From a real estate perspective, recent bankruptcies and corporate reorganizations have immunized the industry to the harsh realities of receiving quick, unexpected negative news. Numerous high-profile bankruptcies including WorldCom, Adelphia, Enron, Kmart, Sears HomeLife, Jacobson’s Department Stores, United Airlines and Burlington Industries have blanketed the real estate community with dark office buildings and vacant stores. These bankruptcy filings have established new challenges and a surprising number of opportunities for all professionals in the real estate community, but none more so than principals.

As an owner of real estate during this turbulent period, the necessity and burden of understanding the bankruptcy process has never been more critical. Whether you are a long-term holder, or an active buyer and seller of real estate, the days of maintaining a passive perspective of ownership are no longer advised. To a certain degree, as evidenced by bankruptcies such as those mentioned above, there is no longer a true “credit” deal in the marketplace. Proactive ownership, including extensive analysis and due diligence of tenants, is more important than ever. The WorldCom and Kmart bankruptcies are two prime examples of these challenges:

• In the mid- to late-1990s, WorldCom was close to being the strongest company an owner could have as a tenant. Prior to becoming the country’s largest historical bankruptcy, WorldCom was a true Wall Street darling, gobbling up every competitor and tangential business to dominate the telecommunications industry. However, assume you owned a single-tenant technical facility in which WorldCom leased the entire premises on a long-term basis. As part of the transaction, the lessor and the lessee contributed a significant amount of money to build out the space (several million dollars in most cases). The majority of this money was spent on equipment specifically used for telecom services. With the transaction completed, the building’s infrastructure was now designed for WorldCom’s use. Then the bankruptcy filing occurred, notice was received that WorldCom was rejecting the lease and that you are set to recapture control of your building in the near term. With fewer businesses expanding, recapturing control of the space would not be advantageous in most cases. Since the time the lease was signed, the telecom industry’s presence has accelerated downward, and the possibility of backfilling the building with another telecom user is minimal. Now, the lease has been rejected, you have recaptured control of the space and you are confronted with the challenge of finding a replacement tenant in a difficult environment.

• Kmart, historically one of the most prominent retailers in the country, anchors your 125,000-square-foot community shopping center. The retailer has 18 years remaining on the lease of an 80,000-square-foot building in the center. The shopping center is located in a secondary market, and it features a number of local and regional retailers complementing Kmart. Since it has remained a seller’s market the past few years, you are contemplating placing your property on the market to capitalize on the aggressive pricing of the buying community. Suddenly, notice is received that Kmart has filed for bankruptcy and has rejected the lease. Any possibility of selling the property and capitalizing on the current pricing levels of retail assets has evaporated. You are now confronted with backfilling your 80,000-square-foot space in a secondary market as well as dealing with the negative effect this will have on your remaining tenants.

As a smart, quick-thinking buyer of real estate during these economic doldrums, there have never been as many opportunities. The number of distressed real estate assets across the country continues to be awe-inspiring. Buyers of distressed real estate have a different approach to the pursuit and execution of transactions. It is important to remember that bankruptcy sales are typically rapid and adhere to a defined disposition process for bankruptcy court requirements. In the majority of these sales, the disposition process is structured so that a buyer is required to sign a contract without any due diligence or financing contingencies, and he must complete an expeditious closing. Buyers of distressed properties are more willing and able to give an immediate financial commitment to a transaction than a traditional buyer. Many of these transactions are consummated at pricing levels with attractive discounts for the investors, primarily due to their ability to react more quickly than other buyers. These buyers understand the risks associated with participating in this process but also are cognizant of the potentially rewarding yields on their investments.

There continues to be a tremendous amount of distressed real estate coming onto the market due to bankruptcies and corporate reorganizations. While bankruptcies remain active, the current trend seems to be leaning toward available surplus real estate as a result of corporate reorganizations. During the economic growth of the 1990s, many companies accumulated vast real estate portfolios that assisted in their expansions. With the economy struggling, many companies are consolidating operations and now have the ability to raise extra capital through disposing of surplus real estate. For the foreseeable future, bankruptcies and corporate reorganizations will continue to pose both challenges and opportunities for real estate professionals.

Joshua Joseph is vice president of Northbrook, Illinois-based Hilco Real Estate.

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