Articles

Examples of how and why industry-leading real estate and construction companies, such as WeWork and China Hengda Group, go bankrupt (8 companies)

In August 2023, China's second largest real estate company, Evergrande Group, filed for Chapter 15 bankruptcy protection in a New York court, which is expected to have a profound impact on the economy and society as well as on its many business partners due to the size of the company.

In November 2023, WeWork, the world's leading shared office service provider, filed for Chapter 11 bankruptcy protection, which made headlines because it is one of the most famous and fastest-growing startups since its founding in 2010.

In this section, we discuss eight examples of how and why industry-leading real estate and construction companies go bankrupt globally, including China Hengda Group and WeWork, and examine the general factors and countermeasures that lead to bankruptcy for real estate and construction companies.

Leading Real Estate and Construction Companies in Bankruptcy

The following seven companies were selected to provide a balance of business models, geographies, and time periods.

General Growth Properties

https://en.m.wikipedia.org/wiki/GGP_Inc.

Company Overview

General Growth Properties (GGP) is a leading U.S. real estate investment trust (REIT) that owns and operates shopping malls across the U.S. Founded in Iowa in 1954 by brothers Martin and Matthew Bucksbaum, GGP has grown to become the second largest shopping mall operator in the nation in the 21st century.

Business Model:

GGP 's primary business model was the acquisition, development, and operation of shopping malls; by owning these properties, the company profited by leasing space to various retailers and maintaining high occupancy rates; REITs such as GGP also have a unique model of distributing at least 90% of their taxable income to shareholders, who benefit from a tax exemption on distributed income(Chen, 2003)

Pre-bankruptcy asset size:

Prior to filing for bankruptcy in 2009, GGP had approximately $29.5 billion in debt, making it one of the largest commercial real estate bankruptcies of its time(Taub & Louis, 2009).

Reasons for bankruptcy

Overleveraged and maturing debt: Since most of GGP's real estate was acquired through leveraged buyouts, the company was heavily indebted; by 2009, much of this debt had matured and the company was having difficulty refinancing due to tight credit markets.
The financial crisis of 2008: The financial downturn severely impacted consumer spending and the retail sector, leading to a decline in revenues for mall operators like GGP; reduced foot traffic and store closures impacted rental revenues; and the company's ability to maintain a profitable retail business was severely impacted by the financial crisis.
Decline in bricks-and-mortar retailing: The gradual shift to e-commerce and the decline of traditional retailers impacted GGP's revenues; this trend had been ongoing for some time, but the financial crisis accelerated the trend.
Debt renegotiations failed: GGP tried to negotiate with its creditors to extend the terms of its loans; however, these efforts were fruitless and the company was forced into bankruptcy.

(Singh, n.d.)

Thornburg Mortgage

https://content.time.com/time/specials/packages/article/0,28804,1841334_1841431_1902021,00.html

Company Overview

Founded in 1993 and headquartered in Santa Fe, New Mexico, Thornburg Mortgage was once one of the largest independent mortgage lenders in the U.S. Unlike many of its competitors, it specialized in originating, acquiring, and managing high-quality variable-rate mortgages; these loans were typically offered to creditworthy borrowers, differentiating it from other lenders that service subprime.

Business Model

Variable Rate: focused on interest rate-adjusted mortgages that were larger in size than typical mortgages purchased by government-sponsored institutions; these mortgages were issued primarily to borrowers with higher credit scores and larger asset sizes
Securitization: After acquiring mortgages, the institutions often pooled them and sold mortgage-backed securities, keeping the least risky tranche in the portfolio and selling the riskier portion to other investors.

Asset size before bankruptcy.

At its peak in 2007, Thornburg Mortgage's loan portfolio was worth approximately $36.5 billion; at the time, it was the nation's leading single-family mortgage lender.

("Top 10 Bankruptcies," n.d.)

