By V. Dion Haynes
Washington Post Staff Writer
Friday, February 19, 2010; A01

A mortgage crisis like the one that has devastated homeowners is enveloping the nation's office and retail buildings, and few places are likely to be hit as hard as Washington.

The foreclosure wave is likely to swamp many smaller community banks across the country, and many well-known properties, including Washington's Mayflower Hotel and the Boulevard at the Capital Centre in Largo, are at risk, industry analysts say.

The new round of financial pain, which some had anticipated but hoped to avoid, now seems all but certain. "There's been an enormous bubble in commercial real estate, and it has to come down," said Elizabeth Warren, chairman of the Congressional Oversight Panel, the watchdog created by Congress to monitor the financial bailout. "There will be significant bankruptcies among developers and significant failures among community banks."

Unlike the largest banks, such as Citigroup and Wachovia, that got into so much trouble early on, the community banks in general fared better in the residential mortgage crisis. But their turn is coming: Not only did community banks issue a higher proportion of commercial loans, but they also have held on to them rather than sell them to other investors.

Nearly 3,000 community banks -- 40 percent of the banking system -- have a high proportion of commercial real estate loans relative to their capital, said Warren, whose committee issued a report on commercial real estate last week. "Every dollar they lose in commercial real estate is a dollar they can't use for small businesses," she said. Individuals -- who saw their home values drop in the residential mortgage crisis -- would not feel that kind of loss, but, Warren said, a large-scale failure would "throw sand into the gears of economic recovery."

In Washington, the number of troubled properties has multiplied at a phenomenal rate, with the value growing from only $13 million in 2007 to $40 billion now, according to CoStar Group, a Bethesda real estate research company. The region trails only South Florida and metropolitan New York in the per capita value of commercial real estate assets in foreclosure, default or delinquency, according to the research group Real Capital Analytics.

The threat is especially acute in the District, the firm said, where the catalogue of troubled commercial real estate properties has grown tenfold since April. Moreover, the region has $7.3 billion in commercial properties that are underwater -- worth less than the mortgages on them -- according to CoStar.

Whether the commercial real estate bubble bursts in a catastrophic event or subsides slowly and less dangerously will be determined during the next year. An immediate crisis was postponed when domestic and foreign investors began snatching up troubled properties at bargain prices. And banks more and more are renegotiating loans, extending the terms by a year or two in the hope that conditions will improve rather than calling in mortgages that cannot be paid.

In Washington, the office vacancy rate stopped ballooning in the fourth quarter of last year for the first time since the first quarter of 2006, according to CoStar, although largely for an unfortunate reason: The space was being filled mainly by office workers hired to handle the plethora of bankruptcy filings and "workouts" of borrowers who need to renegotiate bad debt.

And last quarter, for the first time since the second quarter of 2008, the Washington area office market saw a strong net gain -- 925,000 square feet of space that had been "absorbed" or leased by new tenants, according to CoStar.

"There's light at the end of the tunnel," said Andrew Florance, chief executive of CoStar. "But in commercial real estate it's a very, very long tunnel and many people will not come out of it."

Nationwide, at least $1.4 trillion in commercial real estate debt is expected to roll over during the next three years. Warren said that half of commercial real estate mortgages will be underwater by the beginning of 2011. A fifth of residential mortgages are underwater now, she said.

Unlike residential mortgages, which often can be paid over 30 years, commercial real estate mortgages typically must be paid off or refinanced within five years. Commercial properties mortgaged in 2005, 2006 and 2007, at the height of the boom, are reaching their maturity date. "Do the math on this," Warren said. "This is a significant problem."

The Renaissance Mayflower Hotel in downtown Washington is unable to meet its debt because of falling room rates, said Frank Innaurato, managing director of the credit-rating firm Realpoint, and the Boulevard at the Capital Centre in Largo, after losing several national retailers, had to extend its $71.5 million bank loan when it matured last fall, according to CoStar.

An office building at 1150 18th St. NW, bought in 2007 for $57.5 million, was sold at foreclosure in December for $21.7 million after losing 25 percent of its tenants, according to CoStar. Even the Mortgage Bankers Association has fallen victim, selling its $90 million Washington headquarters earlier this month for $41 million. Real Capital Analytics and others, however, attribute the surge here largely to Tishman Speyer Properties, which has about 20 D.C. office buildings, according to public records and real estate analysts, and last month walked away from its $5.4 billion Stuyvesant Town and Peter Cooper Village apartments in New York after defaulting on the mortgage.

Now a rival, Brookfield Properties, is buying the company's debt on the D.C. buildings, according to Debtwire, which reports on distressed properties. They include International Square on the 1800 block of I Street NW and several buildings on Pennsylvania Avenue NW. The company, according to the report, defaulted on its loan during the summer.

In a statement, Tishman Speyer said it is continuing "discussions with our lender group" on its D.C. area debt. Neither Tishman Speyer nor Brookfield commented on the purported deal.

What happened to Broadway 401, which operates the Dumont on Massachusetts Avenue NW near Fourth Street, has become an all-too-familiar story. In 2006, it borrowed $190 million, constructing two high-rise condominium buildings at the height of the District's real estate boom.

But the market crashed, and Broadway wasn't able pay off the loan when it matured in August 2008 because it couldn't sell enough units, according to court filings. About a year later, with the lenders seeking to foreclose, Broadway tried to sell the properties. It gave up after the buildings, appraised at only $140 million, garnered bids ranging from $90 million to $133 million. Finally, last month, Broadway filed for Chapter 11 bankruptcy protection, saying it owed $250 million from its unpaid principal and accrued interest from various loans.

David Weldler, manager of the Broadway properties, did not respond to phone messages seeking comment. In the bankruptcy filing, he said the recession undermined the business plan. "The volume of residential sales has dropped significantly in the U.S., residential prices have declined and credit standards have been tightened, making it considerably more difficult" for buyers to qualify for loans, he wrote.

Rockwood Capital, which owns the Mayflower, is in discussions with its lender to modify its loan, Innaurato said. The hotel reduced its rates to maintain occupancy, Innaurato said, and fell behind on payments.

"The loan was 30 days delinquent in January 2010," Innaurato said. Officials at Rockwood Capital declined to comment. "They're most likely asking to lower the interest rate or forbearance of payment."

Staff researcher Meg Smith contributed to this report.