 114
2.2.2 Volume Basis 114
Example 116
2.2.3 Risk Allocation Between Tenants and Landlords 117
2.2.4 Gross Rental Income 117
2.2.4.1 Gross Rental Income vs. Passing Rents 117
2.2.4.2 Development of New Contract Rents vs. Portfolio Rents 118
Example 118
2.2.4.3 Weighted Average Lease Tenure (WALT) 119
2.2.4.4 EBITDAR Rent Coverage 119
2.2.5 Vacancy Losses 120
2.2.6 Like-for-Like or Stabilised Portfolio Analysis 120
2.2.7 Recoverable and Non-recoverable Operating Costs 121
2.2.8 Maintenance Costs 121
Example 122
2.2.9 Adjusted EBITDA 123
2.2.10 Current Trading Analysis 124
Example 125
2.2.11 Financial Results 125
2.2.12 Income Taxes and Other Taxes 125
2.2.13 EPRA Earnings 127
2.3 Analysis of the Quality of Net Assets 128
2.3.1 Purpose of the Analysis of the Quality of Net Assets 128
2.3.2 Key Hypotheses and Resulting Analysis 129
2.3.3 Investment Properties 129
2.3.3.1 Acquisition Costs and Fair Values 129
2.3.3.2 Age Structure of Investment Properties 130
2.3.3.3 Regional Footprint of Investment Properties 131
2.3.4 Working Capital 132
2.3.4.1 Recurring Levels and Working Capital Benchmarks 132
2.3.4.2 Seasonality of Working Capital 132
2.3.5 Debt-Like Items and Other Non-recurring Items 133
2.3.5.1 Debt 134
2.3.5.2 Debt-Like Items 134
2.3.5.3 Cash and Cash-Like Items 134
2.3.6 Equity 134
2.3.6.1 Capital Maintenance Rules for Limited Liability Companies 137
2.3.6.2 EPRA NAV and NNNAV 138
2.4 Analysis of the Quality of Cash Flows 139
2.4.1 Purpose of the Analysis of Quality of Cash Flows 139
2.4.2 Key Hypotheses and Resulting Analysis 140
2.4.3 Operating Cash Flow 140
2.4.4 Investing Cash Flow 141
2.4.4.1 Maintenance CAPEX and Tenant Improvements 141
2.4.4.2 Acquisitions and Disposals 142
2.4.5 Free Cash Flow 142
2.4.6 Financing Cash Flow 143
2.4.6.1 Debt Service 143
2.4.6.2 Flow to Equity 144
2.4.6.3 FFO and AFFO 145
3 Conclusion and Outlook 147
Appendix 148
A.1 ICAEW ``Twenty Principles for Good Spreadsheet Practice´´ 148
A.1.1 The Spreadsheet´s Business Environment 148
A.1.2 Designing and Building Your Spreadsheet 148
A.1.3 Spreadsheet Risks and Controls 149
A.2 FAST Principles 149
A.2.1 Workbook Design 149
A.2.1.1 General Workbook Design Principles 149
A.2.1.2 Sheet Organisation 149
A.2.1.3 Multiple Workbook Models 150
A.2.2 Worksheet Design 150
A.2.2.1 Universal Design Layout Principles 150
A.2.2.2 Calculation Blocks 150
A.2.2.3 Header Design 150
A.2.2.4 Input Sheets 151
A.2.2.5 Presentation Sheets 151
A.2.2.6 Control Sheets 151
A.2.3 The Line Item 151
A.2.3.1 Line Item Taxonomy 151
A.2.3.2 Formula Design Fundamentals 151
A.2.3.3 Formula Simplicity 152
A.2.3.4 Formula Clarity 152
A.2.3.5 FAST Labelling Conventions 152
A.2.3.6 Links 153
A.2.3.7 Timing Flags and Partial Period Factors (PPFs) 153
A.3 Excel Features Used in Modelling 153
A.3.1 Excel Functions 153
A.3.2 Formatting Features 153
A.3.3 Excel Names 153
References 153
Technical Due Diligence 156
1 Introduction 156
1.1 Conceptual Framework 157
1.2 Purpose and Objective of a Due Diligence 159
1.2.1 Buyer´s Perspective on a Technical Due Diligence 159
1.2.2 Vendor´s Perspective on a Technical Due Diligence 161
1.3 Sources of Information 162
2 The Process of a Technical Due Diligence 162
2.1 Initial Phase 162
Professional Indemnity Insurance 163
Example 163
Conflict of Interest 165
2.1.1 Materiality Threshold 166
2.2 Data Room Phase 167
2.2.1 Information Memorandum 167
2.2.2 Data Room 167
2.2.3 Red Flag Report 170
2.3 Phase I/Phase II Site Assessment 170
2.3.1 Phase I Environmental Site Assessment 170
