Q&A: Distressed real estate litigation and restructuring
October 2021 | SPECIAL REPORT: RESTRUCTURING & INSOLVENCY
Financier Worldwide Magazine
October 2021 Issue
FW discusses distressed real estate litigation and restructuring with Brent Worthy and Kristi Gibson at BDO.
FW: Reflecting on the last 12-18 months, what do you consider to be the key trends shaping the real estate sector? In particular, what effect has the coronavirus (COVID-19) pandemic had on real estate assets and returns?
Gibson: The key trends for the commercial real estate industry really depend on the specific sectors, which, at the highest level, can be broken into industrial, corporate office space, retail and restaurant, travel and hospitality, and residential. Industrial, for the most part, has fared the best, and, in some cases, even expanded its market share, as it has met increased demand levels resulting from the pandemic. Corporate office space remains the most ambiguous, as companies continue to re-evaluate their real estate footprints and workforce engagement models. Retail and restaurants continue to adjust and transform their underlying business models to satisfy different customer experience demands. As vaccination rates increase and we emerge from the pandemic, significant business and recreational travel activity trends should continue to improve toward pre-pandemic levels. Multifamily properties, particularly in some central business districts, are facing significant challenges. Landlords faced increasing economic hardship with governmental eviction moratoriums which will likely be exacerbated by tenants unable to afford their rent. The coronavirus (COVID-19) pandemic produced unprecedented volatility regarding how assets are valued. As a result, major valuers have indicated their intention to introduce a material uncertainty qualification for valuations dated 31 March 2020 and onward. This approach is likely to be implemented globally for all RICS Red Book valuations.
FW: How would you describe the level of disputes arising in the real estate space? Are you seeing any common types of dispute leading to litigation?
Worthy: The level of disputes spiked early in the pandemic as corporate bankruptcy filings neared 2008 levels during the late spring and early summer of 2020. As the economy has experienced a relatively sharp ‘V-shaped’ recovery, the number of formal disputes requiring litigation has significantly declined. Among companies with more than $10m in debt, real estate bankruptcy filings comprised only 2 percent of total cases in 2020 and 5 percent of cases up to 24 August, according to Debtwire Restructuring Database. Litigation is still required, mainly when significant reduction in real estate and labour expenses are not enough for businesses to remain operational and a formal plan of reorganisation, or liquidation in some cases, is necessary.
“Assuming no further government intervention or regulation is implemented, it is a reasonable assumption that we will see a sharp increase in defaults and eviction proceedings.”
FW: To what extent have recent regulatory developments impacted the landlord/tenant dynamic, and related litigation?
Gibson: Recent regulatory developments, such as tenant eviction moratoriums, had shifted the contention from landlord versus tenant to landlord versus governmental intervention. The regulation provided the opportunity for out-of-court negotiations to take place in a less hostile environment. However, as landlords’ balance sheets continue to deteriorate, the strain on the tenant/landlord relationship will return and increase until a new baseline and equilibrium can be established industry by industry. One important update, the immediate impact of which remains to be seen, is the recent ruling by the Supreme Court of the US striking down a recent federal eviction moratorium, imposed in August by the Centers for Disease Control and Prevention (CDC), which was originally set to expire in October. The outcomes of this decision, both in the short and long term, will be closely watched by the industry to see how things play out. Assuming no further government intervention or regulation is implemented, it is a reasonable assumption that we will see a sharp increase in defaults and eviction proceedings.
FW: Based on your experience, does there seem to be a general desire to reach a compromise without the need for court proceedings? What options are available to parties?
Gibson: Generally, both tenants and landlords are seeking to work together to find a reasonable and suitable outcome for each party. Several options available are a renegotiation of contract terms, near-term rent rates and forgiveness coupled with an extension of the duration of the contract, access to federal funds to cover all or a portion of current rent rates, and, in some cases, outright release and remarketing of unused space. That being said, landlords will only be willing and able to work outside of court proceedings for so long, especially as federal relief programmes continue to expire or deplete entirely.
FW: With the real estate sector suffering the financial impact of the pandemic, are you seeing — or do you expect to see — a rise in restructuring efforts related to distressed property assets and portfolios? What strategies are likely to be deployed in these scenarios?
Worthy: Overall, the market expects to see a rise in both in-court and out-of-court restructurings, particularly where real estate and real estate-related capital expenditures make up a significant portion of a company’s ability to generate the revenue and returns required to satisfy all other financial obligations. One key factor in the expected increase in restructuring activity will be a return to fundamental monetary policy in the debt and capital markets. As banks and other lenders are encouraged to reassess the underlying values of properties and assets supporting both cash flow and asset-based loans, the market will likely see a surge in refinancing and recapitalisations. Assuming property values improve to pre-pandemic levels, a rise in asset sales and repurposing can also be expected.
“For those industries that have been the most severely impacted, they will drive the next surge in restructuring and litigation activity without the benefit of a sharp recovery.”
FW: With record levels of dry powder available, how would you characterise the opportunities available to investors looking to acquire distressed real estate assets?
Worthy: Like the key trends impacting the commercial real estate market, the opportunities for investors to deploy capital and acquire distressed real estate assets will vary industry by industry. Those firms, be they private equity, hedge funds, family offices and so on, with the expertise to value, manage and reinvent certain types of assets will be highly successful and play a significant role in the long-term recovery of the market. Similarly, landlords with substantial amounts of cash and access to capital will have the opportunity to consolidate real estate assets. Most of the capital is being deployed where margins and growth, or return to growth, are sustainable, whereas real estate-heavy assets are going to be more highly scrutinised in the near term. Fund size also plays a role in the types of opportunities pursued. For example, we are seeing many of the larger real estate funds target a broad opportunity set, whereas many mid-sized funds seem to be focused on the multifamily category.
FW: In your opinion, what is the current outlook for the real estate sector? What are your predictions for levels of distress, restructuring and litigation activity in the coming months?
Worthy: We have already seen normalisation, and even some appreciation, in certain industries and in certain geographic markets. However, a fundamental shift in where and how people work and engage with their employer has occurred, at least for the foreseeable future, and businesses are continuing to assess their overall strategies. We expect the market to heal and recover over time. But for those industries that have been the most severely impacted, they will drive the next surge in restructuring and litigation activity without the benefit of a sharp recovery. Depending on the impacts of the delta variant and a potential ‘W-shaped’ or ‘double-dip’ recovery, that expected increase in restructuring and litigation could come sooner rather than later. In either case, the levels of activity are expected to remain below early pandemic levels with a significant amount of ‘restructuring’ occurring in the transaction market.
Brent Worthy has over 15 years of crisis management, corporate restructuring, M&A and digital finance transformation experience. He has led numerous debtor-side, creditor-side and interim management engagements for public, private and PE-sponsored companies. For the past several years, he has transformed all aspects of the CFO’s organisation for distressed and non-distressed companies through a combination of strategic and operational initiatives across people, process, data and technology solutions aimed at driving long-term shareholder value and sustainable growth. He can be contacted on +1 (214) 665 0760 or by email: bworthy@bdo-ba.com.
Kristi Gibson co-leads the BDO real estate & construction practice and is responsible for strategy design and implementation and thought leadership. She has more than 25 years of experience advising public and private clients in every sector of real estate and construction. She guides her clients through every stage of the entity lifecycle, providing value-added advice at each stage. She also has extensive experience structuring settlements to minimise taxes and providing litigation support and management. She can be contacted on +1 (214) 665 0656 or by email: kgibson@bdo.com.
© Financier Worldwide
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