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Subscription-Secured Credit Facilities: Recent Developments in the US Market and Considerations for Real Estate Funds | Goodwin



Fund-level subscription-secured revolving lines of credit are a well-established instrument in the toolkits of a variety of private equity fund sponsors and managers, including for venture capital funds, hedge funds, debt funds, secondaries funds, and real estate funds. In many respects, real estate funds’ subscription-secured credit facilities are operationally similar to those of funds investing in various other asset classes. Subscription lines are generally secured solely by pledges of a fund’s rights to capital contributions from its investors (in addition to pledges of fund-level accounts into which investor capital is contributed), which allows real estate fund managers to provide collateral to the subscription lender without impairing their ability to pledge equity interests and real property held by the funds’ subsidiaries to property-level lenders. However, the nature of the underlying assets of a real estate fund can nevertheless have significant implications with respect to the negotiation of the credit facility documents, as further discussed herein. Changes to the market in recent years have enhanced the need for sponsors to be aware of these considerations as existing lenders and new entrants to the market present borrowers with novel terms.

Real estate fund sponsors use subscription-secured revolving credit facilities to allow for nimble deal execution in addition to general flexibility with respect to working capital of the fund and its subsidiaries. For example:

  • The majority of real estate acquisition transactions require buyers to post a deposit, which is often refundable through expiration of a due diligence period. A credit line provides fund sponsors the flexibility to post deposits quickly and without the risk that, where a deal may terminate during a due diligence period while the deposit is still refundable, capital may need to be returned to investors.
  • Subscription-line proceeds also can be used as bridge financing, which has a variety of benefits for sponsors. First, it allows them to place more-competitive bids by closing on asset transactions on an “all cash basis,” and it can help facilitate more-aggressive closing timelines. Second, in a challenging market for mortgage financing, using a subscription line as bridge debt for closing gives buyers a longer runway to obtain permanent mortgage financing.
  • Outside of acquisitions, subscription lines also provide real estate funds with flexibility to draw for other working capital purposes, such as property repairs, insurance premiums, and other property-level expenses on short notice without the operational burden (from both a timing perspective and an investor relations perspective) of calling capital from investors regularly (or in small amounts) for such purposes.
  • Subscription lines also often allow borrowers to use borrowing base capacity to obtain letters of credit, which is particularly useful for posting security deposits and collateral for mortgage lenders and development activity.

Interplay Between Fund Credit Facilities and Underlying Mortgage Loans

There are a number of items particular to the real estate asset class that should be considered by borrowers and their counsel as part of negotiating both the credit documents for the subscription line and underlying property-level mortgage loan documents.

As noted above, the “upward-looking” nature of a subscription line’s collateral package generally means the line should not affect collateral granted to property-level lenders. However, financial covenants and covenants related to indebtedness in subscription-line credit documents — particularly for real estate equity funds for which the borrowing base is affected by the fund’s other indebtedness — need to be carefully considered due to the following complications, among others, that can arise in connection with mortgage loans obtained by a fund’s subsidiaries:

  • Real estate funds routinely provide guaranties to property-level lenders: non-recourse carve-out guaranties backstopping lenders’ losses arising from “bad act” carve-outs, environmental indemnities, completion and carry guaranties for development projects, and, in certain circumstances, equity and payment guaranties. While it is not industry standard for most lenders to factor a fund’s indebtedness into the borrowing base for a subscription facility, where lenders require reduction of the borrowing base in connection with other fund indebtedness it is key that any contingent guaranty liabilities are carved out from the definition of “indebtedness” in the credit facility documentation (until such time as any such contingent liability becomes due and payable, and subject to negotiated carve-outs).
  • In connection with the aforementioned guaranties, real estate funds and their subsidiaries often agree to net worth and liquidity covenants that factor in the ability to call capital directly or indirectly from the fund’s investors. In negotiating these terms with property-level lenders, borrowers should carefully review exclusions on pledged capital commitments from net worth and liquidity covenants to ensure that the existence of a subscription line does not preclude inclusion of investor commitments in the calculation of these covenants. Often borrowers can negotiate for the right to have such capital commitments included with a reduction for amounts outstanding on a subscription line, or for available subscription-line borrowings to count toward liquidity.
  • Some subscription-line lenders will push to obtain an “all assets” pledge from, or file an “all assets” UCC financing statement against, a subscription-line borrower or fund. This approach is overly broad with respect to typical subscription facility collateral. It can cause issues with respect to permitted transfer provisions under mortgage loan or joint venture documents, and it can result in confusion when mortgage lenders obtain typical diligence searches.

Transactional and legal teams representing asset-level borrowers should be aware of the upper-tier credit facility when negotiating mortgage loan documents. Generally speaking, credit facility documents should not restrict lower-tier debt, and mortgage loan documents should not restrict upward-facing liens, but a careful review of language is necessary to confirm this is the case. This is of particular importance in light of recent tightening in the subscription line market and in light of real estate fund sponsors increasingly engaging with lenders that have historically provided subscription lines to other fund types and may not be as attuned to these types of sensitivities that are specific to real estate funds.

Temporary Versus Permanent Increases

As a result of recent market volatility, fundraising challenges, and increases in the “upfront” and “unused” fees charged by subscription-line lenders, in some instances borrowers are forgoing traditional rights to permanently increase the maximum commitment of subscription-line lenders, instead (or in addition to such permanent increase rights) negotiating an ability to trigger temporary commitment increases to carry through periods of significant cash need, with a fallback to baseline thereafter. This can allow a credit line borrower to save on upfront fees charged on the maximum facility amount at closing and avoid paying unused fees on an increased maximum facility amount when the larger facility amount is not needed. Borrowers should be aware, however, that temporary increases are typically uncommitted and therefore often subject to the lender’s discretion.

Other Real-Estate-Specific Factors in Credit Documents

Borrowers and their counsel should carefully consider any real property-level covenants contained in any subscription-secured credit documents (e.g., those related to property operations, environmental conditions, and financial performance). From a borrower’s perspective, the operation of underlying assets should generally not be a subscription-secured facility lender’s concern as it is not a part of such lender’s collateral. To the extent that any covenants relating to the fund’s underlying assets are included, they should be qualified with “material adverse effect” or similar qualifiers on the grounds that property-level issues should not be the basis for an event of default under the facility unless they have a significant adverse impact on the condition of the fund and its subsidiaries, taken as a whole.

Additionally, while historically not the norm for real estate fund subscription lines, lenders (often in connection with extensions or after-care facilities) have recently been including net asset value (NAV) tests in respect to underlying real property assets, either in the form of maintenance NAV covenants (which can result in an event of default if not complied with) or for purposes of determining the borrowing base. These terms can be problematic if the fund’s business plan includes purchasing development assets where an increase in value may not be achieved for several years. NAV provisions also should be considered from a cost perspective, particularly if they require any property-level appraisals to confirm compliance.

As the subscription-line market continues to evolve rapidly, real estate fund sponsors need to ensure that they are adequately addressing the interplay between real property transactions and operations, including in the context of mortgage-level borrowing and subscription-secured credit facilities. 

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