2.3.2 Property Condition Assessment or Building Survey 172
2.3.3 Site Visit 174
2.3.4 Interviews 174
Cover Story 175
2.3.5 Reporting 175
2.3.6 Phase II 176
Selection of the Service Provider for a Phase II Investigation 177
Example 177
2.4 Contract Phase 178
2.4.1 Technical Review of Contract Clauses 178
2.4.2 Disclosure Lists 178
2.4.3 Negotiation Support 178
2.4.4 Reliance Letter and Contract Transfer Agreement 179
2.4.5 Deal Closure 179
2.4.6 Follow-up 180
3 Methodology 180
3.1 Data Collection 181
3.1.1 Limitations and Safety 181
3.1.2 Site History 181
3.1.3 Permits/Acceptances 182
3.1.4 Maintenance Status 182
3.1.5 Development Options 183
3.2 Assessment 183
3.2.1 Basis: Regulatory Requirements 183
3.2.2 Relevance Versus Materiality 183
3.2.3 Top-Down Versus Bottom-Up Approach 184
3.2.4 Rating of the Condition 185
3.3 Cost Analysis 186
3.3.1 Capital Expenditure for Deferred Maintenance Issues (Deferred Capex) 187
3.3.2 Capital Expenditure Forecast 187
3.3.3 Opex Analysis 189
3.3.4 Reinstatement Costs 190
3.4 Risk Transfer 190
3.4.1 Contingencies 191
3.4.2 Price Adjustments 191
3.4.3 Warranties, Representations and Guarantees 192
3.4.4 Indemnities 192
3.4.5 Insurance Solutions 192
3.4.6 Closing Conditions 192
3.4.7 Retention 192
4 Topics Covered by the Technical Due Diligence Assessment 193
4.1 Technical Due Diligence Assessment 193
4.1.1 Site Location: Topography, Setting, Neighbourhood 193
4.1.2 Regional Planning and Zoning 193
4.1.3 Building Permits and Building Code Compliance 194
Example: Missing Construction Permits 194
4.1.4 Building Envelope: Façade, Windows and Walls 195
Example: Façade Failures 195
4.1.5 Structural: Foundation and Framing 195
Example: Mining Subsidence Damage in the Ruhr Area 195
4.1.6 Roofing Systems 195
4.1.7 Interior Elements: Stairways, Hallways, Common Areas 196
4.1.8 Mechanical: Heating, Ventilation and Air Conditioning (HVAC) Including Indoor Air Quality 196
Example: Sick of Air-Conditioning? 196
4.1.9 Electrical Appliances: High/Low Voltage, Illumination, Security/Alarm Systems, CCTV and Building Automation Systems 196
4.1.10 Plumbing 197
Example: Biogenic Sulphuric Acid Corrosion (BSC) 197
4.1.11 Vertical Transportation: Elevators and Escalators 197
4.1.12 Fire Safety 198
4.1.13 Energy Efficiency Including Energy Loss, Air Leakage and Roofing and Building Envelope Moisture Intrusion 199
Example: Energy Audits as a Legal Duty 199
4.1.14 Building Services, Operational Safety and Building Safety 199
4.1.15 Exterior Areas 200
4.1.16 Transport Connections and Accessibility 200
4.2 Environmental Due Diligence Assessment 201
4.2.1 Site History 201
4.2.2 Site Sensitivity and Vulnerability 201
4.2.3 Zoning and Environmental Permits 201
4.2.4 Environmental Management 202
4.2.5 Emissions 202
4.2.6 Waste Management 202
4.2.7 Water and Wastewater 203
4.2.8 Storage and Handling of Hazardous Materials 204
4.2.9 Soil and Groundwater 204
4.2.10 Building Contaminants 206
4.2.11 Environmental Risks and Resilience 207
4.2.12 Unexploded Ordnance 208
4.3 Social Due Diligence Assessment 208
4.3.1 Corporate Level 209
4.3.1.1 Different Perspectives 209
4.3.1.2 Topics to Be Covered 209
4.3.1.3 Health and Safety 209
4.3.1.4 Labour and Workplace Conditions 209
4.3.1.5 Training and Education 210
4.3.1.6 CSR Reporting 210
4.3.2 Asset Level 210
4.3.2.1 Workplace Conditions 211
4.3.2.2 Accessibility for Disabled Persons 211
4.4 Governance 212
5 Conclusion and Outlook 213
References 214
Erratum to: Real Estate Transactions 216
Glossary 218