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Protect Your Real Estate Project in a Rising Interest Rate Environment By John R. Blake, Jr., Esq.

Wednesday, June 16, 2004 - By: John R. Blake, Jr.

By John R. Blake, Jr., Esq.

With the expected rise in interest rates looming, the cost of real estate projects will be more closely scrutinized. Perhaps the most critical factor in the cost equation with respect to interest rates is time. Identifying possible sources of delays and working to minimize the risks of delays maximizes the project proponent's chances of taking advantage of lower interest rates.

The first opportunity to avoid delays comes at the due diligence phase of a project. With the advent of many federal, state and local government agencies providing access to government records via the internet, thereby eliminating the need to visit several different government offices in person, the initial due diligence investigation can, in some cases, be completed in a matter of hours. Examples of government records available on-line include municipal assessor's records, registry of deeds records (and in some cases document images), zoning regulations, environmental information, corporate and U.C.C. records, court filings, and statutes and regulations. The web portal is an excellent resource for finding such information in all states as well as the federal government. In some cases, certificates from government agencies can be ordered on-line, eliminating the typical delays in mailing requests.

Preliminary due diligence done early in the process can identify lead time items such as required permits or outstanding title issues which, if discovered too late on the process, could result in project delays.

While the foregoing items are helpful to the project proponent in avoiding delays within the proponent's control, the proponent must take into consideration delays caused by other parties. The opportunity to eliminate those delays comes in the operative transaction document, whether it is a purchase agreement, lease or construction contract. Setting early deadlines for delivery of documents, such as consents, from the respective parties or from third parties (e.g. lenders or lessors) can give early clues to problems if those deadlines are not met. If third party consent to a project is not timely delivered, such failure might indicate further negotiations with the third party are needed, which can lead to delays.

Scrutinizing a lender's financing commitment also provides opportunities to avoid delays that can result in a lost interest rate. Foremost is the commitment's expiration date.  In the event the financing commitment expires, its extension on the same terms may require payment of additional fees to the lender.  In addition, the preconditions to closing must be reviewed to identify long lead time items.  Delays in obtaining lender required permits and approvals, surveys, environmental reports or appraisals can also jeopardize a closing date, and consequently jeopardize an attractive interest rate. In some cases, a lender might require delivery of such items in advance of the closing in order for the lender to complete its review of the same.

Protections in the form of compensation for delays built into a contract can help to offset increased costs from a rise in the interest rate. Liquidated damages clauses, or "penalty" clauses in contracts are one method of addressing delays in contracts. Penalty clauses have the effect of shifting the cost of the delay onto the non-performing party. Whether in the form of an adjustment to the purchase price for delays caused by the seller, or per diem damages for delays in completing construction (and consequently the closing of the permanent financing), penalty clauses can compensate the proponent for an increased interest rate caused by a delay.

While true "penalty" clauses are not generally enforced in contracts, if the penalty clause is in the nature of a liquidated damages provision, where the amount paid to the non-breaching party bears a reasonable relationship to the harm suffered because of the delay, then courts are generally more likely to enforce such a provision in a contract.

While no one can see into the future and eliminate all risk of delays in a project, foresight in the due diligence process and the contract itself can reduce the risks of losing the benefits of an attractive interest rate, especially in the current economic environment.