Although securitized residential mortgages have been at the forefront of the credit crisis, commercial real estate debt has also been securitized, sliced, diced and sold to investors. Some estimate that over $700 billion in commercial mortgage-backed securities are held by investors. Now it seems a new front may be opening in the mortgage meltdown litigation - legal battles among holders of different tranches of securities backed by troubled commercial real estate. What some have dubbed "tranche warfare."
Last week several outlets reported on the dispute among holders of various tranches of debt secured by the John Hancock Tower in Boston. In 2006, a real estate investment firm called Broadway Real Estate Partners bought the building and a portfolio of other commercial real estate for $3.3 billion. Back then, the Hancock Tower was valued at $1.3 billion. Almost all of the purchase price was funded with debt. There is a $650 million senior loan, and then about $450 million in a "mezzanine" loan that was split up amongh 9 investors. This mezzanine debt was essentially a bridge loan which had to be paid within two years.
In times of easy credit and soaring real estate values, it would have been easy for Broadway to refinance the debt at the end of the two-year period. But now credit has become scarce, and in the sagging economy the Tower has gone from fully occupied to only 85% full, causing cash flow problems. Thus, Broadway recently defaulted on a payment for the mezzanine loan.
That has touched off a battle among the holders of the various tranches of the mezzanine debt secured by the Tower. Some estimate that the building is now worth only $700 to $900 million. The terms of the mezzanine agreement provide that the most junior creditor still in the money (i.e. it would be paid off in a liquidation) based on an appraisal of the property would become the "controlling holder" and determine whether to foreclose on the mortgage. The current skirmish is over which investor is "still in the money" should therefore be in control of decisions about foreclosure.
If the holders of the various tranches of the mezzanine funding cannot agree, one holder would likely file a foreclosure action and the other investors would then intervene to block the foreclosure or stay it pending a declaration from the court about who should be in charge.