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November 10, 2020
Commercial Real Estate Bankruptcies During a Pandemic
By Gregory S. Milligan, CTP

Commercial Real Estate Bankruptcies on the Rise?

Will the trend of distressed real estate sitting idle continue as some sellers refuse to make material price reductions? While we cannot predict what 2021 will bring, CBRE, the world’s largest commercial real estate services company, reports that distressed selling in 2020 has been limited. While investors expect property values to drop based upon depressed rental income, some sellers are taking assets off the market rather than incurring major price reductions. CBRE’s preliminary forecast is for a 14% drop in capital value in 2020 and a 3.4% increase in 2021. So, it seems that owners who are unwilling to sell at a discount will have to extend the holding pattern by a few years to make up the loss in value. However, holding on was not an option for a recent transaction in which Harney Partners was involved.

Harney Partners’ Greg Milligan was appointed Chapter 11 Trustee (professional fiduciary services) of 3443 Zen Garden, LP which owned and was redeveloping a former Motorola semiconductor campus located six miles from downtown Austin and near Austin Bergstrom International Airport. The developer’s goal was to redevelop the 109-acre mixed use campus with offices, hotels, and retail spaces and utilize state of the art “green” technology, renewable energy resources and sustainable design. Unfortunately, legal disputes among its partners and with its senior lender led to a cessation of meaningful work, a failed receivership proceeding in state court and ultimately an involuntary Chapter 11filing. Immediately after the Court entered its Consent Order for Entry of Relief granting the involuntary relief, the petitioning creditors filed their motion for the appointment of a trustee, which resulted in Milligan’s appointment.

According to data from the American Bankruptcy Institute, Chapter 11 filings in 2020 are on pace to be approximately 25% higher than 2019.  This will include a record number of very large cases, and about 50% of the Chapter 11 cases will be related filings by subsidiaries of a corporate group.

Following financial difficulties and a spinoff of Motorola’s semiconductor business, the Motorola campus was largely abandoned and sat stagnant for more than a decade prior to purchase by Zen Garden, during which time the property deteriorated. Given the debtor’s internal disputes between management and ownership, and its inability to access sufficient capital to complete the next phase of the redevelopment, Milligan determined that a sale of the property was required. Milligan engaged Cushman & Wakefield to assist in the sale of the property during which time the opportunity was directly marketed to more than 2,500 targets with 79 potential buyers executing nondisclosure agreements.

After a court-approved sale process, which included the senior lender’s right to credit bid its asserted claim of approximately $100MM, the lender was the highest bidder at $45 million and the sale was closed on October 15, 2020.

What do other experts have to say?

Various industry observers report that through October, commercial real estate activity is down 48% year over year globally.  Retail, hotel and lodging, and office are the three commercial real estate sectors that were hit the hardest, with experts estimating a 12-month or more recovery period. Currently, industrial/logistics is by far the leader among commercial real estate with multifamily properties, particularly those in suburban areas, trailing behind. Despite certain sectors having a tough time, there are relatively few distressed asset sales in the commercial space, with most property owners expecting prices that match or beat values in Q1 of 2020.

Is the pandemic negatively affecting every deal?

Apparently not, because in another recent case, Milligan, as Receiver appointed by the Securities and Exchange Commission related to a $400 million Ponzi scheme, sold a $6 billion portfolio of defaulted consumer debt with the assistance of Garnet Capital Advisors and found that sale not to be negatively impacted by COVID-19. Given the lack of inventory on the market during the pandemic, combined with the pent-up capital chasing deals, potential buyer interest/activity was actually increased, and the ultimate sale price was in line with pre-COVID results. In this case, strategically moving certain assets during the pandemic achieved higher returns versus waiting until the market is later flooded with pent-up inventory, which will depress pricing and returns.

What’s on the horizon?

All we know for certain (besides death and taxes) is that 2020 has been a crazy year filled with lots of challenges across many industries, including the commercial real estate industry. We don’t have all the answers, but we are certainly looking forward to a new year.

Gregory S. Milligan, CTP
Executive Vice President

For more than 25 years, and with engagements involving onsite advisory to clients in more than 25 states and multiple foreign countries, Greg has maintained a practice surrounding troubled situations or situations that require fiduciary oversight. He joined Harney Partners in 1998 and opened the Austin office in 2001. Since that time, he has both led and collaborated on engagements with highly successful outcomes, meriting multiple peer-review awards from the Turnaround Management Association and the M&A Advisor.