One of the biggest loans in multifamily history is on the verge of default.

When Tishman Speyer and BlackRock Realty purchased Stuyvesant Town/Peter Cooper Village for $5.4 billion in 2006, it represented the largest single multifamily transaction in the country’s history. But now, the owners are running out of money to pay off the property’s $3 billion in securitized debt and an additional $1.5 billion mezzanine loan. The borrowers’ debt service reserves are nearly depleted and should run out by the end of the year, according to Moody’s and Fitch Ratings.

The deal has become a poster child for the excesses of 2006, when cheap money flowed and underwriting assumptions pushed the envelope. When the sprawling 56-building 11,250-unit complex was sold in 2006, about 80 percent of the development’s units were rent-stabilized. The new owners hoped to convert the bulk of those units to market-rate units with regularity, but the pace of conversions was slower than expected. As of July, the mix was about 60 percent rent-stabilized, 40 percent market rate.

“They had an aggressive assumption,” says Adam Fox, senior director for Fitch Ratings. “Up until the end of 2008, they were converting just over 6 percent of the stabilized units to market (per year), but their initial expectation was a much higher number.”

The biggest fly in the ointment is litigation brought on by tenants of Stuyvesant Town/Peter Cooper Village. The tenants allege that a number of units have been wrongfully deregulated, and in March, the New York State Supreme Court denied the owners’ request to dismiss the claims. A week later, a court of appeals sided with the tenants, saying that the owners cannot deregulate the units while receiving city tax abatements, called J-51 city tax credits.

Therefore, the owners are now in limbo, unable to deregulate any additional units until the litigation is settled, which could take months or even years. During the legal process, the owners are required to deposit the difference between the stabilized rents and market-rate rents on the converted units, an escrow account currently totaling $10 million, with monthly payments of $2.5 million.

“The litigation is driving the performance,” Fox says. “It limits their ability to convert the units, and because they have not been able to do that, they are using more of their reserves and burning through them much quicker.”

The owners are facing a catch-22: They must put more equity into the deal, or recapitalize, to continue paying the debt. But that’s difficult to do without knowing the property’s value, which largely depends on the outcome of the litigation.

Meanwhile, the debt reserves are dwindling. As of July, the deal’s debt service reserve balance was just $56.5 million, down from $400 million at issuance. And a general reserve account, which totaled $190 million at issuance and was used for capital improvements and to pay down the debt, is now gone. The $3 billion in securitized debt was originated by Wachovia, and portions of it are spread among five different CMBS pools. 

If the owners default, it would only add more grist for the mill of CMBS delinquencies. The current Fitch CMBS loan delinquency index is 3.04 percent overall, and 5.44 percent for multifamily. If Stuyvesant Town/Peter Cooper Village becomes delinquent, the overall number would increase to 3.63 percent, and 9.49 percent for multifamily.