Download This PageClient Background
Our client is a national real estate development company specializing in the development of office and warehouse properties.
Client Situation
Our client had assembled a $90 million portfolio of mid-rise office properties and was seeking a tax-efficient approach to achieving liquidity. We were asked to assist in developing a strategy.
Our client considered traditional refinancing alternatives, which were tax-efficient but did not result in a high enough level of liquidity. An outright sale of the portfolio was considered undesirable as the client was not confident that it could defer its gain under the Internal Revenue Code Section 1031 like-kind exchange rules, owing to the limited period of time in which qualified replacement property must be acquired. Further complicating our task, the client was interested in retaining a modest level of ownership of and management control over the portfolio.
Our client explored joint venture recapitalization alternatives with an institutional real estate investment advisory firm (that also happens to be a client of our firm). Our client saw that the economic terms of a JV/recap would be attractive. However, given our client’s high liquidity objectives, an ordinary JV/recap would have resulted in a taxable event.
In the course of analyzing alternatives with the client and the investment advisor, we learned that one of the investment advisor’s possible funding sources was a Middle Eastern investment fund whose investment guidelines prohibited interest-based borrowing in order to comply with Islamic Sharia law.
Having worked with Sharia-compliant structures in the past, we recognized a planning opportunity. The investment fund could not acquire the portfolio because it could not become a borrower of the new loan to be placed on the portfolio. As a result there was a proper non-tax business purpose for our client to remain in ownership of the portfolio and avoid a disposition event for tax purposes.
Primary Goals
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Achieve higher level of liquidity than traditional refinancing alternatives
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Avoid a taxable event
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Retain a modest level of ownership of and management control over the portfolio
Anticipated Problems
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Potential taxable event
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Securitized (CMBS) financing
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Investment fund required to comply Islamic Sharia law constraints on borrowing
Service Summary
We were able to meet our client’s liquidity objectives in two ways. First, our client was able to withdraw a conventional proportion of its portfolio equity through a tax-free refinancing. We then structured a master lease of the entire portfolio to a joint venture between the investment fund and our client. Through the master lease and an integrated put option held by the joint venture, we were able to create a spigot for our client to realize additional liquidity on a tax-efficient basis.
The objectives of the investment fund were satisfied by securing a participation in the portfolio through the joint venture/master lessee, without becoming a direct or indirect obligor on the interest-bearing portfolio loan. The new loan was securitized (CMBS) debt, and because it was layered over a master lease the structure made for a rather unusual and lengthy loan negotiation.
Results
The master lease, the joint venture between our client and the investment fund and a related property management agreement were negotiated with four sets of attorneys: our firm’s corporate, tax and real estate lawyers, the corporate, tax and real estate lawyers representing the investment fund, special counsel for the investment fund familiar with Sharia law and the lender’s counsel.
The legal structure of this transaction was exceptionally complex and took approximately five months to negotiate and close. In the end our client’s business and tax objectives were reconciled with the investment fund’s business objectives and Sharia law requirements. More interesting, though, is how the investment fund’s unique Sharia law requirements created an opportunity for our client to achieve a higher level of tax-efficiency.
