Bobby Kofman, MBA, CIRP
President and Managing Director
KSV Advisory Inc.
There’s no questioning that the real estate market across Canada has been on a tear for the last several years. Like any industry though, it is not immune to problems. Just ask Bobby Kofman, who has handled several insolvencies in the space. Recently, Bobby and his team led the restructuring of Toronto-based developer Urbancorp. Bobby shares with us KSV’s approach to dealing with a real estate restructuring, the lessons home buyers can learn from Urbancorp, and more.
Given the strength of the Canadian real estate market for the last several years, you will not be surprised to know that I’ve been asked this question several times. Common themes on our real estate files include:
- Over-leverage / too many projects at one time. Certain developers are not sufficiently capitalized to take on several projects at once. This leads to a more expensive capital structure, which leads to competing interests among stakeholders when a development goes sideways. In such a situation, if one project goes sideways, it may have implications on others, particularly if there are cross guarantees or the like.
- Inexperienced developers. Like many booming industries, we’ve seen many new, inexperienced entrants into the industry. Like any industry, you need to know what you’re doing. Home buyers are well advised to buy properties from experienced developers.
- Misrepresentations. Unscrupulous developers have raised a great deal of capital from unsophisticated investors. In one of our situations, a developer with several projects across Ontario raised nearly $100 million through syndicated mortgage investments from mom and pop investors on the belief that their investments were well secured and had a steady income stream. The disclosure on the projects was misleading and the economics did not make sense. These investors will suffer staggering losses. The crux is that not all real estate investments are safe and investors should consult professional advisors to understand the risks involved.
Generally speaking, each case is different. For example, one is going to look at raw land very differently than a partially developed, sold out residential project.
The first step is to understand the project and to determine its viability. This involves understanding the state of the project, its cost to complete and its revenue. It is also helpful to understand the relevant real estate market and the developers active in that area.
We then gain an understanding of its financial position and the interests of the various financial stakeholders in the capital structure. For example, a well collateralized senior lender may wish to see a project sold immediately, whereas an under-secured junior lender may only have a recovery if the project is completed.
We also commonly consult a qualified realtor to provide an estimate of the value of the project at that point in time. That provides a decent starting point for all other options. We do not necessarily incur the cost of an appraisal as their value is hypothetical, whereas a strategic process will provide the best indication of value.
Several factors influence the process. For example, the state of the project (raw land versus a development in progress versus a completed project), whether financing is available to complete the project, stakeholder urgency (or not), ability to continue to work with trades, number of lien claims and the consequences of terminating contracts (such as home buyer agreements).
3) What are the warning signs that lenders/trades/customers should look out for?
- Project delays/limited on-site activity;
- Use of home buyer deposits on one project to cover losses on others;
- Use of alternative funding sources and expensive cost of capital;
- Project development issues, such as repeated changes to the plan, issues with Tarion (Ontario’s home warranty insurer);
- Adverse project publicity; and
- Numerous lien claims.
4) What are the main benefits for a developer in pursuing a formal restructuring under the BIA or CCAA vs. trying to do an informal restructuring? What are some of the tools or levers that a trustee can bring to the situation?
As with any distress situation, the stay of proceedings in a formal process assists to stabilize a situation. The consideration as to whether the filing should be under the CCAA or the BIA will typically depend on its complexity and the amount of time required to deal with the situation. Like most complicated situations, the CCAA is preferable to the BIA, particularly where you are likely to require more than six months to resolve the problem. We have also acted as court-appointed receiver in several real estate situations involving multiple lenders where the intention is to simply run a sales process. Senior ranking mortgagees seem to prefer this process over a power of sale in situations where there are junior lenders, guarantors or other potentially adverse parties.
One of the primary attributes of a formal process is the ability to terminate contracts that contribute to make a project uneconomic. For example, home buyers on certain Urbancorp projects lost their contractual right to purchase a home, particularly in the context of early stage developments where the homes are yet to be constructed. The developers who purchased Urbancorp’s properties (which were raw land at the time) were unwilling to assume the home buyer contracts because they could not economically complete those homes based on the acquisition cost of the land. Home buyer agreements do not attach to the land. They are a claim against the development entity.
A formal process can also provide for the appointment of a Construction Lien Trustee, with which construction trades have familiarity and confidence. This provides a structure to deal with these claims and a mechanism to facilitate completion of the project.
5) What are some of the hiccups or issues that can potentially derail a restructuring or make it less successful?
The greater the complexity of the project, the more challenging it is to achieve a result that works for all stakeholders. A large, partially completed development project with home buyers, lien claimants and multiple lenders is going to be more difficult than one which only has raw land and a small number of financial stakeholders.
6) What was the most challenging aspect for you on the Urbancorp restructuring?
There have been several, however the home buyer situation stands out because of its media attention. Dozens of individuals were trapped by the insolvency process, unable to get refunds of their deposits or the homes for which they bargained. The human element is always difficult. These people made plans to move in to their new home on a specific date, only to find out that they would never be able to do that and that they have no special rights in an insolvency process. We spent a great deal of time speaking with these people and working to return their deposits as quickly as possible. Eventually all home buyers recovered their deposits in full, but it was challenging because we had to address competing claims. Also, certain home buyers tried to bargain for greater rights than they had, which impacted those who wanted an immediate return of their deposits. It made for interesting press.
7) Is there any way home buyers can avoid a similar situation in future or is this just one of the risks of buying pre-construction?
For the most part, home buyers do not have special rights in an insolvency process. With insolvent developers, there is no certainty that a home buyer will receive its home and in certain instances, the buyer’s deposit may be at risk. For purchasers of condominiums, the developer is required to hold any deposit in trust, but that is not the case for a freehold home. Tarion, which offers home warranty protection to purchasers of new homes in Ontario, provides deposit protection of up to $20,000 for condominiums and $40,000 for freehold homes. In addition to offering construction warranties on new homes, Tarion also offers some protection for home buyers in respect of delayed occupancy costs.
Because home buyer contracts do not attach to the land, they are just an obligation of the development company. If a developer fails, and a deposit has not been held in trust, the home buyer only has a claim against the development entity.
As long as we have a strong seller’s market, I don’t see the dynamics changing. If a home buyer doesn’t like the terms of a developer’s standard purchaser agreement, the developer will find someone who is prepared to live with those terms. Accordingly, it is critical for home buyers to deal with credible developers, with a proven track record and who are mindful of their reputation.
8) What is the most interesting story involving a real estate insolvency that you have been involved with?
I referenced the syndicated mortgage investment situation above. Nearly $100 million was raised from individual investors on the pretense that their life savings were well secured in real estate development projects. The investment structure was not viable from the outset, there were misrepresentations throughout the capital raising process and investors will have insignificant recoveries. This story could just as easily be about any industry. It’s about taking advantage of unsophisticated investors who were attracted to the hottest industry – today, that happens to be real estate. The final chapter in this story is yet to be written.