Investment Analysis

Distressed Opportunities

Could an increase in bankruptcy sales change the game?

The recent bankruptcy filing by retailer Syms signals that the distressed asset fallout is far from over in the commercial real estate market. In addition, roiling credit markets and the reduction in both commercial and residential real estate values have resulted in a new interest in the impact of bankruptcy filings upon real estate investments. As banks succumb to the pressure to move bad loans off their books, more distressed properties will come onto the market this year. Here's a look at what this can mean for investors and landlords.

Are asset sales in bankruptcy cases an opportunity to buy real estate on the cheap?

Although it might seem counterintuitive, the distressed nature of bankruptcy sales doesn't always lead to depressed sales prices. While I have recently seen more real estate sales in bankruptcy cases than at any other time in my nearly 25 years as an insolvency attorney, whether those sales resulted in good investment opportunities still depends upon the investor's knowledge of both the asset being sold and the particular market niche involved.

However, knowledge of the bankruptcy sales process helps to increase the chance of getting a good buy. All bankruptcy sales are subject to overbid, but the process for obtaining the highest bid is somewhat malleable. Most sales occur only after a separate notice and a hearing establish sales procedures. These often include provisions such as breakup fees, bid deposits, and bid qualification deadlines that ostensibly streamline the process but can also operate to restrict the number of bidders.

Inherent in the process of restricting bidders is the potential that a debtor's management could be attempting to steer a bankruptcy sale toward
a desired bidder. Thus, the most successful investors in this arena are those who realize how the sales process works — that it is based upon the inherent contradiction between the creditors' interest in obtaining the highest sales price and the desire of a debtor's insiders to maintain control of an asset or steer the sale toward a preferred purchaser. To be successful, investors must understand the target asset, the details of the sales process, and how to combat any attempts at manipulation of that process. These goals are more likely to be achieved if the investor is involved in the early stages of a debtor's bankruptcy case and is nimble in its due diligence capabilities.

Has the proliferation of single-asset real estate cases increased the likelihood that the bankruptcy sales process will result in a good investment opportunity?

The bankruptcy code was revised in 1994 to apply special rules limiting the automatic stay in single-asset real estate cases and those rules were expanded as part of the bankruptcy code revisions of 2005. Limiting the automatic stay was intended to expedite SARE cases involving "real property constituting a single [nonresidential] property or project … with fewer than four units … on which no substantial business is being conducted by the debtor other than the business of operating the real property" [11 U.S.C. §363(d)(3)]. But it hasn't quite played out that way.

Instead, many courts have loosely applied the SARE standards. For example, one court held that the "historic synergy" between multiple single-asset properties in a case prevented the single-asset standard from being applied to any of those properties, while another court held that a hotel was not a single-asset property because room cleaning, Internet service, and food service constituted enough business beyond the mere operation of the real property.

These types of exceptions to the rule appear to be indicative of a larger trend that has resulted in many potential investment properties remaining in bankruptcy longer, thereby regulating the flow of assets to market and reducing the likelihood that bankruptcy sales will result in an extraordinary investment opportunity.

How might existing real estate investments be impacted by the influx of commercial tenant bankruptcies?

While a tenant's bankruptcy often portends a reduced income stream from a commercial property, the bankruptcy code does contain a number of provisions that are calculated to protect a landlord's interests. Those provisions include administrative claim priority and expedited payment requirements for post-petition occupation of leased premises; restrictions on assumption and assignment (although the bankruptcy code does permit assignment even if the underlying lease prohibits it); and an expedited process for requiring a debtor tenant to determine whether it will assume or reject a pending lease [11 U.S.C. §365].

These provisions are very complicated and can be tricky in their application, but with the help of experienced bankruptcy counsel, the owner of commercial real estate can effectively limit the losses typically incurred when a commercial tenant files a bankruptcy petition.

Bankruptcies and distressed assets will continue to affect the commercial real estate market throughout this year and probably beyond. While such investments can offer value-add opportunities that may pay off handsomely when the market recovers, investors must have an in-depth understanding of the asset and its market before moving forward.

Bernard D. "Bo" Bollinger is chair of the insolvency and financial solutions practice group at law firm Buchalter Nemer in Los Angeles. Contact him at


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