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By: Evan Hudson, Jeffrey S. Lowenthal, Jeffrey D. Uffner, and Michelle M., Jewett Stroock & Stroock & Lavan
The World Health Organization declared COVID-19 a pandemic, then markets continued a steep decline, as the coronavirus morphed from a public health crisis to a financial black swan event. As owners of much of the real estate that supports the U.S. economy, real estate investment trusts (REITs) face unique exposures and their general counsel (GC) face unique challenges. Some key considerations for REIT general counsel are set forth in this article.
The general counsel is not just the chief legal officer of the company. The general counsel is a leader in every sense of the word. In times of crisis, leadership requires presence, equanimity, and communication.1
Presence means mindfulness and situational awareness. Keeping abreast of evolving threats is paramount. In working with others in senior management to guide the ship, the general counsel must readily assimilate, evaluate, and act on fluid and imperfect information about public health, biology, the capital markets, NGOs, governments, politics, and human reactions.
Equanimity means setting the right tone. Presenting a calm and informed demeanor before the board, the CEO, and the employees is critical in helping the organization weather the crisis.
Communication is something to be done proactively, and it ties in with situational awareness. By communicating inside and outside the firm, the GC can gather the information needed to make informed decisions. Especially as the REITwise conference and other industry meetups get canceled, now is a good time to reach out to your law school classmates, your law firm alumni network, and your colleagues at other REITs to better understand the lay of the land.
On the topic of communication, investor relations take on heightened importance during a fast-moving crisis. Some REITs have issued letters to investors outlining the steps they are taking in response to the coronavirus pandemic and the implications of the crisis for the real estate portfolio and the REIT’s securities. GCs should take care to ensure everyone is receiving the same information when investors call with questions and concerns, paying particular attention to the requirements of SEC Regulation FD.
REITs engaged in stock buybacks or securities offerings should ensure that their disclosures are up to date. In particular, GCs should see that the risk factors and forward-looking statements legends in ’34 Act and ’33 Act disclosure documents continue to evolve in appropriate ways.
Ongoing offerings, both private and public, may require the preparation and distribution of a disclosure supplement. We are also seeing non-traded REITs revise their disclaimers about the limitations of their net asset value (NAV) calculations given new uncertainty in NAVs.
The GC may have observed that on March 4, 2020, the Securities and Exchange Commission (SEC) issued an order that, subject to certain conditions, provides publicly traded companies with an additional 45 days to file certain disclosure reports that would otherwise have been due between March 1 and April 30, 2020. The SEC reserves the right to extend the time period for the relief, although as of the time of writing has not done so.
Non-traded REITs that allow repurchases should carefully review their repurchase plans and decide whether any actions are needed. Managers should prepare for the possibility of increased redemptions in coming months, consider the REIT’s liquidity levels, and review the documents with an eye toward potential suspensions.
Unfortunately, certain publicly traded REITs may need to consider withdrawing their earlier earnings guidance. We are seeing this become a reality right now for hotel operators faced with declining demand for rooms. The GC of a hotel REIT also should be in close contact with the CEO, the CFO, and the board as they consider how the pandemic will affect the company’s dividend policy and how any change to the policy will be communicated to stockholders. To the extent that the firm’s liquidity is at issue, the GC should consider discussing the pandemic’s impact in the Management’s Discussion and Analysis of Financial Position and Results of Operations portions of relevant disclosure documents.
At the same time, some REITs view the market decline as a buying opportunity, both for their own stock and for the securities of other REITs. Issuers should be cognizant of all relevant securities law considerations and should coordinate with outside counsel on sensitive questions about public disclosures and the timing of repurchases. The relationship between NAVs and public market values should be monitored closely. Whether REITs continue to trade at a discount to NAV, as they have for years, remains a question mark while the equity capital markets are this unsettled and the commercial real estate markets have not yet had time to digest the full implications of the pandemic.
It would be reasonable to expect the IPO window, such as it was, to close for the time being, and for follow-on offerings to be put on hold. Proposed at-the-market programs are getting delayed at the moment, in our experience—generally because issuers view current market conditions as more conducive to buying rather than selling equity securities. Lastly, we are seeing REITs notify investors that the annual stockholder meeting will be held by remote communication. We have every reason to expect that this will become the new normal for the spring of 2020.
