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Investor Survey Projects Further Drop In Property Values Amid Faltering Economy

ATLANTA — Commercial property values have dropped 5% to 10% over the past year, and in the next 24 months they are likely to drop again by a similar amount. That’s the majority view of a regional real estate investment group, and Sam Chandan, chief economist and senior vice president of the New York-based research firm Reis.

“If credit is significantly constrained, we may see properties trading at a discount relative to their underlying worth,” Chandan says. “People who are going to be selling over the next 12 to 24 months are largely people who need an exit strategy.”

Chandan’s remarks came during a gathering Wednesday of the Southeast chapter of the Real Estate Investment Advisory Council (REIAC), where nearly 300 members voted electronically on current economic topics, offering an instant snapshot of the developers and investors’ concerns.

Nearly two-thirds of the investors —65% — predicted that commercial real estate values would drop over the next two years. More specifically, 51% said property values would drop 5% to 10% while 14% expected them to decrease by 10% to 20%. About one-third of respondents were more optimistic, saying values would rise slightly or stay the same.

An overwhelming number of the group, 82%, said the country already has entered a recession. Nearly half the voters, 49%, predicted that the slowdown would be mild with a quick rebound. Ominously, however, one-third said the slowdown “will prove deep and protracted.” Chandan, a panelist at the seminar along with Bret Wilkerson, CEO of Boston-based Property & Portfolio Research, agreed with the latter view.

More than half the group said it would be late 2009 — at least — before the economy gains momentum. The current climate of tightened credit for borrowers, a result of the subprime crisis that started in the residential sector, could prolong the nation’s recovery. Credit issues now have moved from concern over the ability to obtain affordable mortgages to the widespread use of credit cards to finance mortgage debt in addition to consumer spending.

“The revolving credit issue is a significant one,” Chandan said. “A lot of people are writing checks from their credit cards to their mortgage companies.”

A strong majority, 58% of the gathering, called multifamily the strongest commercial real estate sector, and forecast that it would perform better than other sectors through 2010.

As for the sector most likely to perform the worst over the next two years, 42% cited retail, while 38% said it would be the office sector. Only 17% thought hospitality would perform the worst.

“It’s such a toss-up between office and retail,” Chandan told the group. “In the retail sector, I think there’s a great deal of uncertainty.”

Wilkerson defended the office sector, saying that while nationally it is likely to take a pounding in the capital markets and values may drop — good news could follow for office investors. “By 2010, it’s far and away the best buying opportunity,” Wilkerson said.

More than three-fourths of the REIAC group predicted that underwriting for the “worst” sector would rise strongly for unleveraged internal rates of return — 39% said it would rise 50 to 100 basis points, while nearly as many, 38%, said it would rise more than 100 basis points.

Healthy fundamentals, along with a weak dollar and cheap foreign debt, provide a recipe that will entice foreign buyers to invest in U.S. real estate, more than half the group concluded.

A smaller but substantial percentage, 42%, said foreign capital’s current search for economic stability, concerns about exit risk and dollar depreciation would lead to a “wait-and-see” attitude among international investors.

That’s already happening, says Wilkerson. “The consensus is the dollar is going to fall further.”

The planned buyout of Bear, Stearns by JP Morgan Chase & Co. , and the Federal Reserve’s decision to step in on March 14 and bail out the New York-based brokerage with emergency funding after clients lost confidence and withdrew $17 billion in two days, prompted fears that more banks could find themselves in similar situations.

More than half the Southeast investment group — 57% — said they expected moderate bank distress in the coming days, with minor support for the banks and bailouts. But 41% were more pessimistic, saying that a handful of name-brand bank collapses were likely, in a situation reminiscent of the failure of financial institutions in 1992.

“When The Fed pushes an institution to be acquired at $2 a share where their 52-week high was $170 a share, it sends [the following] message: ‘We’re going to make this painful. Don’t tread lightly and don’t expect us to bail you out,’” Chandan said.

More than half the real estate investors said it would be early 2009 before inflationary concerns prompt The Fed to start raising interest rates.

But Wilkerson said that if inflation increases, there could be an upside. “Inflation is a friend of real estate,” he asserted. “You will see even more capital flowing into real estate. It’s viewed as an inflation hedge.”

The discussion of deep-seated problems in the economy and their effect on the commercial real estate market prompted a bit of dark humor at the meeting’s outset.

“We should have called this program ‘Fear and Loathing in the Capital Markets,’” joked Jerry Monash, founder of the Southeast REIAC chapter.

Denise Kalette is Senior Editor of NREI

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