Foreclosing on the equity, not the real estate

By Adam Pincus | August 01, 2011 06:26PM

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From top left: Attorney Edward Harris, Bluestone Group’s Eli Tabak and Lowell Dansker of Intervest Bancshares. Bottom: Jamaica streetscape
The setup

In a strategy that many insiders say was highly unusual (and very creative), the Bluestone Group wrested control of a 200-plus-unit apartment building in Jamaica, Queens, by getting its hands on the owner’s line of credit. The property owner had taken out both a first mortgage and a revolving line of credit from a regional community bank. While the owner never stopped making payments on its mortgage, it defaulted on the line of credit about a year and a half ago. Bluestone agreed to discuss the transaction on the condition that the identities of the owner and the bank, and the exact address, were withheld, because the ownership structure is still being finalized. City property records, which will identify the parties, ultimately must be filed.

Dealing with distress

To recoup the money it was owed on the line of credit, the regional bank sued in State Supreme Court, and won a judgment against the borrower earlier this year. Because the line of credit was secured by the owner’s 51 percent stake in the Jamaica apartment building, the bank could have taken control of the property. But banks are often reluctant to engage in messy real estate battles. So when Bluestone got wind of the judgment, it approached the bank to buy the line of credit.

Identifying the deal

Gaining control of a property through the line of credit is “unusual,” explained Lowell Dansker, chairman and CEO of Midtown-based regional bank Intervest Bancshares, which is not involved in the deal.

Eli Tabak, a principal with Bluestone, said he first learned of the defaulted line of credit through the special assets department at the community bank. Tabak noted that one advantage to purchasing an equity interest is that competing investors are less keen on doing the same, since it’s considered a risky play.

“People are afraid to buy high in the capital stack, so the paper is not worth that much,” Tabak said.

Closing the deal

In early May, Bluestone officially bought the defaulted line of credit from the unnamed bank. Tabak declined to disclose how much he paid. But once he had the line of credit in hand, he was able to foreclose on the equity (rather than the real estate, as most foreclosures do). Bluestone was also able to foreclose much faster than a standard property foreclosure.

In mid-June, Tabak held a nonjudicial foreclosure sale in his attorney’s office. Such a foreclosure provides fewer protections for the borrower and is less regulated than a standard foreclosure. There were no other bidders. And, as the new owner, Tabak will be responsible for paying the in-place mortgage.

The whole process, from buying the debt to foreclosing, took him only about a month. “It’s actually much simpler,” said Edward Harris, an attorney in the real estate department at law firm Cozen O’Connor.

Still, there are downsides to a mezzanine or other equity foreclosures. “You have all the warts, all of the mechanic’s liens [and other liens], but when you foreclose on the first mortgage you extinguish most liens and other encumbrances. Some things, like unpaid taxes, survive foreclosure, of course,” Harris said.