As the pandemic continues, certain sectors of commercial real
estate have been impacted, particularly the office, hospitality and
retail sectors.
Pressure is being felt especially by Canada’s brick and
mortar retail and hospitality industries as some businesses are
struggling to maintain healthy balance sheets, and all indicators
suggest that the commercial real estate market will face more
challenges in 2021. As market pressures mount, dealmaking
opportunities are emerging. In this article, we explore important
considerations that landlords and lenders, owners/occupiers and
purchasers should keep in mind as they engage in distressed and
other opportunistic commercial real estate transactions in the
coming months.
Current landscape
To date, the Canadian commercial real estate market has not
witnessed a wave of bankruptcies or insolvencies as a result of the
COVID-19 pandemic, although some warning signs are emerging that we
will continue to monitor. In the United States, there has been a
host of bankruptcies by large retailers, such as Neiman Marcus,
Brooks Brothers and Muji, among others, leaving empty lease spaces
that landlords must repurpose for other uses. It remains to be seen
whether these types of large-scale insolvencies will impact the
Canadian real estate market.
Insolvency proceedings present several opportunities. A company
whose real estate is overleveraged cannot sell a property, at least
without the consent of the lender.
For those tenants who are surviving, landlords are working with
them to offer concessions, such as rent abatement or reduced rent
payments determined as a percentage of sales, if any. Other major
issues faced by landlords include lease terminations on grounds of
force majeure and renegotiations of co-tenancy agreements. In
addition, tenants have had access to government rent-support
programs which have provided some relief.
In contrast, in the residential real estate market, major
Canadian cities have broadly fared well, though smaller markets are
equally beginning to witness mounting pressures, especially with
regard to maximum loan-to-value (LTV) analyses which lenders are
undertaking as property owners seek to finance new, or re-finance
existing, properties.
The short and long-term prospects for office properties remains
unknown at this time and will only play out as the length of the
pandemic becomes determined, office workers feel safe (or are
mandated) to return to work and the extent to which the “work
from home” trend continues following the crisis.
Seeking relief from mounting market pressures
The commencement of insolvency proceedings may present an
opportunity for commercial real estate players to seek relief from
mounting financial challenges, although landlords, lenders and
prospective purchasers will need to weigh different considerations
as they engage in these processes.
Insolvency proceedings present several opportunities. A company
whose real estate is overleveraged cannot sell a property, at least
without the consent of the lender. Insolvency proceedings allow a
party to apply to the court for a vesting order—a powerful
remedy giving the court broad discretion to deal with property
which is subject to multiple creditor claims and needs to be sold
or conveyed.
In the context of an insolvency proceeding, a court may remove
from title all encumbrances, transfer title, and hold back funds
for claims. Another benefit of an insolvency proceeding is the
ability to market the assets in an expedited manner. Finally, if
the relevant property is a development of pre-sales or pre-leases,
those contracts may no longer reflect market value; the court has
discretion to terminate these contracts and transfer title to the
purchaser without it being bound by those contractual terms.
Many industries are surviving through government funding, and
this will not last forever—there will likely be a wave of
opportunities in the commercial real estate market in 2021 and
beyond.
From a landlord perspective, if a tenant is going through a
creditor protection or bankruptcy process, the landlord may be
prohibited from exercising certain rights that it would otherwise
have in normal circumstances, such as the right to terminate a
lease, the right to distrain, and so on. Landlords will need to
exercise caution when evaluating enforcement options in this
context.
For lenders, they will need to determine if they want to go
through foreclosure or power of sale proceedings when dealing with
distressed assets and should understand timelines of both
processes.
Finally, in terms of vesting orders, care must be taken when
evaluating the language of the order. From the purchaser’s
perspective, there may be limited avenues to perform satisfactory
due diligence, including issues around tenant estoppels, or lack of
representations and warranties.
Distressed opportunities on the horizon
While many market players are looking to acquire distressed
commercial real estate assets, dealmaking opportunities have yet to
fully materialize as the level of insolvency in the Canadian
commercial real estate market remains relatively low. However, many
industries are surviving with the benefit of government funding,
and this will not last forever—there will likely be a wave of
opportunities in the commercial real estate market in 2021 and
beyond, with the long-term impact of the pandemic to play out in
the commercial real estate market in a 3-5-year time horizon.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