Reasons for Bankruptcy

National housing recession and subsequent credit crisis.
Liquidity problems: after the summer of 2007, the value of mortgages on balance sheets began to decline, resulting in a series of margin calls from creditors.
Inability to support the equity (margin) needed to fund the mortgage-backed securities portfolio given the continued decline in mortgage-backed securities prices(Stempel, 2009).

Carillion

https://www.google.com/url?sa=i&url=https%3A%2F%2Fwww.crowe.com%2Fie%2Finsights%2Flessons-to-be-learned-from-the-carillion-uk-collapse&psig=AOvVaw34Z_wOXTTUYrxZy-3F1fxl&ust=1697530496524000&source=images&cd=vfe&opi=89978449&ved=0CBIQjhxqFwoTCKDXioWQ-oEDFQAAAAAdAAAAABAE

Company Profile

Carillion plc is a British multinational facilities management and construction services company. spun off from Tarmac in 1999, the company quickly emerged as one of the largest contractors in the U.K. In addition to high-profile projects in the U.K., including the Royal Liverpool University Hospital and the Aberdeen Bypass, the company has completed numerous projects abroad in Canada and the Middle East.

Business Model

Carillion operated primarily in the public and private sectors, offering a wide range of services

Construction Services: Carillion's traditional area of business was in the construction of buildings, infrastructure, and civil engineering projects.
Support services: Carillion provided outsourced maintenance services, including facilities management for hospitals, schools, and defense facilities.
Public-Private Partnership (PPP) ProjectsCarillion was involved in a number of PPP projects where private entities and governments collaborated on infrastructure projects, particularly in the healthcare and defense sectors.
Construction in the Middle EastCarillion has a large presence in the Middle East, often entering into construction contracts in joint ventures with local partners.

Asset size prior to bankruptcy

At the end of 2016, just one year before its bankruptcy, Carillion's total assets were approximately £1.57 billion.

(London Business School, 2018)

Reasons for bankruptcy

Huge debt: Carillion faced a significant financial burden with debts of £1.5 billion; despite discussions with financial institutions and the government, no agreement was reached to bail the company out.
Risky contracts: Some analysts believe that Carillion took on too many risky contracts that proved unprofitable; these contracts strained the company's resources and caused financial instability.
Payments in the Middle East: The company suffered delays in project payments in the Middle East, which adversely affected its accounting and cash flow.
Major project failures: several public sector construction contracts faced cost overruns; delays, technical problems, and other challenges added to the company's financial woes.
Difficulties from lenders: major banks were hesitant to extend additional financing to the struggling company.

(D. Thomas, 2018)

Enron

https://www.google.com/url?sa=i&url=https%3A%2F%2Fwww.chron.com%2Flocal%2Fhistory%2Feconomy-business%2Farticle%2FThe-rise-and-fall-of-Enron-9712210.php&psig=AOvVaw0H8qpQ2ttT8msVGBkr8l6J&ust=1697530716176000&source=images&cd=vfe&opi=89978449&ved=0CBIQjhxqFwoTCNjT0u2Q-oEDFQAAAAAdAAAAABAE

Company Overview.

1985年に設立されたEnronは、Houston Natural Gas と InterNorthの合併により誕生した。当初は天然ガス会社であったEnronは、年々多角化を進め、世界各地で事業を展開するエネルギー、商品、サービスの大手企業となった。テキサス州ヒューストンに本社を置く同社は、『フォーチュン』誌から6年連続で「米国で最も革新的な企業」と賞賛された。

Business Model

The company's model was vast, encompassing energy production, trading, and other related businesses, and its model was as follows

Energy production and sales: production and sale of electricity and natural gas, distribution of energy and other physical commodities, and provision of financial and risk management services to customers worldwide.
Energy Trading: Launched in 1999, EnronOnline was an electronic trading platform that facilitated the sale of commodities; it became the world's largest e-commerce site by transaction value; it was also the world's largest energy trading site by value.
Special Purpose Entities (SPEs): Enron utilized SPEs to finance a significant portion of its business without consolidating liabilities on its balance sheet and to hide its liabilities and show off its profitability.

pre-bankruptcy asset size.

