When Boston's landmark John Hancock Tower sold at auction in late March for a little more than half of the $1.3 billion that private equity firm Broadway Partners paid for it only two years earlier, many analysts pointed to the sales price as a new gauge of property values. But more likely it was the precursor to a tidal wave of commercial real estate foreclosures and auctions in the coming months.

“To me it's like a drain that's starting to clog but it hasn't spilled over the side of the tub yet,” says Bernard Haddigan, managing director with Marcus & Millichap Real Estate Investment Services in Atlanta. “I think the foreclosure business is going to be huge over the next five years.”

There are two main triggers for the coming tide. First, some $250 billion in loans originated during a three-year stretch beginning in 2005 and packaged and sold as commercial mortgage-backed securities (CMBS) are coming due by the end of 2009.

New York-based research firm Reis predicts that between now and 2012, building owners will face more than $1.5 trillion in maturing debt and that the default rate could reach 5%, the highest level since the early 1990s. With the credit markets still in lockdown mode, the ability to refinance that debt spells trouble.

The scenario is particularly somber news for the nation's commercial banks. According to researcher Foresight Analytics, banks were carrying some $3.4 billion in commercial real estate loans on their balance sheets at the end of 2008, up from $1.5 billion a year earlier.

Certainly the case can be made that banks — the primary lenders to the industry — have experienced their fair share of trouble lately. According to the Federal Deposit Insurance Corp. (FDIC), 21 commercial banks failed in the first three months of 2009 compared with 25 for all of 2008.

The second trigger is the continued sluggish U.S. economy, which is putting more pressure on borrowers to keep up with their mortgage payments. Because commercial real estate tends to lag the broader economy, the pain has yet to be felt to a large degree.

Workout window open — for now

Facing a potential flood of foreclosures, most banks are ill prepared for the tide that may wash over them. Most are understaffed and many are already overwhelmed with other problems, like how to keep their doors open.

Rather than take back properties from struggling borrowers and place the assets on their balance sheets at an unknown value, a growing number of banks today are opting to extend existing loan terms in the hopes that the market turns around. Loan extensions also buy the borrower time to realize more net operating income and pay back their debts.

“Lenders have been more willing to extend loans for six or 12 months and try to get a better lay of the land as to what the future holds for the asset,” says Jerry Cataldo, executive vice president with Hostmark Hospitality Group, a leading hotel management firm in Schaumburg, Ill.

“Right now it appears there is almost reluctance to move all the way through to foreclosure,” says Jon Barry, president of retail brokerage and property management for Colliers Spectrum Cauble in Atlanta, who leads the asset resolution services group.

One major reason is that lending institutions don't have the manpower due to layoffs and leaner operational staffs to handle troubled loans. “It's relatively quiet. We're seeing a trickle of assets moving back to the lenders, but it is just the beginning,” says Barry.

In lieu of foreclosure, many banks are selling their distressed mortgages to investors. “For a lot of these banks that gives them greater accounting flexibility,” says Brian Olasov, a managing director of law firm McKenna Long & Aldridge LLP in Atlanta.

“When you have an REO property, you can't play any accounting games with that. You get an appraisal, and that's the value of the REO,” continues Olasov. “Most bank analysts would agree that most banks have been slow to write down the value of the underlying collateral securing that loan. This is all about preserving capital that the bank needs from a regulatory perspective. That's one reason you haven't seen aggressive foreclosures,” adds Olasov.

Given the banking industry's woes, many borrowers could have the upper hand when it comes to negotiating with their lenders, according to Ted Hunter, head of the real estate group at law firm Lowenstein Sandler in New York.

While many loans may fall into technical default when the value of the property falls below certain pre-set loan covenants, the borrower is still making its mortgage payments. In these cases, Hunter says lenders will be more inclined to restructure the loan to give the borrower time to come up with additional equity rather than foreclose.