Mezz gets aggressive

Many mezzanine lenders are still sitting on the fence when it comes to taking drastic steps. “A lot of the mezzanine debt holders know that their debt is worthless, so they don't want to foreclose because that would mean they would have to recognize a loss on their investment,” says Peter Miller, a partner in the real estate law practice of Akin Gump in New York. “They're perfectly content to let the world drift the way it is.”

Some mezzanine lenders, however, are aggressively seeking more drastic steps to recoup their investments, particularly when it appears that the primary lender is ready to foreclose on a property.

In the case of the Hancock Tower sale, two mezzanine lenders, Normandy Real Estate Partners and Five Mile Capital Partners, bought enough debt from other lenders on the tower to gain a senior position. They also wanted to hold onto the trophy to recognize the potential upside of a market recovery, even if it proved to be years away.

“The deal structures are much more complex than in the 1990s because they're so highly structured and so highly leveraged that you're going to have these battles between the different capital providers in a way that you've never seen before,” says Olasov.

Troubling fundamentals

While there is a general proclivity among lenders to modify loan terms and work out distressed loans, many analysts fear that the continued weakening of real estate fundamentals will ultimately lead to more REO properties across all major sectors in the months and years ahead.

“There will be a point in time where fundamentals will get so weak that it's possible that some assets will go into foreclosure because the fundamentals have fallen apart,” says Spencer Levy, senior director of capital markets with CB Richard Ellis.

This dynamic is creating a bubble of potential trouble. “The volume of negotiations taking place between landlords and tenants is staggering, which leads me to believe there is going to be a much steadier stream later this year of properties being at risk from a cash flow perspective,” says Hunter.

“We are seeing a lot more tenants coming to us saying they need to get out of their lease or need to lower their rent burden because they can't afford it anymore.” Landlords, too, are much more willing to renegotiate lease terms today since they need cash flow to pay debt service.

Hostmark's Cataldo agrees. “There are going to be owners who hand in the keys because they're going to get to the point where they don't want to throw more money at an asset to keep it going. It may not be the lender pursuing it, but the other way around.”

In the meantime, banks are slowly starting to get a handle on how to best manage their troubled loans, according to Cataldo. “Lenders are putting their loans in buckets and will then attack the buckets in turn. Toward the second half of this year they are going to have a better feeling about what they can do with their assets, if they do take control of them.”

Ben Johnson is a Dallas-based writer.

MOUNTING PROBLEMS FOR COMMERCIAL REAL ESTATE

Commercial and multifamily assets in foreclosure, bankruptcy or whose mortgages are being modified or restructured are considered to be troubled properties.