Time for Rescue Capital? Is the Window Opening to Use Rescue Capital for Distressed Real Estate Projects?

Description

The real estate industry is in the fourth year of stress caused by an inflationary, high interest rate environment, remote work, and other changes in demand and use patterns across industry sectors. Many joint ventures have capital stacks that have buckled or are shaky due to the "equity gap" that has resulted. The real estate world is replete with properties that have experienced foreclosure, short sales, or deeds in lieu, but many troubled owners are hanging on in an "extend and pretend" status, or threatened by a loan maturity or lease expiration that will destabilize them, or are trapped by a lender unwilling to take back the property.

In past cycles, and to a limited extent so far in the current environment, distressed real estate owners had the option of a rescue capital event, in which preferred equity would be injected into existing capital stacks by new capital sources. The result would be a squeeze down or squeeze out of the original ownership group, but their retention of some rights to future economics and a potential deferral of tax consequences. Existing lenders could participate in this infusion, and debt would almost always have to be renegotiated or rejiggered.

Conversely, since 2022 private equity firms and other alternative sources of capital, including family offices, have joined institutional lenders in amassing an unprecedented amount of "dry powder" in reserve for these transactions, waiting for a "goldilocks" moment in which there is room in the capital stacks for their investment.

As the real estate environment ameliorates, rescue capital will generate increasing interest from both existing owners and potential investors. However, rescue capital transactions often are structured as hybrids between debt and equity, and thus present numerous tax and non-tax considerations for all parties. These are extremely complicated and sophisticated transactions, including from a tax perspective, and require highly seasoned advisers on all sides.

Listen as our hybrid panel, one "dirt" lawyer, one tax lawyer, and a real estate capital markets expert, discusses key tax and non-tax considerations and structures and planning techniques for parties seeking to engage in rescue capital transactions.