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December 14, 2022

Red Flags That a Company May Be in Financial Trouble, Part 3: Real Estate

The earlier you learn that a company you do business with is in financial trouble, the better you are situated to mitigate the disruption and expense if it fails or files for bankruptcy. Part 1 and Part 2 of this alert series describe a number of red flags applicable to all types of businesses. This final installment of the series includes examples of red flags particular to real estate developers, owners, and projects. As with Parts 1 and 2, the occurrence of one or more of these factors does not necessarily mean a business is or will soon be in trouble. However, they should at least cause a heightened awareness and, if possible, some additional inquiry and investigation to make sure the company you are doing business with is financially healthy and able to fulfill its obligations.

1.   Declining Rents 

Even if the company is not yet in financial trouble, declining rents, either for the property in particular or generally for the market, may be an early indicator of financial problems to come. 

2.   Increased Vacancies

Similar to declining rents, increased vacancies, either for the property or the market, if unchecked, will lead to financial problems down the road.

3.    Tenant or Other Financial Difficulties

If a company or property relies on one tenant for a major portion of its rental income, the tenant’s financial problems can quickly lead to the landlord having financial problems. A decline in tenant reputation (especially if in the news or otherwise broadly known) could be a precursor of financial difficulties.

4.    Construction or Renovation Problems or Delays

Problems or delays completing a project can be an indication of lack of funds, cost overruns, or other current financial problems. Even if the company is not yet in trouble, these problems can lead to future financial problems by delaying the sale or rental of the property.

5.    Mechanic’s Liens

The filing of mechanic’s liens, and especially the foreclosure of the liens, is a clear indication that the company is experiencing cash flow or other financial problems.

6.    Delinquent Property Taxes or Other Assessments

A company’s failure to pay its property taxes and other assessments is another indication of present financial troubles. This type of unpaid obligation is especially troublesome for a mortgage lender since these liens would have priority over the mortgage.

7.    Deferred Maintenance

Not only does deferred maintenance indicate a present financial problem, a management problem, or both but also will lead to further financial problems in the future as the value and desirability of the property deteriorates, which will result in reduced future income from sales and rental.

8.    Code Violations

Finally, not only do code violations create a current problem due to the inability to sell or lease the property and the costs of correction and possible fines but also can lead to future problems due to the delay in the ability to sell or lease the property.

Knowing in advance that a company may be heading for financial trouble can help protect you against the fallout if the company eventually fails or ends up in bankruptcy. Watching for these red flags may give you the head start you need.

The Thought Leadership Committee of Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts and blogs on an ongoing basis to keep clients, colleagues, and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Robert Wonneberger, Thought Leadership Committee chair, at rwonneberger@barclaydamon.com, or Janice Grubin or Jeff Dove, co-chairs of the Restructuring, Bankruptcy & Creditors’ Rights Practices Area, at jgrubin@barclaydamon.com and jdove@barclaydamon.com

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