Prior to its bankruptcy, Enron was one of the world's leading power, natural gas, pulp and paper, and telecommunications companies; in 2000, it had revenues of approximately $101 billion, ranking it seventh among Fortune 500 companies at the time.

(C. W. Thomas, 2002)

Reasons for bankruptcy

Corporate greed and arrogance: Enron's leadership was driven by an atmosphere of greed and corporate arrogance; the company was involved in high-risk transactions, many of which circumvented the company's typical risk management processes; these transactions began to deteriorate in 2001, leading to a loss of confidence from investors and creditors; the company's financial statements were not in accordance with the Fortune 500, and the company's financial statements were not in accordance with the Fortune 500.
Lack of transparency: Enron's financial statements were complex and lacked transparency; the company used creative methods to obscure financial transactions, leading to erroneous and potentially deceptive reporting.
Special Purpose Entities (SPEs): Enron made extensive use of special purpose entities (SPEs) to avoid recording liabilities on its balance sheet and to make the company appear more attractive to investors and rating agencies; however, these entities were complex and often lacked adequate disclosure, resulting in significant financial inconsistencies.
Market Value Accounting: Enron employed "market value accounting" in its energy trading business, which required adjustments to the value of energy contracts to market value, resulting in unrealized gains and losses; the subjective nature of this accounting method allowed Enron to potentially overstate its profits.
Internal Culture and Pressure: Enron's corporate culture emphasized aggressive dealmaking and dealmaking; employees felt pressured to make a profit, leading to a corporate culture where the ends justified the means.
Overexpansion and poor investment: Enron expanded into new markets such as broadband and video-on-demand, pouring millions of dollars into areas that did not yield significant returns; as these ventures failed, Wall Street's confidence in Enron declined.

(C. W. Thomas, 2002)

Western Environmental Development

https://www.google.com/url?sa=i&url=https%3A%2F%2Fwww.machinami.or.jp%2Fpages%2Fmachinami_search%2Fsearch_japanese_detail.php%3Fmid%3D9072&psig=AOvVaw0nwgvgDSx5dBvKxPL1owO6&ust=1697531051905000&source=images&cd=vfe&opi=89978449&ved=0CBIQjhxqFwoTCKi-n42S-oEDFQAAAAAdAAAAABAE

Company Overview

Once an important player in the Japanese real estate industry, Seiyo Kankyo Kaihatsu enjoyed great success during Japan's real estate boom. based in Tokyo, the company was involved in a variety of real estate sectors, from residential to commercial development and management.

Business Model

Western Environmental Development's business spanned many aspects of real estate:

He was involved in development real estate development and was responsible for the construction and sale of commercial and residential properties.
A significant portion of revenues came from leasing commercial space, including office and retail space.
Property management services to maintain and optimize the operation of the facilities.
Taking advantage of the surge in Japanese real estate prices during its heyday, the company also expanded into real estate asset management.

Asset size before bankruptcy

517.5 billion yen ($4.79 billion) in total.

(Lopez, n.d.)

Reason for bankruptcy

Excessive investment during the bubble period caused the company's debt to grow to 752.7 billion yen in 1994.
The focus on adding value resulted in excessive construction spending, which contributed to the increase in debt.

(Yui et al., n.d.)

