Cramer Levin's Jay Neveloff has seen commercial real estate transactions take many different forms during his 36 years at the law firm. Recently, as transactions began to get more complex, he decided to get more proactive.
Neveloff, chairman of Cramer Levin's real estate practice, has focused his recruiting efforts in early 2024 on mid- to senior-level associates with the experience needed to navigate the many moving parts of closing a CRE deal in a turbulent market.
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“A few months ago, when we noticed that our deal volume was increasing, and it wasn't just simple deals, we looked at the situation and realized we really needed more senior talent,” Neveroff said. “Many other law firms weren't as busy, so we saw this as an opportunity in the market to hire senior, talented people who fit the outlook for our business over the next 1-2 years.”
Kramer Levin's focus on experienced attorneys comes in response to a rise in CRE transactions, which often go far beyond the typical transaction between borrower and lender or buyer and seller. Neveloff said many of today's transactions consist of negotiations between multiple lenders and developers who bring in limited partners and investors to acquire the assets.
CRE deals have become especially complex since the Federal Reserve began raising interest rates in early 2022, often requiring more capital due to rising debt costs, but Neveroff said the complexity of the debt stack was established long before that, primarily with the emergence of the commercial mortgage-backed securities (CMBS) market 30 years ago. The number of portfolio loans has also grown, which includes senior and junior mortgages as well as senior and junior mezzanine debt that often mimics CMBS structures.
“When you have so many different factors, you have so many different people and groups that influence you, and they all have different perspectives,” Neveloff said. “You have a worst-case scenario where rates are going sideways and you have people that want to get out of the deal.”
The complex legal work required to close large transactions involving multiple entities was particularly evident in late 2022, when Fried Frank advised Citadel Securities on its plans to build an office tower at 350 Park Avenue. CEO Ken Griffin acquired a 60 percent interest in a joint venture with Vornado Realty Trust (VNO) and Rudin Management Company to develop the 62-story office building on the site that includes 350 Park, 40 East 52nd Street and 39 East 51st Street.
Concurrent with that transaction, Fried Frank also advised Citadel on a 10-year master lease agreement for Vornado's 585,000 square feet of office space at 350 Park and Rudin's 390,000-square-foot tower adjacent to it at 40 East 52nd Street, and on a deal in which Citadel could potentially lease 850,000 square feet of the tower for the hedge fund giant's new Manhattan headquarters once the project is complete.
A few months later, in the spring of 2023, the Griffin, Vornado and Rudin partnership signed a deal to acquire 250,000 feet of air rights from St. Bartholomew's Church for $78 million for the development of a skyscraper scheduled for completion in 2032.
“There was a master lease, then there was a joint venture to develop the building, and once the building was completed, a development lease was signed and separate parcels were acquired with three different parties,” said Jonathan Mechanic, head of real estate at Fried Frank. “It was a complicated deal with people trying to move different pieces together to accommodate what everyone needed to make it work.”
Mechanic said the city's rezoning of Midtown East in 2017 allowed landmark-status buildings to sell air rights for development projects within a 78-block radius, paving the way for multi-faceted deals like 350 Park Avenue.
The first project to take shape thanks to the new zoning laws was JPMorgan Chase's 2.5 million-square-foot headquarters at 270 Park Avenue. Fried Frank helped the bank navigate the new zoning process and negotiated a deal to transfer development rights to up to 668,000 square feet at the site in early 2018. As part of the ongoing project, JPMorgan also purchased the air rights to nearby St. Bartholomew's Church and Grand Central Terminal.
Mechanic said transactions that would previously have been completed within weeks are now taking months due to higher borrowing costs and efforts to acquire preferred shares to successfully raise capital, with deals set to close in 2024. Mechanic said that while deals are taking longer to complete, overall activity is much stronger than in 2023 due to recent clarity around interest rates and an increased number of lenders and equity players deploying capital in the market.
Daniel Berman, a partner in Cramer Levin's real estate practice who joined the firm in 2006, just before the GFC, said CRE financings take time to complete because they involve multiple parties and deal structures often change as the deal progresses from placing equity and finding a lender. He noted that another dynamic that plays out in many deals is that owners contribute a portion of the property as equity to make the economics work.
“Right now, there are some transactions where the land itself is being used as equity, but that's because the deal is not going through,” Berman said. “It's not about giving the seller a loan. The seller is actually providing the land as part of the deal, building up capital that the lender can lend against.”
One reason CRE deals are taking longer is because more elements are being added to the capital stack to compensate senior lenders, from mezzanine debt to preferred and common stock, says Laurie Grasso, partner and co-head of the global real estate practice at Hunton Andrews Kurth. Grasso has also been involved in a rise in deals nationwide that incorporate Commercial Property Assessed Clean Energy (C-PACE) loans into the capital structure. This adds an extra layer of complexity, as the program is relatively new and each state has different rules and often requires an education component.
“It's a different source of capital stack, a different group of lawyers, plus the relationship between the senior lender and the C-PACE lender is complicated,” Grasso said. “Many senior lenders don't understand it, so an endorsement agreement has to be negotiated between the parties, which requires a lot of learning and guidance and will undoubtedly take a lot of time.”
Adding further complexity to the CRE legal profession in 2024, Grasso said, is the growing trend of developers teaming up as joint general partners (GPs) in new project and redevelopment deals, which results in two sets of lawyers navigating the joint ownership structure while also negotiating with lawyers who may be limited partners (LPs), senior lenders or mezzanine lenders in the deal.
Grasso said a big driver for the co-GP structure is that developers often want to team with another partner who has ties to the LP in the deal, as well as a senior lender who can weigh in on the negotiations. The arrangement also allows developers to share in the equity contributions to the LP while also gaining additional liquidity to help secure the construction loan, Grasso said.
“It adds an extra layer of complexity because there are two parties that make up the general partner or developer, and each party has their own concerns and interests,” Grasso said.
Navigating real estate transactions in a rising-rate environment becomes more challenging for lawyers because there are more parties involved in the capital structure, given each investor's individual priorities, said Sonia Kaur Bain, a partner at Blank Rome. Buyers are also increasingly taking on existing loans at more favorable rates from owners who are willing to sell, which creates more tension for lenders, Bain noted.
While deals with multiple competing stakeholders face many obstacles to closing, Bain said that when there are fewer participants, market uncertainty creates even more incentive to close early, especially in certain high-performing asset classes. In those cases, the financing is worked out later.
“We are seeing deals being completed more quickly to avoid potential market risks across parties, lenders and terms,” Bain said. “Or, deals are being completed unfinanced and then subsequently funded due to the difficulty of securing adequate financing in the time frame required to close the deal.”
Bain said experience with previous CRE market disruptions, such as the global financial crisis, has been valuable for lawyers in strategizing how to respond to the headwinds their clients are facing. She highlighted that a big difference now compared to previous downturns is that there is less readily available debt capital, requiring more unconventional approaches to get deals done.
“Leverage is changing a lot on any given day,” Bain says. “I'm not sure that a typical private equity or investor has the same kind of leverage that they probably would have had in the past, so they're just stuck with the capital that's coming in and they're being forced to come up with these creative structures.”
Andrew Coen can be reached at acoen@commercialobserver.com.