By now the tale of the failed Stuyvesant Town/Peter Cooper Village deal is well known: Bought at the height of the market in 2006 by a JV of Tishman Speyer and BlackRock Realty, the 1l0-building, 11,200-plus-unit residential property is one of Manhattan's premier residential complexes. Tishman paid $5.4 billion for the SO-acre asset, thanks to $3 billion in CMBS financing and $1.4 billion in mezzanine debt, with the balance made up of equity from the JV and other investors.

Upon taking control of the property, the new owners embarked on their plan to increase its cash flow by bringing some rent-stabilized units-comprising about 73% of the complex's units-to market rate through rollovers and the eviction of illegal tenants. The JV intended to spend about $125 million, or $11,300 per unit, for capital improvements over the next three years. But the rollover and renovation process went slower than had been expected, due in part to legal snags as well as general economic conditions. As of the third quarter of2009, average monthly rents per unit at Stuy- Town were $2,021, by comparison, average market rents for New York City apartment units were significantly higher, at $3,491 per month in Q3.

As a result, the property's cash flow remained lower than what the buyers had hoped-at least, too low to cover debt service obligations. By year-end 2009, the Tishman- BlackRock JV had not only gone through its $400-million debt-service reserve but also a nearly $200-million general reserve.

What was to be the final blow came when the New York State appeals court ruled that the JV and its predecessors had improperly deregulated and raised rents on thousands of units at the complex. Not only was the further conversion of more units halted, but the court also found that the tenants were due some $215 million in rent rebates.

At this point, the $3-billion first mortgage on the property was severely underwater. The property, based on current rent rolls, was now widely valued at around $1.8 billion-a 67% decline from its 2006 purchase price.

In January, the Tishman-BlackRock JV said it would be handing the keys to the complex back to the lenders after being unable to negotiate a restructuring of its debt that would maintain its ownership. The ownership stake was also why Tishman bowed out of managing the property, special servicer CWCapital has since hired local firm Rose Associates.

Calls made to CWCapital were not returned. BlackRock deferred comments to Tishman, which would not comment beyond its Jan. 25 joint statement announcing its intention to transfer control of the complex to its creditors.

Observers generally concur that the Stuyvesant Town/Peter Cooper Village predicament is a result of market conditions at the peak of the cycle and a "perfect storm" of assumptions going awry. And while its sheer size and the players involved give it a degree of notoriety, this transaction really isn't any different than hundreds of others that took place during that period.

The hyper-liquid credit market was much of what fueled investor appetite for the deal, asserts Woody Heller, executive managing director and head of the capital transactions group at Studley. He notes that the players involved shouldn't be vilified for what transpired. "If there was one group that bid $5.4 billion and everyone else bid $3 billion-yes, then they'd be at fault. But you had about 20 groups clamoring for this asset and were furious when they weren't the ones that were selected," he says. "Everyone was prepared to make the same mistake, and desperate to make the same mistake."

In the Jan. 25 statement, the partnership indicated that transferring control was the "only viable alternative to bankruptcy" A property transfer also tends to be a lot easier and cost-effective than a time-intensive foreclosure for all parties involved.

Only that didn't happen. On Feb. 16, the lenders on the $3-billion first mortgage sought court approval to foreclose on the property and have it sold.

According to sources, the property transfer hit a snag when the question arose over who would be responsible for nearly $100 million in real estate transfer taxes. A foreclosure would avoid the transfer tax and from the filing, it seems that the plaintiffs are hoping the proceeds of the sale would cover the legal costs involved with the proceeding, along with the other expenses.

The tax issues that have emerged in the Stuy- Town transaction are not unique to this deal, in fact, it's among the first of many more we will likely see, and will lead to changes in the way we approach this business for years to come.

"The tax implications in these situations are definitely problematic, as opposed to doing a quick, unopposed foreclosure," says Edward A. Mermelstein, co-founder of Edward A. Mermelstein & Associates. "These are issues that no one has necessarily dealt with in the past 15 to 20 years. We're seeing a lot of proposed legislation to address this because it's going to become increasingly prevalent. With all of these underwater assets, we're going to have debt forgiveness issues popping up on a regular basis."

A Complicated Pie

The Stuy-Town deal could serve as a poster child to the hundreds oflarge, complicated structured financings that were put together in the past several years. The deal includes a huge first mortgage that was then securitized and mezzanine financing from several sources, as well as equity stakes by a variety of investors. With the property valued at a fraction of its purchase price, it's obvious that quite a few players will have lost money. The question is, who will have taken the greatest hit when this all shakes out?

