The Clearest Sign Yet That Commercial Real Estate Is in Trouble

The Clearest Sign Yet That Commercial Real Estate Is in Trouble

By Konrad Putzier

Foreclosures are surging in an opaque and risky corner of commercial real-estate finance, offering one of the starkest signs yet that turmoil in the property market is worsening.

Lenders this year have issued a record number of foreclosure notices for high-risk property loans, according to a Wall Street Journal analysis. Many of these loans are similar to second mortgages and commonly known as mezzanine loans.

Mezzanine loans have high interest rates and offer a faster and easier path to foreclose than mortgages. The Journal analysis found notices for 62 mezzanine loans and other high-risk loans this year through October. That is more than double the number for all of last year, and likely the highest total ever for a single year, as higher interest rates and rising vacancies punish the property sector. 

The increase in mezzanine-loan foreclosure announcements—while not large in absolute numbers—matters because it offers a more immediate measure of commercial real-estate distress than mortgage foreclosure rates

The number of commercial mortgage foreclosures tracked by data companies is still low. It can take many months or even years between default and a traditional mortgage foreclosure, as cases inch through courts. Banks are also often reluctant to take over buildings. 

In contrast, foreclosing on mezzanine loans is often quick and easy because they aren’t technically mortgages. Because the loans don’t appear in property records, the Journal was unable to determine the dollar value of the announced foreclosures.

These loans took off in the decade following the 2008-09 financial crisis as regulators cracked down on big banks and they became more conservative lenders. Many property owners made up the financing shortfall by borrowing from smaller banks, or by taking out these second loans from debt funds and other nonbank lenders, often on top of bank mortgages. 

Lenders liked providing mezzanine debt because these loans generated higher yields, often more than 10% during years when interest rates on long-term government bonds hovered around 2%. 

Mezzanine lending became big business for companies such as Blackstone, 

KKR and Starwood Capital, which collectively lent billions. South Korean asset managers also became big mezzanine lenders, lending against hotels and office towers in cities such as New York and Los Angeles. Finance companies pooled billions from thousands of would-be immigrants in the EB-5 cash-for-visa program, turning them into mezzanine loans to developers. 

That debt allowed investors to bid up prices while putting in little of their own money, inflating the commercial real-estate market leading up to 2022. 

Now, real-estate prices are falling and many of these loans are in default, the latest sign that regulators’ efforts to shore up big banks after the 2008-09 crisis have created new trouble spots in property finance. 

“A lot of borrowers have basically said ‘I can’t hold this asset any longer, I can’t keep putting money in,’” said Terri Adler, managing partner at law firm Adler & Stachenfeld. “And the lenders have said ‘OK, we’ll take it back.’”

Mezzanine loans are notoriously opaque. Unlike mortgages, they don’t appear in property records, so real-estate data companies can’t track many of them. No one knows how much of this debt is out there. 

To measure distress, The Wall Street Journal counted so-called uniform-commercial-code foreclosure-sale notices for commercial-property loans published in the print editions of dozens of national and regional newspapers going back 15 years. These notices are typically for mezzanine loans, although sometimes mortgage lenders also use them, brokers say. 

Mezzanine loans are secured by the limited-liability company owning the building, not by the real estate itself. That means lenders can often take over the building in a matter of weeks, though not all announced foreclosure sales actually happen.

One of the buildings caught in the mezzanine meltdown is the Margaritaville Resort in Times Square, a 32-story tower with an outdoor swimming pool that opened to great fanfare in July 2021. 

Two months later, with interest rates near record lows, developer Sharif El-Gamal took out a $57 million mezzanine loan against the building, on top of a $167 million mortgage, according to court records. 

In March of this year, El-Gamal defaulted on the loan. In an email to his lenders, he blamed higher interest rates, tight capital markets and the tower’s vacant retail space, among other challenges, according to court records. Last month the mezzanine lender, Arden Group, won a foreclosure auction for the skyscraper.

Many recent foreclosures are office buildings. Earlier this year, an affiliate of asset manager 

Brookfield foreclosed on a 48-story tower in Los Angeles after the building’s owner defaulted on a $64.7 million mezzanine loan. Some apartment investors who took on too much floating-rate debt to buy rundown properties with plans to aggressively raise rents are also in trouble. 

Before rates started rising last year, mezzanine loans often came with interest rates of around 10% to 12% or more, said Alex Draganiuk, who runs the commercial-loan sales desk at brokerage Mission Capital. Now these same loans often cost more than 15%. That makes it much harder to refinance when they expire, leading to more defaults and foreclosures. 

Mezzanine loans helped fund some large deals in the years leading up to 2008. While there were fewer of these loans then, they often had many layers piled on top of each other.

“Things got so crazy,” said Kenneth Chin, a partner at law firm Kramer Levin Naftalis & Frankel. “I did a deal where there were six levels of mezzanine debt.” 

Often loans added up to more than the value of the building. The Stuyvesant Town and Peter Cooper Village apartment complex in Manhattan, which was taken over by lenders following the crash, had 11 layers of mezzanine debt, according to the property’s bond prospectus. Many loans across the country were wiped out when the market turned.

In recent years, layering mezzanine loans made a comeback. The 42-story hotel and retail tower 20 Times Square in Manhattan was once valued at $2.4 billion. It had four mezzanine loans, according to court records. 

The developer struggled to fill the retail space and the hotel sat empty when the pandemic halted global travel. One of the mezzanine lenders, an affiliate of 

Hana Financial Group of South Korea, took over the building in September. 


The Journal counted Uniform Commercial Code foreclosure-sale notices that list commercial real estate as collateral. When a property or loan had multiple notices over a period, we only counted the first. We excluded loans where real estate is listed alongside other types of collateral, such as inventory or intellectual property. To weed out personal loans, we also excluded notices that listed individuals, not limited liability companies, as borrowers. The analysis covers notices published in dozens of national and regional newspapers between Jan. 1, 2008, and Oct. 31, 2023.

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