Buyers find silver lining in commercial market

The economic downturn has all but crippled the commercial real estate market, leaving private equity groups and other strategic buyers to begin exploring the advantages of purchasing commercial properties out of bankruptcy.

The opportunities are plentiful, though the market is still
establishing its pricing scale, and few buyers want to tip their hands about how much they would pay. But the bankruptcy filing rate for South Florida businesses increased 28 percent in 2009, according to statistics reported by the U.S. Bankruptcy Court for the Southern District of Florida.

No company wants to file for bankruptcy, but there is a silver lining for strategic buyers, according to Kevin Lamb, a corporate attorney and shareholder at the Gunster law firm in West Palm Beach. Strategic buyers with funds at the ready in mergers and acquisitions, he said, can cherry-pick the company’s real estate assets while leaving the liabilities behind.

“In a down economy, a substantial portion of [mergers and acquisitions] activity takes place in a bankruptcy setting. Buyers familiar with the process can reap substantial value,” Lamb said. “A bankruptcy sale can also benefit the bankrupt company’s employees, who often find a home with the buyer.”

Lamb said he helped close three deals for strategic buyers at the end of last year, but declined to disclose any details. Private equity
firms are getting more aggressive about making bids for real estate in bankruptcy, he said. At the same time, lenders are looking to sell
properties on which they foreclosed and strategic investors are
preparing to build their portfolios.

“Strategic buyers and hedge funds with large cash reserves are finding opportunities in commercial bankruptcy cases,” said Jack Williams, southeast regional director of business restructuring at BDO Consulting in Atlanta. “The trick is wading through the bankruptcy sale without tripping any mines. The lack of publication in local papers works to the advantage of those playing in the market.”

For all the deals that haven’t been publicized, there are some high-profile South Florida companies selling real estate out of bankruptcy that are well-documented.

Hollywood-based bankrupted home builder Tousa is in the process of selling off its real estate to Starwood Land Ventures. Hoboken, N.J.-based homebuilder Tarragon filed for Chapter 11 bankruptcy in January. Tarragon also
operates in Florida.

Most hotels filing for bankruptcy are sold through the Bankruptcy Code section 363, which is used to speed up the bankruptcy process when the company has identified a prospective purchaser. One recent fire sale out of bankruptcy was the 239-suite Resort at Singer Island. The two-year-old resort was sold for $7.1 million, or $29,707 per unit, to Urgo Hotels of Bethesda, Md. in November.

Bankruptcy sales are efficient and expeditious because the court
supervises the process. Supervision tends to also lead to lower due
diligence costs because the bankruptcy sale order extinguishes all
liens, claims and encumbrances on the property. But there are often
obstacles to these transactions.

“Bankruptcy sales, even if they begin as a private sale, are always
subject to an auction test,” Williams said. “You can prepare all the
documents and be ready to close the deal, but if a competing bidder shows up with a better offer, it launches a bidding war. So you always run the risk of losing the deal.”

Savvy purchasers protect themselves with capping fees, break-up fees and other measures, to ensure they get not only their initial
investment in due diligence backed up but also any lost opportunity costs, Williams said. Smart purchasers are also cautious about which opportunities they pursue.

Strategic buyers want companies that are undervalued or struggling
under large debt burdens — but still retain strong fundamentals.
Broken companies with poor management and or companies with high legacy costs are not desirable targets.

“’Cherry-picking’ is a good word because you do get the opportunity to target the assets you are interested in and disregard the others so you get maximum value,” Williams said. “This is not unlike other downturns in the real estate market in the past, except for the fact that we really don’t have major participation by financial buyers because financing is unavailable at this time. So strategic buyers have a keen advantage and can really get value for their money now.”