Tishman and BlackRock, with their investors, each kicked about $112 million in equity into the deal. Other equity investors are the California Public Employees' Retirement System (with a $500-million stake), the Florida State Board of Administration ($250 million), the California State Teachers' Retirement System ($100 million), and the Church of England ($70 million). Most of the investors have accepted their losses and written their stakes down to zero.

Meanwhile, the $3 billion in mortgage debt was split into five notes and pooled into larger transactions. CWCapital services the CMBS deals with the three largest pieces: a $250-million note in the COBALT 2007-C2 deal, an $800-million piece of the ML-CFC 2007-5 offering and a $1.5-billion note in the Wachovia 2007 -C30 deal (to which the four other CMBS deals defer). LNR Partners services the other two deals- Wachovia 2007-C31 (a $247.7-million note) and ML-CFC 2007-6 ($202.3 million).

When the loan was transferred into special servicing in November, Fitch calculated the losses at about 40%, and the loan-to-value at 189.2%. When the debt was originated in 2006, the LTV on the first mortgage was 76.2%. Yet the ratings agency "does not anticipate any immediate rating actions following CWCapital's foreclosure filing," according to Fitch senior director Adam Fox.

And then there are the mezzanine lenders, which provided a total of $1.4 billion. In the $300-million senior tranche are Hartford Life Insurance Co. ($100 million), Deutsche Genossenschafts- Hypothekenbank ($100 million), Allied Irish Bank ($50 million) and Wachovia ($50 million). The $1.1- billion junior tranche houses still control issues within the CMBS stack. "With these CMBS deals, it's becoming increasingly difficult to determine who's got control, even if you go beyond the mezz and you get into the first mortgage," says Bram. "If the CMBS first takes control, questions are going to be raised as to who runs the first."

At the same time, there have been reports that some real estate investors are looking into buying certain investment-grade tranches of the Wachovia 2007-C30, the controlling piece of the debt stack. The one holding the controlling piece usually has a say in the special servicers actions and gets priority in bidding on the asset when it goes on the block.

But for this strategy to work, "would be buyers will have to pick accurately which of the multiple classes in the massive $7.9-billion deal will become the fulcrum," according to a report from Debtwire. "Historically, controlling classes have always been unrated junior tranches at the bottom of the structure but the massive losses caused by the collapse of the Stuyvesant deal pushed the fulcrum up in the Wachovia 2007 -C30 deal."

Before the walls came tumbling down, the controlling class in the CMBS deal was an affiliate of CWCapital, which also serves as special servicer. The new controlling class, if any, will be determined once the property-and, subsequently, the loan-is reappraised, and it's likely it will be at some point this year.

The most senior CMBS tranche, meanwhile, would get paid above all others. In the case of the Stuy Town transaction, that tranche includes Fannie Mae and Freddie Mac, which together hold more than $2 billion in Stuy-Town securities. Their senior debt position gives them little to no say in what's done to the asset. But an ultimate sale may increase the GSEs' stake in the property, since it's likely that the buyer in the deal will obtain agency financing. (The GSEs held $359 billion, or 39% of all outstanding multifamily debt, at the end of 2009, according to the Mortgage Bankers Association. )

That aside, a number of entities, most of them major names in the industry, have been circling the Stuy- Town deal since signs of trouble started emerging several months ago. Even after the foreclosure filing, the most visible parties- Wilbur Ross of the Related Cos. and the Lefrak Organization's Richard Lefrak-told the New York Post that they are still interested in buying the complex. A group comprised of Stuy-Town tenants-which placed a losing bid in the 2006 sale-also indicated their interest in acquiring the property.

One in a Line of Many

There are observers who believe what happens in the Stuy-Town deal is a large-scale illustration of what's occurring on deals all over the country, since this obviously isn't the only big transaction that was split up and put into several CMBS pools. It was, after all, the CMBS market that fueled the frenzied credit and investment conditions of the investment arena.

A simple look at CMBS volume will tell the story of the commercial property financing market, relates Jeffrey Rogers, president and COO of Integra Realty Resources Inc. When things started to heat up in 2005, there was $169 billion in CMBS deals, up from $93 billion in 2004. In 2006, it jumped to $203 billion, and in 2007, it jumped to a record $230 billion. "Any deals done during that period are probably underwater at this point," he states.