Katerra

https://www.google.com/url?sa=i&url=https%3A%2F%2Fwww.architectmagazine.com%2Ftechnology%2Fkaterras-2-billion-legacy_o&psig=AOvVaw0P9My8e5YIJwcBgwAB1OMC&ust=1697531113814000&source=images&cd=vfe&opi=89978449&ved=0CBIQjhxqFwoTCLCm2qqS-oEDFQAAAAAdAAAAABAE

Company Overview

Katerra Inc. emerged as a promising startup looking to transform the construction sector Founded in 2015 and headquartered in Menlo Park, CA, the company positioned itself at the intersection of technology and architecture, aiming to streamline and integrate fragmented construction processes Its innovative approach quickly attracted significant investment, most notably from the SoftBank Vision Fund Katerra was the first company to receive the SoftBank Vision Fund's investment in the company

Business Model

End-to-end integration: Katerra sought to manage all phases of the construction process: design, material procurement, manufacturing, and actual construction; in doing so, the company sought to reduce the inefficiencies prevalent in traditional construction.
Off-site manufacturing: The company invested heavily in technology and equipment to prefabricate building components off-site, minimizing on-site labor and potential errors.
Technology-driven: Katerra considered itself a technology company as well as a construction company; it developed a software platform for project management, leveraged innovative building technologies, and employed data analytics for decision making.
Scale through acquisitions: To rapidly expand its footprint and capabilities, Katerra acquired a variety of companies, from architectural firms to material manufacturers.

Pre-bankruptcy asset size.
By the time of the 2021 challenge, Katerra had reportedly secured over $2 billion.

Reasons for Bankruptcy

Project delays and construction costs: Katerra faced challenges of project delays and rising construction costs, which strained its financial base.
Pandemic-related effects: The global pandemic affected many industries, including construction, and Katerra was not immune to these effects, further exacerbating its financial difficulties.
Reluctance to adopt new practices: Katerra has struggled to convince developers and contractors to move away from traditional subcontractors, indicating resistance to change in the industry.
Overzealous business model: Katerra's approach was described as "trying to boil the ocean"; they aimed to do everything at once and expanded rapidly with thousands of employees across multiple countries; this over-extension and lack of focus contributed to their downfall; they were unable to convince developers and contractors to move away from traditional subcontracting; they were unable to convince developers and contractors to move away from traditional subcontracting; they were unable to convince developers and contractors to move away from traditional subcontracting; they were unable to convince developers and contractors to move away from traditional subcontracting
Complexity and overcomplication: Katerra's operations were characterized by a high level of complexity; it invested heavily in advanced technology, which at times led to increased complexity; for example, it spent tens of millions of dollars on an ERP system; and it spent more than $100 million on a new software development system, which was not designed for the company's core competencies.
Deviation from core competencies: Katerra sought to control all aspects of the supply chain, from design to manufacturing; this approach differed from others that sought to mitigate supply chain risk without necessarily controlling all elements.

(Obando, 2021)

Evergrande Group

https://www.google.com/url?sa=i&url=https%3A%2F%2Fwww.sbbit.jp%2Farticle%2Ffj%2F70549&psig=AOvVaw1CTYlNwawbmzwmPOrlIA2T&ust=1697532140583000&source=images&cd=vfe&opi=89978449&ved=0CBIQjhxqFwoTCOCJqZSW-oEDFQAAAAAdAAAAABAX

Evergrande Group Company Profile

Evergrande Group was founded in 1996 by Xu Jiayin and quickly became one of China's largest real estate developers The company's business model was to acquire land at low prices, develop it into residential and commercial properties, and sell those properties at high prices Evergrande also diversified into other businesses, including property management, financial services, and electric vehicles

Business Model

Evergrande's business model was based on rapid expansion and high levels of debt: the company acquired large tracts of land at low prices, developed them into residential and commercial properties, and then sold them at high prices Evergrande also pre-sold pre-completed properties to buyers, allowing it to generate cash flow early in the development process.

Evergrande's pre-bankruptcy assets

In 2021, Evergrande had over 160,000 employees( Evergrande Group: Number of Employees 2021, n.d. ) and assets worth over US$256 billion in 2022("Evergrande Posts Losses of $81 Billion over Two Years as It Reports Long-Delayed Results," 2023).

