Commercial real estate sector now also feeling the pinch

For months there's been a debate brewing about if, when and how much commercial property values would plummet due to softening economic fundamentals and the drying of up credit. A story in the Wall Street Journal reviews:

For the commercial-real-estate players that were in hot water before the capital-markets crisis of the past two weeks, the temperature is rising...

After these and other market crises, cash-flow projections for properties are being scaled back in anticipation of a greater economic slowdown. The sales market -- long considered the last hope of many distressed players -- has virtually ground to a halt.

Even creditors that were willing to make real-estate loans before the upheaval are pulling back, having witnessed the spectacle of some of the biggest names in finance and banking vanishing in a period of days...

To be sure, commercial real estate so far has fared better than residential properties. Many office buildings, shopping centers, warehouses and other income-producing properties are generating enough cash to pay their debt, and their default rates remain low.

Nevertheless, values have fallen because of the credit crisis and economic uncertainty, which is in particular creating headaches for investors who bought at the top of the market with short-term debt. Financial institutions holding mortgages backed by commercial real estate have suffered tens of billions of dollars in losses and face more.

In the long run, liquidity might be restored to the market by the government's proposed $700 billion financial-bailout plan, which partly involves buying troubled commercial-real-estate debt. But many institutions may be reluctant to accept the government's price if steep discounts are required because the underlying real estate may still be performing well...

In the near term, commercial-real-estate markets have been particularly devastated by the bankruptcy of Lehman Brothers. The firm owned more than $32 billion of debt and equity assets -- running from land in California to apartment buildings in Boston -- that will now be liquidated, putting downward pressure on prices.

Complicating things further, Lehman pledged many of its real-estate assets as collateral on loans for desperately needed cash in the days before it collapsed. For example, Swedbank AB, a Swedish bank, was left holding 70 commercial loans valued at $1.35 billion, which were backed by properties including partially built developments. It is unclear if Swedbank will fund the balances to keep construction going.

The financial crisis of the past few weeks also has hurt the economic outlook for many properties, particularly office buildings in New York and other financial centers.

In a worst-case scenario, in the New York region, vacancy will hit 19% by 2011 and values will scale back over 13% through 2009, according to a projection scheduled to be released Wednesday by Property & Portfolio Research Inc...

Richard Coppola, managing director of commercial-mortgage investments for TIAA-CREF, the largest U.S. retirement system, predicts lending costs will rise. "We want to make sure that we're compensated for the risk we take on over the long term," he says.