Commercial Real Estate Distress
There has been a huge amount of media coverage and commentary recently regarding the significant challenges that owners in the commercial real estate space are facing, with McKinsey Global Institute estimating that as much as $1.3 trillion of commercial real estate value will be erased in big cities around the world by 2030. In addition, the continuing work-from-home impact that is driving down occupancy and leasing rates, combined with the fastest pace of interest-rate hikes in a generation, is contributing to the global debt crisis. The challenges experienced by commercial real estate owners are ubiquitous. So, what can owners and debtholders do to overcome them?
To date, the typical real estate playbook has had a limited number of options. The owner – when faced with an impending maturity that cannot be refinanced or a capital requirement that cannot be met – hands the keys over to lenders and walks away. As a result, (1) the owner loses all equity value in the property, and (2) the lenders must either attempt to manage and invest even more capital to improve its value or run their own sale process (which often yields a significant loss in recovery). In short, this well-traveled path often leads to a suboptimal result for all parties.
However, there are alternatives to the traditional playbook that provide opportunities for significantly better outcomes. For example, during the Great Recession, many retail malls – which were some of the most distressed assets in the U.S. at the time – filed for Chapter 11. At the time, a shopping mall filing for Chapter 11 was a de nouveau idea, since many were set up in separate bankruptcy remote special purpose vehicles – specifically to avoid being subject to a Chapter 11 filing. To overcome this, new entities were created, and new boards of directors were established that enabled the owners of the mall to employ Chapter 11 to their benefit.
The most important benefit that was realized as a result of developing a creative way to utilize the Chapter 11 bankruptcy process was simple: time.
More specifically, a Chapter 11 bankruptcy gave owners the time to evaluate and determine the best path forward – including the best restructuring alternatives for the owners, lenders, and creditors and for capital markets to improve. In addition, the Chapter 11 filing stayed all actions and enforcements against the Company or property and created a path for a consensual resolution to maximize value for all parties. For example, when General Growth Properties filed for Chapter 11 in 2009, its debt and equity was trading at $.05 and $.25 per share, respectively. However, when the company emerged from bankruptcy the following year, debtholders received a full par recovery and equity was trading at $15/share.
The tools of a Chapter 11 filing – and the resulting benefits – can also be realized in today’s commercial office real estate environment. In Part II of this analysis, I will discuss these dynamics and detail the factors distressed owners should consider when determining the viability of a Chapter 11 process.