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GENERATING LIQUIDITY THROUGH REAL ESTATE IN AN ECONOMIC DOWNTURN

By Jamie Cote

Home / Perspectives / Generating Liquidity Through Real Estate in an Economic
Downturn
SMARTER PERSPECTIVES: Real Estate
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In this article, we discuss how, during times of financial tightening and
uncertainty, real estate owners and occupiers often need to broaden their
traditional sources of financing to create liquidity and stay afloat.

Over the course of the past year, there has been persistent talk of an impending
recession in the U.S. Various factors have been cited as potential triggers,
including rising interest rates, high inflation, an inverted yield curve and the
recent unexpected banking crisis. In the real estate world, the signs of
financial difficulty associated with the economic downturn have become more and
more evident over the past 18 months.



Recent examples of this shift include Brookfield Properties losing its anchor
tenant, Macy’s, at the iconic Chicago Water Tower Place. This ultimately
resulted in Brookfield turning over the keys to its lender, a unit of MetLife,
just a year later in April 2022. Late last year, we saw GFP Real Estate default
on its $103 million mortgage-backed securities loan at 515 Madison Avenue in
Manhattan.

High profile defaults early in 2023 included both a $270 million Blackstone CMBS
loan on a Manhattan multifamily portfolio sent to special servicing and
Brookfield’s default on $784 million in loans associated with two prominent
skyscrapers in Los Angeles. Most recently, RXR defaulted on a $240 million loan
for 61 Broadway. Park Hotels and Resorts stopped making payments on $725 million
in debt associated with the Hilton San Francisco Union Square and Parc 55
hotels, handing the keys to those properties over to lender, J.P. Morgan Chase.

Current conditions clearly indicate a high probability of increased distress
moving ahead, with some experts suggesting that levels could exceed those
experienced during the financial crisis and Great Recession. The New York Fed’s
Recession Probability Indicator has added weight to these concerns, as it
currently suggests a 68.2% chance of a U.S. recession within the next 12 months.
Notably, this reading is higher than at any time over the past 40 years. Despite
these potential triggers and indicators, the U.S. labor market remains robust,
with strong employment figures and a healthy job market. This has led to a
division among economists regarding whether a recession is inevitable in this
unique economic environment.

Staying well informed, advised and proactive in the face of such potential
adversity can empower property owners and occupants of leased spaces to face the
challenge of maintaining their financial stability and minimize downside risks.
In such situations, there are specific approaches that can be utilized to
monetize real estate assets effectively and efficiently, to provide needed
liquidity and/or minimize mounting costs.

While it may seem somewhat counterintuitive, from a historic perspective,
recessions have frequently presented opportunities for savvy, long-term real
estate investors. This is great news for investors with ready money that can be
put to work in value-add opportunities. And for those occupants struggling with
liquidity issues, who need to evaluate other potential sources of funding, the
investors looking for deals can provide a potential liquidity source.

The information below outlines three effective methods that property owners and
tenants of leased spaces can leverage to both protect their interests and
continue to capitalize on their investments during times of turbulence.



SALE-LEASEBACK

Sale-leaseback is a strategy in which a property owner sells an asset to a buyer
and simultaneously leases it back from that buyer. This strategy is often
deployed on behalf of clients
as it provides several advantages in a recessionary environment, including the
delivery of an immediate, and often urgent, capital infusion. Selling a property
unlocks its value, providing the original owner with access to substantial
liquidity that can then be used to bolster its financial position, repay debts,
invest in other areas or simply provide cushion during an economic downturn.
While sale-leasebacks have become more prevalent in strong economic times due to
cap rate compression and investors paying top dollar for strong credit tenants,
they can be even more important in a high interest rate environment where this
strategy often provides capital at a lower rate than simply borrowing it.

Sellers in a sale-leaseback scenario also unlock the full value of their
property as opposed to only 60-70% in a traditional financing scenario.
Additionally, the seller will set the terms of the lease
and unlock all that capital with no loan covenants. This strategy can also
provide added operational flexibility by enabling an original property owner to
continue to operate without interruption in the facilities as its tenant. The
leases are traditionally structured as “triple net,” meaning the tenant remains
responsible for the operational costs of the property. These costs retained by
the lessee, such as taxes and maintenance, are often tax-deductible expenses.
Transferring ownership to a new buyer also mitigates an original owner’s future
risks associated with property value fluctuations and potential market
downturns, providing an added degree of stability during uncertain economic
times.

Two recent, but very different, examples illustrate how sale-leaseback is being
used in the current market environment:

 1. Late last year, Oak Street Real Estate Capital concluded a $200 million
    purchase of the former 30-acre Chicago Tribune Publishing center as part of
    its sale-leaseback transaction with Bally’s. As a result, Bally’s is now
    constructing a $1.7 billion hotel, casino and entertainment complex on the
    site.
 2. Earlier this year, an affiliate of PSP Partners spent $19.5 million to
    purchase a 173,000-square-foot industrial plant in Waukegan, Illinois.
    Thermoflex, an automotive accessories manufacturer had owned and operated
    the plant for over 60 years. Under the deal terms, the company gained needed
    access to liquid capital, which it is now using, in part, to pay rent to the
    PSP affiliate on a new, long-term lease.
 3. HRE’s work with Service King, the premier collision repair provider of
    choice in the U.S. with over 330 locations across 24 states, involved an
    assessment of the company’s
    37 owned properties. Based on HRE’s portfolio analysis, 21 of the owned
    properties were marketed to a targeted, qualified group of investors as a
    sale-leaseback opportunity. In less than 60 days, HRE coordinated full due
    diligence on each site, marketed the portfolio, generated offers from six
    groups, conducted a best and final round and closed on the portfolio with a
    major institutional buyer for proceeds in excess of $66M, with Service King
    retaining possession of the properties on a long term lease. These results
    far exceeded the Seller and Sponsor’s expectations, and supported Service
    King’s financial objectives and ongoing business operations.

