Wednesday, January 21, 2009

Broadway Partners Defaults, Causes Turmoil in CMBS

The Wall Street Journal's Property Report has a great article today detailing how complicated (translation: ugly) a CMBS deal can get when a default is involved.  At the center of the new turmoil in the CMBS market is Boston's famed Hancock Tower and Broadway Real Estate Partners, one of the poster-children of the debt-fueled commercial real estate binge that based its investments on unrealistic cash flow assumptions.  I wrote about Broadway back in April 2008.  Broadway had extended its short-term loan on several properties and was looking for creative new ways to raise capital.  At the time, I enjoyed analyzing and speculating about the impending fissures in the commercial real estate market which was still viewed as immune to the credit crisis.  During the peak of the credit boom, I had often wondered why on earth anyone would buy an illiquid asset with a significant amount of short-term financing that carried much higher rates than the sub-3% cap rate from the property.  What was I missing?  Why did the math just not make sense to me?  Was my abacus just not calibrated correctly?
The answers to my crazy questions are quite clear now as deal after deal struck in 2007 is winding up in complicated angry negotiations with lenders and investors.  Broadway's recent default on the loan tied to the Hancock Tower, and other buildings, will certainly keep the lawyers gainfully employed.  Complicating the matter, the $700 million loan was securitized into mezzanine debt split between nine investors, including Five Mile Capital, BlackRock, RBS (now part of the UK government), Lehman (now bankrupt), and State Street (still kicking, just a really bad day in the market yesterday.)  At least State Street didn't buy the mezz debt because it thought it was a nifty investment, State Street seized the collateral from Lehman after Lehman defaulted on a repo.  What makes this whole kerfuffle somewhat interesting, particularly to the lawyers, is that the foreclosure process is not straight forward in a mezzanine deal.  The property is to be appraised and those investors who are the most junior according to the appraised value, get to decide whether to foreclose.  With commercial real estate values plummeting, and very little property actually changing hands due to a lack of financing, finding an appropriate valuation for the property that everyone can agree on is perhaps not so easy.  Consequently, determining who is the junior creditor who has control over the foreclosure is disputable.  And dispute they will.              


Mr Wrightwood said...

Lawyers will be killing it in the next few years. Not too late to sign up for the LSATs.

Dark Space said...

I was disappointed in the article to be honest. The market is working just right - mezz holders are supposed to disagree, so far the mechanisms put into place are working just like they should when a property has problems.

Also, a few ubernerd comments. The mezzanine debt was not securitized, and really never is. The CMBS market is made up of just the senior mortgages, with a few exceptions.

I'd also argue that foreclosure for a mezzanine investor is more straightforward than with a regular senior mortgage. It is generally well defined, and sure folks are going to disagree and argue and run up legal fees, but they have different interest and millions of dollars on the line.

Outside of all the minutiae that contributes to the decision, the junior mezzanine holder has a relatively easy decision - can the property cashflow enough to cover debt service to everyone above them in the structure (or can I cover shortfalls and turn the property around). If so, then foreclose on the equity and takeover the property. If not, turn the keys over to the next guy in line.