Block 37, the infamous lot in downtown Chicago, has drawn controversy for the past two decades as a series of developers have struggled to turn it into a mixed-use project. The latest drama surrounding the 285,000 sq. ft. retail development took place in late November when Cook County Circuit Court Judge Margaret Brennan appointed CB Richard Ellis (CBRE) as receiver for the property.
The story has been far from straightforward. The developer, Joseph Freed and Associates, remains in control is in the midst of an effort to contest the appointment while CBRE, the Los Angeles-based brokerage giant, has been in limbo pending the resolution of a key insurance transfer, delaying handover of Block 37.
Brennan’s ruling was the result of tensions that have been brewing for the last two years between Freed and primary lender Bank of America. So far, Freed has received $135 million of the $205 million construction loan from the bank in addition to putting about $20 million of its own equity into the project. Both sides agree that the project will require about $72 million to complete, but the bank is loath to continue funding it with Freed in control.
The parties have had disputes over leasing decisions, most prominently in late October when the bank refused to approve a revised lease that Freed had signed with movie theater operator Muvico. More troubling, the bank said that Freed had been in default on its construction loan since March 2008 and that the project was about $42 million over budget.
In part, the project seems to be a victim of timing. Tenant demand for new retail real estate space has dried up and in cases where retailers are moving, they are asking for cheaper rents. A project coming on line in these conditions faces stiff challenges.
Those facts prompted Bank of America to foreclose on the property and press for a receiver to be named. In addition, even before it began the process to remove Freed, the bank hired another Chicago developer, John Buck Co., as an advisor.
The saga resulted in an odd scene with Freed securing the certificate of occupancy and opening a segment of the project to the public on the same day that the court appointed CB Richard Ellis executive Karen Pence Hollan as the receiver. Freed has entered a motion with the court to stay the appointment.
Tricky transition
In the meantime, CBRE has secured the required operational insurance. However, for two straight weeks, the court has refused to transfer control of the project because of the brokerage’s inability to secure from Freed the Owners Controlled Insurance Program (OCIP), the policy that covers construction.
In itself that is an unusual step in a receivership case. As a fiduciary of the court, a receiver typically posts a bond as a surety that it will discharge its duty in accordance with the orders of the court and state law. And CBRE has posted the required $8 million receivership performance bond.
The receiver does not have to line up the construction insurance. Instead, it assumes the existing insurance on a development.
“CBRE is ready, willing and able to take over the complete management of Block 37 and enable the project to fulfill its vision of becoming a major downtown retail destination,” the brokerage said in a statement released today. “It is clear that Mr. Freed is using his control of the insurance policy — and the long lead time required to obtain a replacement OCIP — to thwart the Court’s efforts to give the receiver possession of the retail and transit portions of Block 37, and to divert attention away from the central issue: Mr. Freed is in default on his loan.”
In short, once Freed gives his approval, ACE Insurance, the provider of OCIP, has committed to approving the assignment to CBRE and Karen Pence Hollan, as receiver. To date, CBRE has acted as receiver on more than 20 million sq. ft. of commercial real estate properties, none of which have faced the same level of insurance issues, according to a CBRE spokesperson.
In Block 37’s case, Freed has said it will pull its insurance if removed as developer making it necessary for CBRE to line up its own construction insurance coverage for the project. It has been unable to do that so far.
“The situation gets stranger with every passing week,” said Larry Freed, president of Joseph Freed and Associates, in a statement. “[Now] the receiver — who was suggested by the bank as better qualified to complete the project — fails for a second week in a row to obtain necessary insurance for the project. So far the receiver has only suggested using our insurance and our safety plan.”
Bank of America did not return calls seeking comment.
Outside observers, however, think the bank is making the right move. “It needs to be controlled by an outside entity that really understands what’s going on,” says experienced receiver Greg Maloney, CEO and president of Jones Lang LaSalle Retail in Atlanta. “That will free up some money and get it moving in the right direction. This in my mind is the kind of situation where receivership makes perfect sense.”
Until CBRE has the proper insurance in place, Freed remains in control. However, in court today, Judge Brennan provided for CBRE to be included in the leasing process for Block 37, and to review all current deals and negotiations going forward. The project is currently 70% leased and Freed has moved ahead with operations at the portion of the project that is now open — the Pedway.
“The project is open and it continues to have stores open,” says Jayne Carr Thompson, president and CEO of Jayne Thompson & Associates Ltd., a spokesperson for Freed. “Tenants are reporting brisk foot traffic and sales beyond their expected projections.”
Complex issues
To his credit, Freed has had more success bringing a project to reality on a site that has long vexed developers. Through the years Block 37, which is one of the original 58 blocks on an 1830 survey of the city, has seen its fair share of firms come and go without being able to advance anything meaningful on the site. The site has sat vacant since 1989.
Only in the last decade has there been any traction. The Mills Corp., which was acquired by Indianapolis-based Simon Property Group in early 2007, was the last company to control Block 37. It ultimately sold the retail portion to Freed and the office portion of the project to Golub & Co. and Blackrock. Last year, Golub opened a 16-story office tower on the site, which is now more than 90% occupied.
“A paucity of distressed borrowers over the last decade has left many institutions out of practice in addressing challenging borrower situations,” says Sam Chandan, president and chief economist for New York-based Real Estate Econometrics. “Block 37’s bumpier ride may be anecdotal but it hints at how difficult it can be to bring all parties’ incentives into alignment.”
Yet despite Freed’s efforts to bring the project forward, it appears the company’s story will not have a happy ending. The handover has been delayed, but there’s no indication that the court intends to reverse the decision. Although Freed announced three new leases on Dec. 11, its days heading up the project appear numbered.