PORTFOLIO OPTIMIZATION AND LEASE RESTRUCTURING

Portfolio optimization and lease restructuring involve analyzing an existing
leasehold portfolio and making strategic adjustments to maximize value and
mitigate risks. This approach can be particularly valuable leading into and
during a recession as it provides rental income stability and greater
flexibility in the face of potential adversity. Lessees often benefit by working
with a qualified third-party to assist in objectively reviewing lease
agreements, analyzing the applicable marketplace and identifying opportunities.
Resulting efforts may include lease extensions, rent reductions or adjusting
lease terms via temporary abatement or other methods to retain tenants during
challenging economic periods. HRE specializes in such scenarios as a third-party
provider, which helps reduce lease exposure to tenants in both good economic
times and periods where holding onto cash may be a priority.

Through detailed assessment of lease portfolio composition, HRE has enabled
property occupants to identify assets that may be more vulnerable to
recessionary impacts and strategically diversify a portfolio by reallocating
resources and acquiring properties tailored to different sectors or geographic
locations which have shown historic resilience during economic downturns. HRE’s
work with Southeast Grocers, for example, involved a portfolio-wide lease review
and subsequent lease repositioning project to support the company’s
restructuring. These efforts resulted in $70 million+ in lease savings and
millions more in value to the company from HRE’s concurrent marketing of over
100+ leasehold assets for sale/assignment.

Tenants can also benefit from careful scrutinization of their operating expenses
and implementation of cost-cutting measures and operational inefficiencies. This
may involve renegotiating service contracts, streamlining operational processes
or optimizing energy consumption. Reducing these types of costs can help improve
profitability and financial stability during a recession.

SURPLUS REAL ESTATE SALES

During an impending recession, property owners may have surplus real estate
assets that are underutilized or no longer aligned with their strategic
objectives. Selling these surplus properties, can generate immediate liquidity
that can be used to strengthen the financial position of the property owner. A
subsequent cash infusion can then be reinvested in more profitable ventures or
used to reduce debts. HRE’s work with IDI Logistics, which had accumulated
numerous one-off land parcels in major metro areas, is a prime example. While
these assets had been marketed, no sales resulted. To “clean up” IDI’s balance
sheet and generate proceeds from non-performing assets, the HRE team implemented
a date-certain program culminating in an online auction. Utilizing a
multi-channel marketing strategy to elicit interest from local markets as well
as national industrial players, HRE received over 160 inquiries for these
properties. The combined results from the auction and negotiated post-auction
sales culminated in the successful sale of sixteen of the twenty parcels in less
than six months.

Divesting surplus real estate can also enable property owners to redirect
resources and attention towards core assets that are more critical to their
business operations. Efforts in this area allow for greater concentration on
strengthening the performance and value of key properties within a portfolio.
Additionally, it is important to recognize that some real estate assets have a
greater likelihood of becoming liabilities during a recession. Those with high,
ongoing maintenance expenses, excessive property taxes and other burdensome
operational costs should be considered as prime targets for sale when seeking to
reduce cost and mitigate unwarranted risk associated with holding
underperforming properties during an economic downturn.

SUMMARY

Under any circumstances, seeking proven advisory guidance is highly advisable
when undertaking the complex steps associated with monetizing real estate
through strategies such as sale-leaseback, portfolio optimization, lease
restructuring and the disposition of surplus real estate. The current market
environment and recessionary threat only heighten the need for such specialized
expertise.

Real estate transactions can be highly intricate and involve various legal,
financial and market considerations. Therefore, property owners and portfolio
holders should focus on engaging an advisory team with deep expertise and a
proven track record of navigating complex real estate markets, transaction
structures, legal requirements and utilizing industry best practices.
An understanding of the nuances involved in each strategy provides valuable
insights and guidance to maximize return, limit downside risk, provide access to
added resources, address regulatory compliance issues and execute/close deals in
a timely and efficient manner. If your business, or a business in your portfolio
is a property owner or tenant of leased space seeking to protect its interests
and capitalize on its investments during times of turbulence, we encourage you
to reach out to our team today for a discussion. We are here to help.

ABOUT HILCO REAL ESTATE

Successfully positioning the real estate holdings within a company’s portfolio
is a material component of establishing and maintaining a strong financial
foundation for long-term success. Hilco Real Estate (HRE) advises and executes
strategies to assist clients seeking to optimize their real estate assets,
improve cash flow, maximize asset value and minimize liabilities and portfolio
risk. We help clients traverse complex transactions and transitions,
coordinating with internal and external networks and constituents to navigate
ever-challenging market environment.

Contributors
View Bio


JAMIE COTE

Vice President
Hilco Real Estate
View Bio
jcote@hilcoglobal.com email phone vcard linkedin
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