FEATURE: Chapters in history

The Chapter 11 filings of GGP and Extended Stay fuelled visions of steep discounts to be had for investors willing to wade into the quagmire of the US bankruptcy courts. Opportunities borne out of bankruptcy, however, are limited – and only for those with plenty of cash to invest. PERE Magazine, December 2010/January 2011 issue.

When General Growth Properties (GGP) filed for bankruptcy protection from its creditors on 16 April 2009, it was heralded by some as a “once in a lifetime” buying opportunity for rivals. The largest real estate-related Chapter 11 filing in US history, GGP took with it into bankruptcy protection approximately 158 cash-flowing regional shopping centres, the likes of which competitors could only salivate over. Although the scale of GGP would always ensure the REIT would never be a steal, there were undoubtedly visions among some real estate investors of steep discounts to be had, all for the price of picking through the rubble of the bankruptcy court process.

Yet, when GGP finally emerged from bankruptcy protection after 19 months on 10 November 2010, there was an absence of talk that Chapter 11 had paved the way for a ‘mall-tastic’ buying spree. Instead, the filing affected an unprecedented value creation event that saw even unsecured creditors paid back at par with accrued interest.

If you don’t have debt maturities coming due or if there is nothing pushing a seller to a deal, most people don’t voluntarily transact.

Today, as US property markets slowly grind their way towards some semblance of recovery, expectations that real estate-related corporate entity and single asset Chapter 11 filings could provide a bounty of investment opportunities are being dashed. Rather, Chapter 11 is being seen for what it really is: a legal tool that forces the transparent valuation of a debtor’s assets and an auction.

For some, though, that’s precisely the appeal of Chapter 11 filings. In an environment where few property transactions are taking place and sellers can sometimes prove fickle when it comes to closing a deal in the possible hope of higher values further down the line, Chapter 11 does at least guarantee an outcome.

The Blackstone Group, for instance, has been involved in three entity-level Chapter 11 deals in 2010 alone: GGP, Extended Stay Hotels and the senior living property company Sunwest Enterprise. According to one person familiar with the matter, such certainty of a resolution is an appealing trait for the New York-based firm. “If you don’t have debt maturities coming due or if there is nothing pushing a seller to a deal, most people don’t voluntarily transact,” the person says. Granted, there is no certainty over how long the bankruptcy protection process can take or what side of the fence the bankruptcy judge will come down on, but there will be an outcome. “And that has truly been the most evasive issue in this environment,” the person adds.

Not as expected

Despite having invested in two of the highest-profile, real estate-related Chapter 11 bankruptcies seen during the current downturn, Blackstone – as well as other real estate investors – has not been inundated with opportunities to acquire entities or assets out of bankruptcy protection.

Commercial real estate values may have plummeted 50 percent or more from peak to trough, but the volume of Chapter 11 filings is nowhere near the peak seen in 1991 or even what industry professionals would have anticipated given the severity of the recession.

US government statistics show that, in the fiscal year to 30 September 2010, there were just 12,279 business-related Chapter 11 filings compared to 20,394 in 1991 and 20,070 in 1992, the peak volume for filings since records began in 1987. Although there is no breakdown for real estate-related Chapter 11 filings, data from San Francisco-based Nationwide Research Company, which tracks property-related entity and asset filings on its
www.chapter11library.com website, offers a glimpse at bankruptcy activity in 2010 to date.

We were expecting a lot more bankruptcies to take place by this point in the downturn, but it just didn’t happen.

Dennis Yeskey, senior advisor at the restructuring advisory firm of AlixPartners

As of press time, around 3,250 real estate-related Chapter 11 filings have been made, according to NRC. The vast majority – often involving special purpose entities for individual properties, small brokerages or developers – recorded assets of less than $10 million. Out of more than 3,250 entities to file for Chapter 11, just 34 filed with assets valued between $100 million and $500 million. A further five real estate-related LLCs reported assets between $500 million and $1 billion, and 10 filed with assets between $1 billion and $5 billion. Therefore, the scale of the opportunity to capture opportunistic-style deals through Chapter 11 bankruptcy protection is limited although not impossible.

“We were expecting a lot more bankruptcies to take place by this point in the downturn, but it just didn’t happen,” says Dennis Yeskey, senior advisor at the restructuring advisory firm of AlixPartners. The former head of the real estate group at Deloitte & Touche and a partner at accountancy and consulting firm Kenneth Leventhal during the RTC era, he explains that the phenomenon of banks amending and extending loans has given borrowers an unexpected lifeline.

