Background

AREC recently completed an assignment for a regional developer with a large portfolio of rental properties.  The assignment focused on a single multifamily rental property that was completed shortly before the COVID lockdowns thus reversing the positive leasing momentum that would have otherwise resulted in stabilization of occupancy and net operating income. The project’s capital stack includes non-recourse senior and junior debt tranches with near-term maturities, preferred equity with a high coupon pay rate and the developer’s equity.  Interest on the debt was variable rate and interest rate protection was capped with third party protection through maturity.  Extension options were available subject to certain performance criteria in addition to specified curtailments of the preferred equity. Approximately 40% of the preferred equity was full recourse to the sponsor. 

Occupancy at the property had suffered a setback as a result of the pandemic and efforts were made to regain lost ground with leasing incentives.  The last of these incentives ended at the time of the assignment and rents were being quoted at market.  Leasing activity was modest and inadequate to achieve forward momentum in the face of pending maturities.  Net operating income was insufficient to cover debt service and the client was funding monthly cash flow deficits out of pocket. 

The client had engaged several brokers to assess options and had replaced the property manager.  The brokers provided opinions of value in addition to recapitalization options.  The new property manager was still in the process of transitioning its team and was not yet prepared to make recommendations to the property owner. Four months remained to the first loan extension option, renewal of the interest rate protection and a substantial mandatory principal curtailment of the preferred equity investment.

AREC Assignment

The property owner engaged AREC to evaluate the situation and to make recommendations.  While AREC was given a blank slate the property owner made it clear that its preference would be to follow a recommendation that allowed it to retain ownership and control of the property.  AREC and the property owner agreed to a two phased process that would begin with an assessment and series of recommendations to be followed by a second phase in which AREC would assist in the implementation.

AREC Process

AREC interviewed the property ownership team, prepared a list of documents for review and began its analysis of the facts.  A review of the rent roll confirmed that leasing incentives had ceased and showed that newly signed leases were at peak market rents.  A site inspection confirmed that the property was well maintained and not in need of CAPEX.  The ten-year pro forma assumed that the NOI would be stabilized in 18 months and further assumed that it would peak in five years based on net rent growth.  Thereafter, the net operating income dropped precipitously as the full real estate tax load became effective.  The balance of the pro forma assumed continued gross rent growth which was blunted by the increase in real estate taxes.  As a result, it would take another five years to restore net operating income to its beginning level in the pro forma. 

The broker value opinions showed that there was an outside possibility that a property sale could be achieved at breakeven.  Other scenarios assumed additional out of pocket investment by the property owner to fund operating deficits, principal curtailments and a continuation of the interest rate protection in order to meet the conditions of the debt maturity extensions.  All valuations included a discounted value for the remaining real estate tax abatement in addition to achievement of net operating income growth of ~30% within 18 months.

AREC surveyed the competitive market to consider the timing of new inventory and how the subject might fare relative to assumed rents and physical property characteristics inclusive of unit mix, unit sizes, amenities, parking and location. 

AREC also analyzed potential scenarios including partial conversion to for sale housing and hospitality conversions.

AREC Conclusion and Phase I recommendations

• Review loan and preferred equity documents with legal counsel to understand guaranty carve-out default triggers and draft an agreement to be signed by all parties affirming that all ensuing discussions with the creditors and preferred equity investors would not trigger a default.

• Confirm the identity of the parties with whom a forbearance agreement might be negotiated in the event it becomes necessary.

• Work with the new property manager to create an achievable leasing strategy using current market data and conditions.  Develop a regime for understanding tenant demographics and preferences to optimize leasing performance and improved tenant turnover rates. Perform a comprehensive line-item expense review to determine potential savings.  Revise the ten-year pro forma to incorporate the results of these analyses to support a fresh plan for the property’s future performance inclusive of leasing milestones.

• Share the completed plan with the creditors and preferred equity investors to substantiate a request for temporary payment relief and to demonstrate a commitment to a viable path forward that aligns all the parties’ interests.

Houston is one of the largest cities in the US and home to one of its most challenging office markets. The city’s massive scale—it can take two hours to drive across at rush hour—divides it into many distinct submarkets, each with its own character.

The Galleria Uptown District

The Galleria Uptown district lies west of downtown and is named for the Houston Galleria, a major shopping mall. Once a world-class destination for both Texans and international visitors, the mall has lost some, but not all, of its former prominence. The area surrounding the mall previously housed many major energy companies, their suppliers, and professional service firms.

Originally envisioned as one of the first “edge cities,” the district combined office, residential, and retail spaces. Both domestic and foreign investors provided capital for its high-end properties.

Market Evolution

Today, the Houston Energy Corridor, located about 20 minutes west of the Galleria, has become home to many former Galleria tenants. This area offers proximity to affordable housing and appeals more to younger employees. The residential areas north of the Galleria are now primarily occupied by single professionals and executives, while the area south of the Galleria has become less desirable, affecting mall clientele with reports of increased crime. The hotels in the area are aging and well past their prime. While attractions like quality restaurants and shopping still exist, the district is beginning to show signs of decline.

This deterioration has led to diminished interest in office assets, which has negatively impacted restaurants, hotels, and residential properties in the area.

Client Challenge

In this changing landscape, a South Korean investment firm owned a large office building leased to a company serving the energy market. This tenant once occupied over 1 million square feet in the building and adjacent properties. Post-pandemic, the company considered downsizing to just 200,000 square feet.

