June 26 (Bloomberg) -- Fortress Investment Group LLC, the hedge fund and buyout firm run by Wesley Edens, will acquire a $640 million Manhattan condominium project being built by New York developer Kent Swig through a foreclosure proceeding, according to two people familiar with the transaction.

Fortress bought the most senior mezzanine debt on the development and will take ownership of the property from a company Swig controls, said the people, who asked not to be named because they weren’t authorized to speak publicly. The deal paves the way for construction to resume on the building at West 57th Street, which features multimillion dollar apartments, and for payment of all construction debts, the people said.

The credit crisis and recession have slowed condo sales, reducing income for developers to repay debt. Apartment sales in Manhattan dropped 48 percent in the first quarter, appraiser Miller Samuel Inc. said in an April report. Swig defaulted on the project’s $400 million first mortgage when it matured in April and on the mezzanine debt when it matured in May, one person said. The loans were current until the defaults at maturity, the person said.

The sale of the 58-story building, known as Sheffield57, marks the third high-profile foreclosure by a mezzanine lender in the U.S. this year, following auctions of Boston’s John Hancock Tower and 1330 Avenue of the Americas in New York. Mezzanine loans fill the gap between a borrower’s equity and the senior mortgage.

New York Projects

Lilly Donohue, a spokeswoman for Fortress, declined to comment. A spokesman for Swig declined to comment.

Fortress said this week it won’t pay a second-quarter dividend, choosing to keep the money for future investments and working capital.

Swig has developed $3 billion worth of properties, including seven buildings in lower Manhattan. Earlier this year, his firm was fighting default proceedings on a suspended condo conversion project financed by Lehman Brothers Holdings Inc. at 25 Broad St. in Manhattan. Lehman claimed Swig and his partners owed $273.7 million of unpaid principal on that project, plus interest and fees.

Swig is an owner of Terra Holdings LLC, which owns brokerages Halstead Property and Brown Harris Stevens Co., according to the Halstead Web site. Swig also is on the board of Swig Co., the family-owned real estate and hotel company based in San Francisco that oversees 9 million square feet of U.S. office space.

Loans

Swig borrowed $400 million in mortgage debt in 2006 for the Sheffield development from Column Financial Inc., the commercial real estate lending arm of Credit Suisse First Boston that has since stopped making loans. CSFB securitized the loan. Swig borrowed an additional $240 million in mezzanine debt, the person said. Guggenheim Structured Real Estate Partners LLC held the most senior mezzanine loan, of about $70 million, as well as an unspecified piece of the first mortgage, the person said.

The mortgage and mezzanine debt matured when the credit crisis made refinancing almost impossible and condo sales had slowed, the person said. After learning that Guggenheim was looking to sell the debt, Swig approached Fortress to form a partnership to buy the debt, the person said.

Fortress bought Guggenheim’s portion of the mezzanine debt on the Sheffield57 project last week, according to the person. Guggenheim has been raising money to meet margin calls and reduce debt.

The senior debt matured on April 9 and the mezzanine debt matured on May 9, according to one of the people. The outstanding principal on the mortgage was $32 million as of June 6, according to the auction notice. That has since been paid by Fortress, the person said.

Concern about the Sheffield57 project prompted Moody’s Investors Service on May 21 to downgrade ratings on about $13.4 million of bonds tied to the project.

Auction Date Set

The Sheffield57 project has endured disputes with tenants and Swig has been named as a defendant in several lawsuits. Construction stopped in late 2008 after the contractor wasn’t paid on time. Swig halted condo sales in May.

A foreclosure auction for the property is set for Aug. 6 under New York state rules that govern foreclosures by mezzanine lenders, according to the mandatory notice of sale from broker Eastdil Secured LLC. It will begin at 10 a.m. New York time at the law offices of Allen & Overy.

The Sheffield57 building, at 316-328 West 57th St., is about 80 percent complete, according to one person with knowledge of the project. It has sold 47 percent of the condo units, according to this person. In the first quarter, the median price of Manhattan condos climbed 5.8 percent to $1.23 million, according to the Miller Samuel report.

Pet Spa

Concierge service, a pet spa, Sub-zero and Miele appliances and daily cocktails are among planned amenities, according to the project Web site. A map on the site shows chef Thomas Keller’s four-star restaurant Per Se a block to the north; Central Park one block further; and Lincoln Center, Carnegie Hall and Tiffany’s flagship Fifth Avenue store within walking distance.

Available units range from a studio offered for $755,000 to a four-bedroom priced at $7.4 million, according to the Web site.

To contact the reporters on this story: Hui-yong Yu in Seattle at hyu@bloomberg.net; Sharon L. Lynch in New York at sllynch@bloomberg.net.

Last Updated: June 26, 2009 22:20 EDT