Waltham’s Bay Colony Corporate Center is again teetering on the edge of default, just six months after Eastern Real Estate seized the suburban office trophy from Broadway Partners. 

Several industry sources have told Banker & Tradesman that Eastern’s piece of the Bay Colony mezzanine debt is underwater. Eastern is refusing to invest new capital in the property because the Woburn-based investment firm is unsure whether it will continue to control the 1 million-square-foot office complex.

Eastern continues to service the property’s $144 million first mortgage, but industry sources say cash flow is deteriorating at a rate that puts Bay Colony in line for a June default.

Prudential Insurance, which owns a more senior slice of the property’s mezzanine debt above the $144 million first mortgage, could try to eject Eastern from their ownership position before then by claiming a default on technical grounds.

Eastern’s position sits junior to Prudential, meaning its chances of recouping its debt are slimmer as property values fall. Falling values have already wiped out any debt junior to Eastern’s.

Estimates have pegged the property’s value anywhere from $150 million to $185 million. Considering the primacy of the $144 million first mortgage and Prudential’s seniority in the debt chain, it seems unlikely that Eastern would get anything from a sale, even assuming the more optimistic price.

“It’s just a matter of time before Bay Colony falls,” one industry insider predicted. “It’s over-leveraged. The guys who own it now can’t make progress to get new tenants. It will go to the mezz lenders, and keep going until it winds up with somebody who’s willing to act like an owner.”

Overleveraged, Underwater

Lehman Bros., the now-bankrupt investment bank, financed Broadway Partners’ market-topping 2007 acquisition of the sprawling Waltham office park. Lehman provided Broadway with a $144 million securitized first mortgage. Lehman also arranged for $125 million in mezzanine financing, and $81.6 million in bridge financing.

In all, Broadway and Lehman put more than $350 million of debt on the property. At the time, Lehman valued Bay Colony at $366 million, making the deal more than 95 percent leveraged. Just two years before, Lehman had pegged Bay Colony’s value at $276 million.

The investment bank justified the aggressive financing by reasoning that in-place rents were well below market. Lehman said Broadway could boost cash flow 20 percent by jacking up rents.

But a rapid downward turn in the office market, combined with plummeting real estate values and a lack of available credit, forced Broadway out of Bay Colony last summer. Lehman sold its mezzanine position in Bay Colony to Eastern at a discount, and Eastern foreclosed, gaining control of the property in much the same way that Normandy Real Estate Partners was able to seize another former Broadway trophy property, Boston’s John Hancock Tower.

But where Normandy was able to entrench itself deep in the Hancock’s capital stack, Eastern’s positioning left the firm vulnerable to falling real estate values.

“Eastern made a big mistake,” a second industry insider said. “They bought after the markets crashed, but before real estate values settled out.”

Ticking Time Bomb

The property also isn’t generating income like it used to, putting Eastern on track for a June cash flow default, sources with knowledge of the property’s financials said.

When Eastern took control of the property, it renewed a number of maturing leases in low-rent, no-capital-improvement deals. Asking rents at the property are hovering in the low $30’s, though Eastern did one renewal at a rock-bottom rate of $23 per-square-foot. Asking rents at the property averaged $27 per-square-foot in 1989, according to data from Colliers Meredith & Grew.

Reserves are also dwindling. According to the real estate debt tracking firm Trepp, the property’s tenant improvement and leasing commission reserve stood at $524,000 in February, with a rollover and replacement reserve at $1.1 million – numbers 82.5 percent and 77.6 percent lower, respectively, than 2007.

Eastern also has what one industry source described as a “ticking time bomb” on its hands – the $144 million securitized first mortgage. According to Trepp, the mortgage has been on a servicer’s watch list since last August. The interest-only loan is set to mature in June 2012.

Bay Colony’s future “all depends on what Prudential wants to do,” a third industry source told Banker & Tradesman. The insurance giant essentially has three options: Sell its mezzanine position to an investor, bring in a new management company and own the property outright, or form a joint venture with an investor willing to inject significant amounts of new capital into the property.

“They don’t mind owning real estate, but you wonder if they’re willing to put the money in there,” the third industry source said. “What they need is somebody to say, ‘I can do it, and here’s the cash.’”

References to Bay Colony have disappeared from Eastern’s Web site. The firm declined to comment for this story.