During the last major real estate downturn, in the early 1990s, New York developers frequently used bankruptcy filings to shield troubled assets from foreclosure. This time around, however, that haven may not be available.
Changes to federal bankruptcy laws and a recent court ruling in New Jersey could have a major impact on how the collapses of the commercial and multi-family real estate markets play out in 2009.
Mark Fawer, a partner in the real estate group of law firm Dickstein Shapiro, said developers have often used bankruptcy filings to delay the repayment of delinquent loans or to extract more favorable terms from a lender to prevent a property from going into foreclosure.
“There are those borrowers who would use bankruptcy as just another delaying technique, as a last resort before a foreclosure sale takes place,” said Fawer. “There are others that would look to it as a tool to reorganize.”
Under federal bankruptcy reform legislation passed in 2005, large commercial buildings are now subject to rules that require single-asset real estate companies to submit a reasonable repayment plan or begin paying interest to lenders within 90 days of the commencement of a bankruptcy filing.
In 2006, Kara Homes, an East Brunswick-based homebuilder, filed for bankruptcy protection. A year later, a U.S. bankruptcy court judge held that Kara would be treated as a single-asset real estate case, even though the firm developed condos and planned communities through 22 limited liability companies.
“Generally, other jurisdictions look to New York courts for guidance, especially in the Southern District,” said David Schechtman, a real estate attorney and senior director of the turnaround and distressed group at Eastern Consolidated. “In this instance, the decision in Kara Homes … will likely have some impact in New York.”
Even though the Kara case was not appealed to the Second Circuit, which would have made it legally binding in other jurisdictions, including New York, lawyers say it may serve to guide New York bankruptcy court judges.
The legal uncertainty comes as New York is experiencing the beginning of a wave of commercial and multi-family defaults that could lead to an increase in bankruptcy filings.
A December report by Real Capital Analytics identified 32 distressed properties worth $3.4 billion in the New York area, plus an additional 236 potentially troubled properties valued at $8.6 billion. The report identifies distressed assets as those in default, foreclosure or bankruptcy and potentially troubled assets as those where the owners are known to be in financial distress, but not directly in connection with the individual properties. In Manhattan, it estimated the combined value of distressed and troubled properties at $7 billion.
Experts say the methods used to deal with troubled real estate projects, either bankruptcy, negotiated repayment or some other type of workout, will depend on a few factors, including the ownership structure of a building, the financial conditions of the lender and developer, and whether the property is still under construction or actively generating income.
Dan Fasulo, managing director of research at Real Capital Analytics, said developers who can generate rental income from their properties will be in a stronger negotiating position with their lenders than developers with unfinished construction sites.
Among local firms with distressed assets, New York-based Broadway Partners is being closely watched. The Wall Street Journal reported that the privately held firm defaulted on $700 million in loans tied to Boston’s John Hancock Tower and other buildings, and Real Capital Analytics put the company’s 450 West 33rd Street building on its list of potentially troubled assets
Various lenders involved with Broadway Partners’ properties are wrangling over who will be paid back first. If the lenders can’t resolve the dispute among themselves, sources said, a court may need to resolve it. But, sources familiar with the talks said there is no indication that Broadway Partners as a company is at risk of filing for bankruptcy because the default involves only one of its individual funds.
Meanwhile, in the multi-family market, many condo projects have stalled because they have failed to pre-sell enough units to meet Fannie Mae loan-guarantee requirements, which will rise from 51 to 70 percent in April. If the projects fail to produce income, developers will be hard pressed to stay current on their construction loans and could risk defaulting, which could give them reason to file for bankruptcy protection. That’s because many of these buildings cannot cover the debt service with rental income alone.
At the 583-unit Manhattan House at 200 East 66th Street, fewer than 150 apartments have been sold. Moreover, less than one-third of those deals have closed, as some buyers have been unable to obtain financing and others may walk away from deposits. Manhattan House officials were not immediately available for comment.
O’Connor Capital, which owns the building, originally structured the project into a series of limited liability companies, including MH Residential and MH Commercial, which owned the ground-floor retail space that was sold in October for $86 million.
The limited liability structure would, therefore, protect O’Connor Capital’s other businesses from claims against Manhattan House.
There is no indication that bankruptcy is being considered at the project, but sources say it will be nearly impossible for O’Connor Capital to complete the conversion because of the large number of unsold apartments. Sources say that senior lender HSH Nordbank is looking for a new developer to take over the project.
With other troubled properties, lenders like Manhattan-based iStar Financial have used the courts to protect their financial interests. In December, iStar filed suit against developers Yitzchak Tessler and Meyer and Jacob Chetrit after they allegedly defaulted on a $103 million loan for a mixed-use tower at 855 Sixth Avenue near Herald Square.
The proposed 632,000-square-foot building was set to become a major retail, office and condo building, but the developers allegedly defaulted in October after obtaining a six-month extension on the loan. The loan was part of a huge commercial portfolio that iStar purchased from Fremont General Corp. for $1.9 billion in 2007.
Sources said that iStar would have little incentive to work out a deal, because the site does not currently have any rent-producing space.
Lawyers and financial analysts are closely watching several other projects that appear to be in trouble, including Tishman Speyer’s Stuyvesant Town and Peter Cooper Village, an 11,200-apartment rental community that is quickly running out of cash, according to Fitch Ratings. The agency said the developer is paying the property’s massive debt from a reserve fund, which has only six months of cash remaining.