Little stigma for commercial real estate owners who default on mortgages
BY ANDREW TANGEL
As tenants cut back on space in a sprawling warehouse in Wood-Ridge last year, the property's owner did what many strapped homeowners have done: stopped paying the mortgage.
By August, the 2.2-million-square-foot site — a former World War II bomber engine factory owned by New York real estate company Cammeby's International Inc. — was in foreclosure. The balance on the mortgage backed by the property: $42.5 million.
As the recession continues to weigh on commercial real estate, owners of office buildings, industrial sites and shopping centers around the country, including North Jersey, are increasingly defaulting on their mortgages and walking away.
The roster of landlords who have defaulted include real estate giants Vornado Realty Trust and Mack-Cali Realty Corp., according to loan documents filed with the Securities and Exchange Commission. The delinquency rate for borrowers of commercial mortgages involving New Jersey properties has jumped to 7.65 percent last month from 0.52 percent in August 2008, according to Trepp LLC, which tracks loans bundled into commercial mortgage-backed securities, or CMBS.
But unlike homeowners, who may face a stigma — not to mention a wounded credit score — for defaulting on their mortgages, commercial real estate owners face different expectations.
Commercial owners have stopped making payments in so-called strategic defaults to get servicers to negotiate modified loans. But if a commercial property's value significantly sinks below what is owed on a mortgage, it may make business sense to cut losses and drop the keys in the mail. Commercial mortgages are often "non-recourse" loans, meaning lenders cannot go after borrowers' assets if they fail to repay.
"It's never a good thing to not fulfill your obligation as a borrower,'' said Michael Knott, a managing director at Green Street Advisors, a California-based real estate industry analysis firm. "But if it's a limited instance with minimal longer-term repercussions and it's a property that's deeply underwater, it can be the right business decision to walk away."
Larry Longua, who teaches at New York University's Schack Institute of Real Estate and directs the school's REIT Center, said it's often in the interest of shareholders when borrowers that are real estate investment trusts, or REITs, walk away.
"These are non-recourse loans; they're underwater," he said. "And if the borrower is going to feed these properties, it's money gone down a black hole."
Vornado, the global landlord with offices in Paramus, said in a March filing with securities regulators that it missed a March debt-service payment on a retail property in California. (The company did not elaborate and a spokeswoman did not respond to a request for comment.)
Mack-Cali, the largest office landlord in Bergen County and New Jersey, walked away from a property in Ridgefield Park this summer. Samsung Electronics had been the sole tenant of the nine-story office building at 105 Challenger Road. When a nearby landlord was able to lure the company to its building down the street with lower rent, Mack-Cali's building went vacant.
With dim leasing prospects, Mack-Cali turned over the property's title to loan-server LNR Partners LLC in lieu of a foreclosure in June, when its $19.5 million mortgage matured and would have needed refinancing, according to loan information provided by Bloomberg News.
Scott Tross, a Newark attorney who represents LNR, said commercial property owners rarely continue paying a mortgage on distressed properties, as the loans are typically non-recourse. "It's the rare person who's going to do that," he said in a recent interview. "Arguably, it's bad business. Why give away money when you don't have to?"
"To find a new tenant in an environment where companies are downsizing to take the entire building would really be a difficult sell," said Paul Mancuso, vice president at New York-based Trepp. (Mack-Cali and Cammeby's declined to comment.)
Lenders implicitly make a bet on the performance of commercial properties when they underwrite mortgages, Longua said. Commercial borrowers may not have to worry about their ability to get mortgages in the future if they default, he said, unless a property owner does not readily hand over the property or drags out the process through bankruptcy.
"Walking away from a property, per se, isn't going to make it impossible for that borrower to access the market when the cycle turns," Longua said. "It's a question of how he conducts himself."
Not all commercial property owners simply walk away from troubled properties.
After Levitz Furniture went bankrupt in late 2007, the company left much of a building also occupied by Babies "R" Us at 545 Route 17 south in Paramus. The property's Clifton-based owner, ARC Properties Inc., kept paying the mortgage for 10 months, said Robert Ambrosi, ARC's chairman and chief executive officer.
"We wanted to be a good borrower and we kept making payments," he said. "We have a reputation."
The real estate company approached the mortgage's servicer with a modification plan but did not immediately get cooperation, Ambrosi said.
"When the loan went into default, we got a lot more attention," he said.
A special servicer agreed to let ARC stop making mortgage payments for a year, in exchange for pumping $1.5 million into the property, including improvements to the parking lot, signage and air conditioning, Ambrosi said.
Meanwhile, two new stores — Ashley Furniture and Lazurit Furniture — have taken up Levitz's former space. Ambrosi said ARC is now breaking about even on the mortgage payments and plans to lease the remaining 40,000 square feet of available space at the 157,100-square-foot shopping center.
