Joe Clements is co-editor of Debt & Equity Journal, from which this article is excerpted.

Boston—For commercial real estate borrowers, it is the financial equivalent of being caught on an elevator during a blackout. Rapid deterioration in the debt arena has halted many deals mid-stream, and tales of sales in outright free fall are mounting throughout the CRE industry. After maintaining a calm demeanor when problems spilled over from the housing market's sub-prime woes earlier this year, lenders are now reportedly changing terms halfway through for commercial transactions--or walking away altogether.

When asked whether lenders are using the stubborn "material adverse change" (MAC) clause to sidestep commitments and render safety features like rate locks meaningless, one investor says simply, "Absolutely."

"It is becoming much more prevalent," adds the investor, who nonetheless denies reports that such a situation was responsible for delaying a national portfolio sale in which the source is a participant. The sheer heft of the deal, estimated at more than a half-billion dollars, has been the chief reason for an extended closing, the investor says, expressing confidence the venture will be completed in the near future. Even so, the source concurs that other CRE deals are being disrupted by the debt crisis.

Eastdil Secured debt specialist Frank Petz views the skittishness as understandable, and more prudent than prudish. "There's a lot more risk than there was two weeks ago," says Petz. There are concerns about the breadth of the sub-prime mortgage debacle, along with a growing recognition that CRE underwriting was becoming less exacting, especially for lower-rated tranches backed by questionable collateral.

"We made our own bed," says Meredith & Grew principal Kevin Phelan, whose lineage in structured finance dates long before the days the CMBS market existed. Phelan has since arranged numerous CMBS deals on behalf of clients, and considers it a critical element to the CRE lending stream.

Unfortunately, he notes, rating agencies and investors were shaken by a questionable CMBS loan in New York City earlier this year, and the fallout from that debacle has shaken the core of the system. "There are no B-piece buyers and you can't get real quotes anyone will stand behind," Phelan says, adding, "I don't know how people are doing (CMBS) deals right now."

That appears to be the key issue. Using the MAC excuse, lenders are reportedly bailing out on deals, even when hard deposits have been tendered. While hesitant to name names or list specific deals, industry professionals interviewed seemingly all know of at least one incident where a purchase has been interrupted or quashed. In praising Citigroup for honoring several commitments even after conditions worsened, Phelan says there were other lenders who left clients foundering. "It's not a pleasant situation," says Phelan. An advisor to an Australian fund active in the US tells Debt & Equity Journal that three transactions were abandoned recently just days before the offer sheet was to be submitted. The group was able to scramble and find a replacement financier, says the source, but the bids had to be changed to reflect the higher cost of capital, lessening the chances of a successful outcome.

As for the situation's impact, nearly all of those questioned say highly leveraged players will be the biggest losers, and values of properties could follow suit. Already, says Phelan, "re-trading is off the charts," and he reports an "abrupt progression" to insurance companies and other traditional lenders, with even banks starting to lick their ledgers in anticipation of CRE borrowers returning.

"There's a flight to confidence," says Phelan. Certain products, such as extended interest-only loans, will disappear, according to Phelan, while Petz says some lenders are getting out of the market completely.

Given plentiful sources of capital from cash buyers, established opportunity funds and institutional sources, those questioned predict investment sales activity will remain brisk. But many also agree buyers will have to adjust to higher spreads while sellers may not get the limitless supply of suitors that had been dominating during the days of cheap, plentiful debt. However, while the need to place capital may be the CRE sales sector's salvation, Phelan says he believes the CMBS lending community will not be so quick to rebound. "I think this is a serious injury, and it is going to take some time to repair," says Phelan. In his instance, he says, the lenders who walk away are unlikely to be relied on in the future.

Instant Insights /

Debt Crisis Hitting CRE Borrowers Hard

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