Evergrande's total liabilities reached RMB 2.437 trillion (US$340 billion) by the end of last year("Evergrande Posts Losses of $81 Billion over Two Years as It Reports Long-Delayed Results," 2023 )

Reasons for Evergrande's Bankruptcy

Evergrande filed for Chapter 15 bankruptcy protection in August 2023; Chapter 15 allows foreign companies to restructure their debts under U.S. law("China's Evergrande Files for Bankruptcy," 2023)

There were several reasons for Evergrande's bankruptcy:

Aggressive expansion and high levels of debt: The company was heavily reliant on debt to finance its expansion and was vulnerable to changes in the real estate market; as real estate prices fell, Evergrande had difficulty selling properties and paying down its debt.
Chinese government crackdown on the real estate sector
China's economic slowdown
COVID-19 pandemic

(KYODO NEWS, 2023; Li, 2022)

WeWork

Company Profile (WeWork, n.d.)

Founded in 2010 by Adam Neumann and Miguel McKelvey, WeWork began as a startup with a vision to revolutionize the traditional office space. Headquartered in New York, WeWork quickly expanded to locations around the world and became synonymous with the coworking space revolution. By offering shared workspaces, the company caters to freelancers, startups, small businesses, and large corporations.

Business Model (WeWork, n.d. )

WeWork's business model is multifaceted, combining aspects of real estate, technology, and community building:

Coworking Spaces: The core of WeWork is the provision of coworking spaces. These spaces are typically well-designed and foster an environment of collaboration and innovation. Users can rent desks and offices on flexible terms, which is particularly attractive to startups and freelancers seeking a professional environment without a long-term lease.
Membership model: Individuals and companies join WeWork as members and pay different rates depending on the type and location of space they use. Membership is flexible and allows users to access workspaces worldwide.
Corporate clients: Corporate clients can lease entire floors or buildings.
Ancillary services: WeWork offers not only space, but also a variety of amenities and services, such as Internet access, printers, meeting rooms, and even perks like coffee and beer. The company also hosts networking events, workshops, and social gatherings, making it more attractive as a community.
Real Estate as a Service (RaaS): WeWork's approach can be seen as part of the RaaS model, where large spaces are leased, renovated, and then rented out in smaller lots at higher rates.

Pre-Bankruptcy Assets.

WeWork reported total liabilities of $18.65 billion against total assets of $15.06 billion. (Goswami, 2023)

Reasons for Bankruptcy (Zahn, 2023 )

Sharp decline in valuation: the listing review process revealed significant losses, resulting in a dramatic decline in valuation. The 2019 valuation was $47 billion, but in one year the stock price plummeted more than 98% to $45 million.
Business Model Challenges: WeWork's business model was to lease and renovate office space and then rent it out at higher rates. However, demand for shared office space did not meet expectations, leading to financial strains.
Impact of COVID-19: The pandemic forced many office workers to telecommute, further reducing demand for shared office space and exacerbating WeWork's problems.
Debt driven expansion: WeWork's expansion was largely driven by debt, including a $17 billion investment from SoftBank. The company was unable to generate enough revenue to cover its expenses and debt and fell into financial difficulties.

Conclusion

This paper has reviewed the past major bankruptcies of real estate and construction companies around the world, including China Hengda Group, and briefly discusses some of the common factors that lead to the bankruptcy of real estate and construction companies and how they can be prevented.

There are two main factors that lead to bankruptcy: high debt or low assets.

The most common causes of high debt are inadequate borrowing plans (Enron, WeWork) and risky leverage (General Growth Properties) that significantly exceed the company's revenues.

The cases of small assets include unexpected economic crises such as the Lehman Shock and the COVID-19 pandemic (General Growth Properties, China Hengda Group, WeWork), failure of business models (Katerra), and government intervention (China Hengda Group), as well as maintaining sufficient liquid assets, keeping track of overall economic trends, and anticipating government policies.