The partnership behind Heritage Quarters in downtown Waco filed for Chapter 11 bankruptcy Tuesday to protect the student housing project from foreclosure.

The $22.5 million complex was set for auction Tuesday afternoon after the partnership failed to reach an agreement with its interim lender, Sterling Bank, to secure longer-term financing for the project, the partners said.

The bankruptcy filing will buy time so the limited partnership, called SWB Waco SH, can seek permanent financing elsewhere and pay off construction liens on the property, partner David Wallace said.

“We’ve got plenty of equity in this project,” Wallace said. “We’re confident all the creditors will be paid back 100 cents on the dollar.”

The Heritage Quarters Apartments are protected from foreclosure proceedings for the time being as developer SWB Waco SH filed for Chapter 11 bankruptcy protection.
Duane A. Laverty / Tribune-Herald

Wallace said the bankruptcy is limited to the Heritage Quarters project and will not affect other downtown properties that he and his partners own, such as Heritage Square and RiverSquare Center.

The six-story Heritage Quarters, built on land the city offered as an incentive, has been hailed as an anchor for downtown redevelopment.

Wallace said the 375-bed housing complex is financially healthy with an occupancy rate of more than 80 percent, and the legal process will not affect tenants.

Sterling Bank had the property posted for foreclosure Aug. 18, but until late Tuesday morning, Wallace voiced hope that he could resolve issues with the bank.

“It’s frustrating because we have a quality asset with a positive cash flow, an asset that’s leased up, yet Sterling proceeded to (seek foreclosure) the week that students came back,” he said after filing for bankruptcy.

Sterling Bank officials did not return calls seeking comment Tuesday.

City Manager Larry Groth said the bankruptcy might be a temporary negative for downtown’s image, but Heritage Quarters is fundamentally sound.

“This is not a failed project,” he said. “It sounds like in this case that the property is producing and throwing off cash. This has to do with a financing issue with the development.”

Wallace said the struggles had to do with a difficult financial climate and contractor issues.

Sterling Bank in 2008 agreed to provide $18 million in construction financing for the project until April 2010 and had indicated it would provide two years of “semi-permanent” financing after that, Wallace said.

But the continued financing depended on the property meeting certain expectations for performance, including maintaining a certain debt coverage ratio, he said. The bank reappraised the property in February and found that it has lost value, negatively affecting that ratio.

In the meantime, SWB was struggling with its general contractor, E.E. Reed Construction, over some construction problems at the complex, including flooding, Wallace said.

The partnership withheld its final $1.9 million payment to E.E. Reed until the problems were resolved, and the contractor responded by putting a lien on the property for the same amount.

The two sides came to an agreement early this year, but when the partnership tried to draw down the final $1.9 million, Sterling refused, citing the debt coverage ratio, Wallace said.

Wallace said Sterling withdrew its offer of longer-term financing, and because of the lien still on the property SWB couldn’t get financing elsewhere.

He said the bankruptcy will give SWB a chance to reorganize and find a permanent lender and will ensure that E.E. Reed and its subcontractors are paid.

Wallace’s Houston firm, Wallace Bajjali, owns other major properties in downtown through various partnerships, and he said those properties are doing well. RiverSquare, the retail and office development on Franklin Avenue, is 100 percent leased, he said.

One of Wallace’s groups is the owner and developer of the commercial-residential development around Heritage Square. He said the loft apartments there are 100 percent occupied, while commercial space is 50 percent leased.

Wallace is working on future phases of the project under a development agreement with the city.

jbsmith@wacotrib.com

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