Clothing stores, restaurants, gyms and other businesses find themselves in a $52 billion and growing hole of unpaid retail rent that’s been missed since April 2020. According to CoStar Group Inc. TIAA Real Estate Account – run by the giant Teachers Insurance and Annuity Association of America – noted that as of November 10, 2020, it had received more than 1,000 requests from tenants for rent relief, primarily among retailers, with most asking for deferrals of less than six months.
In 2021, there have already been eight bankruptcies by companies with disclosed liabilities over $50 million. This rate is on par with 2020, which was the biggest year for filings since 2009, according to Bloomberg. So too, hotel operators are filing for bankruptcy at a faster pace in the U.S. More may be on the horizon as lenders lose patience with defaulting property owners.
While the Federal government continues to pump stimulus money into the economy, the Covid-19 pandemic has only accelerated shifts in the real estate market that were already well underway before the pandemic. All of this will have a profound effect on landlords and hospitality owners.
What does this mean for restructuring professionals: likely more single asset real estate cases (“SARE’s”). The law on SARE’s has been part of the bankruptcy code since 1994, but for most insolvency practitioners we are going to need to dust off our old journals. This blog article is a short reminder of the protocols for SARE cases.
The term ‘single asset real estate’ means real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental.
“Single Property or Project” The definition of a SARE includes two separate classifications in the disjunctive, single properties and single projects. The meaning of “single project” encompasses multiple parcels of real property held by a debtor which are beyond the meaning of “single property. Courts have generally defined a “single project” as multiple parcels of real estate purchased, developed, or sold pursuant to a common plan or scheme,” linked together by “common usage” or in pursuit of a “common purpose.
“Substantially All of the Income of the Debtor” It must be the property itself, not the fruit of workers’ labor and management services that is responsible for substantially all of the gross income of the debtor. Therefore, if substantially all of the debtor’s revenue is the product of the efforts of management, labor and services, such as at a golf course, the debtor does not satisfy the definition of a SARE debtor.
“No Other Substantial Business Activity” The question is whether the revenue is the product of entrepreneurial, active labor and effort – and thus is not single asset real estate – or is simply and passively received as investment income by the debtor as the property’s owner – and thus is single asset real estate. Real property that, for the generation of revenues, requires active, day-to-day employment of workers and managers other than, or in addition to, the principals of the debtor, and that would not generate substantial revenue without such labor and efforts, should not be regarded as single asset real estate.
If a bankruptcy case fits within the definition of a SARE, then the bankruptcy code provides that relief from stay shall be granted to a secured creditor in the SARE debtor’s real estate not later than 90 days after the bankruptcy filing unless: (A) the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time, or (B) the debtor has commenced monthly payments that may be made from rents or other income generated by or from the property that is in an amount equal to interest at the then applicable non-default contract rate of interest on the value of the creditor’s interest in the real estate.
This last clause “value of the creditor’s interest in the real estate” means that if a creditor is under-secured, the interest needs only to paid on the secured portion of the debt. Say for example a creditor is owed $10,000,000 but the real estate is only valued at $7,000,000, then the debtor must pay interest at the non-default rate on $7,000,000.
There is considerably more detail and nuance to this, but the above is a reminder to all about the basics of SAREs which likely will see a renewed day.