Another signal has been confirmed that the U.S. commercial real estate market is in crisis. Foreclosures related to so-called mezzanine lending, which involves breaking down large commercial real estate loans into smaller portions, have surged.
The Wall Street Journal (WSJ) reported on the 13th (local time) that foreclosures are rapidly increasing in the opaque and risky sector of commercial real estate finance, calling it "the clearest sign that the commercial real estate market is in trouble." An analysis of foreclosure notices secured by commercial real estate through October this year revealed 62 cases of mezzanine and other high-risk loans, more than double the 30 cases recorded last year. In 2019, just before the pandemic, there were 13 cases.
Mezzanine lending, named after the space between the first and second floors, refers to subordinated loans secured by commercial office buildings and the like. Unlike senior creditors who can decide on collateral disposition and recover investments in the event of default, mezzanine lenders are lower in the recovery priority and are effectively considered to have no remedy. WSJ noted that while foreclosure cases for commercial mortgages, which can take months or years through court litigation, have not yet been widely observed, foreclosures on mezzanine loans are relatively faster and easier.
According to the report, mezzanine lending expanded after regulatory tightening following the 2008 financial crisis. Most property owners supplemented funding shortages by obtaining secondary loans from non-bank lenders alongside bank loans, and asset managers from Korea and other countries eagerly invested in mezzanine loans based on low interest rates. However, the emerging crisis in commercial real estate has dealt a direct blow to this sector.
Alex Draganiuk, who is in charge of commercial lending at Mission Capital, told WSJ that before the interest rate hike cycle fully began last year, mezzanine loan rates were about 10-12%, but now many cases have rates around 15% for the same loan amount. This has made refinancing difficult and increased the likelihood of default and foreclosure. The report added that in many cases, the loan amount exceeded the total building value.
WSJ expressed concern that "due to high interest rates and office vacancy rates impacting the real estate sector, the amount of related foreclosures is likely to reach an all-time high for a single year." It also pointed out that "since loan amounts are not recorded in real estate records, it is difficult to convert foreclosure amounts into dollars," emphasizing that "mezzanine loans are very opaque. It is unknown how much this debt amounts to." The report mentioned that mezzanine lending had become a major business for firms like Blackstone, KKR, and Starwood Capital based on low interest rates, and also referenced Korean asset management companies that were actively purchasing commercial real estate after the pandemic.
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