Developer Dana Spain was weeks away from finishing construction on a $20 million co-living project when she learned her operating partner went out of business.
Quarters, a subsidiary of Germany-based Medici Living Group, had signed a 10-year lease to operate the 186 units at Spain’s project in the trendy Philadelphia neighborhood of Northern Liberties in 2019. It was part of Quarters’ plan to open 1,500 units in the U.S., after securing $300 million in funds that year. So its abrupt bankruptcy two years later took owners like Spain by surprise.
The firm filed for bankruptcy on Friday, Jan. 15. That morning in a company-wide video call, co-CEO Rui Barros explained that the co-living firm couldn’t secure additional capital and was shutting down, according to a source present who spoke on the condition of anonymity.
“It came down to the last week, the last day, and they just ran out of money,” the person said. But Quarters didn’t inform its landlords until the following Monday, which was a federal holiday. Most of its tenants and vendors were left in the dark.
In fact, the circumstances of the firm’s sudden closure were so dire that attorney Alan Nisselson, the court-appointed interim trustee for its Chapter 7 proceedings, petitioned the court to dismiss the case. He cited Quarters’ insufficient records: a mere $17,000 in the bank and frantic tenants.
“I have received and am continuing to receive numerous calls and emails from desperate tenants, who are either moving out and are demanding the return of their security deposits, or moving in and demanding keys and access,” Nisselson told the court in his motion. “No purpose is served by sustaining bankruptcy cases that prevent people from living their lives, while the Debtors accrue enormous administrative debt without any hope of payment.”
Under Chapter 7 bankruptcy, no creditor is able to collect from the filing company. Nisselson argued the case was interfering with unsuspecting people’s lives and only Quarters was equipped to wind up its various agreements with tenants, landlords and vendors. He ultimately resigned as trustee and withdrew his motion, and a new attorney took over the proceeding.
The bottomline for building owners like Spain is that they’re out of pocket and scrambling. Some had signed long-term leases and spent hundreds of thousands to outfit their properties to Quarters’ specifications. Now, they are faced with the choice of finding a new co-living operator, managing the buildings themselves or pivoting to a traditional multifamily rental.
“This was handled particularly poorly and not professionally,” Spain said.
What went wrong
Even before the pandemic, the market for co-living had mixed results for operators and landlords.
In similar circumstances to Quarters, New York-based startup Bedly was unable to raise more financing and suddenly folded in 2019, leaving 600-plus tenants and building owners clamoring to adjust. WeLive, WeWork’s co-living division, never gained the momentum to expand beyond two locations.
Meanwhile, Common has raised more than $113 million to date — $50 million of that in September 2020. But the company has significantly diversified its offerings into workforce housing among other ventures. At this point, co-living units only account for roughly half of its portfolio.
The spread of the pandemic and a rental market depressed by high vacancy in major cities has also taken a heavy toll on the sector. Co-living startup Ollie, which ran into trouble attracting additional investment before the pandemic, was acquired by Starcity in December. Bay-Area-based co-living firm HubHaus collapsed in September.
In the case of Quarters’ U.S. operations, the pandemic appears to have been the start of its undoing. Last spring, New Jersey developer Mark Tress sued Quarters for “opportunistically” bailing on its $8 million lease of his Clinton Hill property just as New York became the epicenter of the virus. (The case is ongoing.)
W5, Quarters’ joint venture partner which committed the $300 million to help the firm break into the U.S. market, said in a statement that the pandemic brought about Quarters’ bankruptcy. Some owners reported noticing red flags in recent weeks.
Two building owners told The Real Deal that the co-living firm reached out to seek concessions on its master leases from them in December. W5’s chief investment officer Raphael Sidelsky was present on the calls with various owners, along with co-CEO Barros.
Philadelphia-based developer Richard Zeghibe said his impression of the conversation with Sidelsky and Barros was that leasing concessions were a prerequisite for Quarters raising more money.
“They were suggesting that these concessions were a requirement for raising additional sums of money,” Zeghibe recalled.
For the developer, however, the conversation seemed odd since Zeghibe hadn’t broken ground on his 239-unit building in the Callowhill neighborhood — he was at least 20 months away from collecting rent. “It just didn’t make any sense to have those discussions,” he said.
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W5 and Quarters did not comment on their relationship and fundraising efforts. Barros, who is no longer listed on Quarter’s website, did not respond.
Beyond the pandemic, multiple sources suggested there were additional factors that exacerbated the firm’s financial strain. Quarters hadn’t been profitable before the advent of Covid-19, according to bankruptcy filings. The firm was also known to offer developers above market-rate terms to master lease their buildings, according to a source with direct knowledge. And Philadelphia developer Spain recalled tensions between the U.S. and Berlin operations.
“Not everyone was speaking the same language, and I don’t mean German and English,” she said. “It was definitely two different ways of doing things, and two different ways of approaching meetings, and problems, and budgets.”
Spain recalled that the design of her building changed at least six times as the Quarters staff came and went. In one instance a new project lead based in Germany came in and wanted to undo the work of his predecessor that he deemed too costly.
“They had a turnover rate that was extraordinary,” said Spain. “I think there was a lot of confusion internally because they were trying to grow so fast and they didn’t have the infrastructure for that growth.”
A spokesperson for Quarters disputed that the firm had any significant turnover and said its U.S. business was managed entirely by the U.S. management team, apart from one U.S. staffer who got stranded in Germany due to Covid restrictions.
Quarters’ U.S. bankruptcy filings are also unearthing questions about the health of its European parent. In his motion, former trustee Nisselson noted that Quarters’ lawyers had not provided him with the necessary information to wind down its U.S. operations, such as access to security deposit funds, keys to the properties and its records. They reportedly told him the documents were unavailable because they were stored on German computer servers controlled by Medici, which was “in German liquidation proceedings.”
In a statement, Quarters denied that it was liquidating its European holdings, which received $1.4 billion in funding in 2018. But the company admitted that closing its U.S. operations required its parent company to restructure, though it emphasized “all existing relationships with property owners in Europe will be continued.”
Soldiering on
It’s not all over for the landlords that Quarters left in the dust on this side of the Atlantic.
Some owners are turning to the courts, like New York developer Victor Sigoura, who had leased his project at 890-911 Jefferson Avenue in Bedford-Stuyvesant to Quarters. He filed a suit against the firm’s Berlin parent company, which acted as the guarantor for its U.S. entities, for $41,230 in unpaid rent and additional $25,000 in legal fees.
Other landlords are rebranding their buildings. With 239 bedrooms, W5’s building in Washington, D.C. was Quarters’ largest U.S. location. In a statement, W5 said it will now offer a mix of conventional apartment rentals and some co-living units. It’s unclear whether W5 and the Related Group’s w28 project in Miami’s Wynwood district will still include co-living units. A rendering of w28 released at the time showed Quarters’ branding on the building.
In Spain’s case, she said five different co-living companies are vying to take over Quarters’ lease at her project, but she is questioning whether the rent-by-the-bedroom model is still viable.
“Personally, I think that the pandemic was the death knell for co-living,” she said, pointing to the rise of remote work as a potential killer of demand for shared housing with strangers. “I don’t know that that model will survive.”
Despite Spain being stuck with an empty building constructed to the whims of a now-defunct company, the developer is confident her project will get back on track because of real estate’s most basic tenet: location.
“We’re in a really desirable neighborhood,” she said. As for what she lost in the deal with Quarters, “it’s just money and it’s time.”