“Banks are providing a hope certificate, and that has never happened before,” Yeskey says. “From past experience, borrowers would not still own their properties at this stage of the down cycle; they would have been wiped out before now.”

Negotiation forum

By postponing a borrower’s day of reckoning, banks have eased the need to employ Chapter 11, which traditionally is seen as a legal mechanism of last resort. “You generally see Chapter 11 filings where there is simply no effective lever to bring to the table the parties required for a solution,” says Stephen Tomlinson, senior partner at Kirkland & Ellis’ real estate group. Kirkland’s restructuring and real estate groups advised GGP during its Chapter 11 process.

A GGP mall,

In the case of both GGP and Extended Stay, Chapter 11 was a tool to get the deals’ myriad of lenders – senior, secured, unsecured and CMBS – to talk around one table. “You have to remember that when GGP filed for Chapter 11, the credit environment was impossible,” adds Marcia Goldstein, chair of Weil, Gotshal & Manges’ business finance and restructuring department and counsel to GGP and Extended Stay. “There was no refinancing option, and it was almost impossible for the corporation to talk to the servicers about the need to restructure the CMBS debt.”

With a total debt load of more than $27 billion, roughly $4 billion of it due in the 12 months following the failure of Lehman Brothers, General Growth’s problems lay in the timing of its debt maturity schedule. For Extended Stay, debt was also the issue. Acquired by private equity real estate firm The Lightstone Group from Blackstone for $8 billion in 2007, the sheer amount of leverage crippled the 664-hotel chain when the crisis hit the hospitality sector.

You generally see Chapter 11 filings where there is simply no effective lever to bring to the table the parties required for a solution.

Stephen Tomlinson, senior partner at Kirkland & Ellis’ real estate group

According to Goldstein, Chapter 11 provided much-needed “stability” for both GGP and Extended Stay, which gave them the time to talk to lenders and servicers. “In the absence of Chapter 11, GGP might have been ripped apart,” she says. “No one was trying to negotiate a haircut on the debt, but rather an extension of the debt without an increase in the interest rate burden.” In both cases, she continues, Chapter 11 was a “forum for an organised approach” at restructuring the companies and their debt burdens.

Of course, cynics will argue that Chapter 11 is primarily about forcing lenders to undertake a restructuring, renegotiation and ultimate “cram down” of the debt, all ruled upon by a US bankruptcy court judge. In essence, it is a legal tool for “purging creditors” from a deal, as one mezzanine investor, who is currently considering throwing a deal into Chapter 11 to get senior lenders to talk, explains.

For those involved in the GGP case, however, that wasn’t the case, with creditors and lenders getting paid back at par with accrued interest. “This company had great assets that had performing loans,” says Tomlinson. “The problem was in the debt maturity schedule. Once you took the pressure of that away, you had enormous value in the assets.”

Value creation

As the largest real estate bankruptcy in US history, GGP could be deemed the ‘model’ Chapter 11 proceedings of the current recession. Prior to filing for bankruptcy protection, GGP’s stock was lingering close to $1 per share. After 19 months in the hands of Judge Allan Gropper, of New York’s southern district bankruptcy court, the REIT emerged with a $6.8 billion recapitalisation plan led by Brookfield Asset Management, Fairholme Capital and Pershing Square Capital Management and the ability to raise $2.28 billion of public equity through a rights issue on the New York Stock Exchange. The value creation of Chapter 11 for GGP was “unprecedented”, according to both Goldstein and Tomlinson.

In the absence of Chapter 11, GGP might have been ripped apart.

Marcia Goldstein, chair of Weil, Gotshal & Manges’ business finance and restructuring department

For Brookfield, however, GGP was no easy win. The Toronto-based firm had been in negotiations with GGP about providing rescue financing prior to its filing, people familiar with the matter say. But the culmination of panic in the wider marketplace, GGP’s inability to get its hundreds of lenders (and their lawyers) to agree on a way forward and circling hedge funds left management feeling there was only one course open to them: bankruptcy protection.

Being an early entrant to the party, Brookfield was in a prime position to take a lead in the restructuring proceedings, not least after it teamed up with Bill Ackman’s Pershing Square, which had invested up to $60 million in GGP equity when shares were seemingly on life support, and Fairholme. However, an unsolicited bid from GGP’s rival, Simon Property Group, threw a surprising wrench in the works. “You could say things got a little weird,” says a source close to the Brookfield deal.