Equity REITs share some of the concerns common to all owners of commercial real estate.2 The GC of an equity REIT should collaborate with the CEO, asset managers, property managers, and acquisition underwriters in evaluating real estate-related risks. The risk level largely depends on the asset class. For example, nursing home owners face special risks, both operational and market-driven. So do hotel owners and owners of retail venues, including certain asset classes previously considered relatively immune to retail woes, like event spaces and grocery-anchored centers. Moreover, REITs holding European or Asian real estate must contend with travel restrictions, which impose myriad complications on property management and supply chain efficiency.
Wearing the landlord hat, the GC should consider reviewing leases to determine potential responses to rent abatement requests. Property managers might inquire with tenants regarding whether scaling back utility usage is feasible given the move toward remote work. Asset management and acquisition teams should take a fresh look at underwriting assumptions for projects in light of an anticipated economic slowdown.
Other items for the GC’s consideration apply to mortgage REITs and specialty REITs just as much as they pertain to traditionalasset equity REITs.
Regarding the credit markets, the impacts of the coronavirus on mortgage rates, corporate credit ratings, and U.S. Treasuries are uncertain and changing quickly. GCs should communicate with other members of the management team about the legions of threats and opportunities presented.
Some clients are asking for a review of their insurance policies to determine whether the policies cover losses from a pandemic. This includes business interruption and key man insurance. Additionally, counsel can help to determine whether and when notices must be given to insurers.
Lastly, the GC or the appropriate designees should consider whether the pandemic constitutes a force majeure or a material adverse event (MAE) under existing purchase and sale agreements, financing agreements and dealer agreements. The REIT may be the party declaring a force majeure or MAE or the party receiving such notice. In either case, as in a chess game, potential responses need to be mapped out before notices are given or received.
A REIT must meet a number of statutory requirements in order to maintain its status as a REIT. For instance, and generally speaking, at least 75% of a REIT’s assets must consist of real estate and real estate-related assets; at least 75% of a REIT’s gross income must consist of items such as rents, mortgage interest, and gain from the sale of real property interests; and 95% of a REIT’s income must consist of those items as well as certain passive income. In addition, a REIT must distribute 90% of its taxable income to its stockholders in order to avoid punitive excise taxes and income taxes.
In times when economic contraction seems likely, the GC of an equity REIT must be mindful of the impact of slumping prices, tenant defaults, and liquidity shortages on satisfying the relevant REIT requirements. As the composition of a REIT portfolio changes, swings in the value of its assets could affect its ability to meet the necessary asset tests. Tenant defaults could affect the dependability of a REIT’s rental revenue and reduce the magnitude of its qualified income basket. Declining profits could also impair a REIT’s ability to satisfy its distribution requirements and, absent bank financing (which may not be readily available), may cause it to resort to “consent dividends,” which would result in taxable income without corresponding cash distributions for stockholders. While responsibility for monitoring these tests is often left to tax and accounting professionals, the GC is still the person in charge and the one with the most immediate access to the information that will drive REIT compliance. Moreover, the GC will be responsible for communicating these risks to management and the stockholders and considering whether relief measures for failure to comply with certain of these requirements should be sought from the Internal Revenue Service.
REITs, like other employers, need to think about employment law issues. The thoughts below are derived from previous Stroock alerts relating to the coronavirus outbreak. (See the full list at the end of the article.)
Returning to the now-familiar topic of communication, the GC should ensure that the REIT is communicating with employees about the coronavirus, including steps that the employer is taking in response. With the assistance of outside counsel, the GC should evaluate company policies relating to remote working, sick leave, and family leave and determine whether any revisions are necessary. As always, GCs should be careful not to ask employees about their medical condition and should not single out any particular groups of employees for any policy based on their national origin, ethnicity, or other protected status.
Some firms have adopted a pandemic preparedness plan. In addition to business continuity, the plan might encourage employees to stay home when sick, include protocols for quarantine situations, and require increased frequency of environmental surface cleaning. A pandemic preparedness task force, if constituted, should either include or closely coordinate with the GC.
Putting the pandemic preparedness plan into action, REITs with substantial employee headcounts might perform stress tests on remote working infrastructure to ensure that it can bear the load of all or most of the firm’s employees working remotely at the same time. This can be critical to not making the REIT a liar with respect to its long-touted business continuity plan.
