Hedging issues in real estate finance transactions
Produced in partnership with Ruth Marken and Mike Tanner of CMS
Hedging issues in real estate finance transactions

The following Banking & Finance guidance note Produced in partnership with Ruth Marken and Mike Tanner of CMS provides comprehensive and up to date legal information covering:

  • Hedging issues in real estate finance transactions
  • Why is hedging used in real estate finance?
  • Who is the hedge counterparty in a real estate finance transaction?
  • Key documentation issues concerning the hedging
  • Hedging and intercreditor issues
  • Regulatory issues

Various documentation issues need to be considered in real estate finance transactions that involve hedging to ensure that the facility documentation and hedging documentation are aligned.

Also, it is important to consider certain intercreditor issues such as where the hedging counterparty ranks in terms of the security package and who can make key decisions under the facility agreement and how that impacts on the hedging counterparty.

Why is hedging used in real estate finance?

Real estate finance structures and hedging

In a real estate finance structure, the borrower will typically be a special purpose vehicle (SPV) set up for the purpose of owning a property or portfolio of properties. It will usually have no revenue streams other than the rental income on the property. For more information, see Structure of a typical real estate finance investment transaction and Borrower entities in real estate finance transactions.

From both the borrower's (investment modelling) and the lender's (credit control) perspective, the financing transaction is predicated on the expectation that the net rental income generated from the property will satisfy the ongoing interest payments under the loan (and amortising principal repayments, if any).

Any external factors which may impact on the certainty of the rental stream or the payments to be made to the lender will need to be mitigated or removed to protect the structure.