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Investment Analysis: Creating Value

Mar 16, 2015
Hilco Real Estate Senior Vice President highlights two case histories in which the companies filing for bankruptcy enhanced the value of their owner-occupied real estate to create new substantial cash flow streams.

Use real estate leases effectively in Chapter 11 situations.

By Joel H. Schneider

Owner-occupied real estate can be an untapped source of balance-sheet value for bankrupt companies. Such real estate assets provide a potential catalyst for exiting bankruptcy successfully or a financial carrot to motivate prospective strategic or financial buyers.

Currently, real estate investors are clamoring for stabilized properties occupied by creditworthy tenants. The competition for income-producing real estate assets has caused capitalization rates to nosedive in recent years. Today, properties in many real estate categories, such as industrial, are priced at cap rates below the 2007 peak. 

This article reviews two cases where bankrupt companies enhanced the value of their owner-occupied real estate. Through new lease agreements that included higher rents, reimbursement of expenses, and multiyear lease terms, substantial cash flow streams were created. The properties were then marketed via auctions to maximize recoveries, and sale proceeds were used to expedite the reorganization process, satisfy creditors, and/or hasten the successful sale of the go-forward enterprise.

A Reorganization

Giordano’s, the Chicago-based deep dish pizza retail chain, filed Chapter 11 bankruptcy in 2011 after defaulting on approximately $45.5 million in loans.

As part of the filing, the company listed 20 parcels of owned real estate associated with corporate and franchised restaurants. Of the 20 parcels, 10 were considered operationally significant to the go-forward business, including a high profile 139,000-square-foot mixed-use property that served as the company’s corporate headquarters and flagship restaurant location. One of the keys to this situation was to position the Giordano’s real estate to take advantage of a re-capitalized corporate balance sheet to encourage buyer interest in buildings occupied by a ”reconstituted” Giordano’s.

Hilco Real Estate worked with the debtor to restructure the company’s leases to make them more attractive and marketable, while concurrently crafting a plan to market the properties to the largest possible real estate investment market. Prior to the lease restructurings, initial bids for the real estate had yielded offers around $20 million. When the newly leased properties went to auction, 14 qualified bidders were at the table. After 13 hours of spirited and contentious bidding, the properties sold for more than $30 million. Proceeds from the real estate sale along with the sale of the operating business yielded nearly $66 million, which enabled the estate’s secured creditor to be paid in full.

A Sale Scenario

The degree of interest in acquiring a bankrupt company, either by a strategic buyer such as a competitor or a financial buyer such as a private equity firm, is often influenced by real estate. In many cases, the potential acquirer plans to maintain operations in the buildings, but does not want to be in the real estate business or simply does not want to use additional capital to buy the buildings.

By structuring new leases based on go-forward tenancy in the building, a valuable asset for the estate is created, which enables the debtor or the acquirer to offer a fully leased building to the investment marketplace.

Based in suburban Chicago, Qualteq was a market leader in manufacturing plastic credit and gift cards for companies such as American Express, Visa, and MasterCard. The owner’s personal financial difficulties forced Qualteq into Chapter 11 in 2013. The bankruptcy trustee and his financial advisers first stabilized the company, then sold the business to Brazil-based Valid S.A. through a Bankruptcy Code Section 363 bankruptcy sale. However, Valid had no interest in purchasing the four buildings Qualteq occupied.

Working in tandem with the bankruptcy trustee and advisers, Hilco structured new, five-year leases on each of the four buildings with Valid as the tenant, based on the strong balance sheet that was created with Valid’s purchase, enabling Qualteq to continue operations in their current facilities.

Prior to the finalization of the new leases and with no certain commitment from Valid to remain as a tenant, there was no immediate interest from the real estate investment community for four potentially vacant industrial buildings. Once the new leases were finalized, the leased buildings were then put through a sale process by Hilco, which garnered significant interest from third-party investors. Stalking horse bidders were obtained for each property, followed by an auction. Hilco estimated the four buildings, on an empty basis, were valued at approximately $10.5 to $12.5 million. When the gavel came down, the auction resulted in total sales of almost $19 million for the four fully occupied buildings.

Utilizing the real estate as a vehicle to enhance value further ensured that the estate achieved maximum value of the Qualteq business/assets and helped to secure a successful transaction with Valid. Furthermore, the added value created by selling buildings occupied by a quality credit tenant resulted in sufficient proceeds to fully pay all mortgage holders.

Whether a company in Chapter 11 reorganizes and exits from bankruptcy on its own or is acquired by a strategic or financial buyer, the real estate occupied by the business can be transformed into a value enhancer. By recasting leases with a strong tenant and aggressively marketing the properties, a significant amount of incremental cash can be generated to benefit the bankruptcy estate in a reorganization and/or a going-concern sale. In bankruptcy, debtors and creditors should regard companies’ real estate as a value-creation tool, not an illiquid liability.

Joel H. Schneider is senior vice president, dispositions, for Hilco Real Estate, LLC, a unit of Hilco Global. Contact him at jschneider@hilcoglobal.com.

© 2015 CCIM INSTITUTE. Reprinted with permission from Commercial Investment Real Estate magazine, Vol. XXXIV No. 2.

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