Supervision of employees while they work remotely presents unique challenges. The fact of a pandemic does not absolve a REIT of its fiduciary responsibilities to investors, securities law liabilities, or legal obligations as an employer. Therefore, the proverbial machinery of the office needs to keep moving even when the workforce has dispersed to remote locations. Work-from-home protocols need to be designed, communicated, and enforced so the REIT can continue delivering high-quality product to its tenants and preserve and grow the capital that public investors have entrusted to it. In this, the GC has a crucial role and can help the REIT ensure that no weapon launched against it, even the coronavirus, will hit the mark.3
The GC should assume that the pandemic will continue to spread and that things will get worse before they get better. Communication with colleagues, investors, and outside counsel is critical during the course of this fast-moving crisis.*
Evan Hudson is an acknowledged leader among a new generation of real estate capital markets lawyers. He draws on skills honed over more than a decade of concentration in the structuring of real estate investment vehicles, including private funds, DSTs and REITs (publicly traded, non-traded and private). With respect to asset management, on the institutional side, Evan represents some of the largest private REITs in the world. On the retail side, Evan helps sponsors tap the large and growing pool of capital controlled by “mass affluent” and high-net-worth private clients. Jeffrey S. Lowenthal is co-chair of Stroock’s Corporate Practice Group. He concentrates in corporate finance, securities, corporate reorganizations, acquisitions and joint ventures, and general corporate law. Jeffrey counsels issuers, investment banking firms and selling security holders involved in public offerings and private placements of debt and equity securities. He regularly advises public companies on disclosure requirements and other issues arising under federal securities laws. He also represents buyers, sellers and investors in purchases and sales of assets and businesses and other types of business combinations, including joint ventures and similar arrangements. In the credit arena, Jeffrey represents bondholder committees, banks, insurance companies, and other financial institutions and investors in the restructuring of debt facilities and other financing arrangements. Jeffrey D. Uffner, chair of Stroock’s Tax Practice and co-chair of its Private Funds Group, represents prominent securities, real estate, distressed debt and infrastructure fund sponsors, and global, national and regional private funds, in all aspects of domestic, foreign and cross-border tax planning. Jeffrey has extensive experience in a wide range of transactional and commercial tax matters, having structured highly complex, tax-efficient investment platforms for taxable and tax-exempt institutions, high net worth individuals, and non-U.S. investors. He advises clients on the taxation of partnership entities; real estate investment trusts; qualified opportunity zone funds; cross-border acquisitions and investments; mergers and acquisitions; structured and derivative products; investment and energy tax credits; real estate investment and exchanges; and the investment activities of pension plans, tax-exempt organizations, venture capital funds and non-U.S. investors such as sovereign and sovereign wealth funds. Michelle M. Jewett, a partner in Stroock’s New York office, focuses on all areas of federal income taxation, offering deep experience in corporate, mergers and acquisitions, partnership, financial instruments, private fund structures, insurance and reinsurance transactions, intellectual property and real estate investment trusts, both domestically and internationally. Michelle has advised on structuring cross-border taxable and tax-free mergers, acquisitions and dispositions, domestic and foreign private equity investments, real estate investments by taxable and taxexempt entities, mortgage-backed securities and other securitization transactions, leveraged leases, various international investments and transactions, bankruptcy and debt workouts, renewable energy investments and corporate transactions in the insurance industry. She has structured numerous cross-border arrangements, including U.S. and foreign private equity funds, real estate funds, timber funds, energy and infrastructure funds, credit funds, and hedge funds.
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Real Estate > Real Estate Investment Trusts > REIT Transactions > Articles
For an overview of practical guidance on the novel coronavirus (COVID-19) covered in many practice area offerings in Lexis Practice Advisor, see
> CORONAVIRUS (COVID-19) RESOURCE KIT
RESEARCH PATH: Real Estate > Trends & Insights > Practice Notes
For access to client alerts and other coronavirus-related content for real estate professionals, see
> COVID-19 POTENTIAL IMPACT ON REAL ESTATE: CLIENT ALERT DIGEST
RESEARCH PATH: Real Estate > Trends & Insights > Articles
For a general discussion of REIT transactions, see
> REIT TRANSACTIONAL CONSIDERATIONS
RESEARCH PATH: Real Estate > Real Estate Investment Trusts > REIT Transactions > Practice Notes
For an overview of the impact of coronavirus on commercial property insurance claims, see
> APPLYING COMMERCIAL PROPERTY INSURANCE TO COVID-19 LOSSES
1. Derived from the March 12, 2020 Stroock Special Bulletin, which includes notes specific to the role of GC. 2. Derived from the March 3, 2020, Stroock Special Bulletin titled “Steps for Businesses to Consider as Coronavirus Spreads.” 3. Additional Stroock alerts identifying additional issues to consider: “What a General Counsel of a Private Fund Advisor Should Be Doing Today to Manage the Coronavirus Crisis” (March 12, 2020). “The Possible Impact of COVID-19 on the OTC Derivatives Markets” (March 6, 2020).
*This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome.