One of the key findings from Aon’s latest C-Suite Series M&A report – Leaving nothing on the table: Unlocking off-radar transaction value – is the need to “rethink the breadth and depth of pre-transaction due diligence.” This has a resonance in the real estate sector where deals, particularly involving hospitality related property acquisitions, often see investors picking up an operational business with all its potential liabilities.
Taking due diligence deeper
In a traditional real estate deal where you’re just buying a building or a number of buildings, and you’re going to be a landlord with tenants for example, then the due diligence we do is often quite light from an insurance perspective; checking what the current insurance arrangements are and whether there are any outstanding claims, before making sure new insurance is in place for completion of the deal. It’s a relatively light touch approach. The real difference we’re seeing in deal due diligence and where investors need to ensure they go much deeper than they may have done previously is in the hospitality sector and not just for hotels, but in businesses like residential co-living arrangements, and care homes.
In deals like these, it’s critical that buyers go well beyond the current insurance arrangements and look at areas such as cyber exposure. We’ve done a lot of hotel deals where we automatically do cyber due diligence just to see what exposures the client might be bringing into their overall risk register through the acquisition of an operational business.
Aon’s M&A report emphasises that cyber risk alone can seriously erode deal value particularly if there has been a systems breach or compromise resulting in the loss of customer data, or where underinvestment in areas like cyber security will require money spent to be spent. Other potential risks for such businesses include human capital and an understanding of what exposure there might be in terms of social security and requirements around pensions, as well as what the contractual relationships are like between a business and its employees – a growing issue of concern in the gig economy.
Reducing long term exposure
Aside from due diligence, a clean entry and clean exit for investors when they’re involved in the buying and selling of properties is key and the use of warranty and indemnity (W&I) insurance is becoming the norm in real estate particularly for private equity funds where they don’t want any long-term exposure. It also helps reduce the need for implementing a costly escrow which could negatively impact on the yield delivered for investors.
There is also a growing demand from investors for protection from new risks. Again, looking at the hospitality sector, it could be buyers looking to prevent a hotel they’ve bought falling foul of a ‘black swan’ risk event such as a nearby terrorist attack that can close an entire area which hits the hotel’s financial projections. Parametric insurance solutions can plot the impact of such an event and compensate losses.
The need for speed
What never changes in the real estate sector however when it comes to deal making is the importance of “speed of execution” for competitive advantage. Buyers and sellers want to get deals done quickly to avoid burning additional time and adviser fees. Insurance solutions and more specialist due diligence can play a critical role in overcoming deal hurdles where risk transfer options are available.
Read the full report: Leaving nothing on the table: Unlocking off-radar transaction value