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US commercial property seen falling by 20%

But office properties should fare relatively well over the near term, say JPMorgan analysts

(NEW YORK) The US commercial real estate market could decline by as much as 20 per cent over the next five to eight years as tighter credit squeezes business property but with less ferocity than it choked the housing market.

‘We believe commercial real estate loan performance peaked in 2007 and will deteriorate on an accelerating trajectory through 2009,’ JPMorgan analysts said on a conference call on Tuesday.

They said they expect values to fall by 20 per cent from their peak last year, and losses to total about US$120 billion, or 4 per cent of the US$3.2 trillion outstanding commercial real estate loans.

Commercial Mortgage Backed Securities (CMBS) would account for about US$30 billion of the losses and collateralised debt obligations (CDOs) would account for about US$40 billion of the losses, they said.

CDOs are bonds based on pools of the riskiest CMBS bonds, leases, mezzanine loans and other real- estate related instruments.

CMBS, including CDOs, accounted for 23.6 per cent of lending at the end of the third quarter of 2007, JPMorgan said.

Problems in the CMBS market will become apparent between 2010 and 2012, as many five-year mortgages mature, the JPMorgan analysts said.

This would lead the commercial property market into a more gradual decline than the housing market, which has been slammed by losses related to sub-prime mortgages. Those losses are expected to reach US$200 billion, or 15 per cent of the US$1.25 trillion of outstanding loans, the JPMorgan analysts wrote in a report discussed on the call.

Many commercial properties have been financed with low-interest, five-year mortgages that will have to be refinanced or the properties will have to be sold.

Lenders who do not sell their loans but rather keep them on their balance sheets, such as insurance companies and commercial banks, are expected to loose US$50 billion over the five-to-eight year period, giving them enough time to adjust reserves, the JPMorgan analysts said.

‘The relatively conservative underwriting of banks and insurance companies is likely to insulate them from many of the problems that will plague loans securitised into fixed-rate CMBS,’ the JPMorgan report said.

Moody’s Investors Service recently said it expected commercial property values to decline 15-20 per cent over the next few years and the delinquency rate to increase into the 1-2 per cent range.

But Michael Pralle, former head of GE Real Estate and now president of JER Partners, a real estate private equity firm, said real estate values already have fallen by 10 per cent or 15 per cent. ‘It’s literally the arithmetic of the lending.’

He said many buyers have lowered offers as they factor in the higher costs of borrowing and lower amounts of cash available to borrow.

Office properties, the largest sector of the commercial real estate market ‘. . . should fare relatively well over the near term due to the longer-term nature of their underlying tenant leases’, the JPMorgan analysts wrote. But, they added, retail and hotel properties, which are very sensitive to changes in the overall economy, are expected to underperform.

Benjamin Lambert, chairman of commercial real estate brokerage Eastdil Secured, said values at the very top of the office market would slip slightly, but the overall market may see values decline 10 per cent or 15 per cent. Eastdil Secured is a subsidiary of Wells Fargo & Co.

JPMorgan analysts said they expected that the relatively restrained construction of offices, apartment buildings, warehouses, shopping centres and hotels that occurred between 2003 and 2007 would mitigate losses.

This compares to the residential market, which has suffered from a glut of houses for sale.

JPMorgan also said declines would not be limited to the United States, adding that UK commercial property prices are like to fall 23 per cent and commercial property prices in Europe and Australia are apt to decline by 5 per cent to 10 per cent.

Source: Reuters (Business Times 6 Mar 08)

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