The recent foreclosure auction of the Pasarroyo office complex in Pasadena, California, serves as a telling example of growing financial distress in the commercial real estate sector. Despite an attractive opening bid of $114 million—less than half of its previous sale price—the auction ended with no bids, leaving the property with its lender. Such scenes are becoming increasingly common across the United States as distressed commercial real estate loans hit a 10-year high.

The Growing Trend of Foreclosure Auctions

Foreclosure auctions like the one held in Pomona, California, are largely driven by nonjudicial foreclosures, a faster and more cost-effective process for lenders to regain ownership of defaulted properties. However, these auctions rarely result in actual sales. According to Selina Perelskin of Beacon Default Management, it’s uncommon for bidders to arrive with cashier’s checks large enough to meet the high opening bids, often leaving properties unsold.

Challenges of Auction Pricing

A significant barrier to sales at these auctions is the gap between opening bids and buyer expectations. Bert Haboucha, principal of Atlas Capital Advisors, attended a recent auction on behalf of a family office hoping to purchase a small office building at a discounted price. However, the opening bid matched the full amount owed on the defaulted loan, leaving no room for negotiation. Haboucha expressed frustration, stating, “It wasn’t even worth giving them our name.” This experience highlights how inflated opening bids deter potential buyers, even as distressed properties flood the market.

Industry-Wide Impacts

The challenges seen in Pasadena are mirrored nationwide. In Houston, Miami, and Washington, D.C., office properties have similarly gone to auction without securing buyers. With 44% of office properties underwater on their loans, the sector remains particularly vulnerable. Even trophy properties like New York’s iconic Flatiron Building have struggled in public auctions due to high reserve prices and significant renovation costs.

The Role of Foreclosure Auctions

While foreclosure auctions rarely lead to outright sales, they play a critical role in allowing lenders to take back properties and clear titles of junior liens or other encumbrances. This “clean slate” enables lenders to reposition distressed assets for potential future transactions. Still, industry professionals, like attorney Kathleen Muñoz, note that lenders have so far shown patience in working with borrowers through loan workouts and forbearance agreements. However, this leniency may wane as financial pressures mount.

Looking Ahead

As the commercial real estate sector grapples with refinancing challenges and rising debt costs, experts like Perelskin anticipate an increase in foreclosure auctions in 2024. Despite the bleak outlook, these auctions remain a vital mechanism for resetting the market and navigating distressed assets.
For investors like Haboucha, these auctions underscore the importance of due diligence and realistic expectations. While some opportunities may emerge as lenders reassess pricing strategies, the current bid-ask gap continues to hinder meaningful transactions.