April 22 (Bloomberg) -- New York developer Harry Macklowe lost 1330 Avenue of the Americas in a foreclosure auction after he defaulted on a $130 million mezzanine loan. The building sold for $240.1 million, 52 percent less than what he paid in 2006.

Otera Capital, a unit of Canada’s biggest pension fund, placed the minimum bid of $100,000 for Macklowe’s stake in the 40-story property, and assumed the $240 million mortgage. It’s the second mezzanine loan foreclosure of a U.S. skyscraper in less than a month. On March 31, Normandy Real Estate Partners and Five Mile Capital Partners acquired Broadway Partners’ stake in Boston’s John Hancock Tower after Broadway defaulted.

“We step in basically to protect our investment,” Otera Chief Executive Officer Jean Lamothe said in an interview. “Values have come down, that’s for sure.”

The auction price suggests values for U.S. office towers may have fallen by half from their 2007 highs. To beat Otera, rivals would have had to overcome Otera’s advantage as the foreclosing mezzanine lender. Otera had the ability to “credit bid” the $130 million mezzanine loan as part of its offer.

The lack of any rival bids means it’s possible investors think the 1330 building is worth less than the $240 million first mortgage, said Mark Zytko, co-chief executive officer of Mesa West Capital, a commercial real estate lender.

Mezzanine Loans Backfire

The first mortgage was an interest-only loan priced at Libor plus 149.5 basis points that’s now due Feb. 9, 2012, after being extended from the original maturity of last January.

“On a lot of these deals, the coupon is so low on the first mortgages that even if the building is worth less than $240 million, the mezzanine lender might bid to stay in,” Zytko said. “They have until 2012 and their only cost out of pocket would be debt-service shortfalls.”

The need to refinance the mortgage in three years may have deterred potential bidders, investors said. About 31 percent of the 525,000 square-foot building is vacant, according to Macklowe Properties’ Web site.

Mezzanine loans are backfiring on borrowers unable to refinance short-term debt in today’s frozen credit markets. The job is even more difficult because commercial properties are losing value, eroding borrower’s equity. Values in the U.S. declined 21.5 percent through February from their October 2007 peak, Moody’s Investors Service reported in its monthly survey.

A mezzanine loan is debt that fills in the gap between a first mortgage and a borrower’s equity. Mezzanine loans became more popular during the real estate takeover boom of 2006 and 2007. They are seen as riskier than a first mortgage and have higher interest rates.

‘Little Money’

The sale of 1330 closes another chapter on Macklowe’s growth ambitions. In 2007, he borrowed $7 billion to buy seven other Manhattan office towers from Sam Zell’s Equity Office Properties Trust.

He put just $50 million of equity into that purchase and ended up losing control of those buildings and selling his flagship property, the General Motors Building, to repay debt.

“Macklowe had so little money in the game,” Zytko said. “If values went up, he was a huge winner, but only a small decrease in value crushed him.”

Macklowe, 71, has been investing in New York real estate since the 1960s. Within days of the sale of the GM Building last June, Macklowe’s family-owned firm announced that Harry’s son William Macklowe would replace his father as chairman and chief executive officer.

Macklowe spokesman Steve Solomon declined to comment.

“The Macklowe group did a very good job in terms of redeveloping the property,” Lamothe, Otera’s CEO, said in a telephone interview. “We are in a different cycle now.”

Gearing Up

Otera plans soon to hire a building manager and is in talks with potential tenants, said Lamothe. “Clearly, we’re adjusting to the market in terms of rental values,” he said.

Investors turned to mezzanine loans during the real estate takeover boom of 2006 and 2007 as the cost of office buildings, retail centers and industrial properties soared.

Today’s auction took place under New York state rules governing mezzanine loan foreclosures, which are different from traditional real estate foreclosures. With a mortgage, a bank has a lien on the physical property. A mezzanine loan is secured by a pledge of the equity ownership in the mortgage borrower, usually a limited liability company created by a buyer such as Macklowe.

Wiping Out Equity

The successful bidder in a mezzanine foreclosure will take over the borrower’s stake in the entity that owns the property, subject to any senior loans including the mortgage. The foreclosure usually wipes out the mezzanine borrower and subordinate lenders. Otera will take Macklowe’s place in the building ownership and will control the various entities as long as it keeps all the loans senior to its position current.

If rents have fallen and space has been vacated, income from the property may not be enough to pay the interest on the mortgage without Otera contributing money. Mezzanine lenders sometimes take a temporary loss to keep loans current if they expect a property to return to profitability.

Macklowe bought 1330 Avenue of the Americas for $498 million in December 2006. He got a $240 million senior mortgage from Deutsche Bank AG and a $130 million mezzanine loan that was later sold to Cadim, a unit of Caisse de Depot et Placement du Quebec, the government-owned pension fund based in Montreal. Cadim’s cost to buy the loan wasn’t disclosed.

Cadim transferred the loan to Otera Capital on Jan. 1 when the Caisse reorganized its real estate finance business. Macklowe defaulted on the loan in January.

Values Drop

Otera handles all of Caisse’s real estate financing. It underwrites, services and securitizes loans, including mortgages and mezzanine loans. Its portfolio was C$11.3 billion (US$9.1 billion) as of Dec. 31, a large portion of which is in Canada. About 10 percent of its assets are in mezzanine loans and about one-third of its assets are in the U.S., Lamothe said.

Because few properties have sold recently, it’s difficult to establish precisely how much prices have fallen.

“When people say values have declined by 25 or even 30 percent, it’s tough not to agree with that,” Lamothe said. “We don’t have to necessarily flip the assets very quickly,” he said. “Better-quality properties really hold onto their values a lot better so I think 1330 falls into that category.”

Broker Eastdil Secured LLC conducted today’s auction at the law offices of Allen & Overy LLP, which represents Otera.

To contact the reporters on this story: Hui-yong Yu in Seattle at hyu@bloomberg.net; David M. Levitt in New York at dlevitt@bloomberg.net

Last Updated: April 22, 2009 23:00 EDT