The property was financed with a CMBS loan managed by a servicer that was unresponsive to basic operational needs and incapable of addressing this challenging situation effectively. The loan required 75% occupancy before Tenant Allowance reserves could be accessed, making it impossible to fund the requirements of the downsizing tenant.

The servicer maintained its rigid position well after the property should have been transferred to the special servicer. By the time this transfer occurred, it was too late to address the tenant’s needs, who ultimately relocated to a property in the Energy Corridor.

While it’s unclear whether the vacancy could have been prevented, tenant retention would have been more likely with a cooperative lender.

Solution Approach

Once it became evident that the single tenant was vacating, we developed a series of potential visions for the building’s future. We created models for continued office use and for conversion to alternative uses including residential and hospitality. Each model incorporated analysis of the building’s physical dimensions and allocations for necessary amenity spaces. Construction and financing costs were determined through market research, as were projected rental rates.

After initial feasibility assessments proved promising, we engaged additional professional expertise—including two architecture firms and a regional construction company—to develop a more comprehensive analysis. This formal study was designed for presentation to ownership, potential development partners, and financing sources.

Conversion Considerations

Despite media coverage about office-to-alternative-use conversions, determining reuse feasibility requires consideration of multiple factors, including:

• Building structure geometry

• Adjacent property uses

• Parking and transit availability

• Local amenities

• Municipal government support for conversion activities

Outcome

Upon completion, we presented the study to ownership, who authorized its use as a marketing document for third parties. The study also supported the owner's demonstration to its lender that it was taking all feasible steps to determine a viable second life for the building.

With our unique combination of expertise, Associated Real Estate Consultants can help you perform future use analysis for your property and orchestrate the many parties required to develop a comprehensive evaluation.

Challenge:

A hedge fund required expert ratings analysis in a real estate-related Collateralized Loan Obligation (CLO) bankruptcy case involving 15 bonds underlying the CLO.

Solution:

The assignment entailed two parts: 1. Analyzing the creditworthiness of 15 REITs and financial service firm bonds based upon rating agency methodologies, and providing estimated ratings for generic senior unsecured debt, subordinated unsecured debt, and preferred stock, at multiple points in time on the basis of publicly available financials. These ratings analyses were crucial in assessing the market value of the CLO. 2. Providing expert witness testimony in court on the ratings methodologies and analysis, and submitted a 98-page expert report.

Result

Credible, methodology-driven evaluations and testimony played a key role in strengthening the client’s position—leading to a favorable settlement in a high-stakes litigation.

Challenge:

A tenant in a shopping center sued their landlord for leasing adjacent space to a user that they claimed was not an appropriate retail tenant.

Solution:

Assessed industry trends on co-location of this type of space user in other similar shopping centers in this and similar locations. Determined that this use was supported by current industry practice and prevalent in similar centers in this and other regions of the country.

Result:

The case is currently ongoing, with the analysis forming a key component of the defense strategy.

Challenge:

A diversified financial services firm launched a new subsidiary with a unique structure that did not align with standard rating agency methodologies.

Solution:

AREC acted as strategic advisors throughout the credit rating process—engaging directly with all major rating agencies (both business and analytical units), managing contracts, coordinating discussions between the rating agencies and client, and ensuring alignment between the client’s business model and rating criteria. The subsidiary’s structure required a creative, hands-on approach to identify the right analytical teams and methodologies.

Result:

Successfully procured credit rating tailored to the unique structure that validated the new subsidiary’s business model, giving the firm the market credibility it needed for optimal bank financing.

Challenge:

A family-owned multifamily real estate business was preparing for an intergenerational transition and needed strategic and operational guidance to ensure continuity, improve performance, and set the stage for long-term success.

Solution:

We served as interim executive to lead the transition process, conducting a comprehensive gap analysis to benchmark current operations against industry best practices. Our involvement spanned multiple functional areas:

• Predevelopment: Oversaw land acquisition, entitlements, site subdivision, and final approvals for residential and commercial development.

• Project Execution: anaged third-party contractors, including site and general contractors, home builders, renovation teams, and commercial expansion crews.

• Lease Transactions: Led tenant negotiations, coordinated with brokers, and oversaw retail and office tenant fit-outs.

• Valuation & Finance: Built acquisition models for all property types, assessed buy/sell scenarios, consolidated asset-level financials, and arranged financing for land, construction, and refinancing of stabilized assets. 

• Ownership Reporting: Consolidated financial valuations for ownership at the asset level.

• Professional Services Management: Directed relationships with legal, accounting, engineering, and appraisal firms.

• Property Management Oversight: Oversaw in-house property management companies.

• Cash Management: Reviewed and optimized banking relationships and internal cash management strategies.

• Business Development: Prospected new tenant opportunities, with a focus on medical office and retail leasing.

Result:

A successful transition to next-generation ownership, with improved governance, streamlined operations, and a sustainable growth platform.

Challenge:

A well-established real estate development firm, known for its success in urban infill residential projects, sought to expand its business into new areas but needed strategic clarity and a structured growth plan.

Solution:

Leveraging our Board in a Box methodology, we provided ongoing strategic support through regular engagements with the CEO and leadership team. Our approach included:

• Organizing and classifying company documents and presentation materials

• Synthesizing the business plan from historical activities

• Identifying and evaluating potential areas for expansion

• Conducting an analysis of strengths and weaknesses to align internal capabilities with growth opportunities

• Developing a phased implementation roadmap

Result:

We collaborated closely with the firm to define a clear strategic direction and establish a timeline for executing their growth objectives—positioning them to scale confidently and sustainably.