Ultimately raising its offer to $6.5 billion, Simon teamed up with Blackstone to bid on a recapitalisation of the company as well as taking over the REIT entirely. The latter deal would have seen Blackstone assume control of 37 of GGP’s malls. For three months, Simon and Brookfield engaged in a public battle to position themselves as the frontrunner. One particular issue of contention for Simon was the issuance of 120 million warrants of GGP, worth an estimated $500 million, to the Brookfield-led consortium as compensation for its financial commitment. Brookfield alone had pledged $1 billion of equity, half of it from its $5.5 billion Real Estate Turnaround Consortium club fund, in return for a 27 percent stake in GGP.

By May, Judge Gropper ruled Brookfield the stalking horse bid, a decision that prompted Simon to withdraw from the race. For Brookfield, however, Simon’s exit at that stage didn’t equate to a certain victory, with the process still needing to go to auction. But as with any auction, the highest bid wins. To further secure its position against potential rivals, Brookfield invited the Teachers Retirement System of Texas to invest $500 million in the recapitalisation plan, as well as Blackstone. The New York-based private equity and real estate shop ultimately invested $481 million in GGP through its $10.9 billion Blackstone Real Estate Partners VI fund.

And that, for bankruptcy veterans, is one of the keys to unlocking Chapter 11 opportunities when they do emerge – ensuring you have the highest, and strongest, bid. Being an early player in the game, like Brookfield in the case of GGP, usually helps, but the strength of your offer is critical.

Extended appetite

From the moment Extended Stay filed for Chapter 11 in September 2009, competition was fierce. Within months, Centerbridge Partners and Paulson & Co. had gone head-to-head with an investment consortium involving Starwood Capital Group, TPG and Five Mile Capital Partners, with bids pushed up from an opening offer of $450 million to $905 million.


When Blackstone joined the Centerbridge and Paulson group in the first quarter of 2010, the temperature rose even further. Through an estimated 11 rounds of bidding, the two sides increased their bids and added sweeteners, including making all-cash offers and significant equity infusions.

By the time of the auction on the morning of 27 May, the atmosphere was electric. More than 150 bankers, lawyers and investment professionals – including those from other firms bidding in the auction, such as Fortress Investment Group – gathered at Weil Gotshal & Manges’ midtown Manhattan offices. As the bidding rose ever higher, some players dropped by the wayside, including Fortress, which withdrew at around the $2 billion tag, people familiar with the matter say.

The Blackstone and Starwood groups, however, remained fixed. As offers and counteroffers were made, the price tag for Extended Stay edged closer to its $4.1 billion first mortgage. By 5am on 28 May, Centerbridge, Paulson and Blackstone made their final offer of $3.925 billion, around $20 million more than Starwood’s last bid.

You can spend a couple of million dollars without any guarantee of success [in Ch. 11]. When you fail, you really do feel it.

In presenting the winning bid, the trio of investors offered to pay $1.5 billion in equity and $2.7 billion in debt, including a $2 billion first mortgage and $700 million of mezzanine loans. With closing costs and upfront reserves, the Blackstone consortium ended up paying a total of $4.2 billion for a 33 percent share each in Extended Stay. Sources say Blackstone is investing $526 million in the deal from BREP Fund VI, as well as $92 million in senior and junior mezzanine pieces through its special situations vehicles.

The costs for the firms in even getting to Extended Stay’s Chapter 11 auction, though, were immense. In June, Starwood asked for the reimbursement of $7.63 million of “reasonable professional fees and out-of-pocket expenses” related to its bidding in the bankruptcy protection case. Court documents argue that Starwood’s involvement in the case pushed valuations up by several hundred million dollars and “provided a substantial benefit to the debtor’s ability to successfully emerge from Chapter 11”.

“You can spend a couple of million dollars without any guarantee of success,” says one investment professional close to the Extended Stay deal. “When you fail, you really do feel it. Not everyone can afford to take advantage of these type of deals.”

And even if you do have the equity presence to take down another GGP or Extended Stay, Lightstone founder David Lichtenstein has some words of caution. Bankruptcy, he told Reuters, “benefits nobody except for the lawyers and some of the senior creditors.”