Meanwhile, CMBS investors will likely look at the fallout from the Stuy- Town situation as an indication of what could happen in upcoming securitized deals. The result could have severe consequences for the future of the securities market. Sam Chandan, global chief economist and executive vice president of Real Capital Analytics, says that a default the magnitude of Stuy- Town "has implications for a broader class of investors' perceptions of risk in holding CMBS exposure. As a result, it has a potentially chilling effect on current efforts to reignite securitization activity and liquidity in secondary markets."

Some investors will view the default as "a result of systemic issues in the CMBS market that have yet to be properly addressed and not an asset-specific issue," he relates, adding that while another huge default may not be looming, "there is a very large pool of securitized mortgages outstanding that has been subjected to far less scrutiny."

Securitized or not, a whopping $14.4 billion in properties fell into default in December alone, and just a few weeks into January, another $4.6 billion in assets defaulted, reports RCA. As of Feb. 3, the level of distressed commercial real estate reached $184.1 billion.

Many of those deals took place during the height of the market, from 2005 to 2007. Some of the biggest trades that took place during that period are now considered "in trouble" by RCA analysts:

The Four Seasons Resort in Irving, TX was put up for auction in February after the owner, Bentley Forbes Group, missed a payment on the $ 183-million CMBS loan and the servicer didn't agree with its plan to pump more money into the resort.

The Renaissance Mayflower, a 660-unit hotel in Washington, DC, entered special servicing in January after the owner, Rockwood Capital, asked servicer Midland Loan Services to rework the terms of the $200- million CMBS first mortgage.

Trilogy, a 1,095-unit multifamily property in Wyncote, PA, was picked up by Fairfield Residential in 2007 for $154 million. The $137.5-million CMBS first mortgage matures this July, but the borrower is currently delinquent or in default on the loan.

The former Robinsons- May Department Store, a 329,749-square-foot vacant mall in Beverly Hills, CA, is to go on the auction block after United Kingdom based CPC Group defaulted on its loan. Lender Credit Suisse had sold the $356.5-million loan to many banks, and Banco Inbursa holds the highest stake. It refused to foreclose on the property, demanding that CPC pay $22.6 million as well as legal fees for breaching its "carrying costs agreement." Now in foreclosure and to be sold in auction, the asset is now in the hands of Chicago Title Co.

Algonquin Commons in Algonquin, IL was transferred to special servicing last year. The owners, a JV of Inland Real Estate Corp., Morgan Stanley and the NY State Teachers Retirement fund, paid $154 million for the 565,000-square-foot power center, which is currently in receivership with a $72.6-million outstanding balance.

And that's just a few of the largest deals, the distressed pool is filled with hundreds of smaller ones, and that pool is growing as the default/delinquency rate rises. As of the third quarter, 4.06% of CMBS loans and 3.43% of debt held by banks and thrifts was delinquent or worse, according to the Mortgage Bankers Association.

Of the $1.45 trillion in outstanding commercial and multifamily debt tracked by the MBA, $183.9 billion will reach maturity this year and $99.8 billion will mature in 2011. Those, along with billions more in 2012 through 2017, will need to be refinanced. Given the tighter conditions of the debt market, there's a good possibility that many borrowers won't find new sources of capital.

On top of that, there are billions of dollars worth of deals that have been extended or worked out, that is, transactions that would likely have defaulted or gone delinquent if the lender hadn't worked out a short-term solution with the borrower. RCA notes that $27.5 billion of the total current distress in the market has been restructured or modified. There's still a chance those loans will turn sour in another few years.

Until recently, many lenders have been open to restructuring or extending loans because they were wary of taking the losses. This whole extend-and-pretend trend kept many defaults at bay and kept distressed transactions to near-nil levels until late last year. Indeed, just 10.8% of all the sales that closed last year involved distressed situations, says RCA.

"There are some large, looming defaults out there, and the properties under special service watch are mushrooming at a level that most people don't understand because it's been happening so quickly over the past year," notes Mermelstein.

But now that banks are somewhat healthier and they have a better understanding of the market, it's likely we'll see more distressed offerings. "There's a tidal wave of debt that's coming due, and no one knows how these owners are going to dig themselves out," says Anton. "The assumptions that were used to finance real estate two to four years ago are now proving to be all wrong. Those chickens are coming home to roost." While all of that may spell bad news for property owners, it's certainly good news to all those distressed investors who have patiently been waiting on the sidelines for deal flow to increase. That, in a nutshell, "is the creative destruction of capitalism," says Anton.

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