Last week, I was thinking about the elephant in the room vis a vis the frozen real estate markets. Everyone is kind of looking at deals and saying something like:
If it weren’t for the huge uncertainty in the economy and the COVID situation, I really like this deal, but with this backdrop, I just can’t price it. I will wait things out.
The problems with this are obvious. No one does business. People miss out on their upside for fear of their downside. The industry just sits there. Parties that raised money have nothing to do with it and are paying their people to sit around. Parties who have great development projects can’t develop them. No one earns a bonus as they haven’t done any business.
We are all frozen, even though many “want” to do deals and have the money to do them, but can’t price them, or if they can price them, it is at too steep of a discount for a seller to be willing to transact.
So I have a solution. It is kind of crazy simple, but sometimes the simplest solutions can work quite well.
Assume that the buyer would be comfortable paying $100M for the property if it could have a level of assurance that the economy isn’t still going off a cliff, that COVID won’t have a second wave, etc. But with all the uncertainty right now, the buyer is comfortable paying only $80M and to bolster that, perhaps that is the maximum pricing at which it can obtain appropriate financing. However, at that lower price, the seller would prefer not to sell and just wait. So there is no deal.
My suggestion is that the buyer and seller should agree on a price of $100M; however, the price will be paid $80M in cash at closing, with the remainder in escrow based on the COVID Earnout.
What is the COVID Earnout, you might ask?
It is whatever the buyer and the seller agree on a macro basis that will justify the higher price. There could be any number of factors, which might include any or all of the following, or others I didn’t think of:
- 2nd quarter, 3rd quarter, 4th quarter or 2020 or 2021 GDP growth
- Interest rates as of a date in the future
- Public market prices for assets of the nature being purchased/sold in the deal
- A COVID related vaccine in effect and/or other COVID related positive data
- Stock market indexes at a certain point as of a date certain
- Positive leasing or other market data in the city/location where the property is
The idea is that the seller gets its price if the macro events pan out, but not otherwise. Both parties can now price the deal, and the deal can get done.
And if you are wondering, the answer is: “no, I don’t have a client doing a deal of this nature right now.” However, if this idea if of interest, please give me a call, and we could discuss it further.
I hope everyone is safe and healthy and not only surviving but thriving as well.
The Real Estate Philosopher