Early Thursday morning, the managers of General Growth Properties (NYSE:GGP) opted to file for Chapter 11 Bankruptcy protection. General Growth has been the poster child of extreme overleveraging in the real estate industry. The filing totals approximately $24 billion in debt and is the largest real estate bankruptcy in U.S. history. General Growth had been working for months to try and settle its debt obligations outside of bankruptcy court. It had been working with creditors to try and relax the terms of the agreements, through not paying interest and extending the time period it would have to repay the debt. However, no across-the-board resolution was reached. It was only on March 31st that the front page of the Marketplace section of The Wall Street Journal had a large article on how General Growth had avoided Chapter 11. So what should you look at going forward and how will this impact the commercial real estate market in general?
In my recent article on Simon Property Group (NYSE:SPG) I stated that if GGP were to file for Chapter 11 or simply continue to struggle that SPG would be positioned to snatch up great pieces of real estate at liquidation prices. Though I don’t think that a fire sale of all the properties is in the mix, it is hard to imagine how they are going to be able to satisfy debt holder demands without raising capital.
Since they are unable to get financing, selling some properties is the next option. I have gotten a lot of criticism regarding SPG because of its recent debt offering and equity raise. What is so essential to note in economic times like these is that even though its debt has a rate of just over 10% they were still able to issue debt! In normal markets a rate that high would be of concern, but I hardly doubt anyone will argue that these aren’t normal markets. I would not be writing this article right now if General Growth were able to obtain financing for more than a couple weeks. They would have loved 10% on its debt, and the ability to issue 17.5 million new shares at around $31.
The point here is that there is financing available to those companies who qualify, such as SPG, and Taubman Centers Inc. (NYSE:TCO). What is very important to note is that the cause of General Growth’s problems did not come from failing properties that the company held in its portfolios, but from the extreme overleveraging that has been the theme song of the economic crisis. Its malls had an average occupancy rate of 92.5% in Q42008 and are rated as above-average. CEO Adam Metz said that the “core business remains sound and is performing with stable cash flows.”
The mountain of debt that GGP must overcome is just daunting. When CEOs such as David Simon of SPG are quoted as saying “you’re the strong and you want to get stronger,” that is a clear signal that SPG is looking at acquisitions. I wouldn’t doubt that an underlying reason for its two most recent capital raises was a speculative bet on General Growth having serious trouble in the near future.
Two things will be interesting to watch going forward. One is whether or not General Growth will survive the process (I think it will, they just need the proper environment to restructure). Second is which competitor will take advantage of the property sales the most and position themselves for long term growth. As I have stated before, it seems like some property sales are necessary in raising capital to pay down debt. It is no mistake that Simon is the cream of the crop and that management is focused on growth. What we are seeing are the markets at work. General Growth made a mistake that cost them and now they are paying for it. There is no government bailout or lobbyists trying to tell politicians how unfortunate GGP’s situation is, just pure market forces. One man’s blunder is another man’s success. Therefore, there will be a shakeup and those that were once positioned behind GGP may be able to make moves upward.
Commercial Real Estate Effect
There is a concensus that commercial real estate still has some bad times ahead of it. The difference of opinions lies in the severity of the bad times. The Fed is contemplating issuing 5 year loans to investors to buy commercial mortgage backed securities through its TALF facility. This is still in the works. This will effect GGP’s bankruptcy filing and will have a substantial impact on the amount of properties that they end up selling.
As I stated before, liquidation does not seem probable. Oversaturating the market with properties will simply depress prices further due to an oversupply. If the demand is only for a handful of properties, then that's all they should sell. It would also be irresponsible of all parties involved to allow a total liquidation where properties flood the market and cause the problem to get worse rather than help to solve it. The one glimmer of hope is that the government doesn’t have its hands in this so the end result has more promise of being successful.
Check back for ongoing analysis of GGP’s filing and the residual effects on the market.