Despite the market changes of recent months, investor appetite for real estate M&A transactions has held up. However, this type of deal is by no means risk-free and Warranty & Indemnity (W&I) insurance has become a common feature in many markets.
Take a quick look at some of the potential exposures and it is easy to understand why.
Material risks typically fall in one of three main categories. First, matters relating to existing lease agreements may not be fully disclosed by the seller, and so may come as an unwelcome surprise to the buyer, with potentially high costs attached. Second, construction defects, damage to the building or poor condition of material equipment could be revealed only after the transaction is completed. And third, tax claims can be an issue, particularly where large portfolios involving multiple buildings are involved.
Beyond these main risks, there is a range of other things to watch out for. These include, among others, deficiency in title, counterparty exposures that can lead to contractual risks, and defects in the building planning, zoning and permitting process. Environmental risk can also be a problem. The list goes on.
All participants in the transaction can benefit from W&I insurance. For the seller, it can enable greater control over the sales process, enhance speed to closing and potentially even attract higher bids. It also enables a clean exit whereby only limited liability remains.
A W&I policy can serve as an advantage in a competitive bidding process. But perhaps equally importantly it helps to protect relationships. Large funds and property developers are mainstays in the market and as such the same parties deal with each other repeatedly over the long term. It is therefore important to maintain good relationships, something W&I insurance can help protect.
Finally, given its increased use, it is important for advisors to understand W&I insurance and how to incorporate it into the transaction process in order to keep the deal moving at speed. Those who are not familiar with the impact that W&I can have on the sales process, and the specific documentation or due diligence requirements, may find it difficult to make the necessary adjustment at short notice without affecting the deal timeline.
Insurance buyers need to select their carrier with care. In the past year there has been a combination of increased W&I insurance capacity and a limited and diminishing pool of transactions. As a result, it is becoming increasingly difficult to differentiate between W&I insurers, whose offerings have converged to become closely aligned on price and processes, as well as terms and conditions.
With the economic future uncertain, insurers could face significant losses, and some may decide to pull their capacity altogether. Those taking out a policy from an established and market leading insurer have the reassurance of financial strength, as well as the advantage of a single point of contact throughout the process.
When selecting a W&I insurer, there is a distinct advantage in seeking out a provider with a long track record of experience in the market and of paying claims . Having underwriters on the ground in the market where assets are located is also vital, as their local knowledge can actively help to identify, mitigate and navigate the risks that are present in real estate transactions.
Peter Dzurianik, M&A Underwriter at AIG.
This article first appeared in Insurance Day