Feast or Famine: The Importance of Contemplating Failure In Commercial Real Estate Transactions

By Mark Ellinghouse

Every spring, usually on the first weekend of good weather, I rush to the local nursery and spend what feels like a week’s worth of wages on new plants, soil, fertilizer, and irrigation lines. I can’t wait to get the seedlings in the dirt, connect the water, and watch the home-grown, organic produce flow from Mother Earth based only on my sweat equity. And every summer, usually around the Fourth of July, I face the cruel realization that my green thumb was apparently lost at childbirth. The return on investment for 12 cherry tomatoes, 6 strawberries and a shriveled zucchini just isn’t there. Not everything goes to plan. 

I’m often faced with a similar circumstance when presented with a new deal from a client. Whether the letter of intent has been signed or, as I prefer, when my client asks for input while LOI negotiations are ongoing, I will ask my client, “What happens if [insert contingency or assumption] does not occur?” On many occasions, my client will respond with uncertainty, evidencing that they had not contemplated a potential unsuccessful outcome. What follows is often a thoughtful discussion of hypotheticals, playing out the possible results of their transaction and the various rights and obligations each party must assume in such situations. My client will then continue or (worse) have to reopen its negotiations to account for the prospect of these events, which negotiations may have proceeded more smoothly had these outcomes been considered earlier.

Recently, I have been asked to assist multiple clients considering long-term ground leases with national retail tenants in their respective commercial developments. While each deal shares many similar characteristics, each one is a little different. In our discussions regarding the specific terms, I received dramatically different answers regarding the potential outcomes of each transaction.

  • What happens if the tenant ceases operating and goes dark?
  • What happens if the tenant decides the location is not profitable and wants to assign the lease?
  • What happens if the tenant elects to scrap their development and try an entirely new business halfway through the lease?

Some landlords had no issue with these changes, while others were fearful of the effect they could have on the rest of their shopping center(s). Regardless of the answer, the key is for each client to consider what could happen if their transaction does not go exactly as planned so they can ensure the tenant is obligated to perform as the landlord prefers.

Now, this newsletter is not designed to be a warning that some deals fail. Rather, it is merely a reminder that when negotiating a new transaction, clients should consider both positive and negative outcomes and plan accordingly. Would I still spend all of that time and money on plants, nutrients and water if I knew that the bounty of my work would fit in the palm of my hand? Perhaps, because I enjoy the process of working outdoors, getting some sunshine, and occasionally sharing a strawberry with my daughter; but it certainly does not produce a strong ROI. The same analysis should apply to each new purchase, lease or development that my clients review, as a little forethought for the prospect of a negative outcome could avoid the result that I am far too familiar with each summer in my home garden.

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Meet the Author: Mark Ellinghouse
Mark Ellinghouse 916-558-6091

I assist clients with commercial real estate matters, including buying, selling, leasing, and management of real property. I also help clients structure investments in real estate, handling projects relating to financing, investment, and joint ventures.

In addition, I regularly advise clients on general corporate matters, from formation and management to operating issues to third party contracts for licensing, research and development. I have a diverse background, with experience in private practice and in-house counsel, on both litigation and transactional cases, and in non-legal roles. I like working with sophisticated clients who demand top notch legal advice to help them manage their legal issues in an efficient and effective manner.

I look forward to working and/or connecting with you soon. 
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