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Eron Lenders
Lenders in Cloverdale Mall and Nanaimo Business Centre
Lender Update
March 3, 1999
Dear Lenders
We are writing to advise you of developments in the captioned mortgages.
Cloverdale Mall
On June 15, 1998 we obtained an Order Nisi, with immediate conduct of sale of the leasehold interest in the Cloverdale Mall pursuant to our second mortgage of the leasehold interest in this mall. We were later granted an Order appointing a Receiver of Rents of the mall.
As you are aware, the Mall is in poor shape. It is a poorly designed facility with severely dated improvements and a significant amount of 'deferred maintenance'. Notwithstanding these problems, we believed there was significant equity to pursue in this project.
The appointment of the Receiver of Rents enabled all cash flow from the mall to be used for necessary repairs, payment of the land lease to the City of Surrey and payment of any surplus to the first mortgagee, MRS Trust, who is owed approximately $2.4 million.
The land lease with the City of Surrey expires in the year 2032. On August 31, 1997, the land lease payments were due for a review. This was the first period in the term of the lease, which commenced in 1972, that increases in the amount of rent were unrestricted. For 1997, the base lease payments were $35,010 per annum. The City also receives participation rent of (roughly) 10% of rents in excess of $190,000. For 1996 and 1997, these participation rents were approximately $42,000 per year.
A. Schiel Construction Ltd., as the tenant with the City of Surrey, did not conclude any agreement with the City in respect of this August 1997 rent review. Our initial discussions with the City indicated they were seeking annual base rents of $400,000 plus participation rents. The gross 1997 rental income of the mall, including property taxes but excluding common area charges was $614,000. A land lease payment of $440,000 plus payment of the property taxes (approx. $109,000) would leave $65,000 per year available for debt service assuming all operating costs were paid by tenants, which is not the case. This amount would be insufficient to service the first mortgage of the leasehold interest and our economic interest would be worth nothing.
The City of Surrey lease allows for arbitration of the amount of base rents if the parties cannot negotiate. The lease also provides instructions to the arbitrator as to the factors to be considered. Our and our counsel's conclusion was that the arbitration mechanism had many inherent risks as should be avoided.
After considering:
* the condition of the Mall,
* that any purchaser would be only interested in a redevelopment of the Mall,
* the fact the lease had only 34 years remaining on it, and
* the unresolved amount of the land lease payments,
we concluded that the leasehold interest over which we had power of sale was not saleable.
We then met with the City of Surrey and suggested they enable us to sell their freehold interest with our leasehold interest in the property to a developer who would redevelop the site. This would then settle the latter three of our four concerns expressed above.
A brief chronology of our dealings with the City of Surrey is as follows:
August, 1998: Meetings with the City of Surrey (Avril Wright, Planning and Development and Maureen St. Cyr, in house legal, ) culminate in our letter of August 27, 1998 with proposal for sale of the City's freehold interest. During this period, City is provided with all information requested on current tenancies, etc. and plan developed for dealing with arrears.
October, 1998: Meetings with the City progressed to the point that the Property Department was going to recommend the sale to Council on the basis outlined in the writer's memorandum of October 21, 1998. [Equal split of total sale value between leasehold and freehold interests, shared costs of sale]. Expected to be heard by Council on November 9, 1998.
November 10: Don Elving advises report has been with Jorgen for two weeks, did not get before Council, now expected to get before Council on November 23; Don Elving mentions Craig MacFarlane's involvement during conversation.
November 18: Don Elving advises report and recommendation going to Council on Nov 23, report did not refer to the contribution of the City's orphan site at north end of property.
November 20: Don Elving sends an email seeking modification of the agreement. Changes include a withdrawal of the orphan site from the deal and the leasehold interests covering one half of the costs of phase 1 environmental and preliminary soils profile. After discussion, we agree to these modifications.
December 5: Don Elving advises 'all have signed off on report, except Parks (and that should be done soon). Council meeting Dec 14.
December 7: Ken Woodward advises they had a meeting with Planning Department and solicitor. He thinks they want to prolong the report so that Planning can issue its report on the development of Cloverdale town centre.
December 8: Ken Woodward advises the report is going to Council in early January. Planning had concerns re: future development and wanted study and recommendation before any sale. Their report expected to be completed in January. Ken advised the Property group and in house legal were recommending proceeding.
December 21: Ken Woodward advises they are on track for getting the report and recommendation to Council in early January.
January 7: Ken Woodward calls. Wanted to incorporate options into report.
January 12: Ken Woodward advises his report is in and the 'brass' are reviewing it. All comments should be in by end of week then to City Manager and then to Council, hopefully January 25.
January 26: Ken Woodward calls and advises Council did not see the report the previous evening. Doesn't return the writers calls over the balance of the week.
January 29: Don Elving returns the writer's call to say that his group has been subjected to a 'gag' order since Wednesday (January 27) and that the writer should call Maureen St. Cyr or Craig MacFarlane. Neither are in; left voice mails.
