Tranche Warfare

“The default rate has been relatively modest,” Mr. Freedman said. “It’s only in the next cycle that we’re going to be able to determine how the mezz debt players have actually fared in the market.”


TO BE SURE, SOME of the biggest pre-recession developers, who scooped up property at the height of the market back in 2006 and 2007, are still entangled in loan repayments and other difficult default challenges. Chief among those battered developers was Harry Macklowe, who took out a $275 million mezzanine loan from Vornado Realty Trust in 2003 to buy the iconic GM Building on Fifth Avenue from Conseco, which he did for a record-shattering $1.4 billion, the highest price ever paid at the time for an office building in the United States.

Although Mr. Macklowe successfully paid off the loan in 2005, another property buying spree two years later—just months before the market began to tank—required a pricey $1.2 billion mezzanine loan from Fortress. The need to repay the hefty loan is what ultimately forced Mr. Macklowe to put the GM Building and several other high-end properties up for sale.

Mr. Macklowe—who still earns a profit on management fees at many of the buildings—paid down the Fortress deal late last year, analysts said.

More recently, New York’s biggest office landlord, SL Green Realty, successfully took over leasing and management responsibilities at 100 Church Street in August after the Sapir Organization failed to cough up $85 million in loans to the REIT and to Gramercy Capital. In a suit that has been closed, Sapir had alleged that SL Green had knowingly hindered its ability to finalize leasing deals.

“The mezzanine lenders are looking more like equity investors, and they’re finding themselves in the position of having to defend their security interests,” said Douglas Hercher, executive vice president and principal of Cushman & Wakefield. “They’re not wondering whether they’re going to get fully paid back; they’re wondering if they’re going to get paid back at all.”

Many of the investment funds and real estate investment trusts that have acted as junior lenders in the past did not return calls for this article, an indication, said industry experts, that they either did not want to reveal their “loan to own” strategies or were simply weary of being cast as a villain.

Unsurprisingly, New York developers hit hardest by recent defaults, like Mr. Macklowe, did not return calls either.

“The anecdotes that go with these are painful for a lot of people, so you’re going to have a hard time finding participants in the market that want to talk,” said William Shanahan, a vice chairman at CB Richard Ellis. “It’s sort of like watching someone die.”

Tranche Warfare