The bidding war had gotten more heated than expected, and the guy in the damp trench coat needed a break. He turned his back on the dozens of onlookers standing around an office suite with scuffed walls and dated carpeting, stepped into a corner, and asked the person on the phone for some more money. Again.

In this room – an empty suite in a downtown Boston office building full of empty suites – the smart money believed the building was worth $4 million or $5 million, tops. Trench Coat was already in it for $7 million, and was asking permission to bid that up. He got it.

And then the building’s lender quickly chased him up to $8 million.

That’s when the guy in the soggy coat finally quit the action, and the lender became the new owner of the distressed office building at 31 Milk St. This particular foreclosure auction was livelier than most, but the result was familiar: A lender taking control of a piece of real estate, and auction attendees asking each other, “What are they going to do with this thing now?”

It’s a question more lenders in and around Boston are becoming acquainted with.

Worst Of The Worst

Polaroid’s partially demolished Waltham headquarters, once envisioned as the site of a massive mixed-use redevelopment, is now in the hands of German bank Helaba. KS Partners has lost 1.6 million square feet of office and light industrial space in the area, including the offices at 31 Milk and six industrial buildings in Billerica that were seized two weeks ago. Wells Fargo recently took back a half-built industrial building in Marlborough and as of press time was marketing it on the cheap. Wells Fargo is also currently in talks to assume Normandy Real Estate Partners’ Prospect Corporate Center in Waltham. GE Capital has scheduled a May 11 auction to foreclose on the Burlington Woods office park.

“There are problems working their way through the system,” said Lisa Campoli, head of investment sales at Colliers Meredith & Grew. “There have been many more restructurings, as opposed to foreclosures. Despite that, some won’t get restructured, because the value gap is too big.”

Federal regulators have encouraged lenders to extend commercial loans, keeping them out of foreclosure. As a result, those properties that do land in foreclosure are often the worst of the worst – development sites lacking cash flow, and buildings with gaping vacancies and owners unwilling to invest in their own properties.

The Urban Land Institute’s 2010 Emerging Trends in Real Estate report called the first wave of foreclosures to hit the market “the worst of the worst – stuff you shouldn’t want.” And industry observers are predicting that assets like the Polaroid property in Waltham could sit on lenders’ books for years.

“I remember foreclosing on a project that was mid-construction 20 years ago,” said Beth Mitchell, co-chair of the commercial finance group at Nutter McClennen & Fish. “It took years to put it in a position where it could be leased and sold. At some point, you have to wonder whether it’s worth the trouble for an institution that’s not otherwise in that business.”

Lessons From Wang

If there’s been less pressure from federal regulators to close out distressed loans than there was in the early 1990s, there’s also been a greater hesitancy on the part of lenders to take quick, painful write-downs on properties they do take back.

“The last time, many lenders disposed of those assets quickly,” Mitchell said. Those bank-owned properties quickly rebounded in value, Mitchell said, and banks were criticized for taking heavy losses. This time around, lenders are hoping to reap the benefits of a pricing rebound.

“Everybody remembers the story of Wang Towers,” Mitchell said, referring to the Lowell office complex that sold for pennies on the dollar at the depths of the 1990s banking crisis – and then turned a $100 million profit soon after. “It’s in the back of everybody’s mind, and nobody wants to be the poster child this time around.”

The real estate arm of UBS pulled three REO properties off the market after appearing to be a contender to inherit the Wang crown.

UBS took the keys to a largely-vacant 667,000-square-foot office portfolio last September, after Gale International and Mack-Cali Realty signed a deed in lieu of foreclosure. Gale and Mack-Cali had purchased the properties in Billerica, Bedford and Andover in 2006, for $53 million, utilizing $58.6 million in debt from UBS.

Initially, UBS spun off pieces of the portfolio at fire-sale prices. 8 Oak Park Drive in Bedford sold for $1.9 million, or less than half the face value of UBS’s deed in lieu of foreclosure. UBS took a 50 percent haircut when it sold 3 and 8 Federal St. in Billerica for $6.7 million. It sold 300 Federal St. in Andover for a scant $2 million, or less than $17 per-square-foot. And then it looked at its returns and pulled the three remaining properties off the market.

Value Add

By contrast, Wells Fargo is pursuing a value-add strategy at Tweeter’s former Canton headquarters, which the lender seized at auction in January, for $7.8 million. Wells had a $12 million mortgage on the property, and auction bidders weren’t willing to go much higher than $3 million. Wells has tapped NAI Hunneman to reposition the property.

Special servicer LNR Partners appears to be pushing a similar strategy with pieces of the former KS Partners empire it seized last month. LNR has brought in Lincoln Property Co. to lease up 31 Milk St. before bringing the building to market.

Still, Jonathan Davis, CEO of the Davis Cos., predicted that leasing fundamentals may spur the spike in foreclosure sales investors have been waiting on for more than a year now. Davis argued that lenders get better returns by making new loans, not managing properties. He said special servicers, which currently hold $12.8 billion in foreclosed or REO properties, don’t have the capital or the staff to manage large portfolios of properties.

“There needs to be capital invested in these assets,” Davis said. “There are many [properties] out there that can’t effectively compete in a very competitive market, whether they’re in the hands of lenders, or borrowers who are underwater.”