February 1: Craig MacFarlane calls to advise the City is preparing letters advising A. Schiel Construction Ltd. of it's repair obligations under the lease and putting it on notice it intends to pursue arbitration of the base lease rents.
February 15: City of Surrey writes advising of tenants breach of repair convenant, breach of covenenant re approval for subleases and breach of covenant to pay participation rent.
February 22: City of Surrey repeats its demand for $400,000 per annum base rent (now retroactive to September 1, 1998). Failing this, the City advises they will seek arbitration.
These developments are cause for considerable concern. We believed our efforts would have resulted in gross sale of approximately $6 million. After sale costs of perhaps $100,000, the City would have received $2.95 million and we would have received approximately $0.5 million after repaying the MRS Trust mortgage of $2.4 million. We have advised the City of our angst that they have abandoned an agreed path of action without notice and our belief we had an agreement with the City, subject to the approval of City Council. We also advised the City we believed this complete reversal to be an act of bad faith.
Notwithstanding our position, all mortgages of the leasehold interests are now imperilled; the City is being extremely aggressive. The Mall has also suffered from the weather and the simple fact the Mall does not spin off enough cash to effect more than patchwork repairs to the building. The condition of the buildings is now causing tenants to withhold rents. MRS Trust commenced their foreclosure action on September 2, 1998. We have kept them apprised of our strategy and developments throughout the past seven months. They have assured us they will not take an Order Absolute (i.e. not foreclose us off title), but will continue to pursue matters with the City of Surrey.
We will continue to co-operate with MRS Trust in their actions with the City but cannot justify continued expense in protecting the questionable equity of the 2nd ( or subsequent) mortgages on this site. We hope MRS Trust can force the City of Surrey into either a sale mandate or a reasonable base rent. As MRS Trust will soon have conduct of sale, we will have to accept any reasonable commercial offer that MRS is prepared to recommend to the Court and this offer may not provide any return on our economic interest in this project.
Nanaimo
As you will recall, we have had conduct of sale of the Nanaimo Business Centre since March 5, 1998 after the first mortgagee obtained an Order Nisi and assigned the power of sale to us. The property was appraised at $2.858 million and our mortgage ranks after a first mortgage of approximately $1.4 million in favour of the Operating Engineers Pension Plan. ("OEPP"). A consultant to the OEPP has been acting as Receiver of Rents since March 1998. We listed the property for sale with RE/Max Nanaimo at a price of $2.6 million. OEPP listed the property for lease at the same time with the same realtor.
The property is the former Eatons building at 13 Victoria Street in downtown Nanaimo. It is built on a hillside and has two floors of commercial space, several odd mezzanine floors which have storage potential. Years ago, a block of condominiums were built above the existing structure and sold off under strata titles. The 2nd floor of the building is presently well tenanted with 18,313 (net) square feet rented generating $222,369 in gross rents. The ground floor has 15,939 (net) square feet of which 12,862 square feet are vacant. The remainder of the floor (3,077 square feet) generates annual gross rents of $26,931. The storage space identified can generate gross rents in the short term of $29,000 to $40,540 over the long term.
We are advised the vacant ground floor space has a market value of $7.00 net per square foot per annum. With property taxes, utilities, repairs, etc. of approximately $137,500 per annum, we believe the property has a value, in normal circumstances of $2.5 million. We believe a fire sale value of the property would be $1.9 million. There does not appear to be any owner/occupier options in the Nanaimo area. From an investment perspective, the existing vacancies are too much for any current buyer to absorb. Strategically, we believe the property should be taken off the market until at least another 6,200 square feet are leased up.
In September 1998 our initial redemption period was expiring and to protect our position, we negotiated a 6 month extension from the OEPP by paying them down by $100,000. We drew these funds from our operating line of credit at that time. Since that time, the use of our operating line to expend preservation costs on any particular project has been scrutinized and this practice will be the focus of further scrutiny with the recent decision against pooling of investor interests. We have decided we cannot justify continued expenditures from the operating line to support this project.
We presently have three options:
1. Fight with the first mortgagee to keep them from foreclosing us off title. This will be expensive and, over time, we would lose this fight.
2. Raise $1.4 million to pay out the existing first mortgage. It is too early for us to raise this amount of financing on the property as many of the cash flow improvements are too recent. The cost of funds would be significantly in excess of that charged by OEPP.
3. Raise $50,000 to pay down the first mortgage in return for an extension of the redemption period. We have confirmed that OEPP would accept this for a (minimum) 6 month extension. They are also in agreement with taking the property off the sale market (at least don't actively market it) until further leasing has been achieved.
Accordingly, we ask investors to raise funds to protect their equity in this property. This would represent 2% of their original investment. We suggest that this pool of money would be repaid to investors with interest (at the same rate as is 'earned' by existing investors), in priority to the existing investor interests, from the proceeds of eventual sale. We suggest the lenders meet to discuss this option and if there is anything we can do to facilitate this discussion, please contact the writer at 806-7913.
Yours truly,
PricewaterhouseCoopers Inc.
Judicial Trustee
Per:
Richard D. Pallen
Vice President
Financial Advisory Services
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