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CCIM sees bleak investing situation for commercial real estate

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Ugly drops in valuations and sales volume this past year have made for a poor commercial real estate investing outlook, but experts say the worst is over.

Property prices, for instance, are expected to fall 30 percent to 35 percent, but the 20 percent drops already seen suggests that they won't fall much further, said Norm Miller, real estate professor at the University of San Diego.

In fact, futures activity anticipates declines of 5 percent over each of the next two years, he told nearly 300 industry professionals at a January conference held by commercial real estate organization CCIM.

"We've already gone through two-thirds of it," Miller said. "You'll see 2010, 2011 looking much better."

Miller and the other event speakers painted a bleak picture of the current investing situation, worsened by the credit crunch, limited liquidity and twisted financial markets.

They blamed the crisis on excessive leverage and credit default swaps, which respectively loaded corporations with debt and falsified ratings.

"The financing model is what's completely broken today," said Allen Greer, Bank of America (NYSE: BAC) senior vice president and director of research for real estate risk assessment.

Commercial real estate sales volumes are down across the board, although Greer observed that price per square foot remains relatively unchanged. Still, industrial is off by about 54 percent year over year, and office and retail sectors are both off by more than 70 percent.

The commercial mortgage-backed securities market was pronounced dead, at least for the time being. While $230.2 billion in CMBS were issued in 2007, issuance fell to $12.1 billion in 2008, with the last deal in June, Greer said.

He anticipates the CMBS market, as well as credit default swaps, will return, but will be utilized much more conservatively and regulated heavily.

At the moment, CMBS prices have skyrocketed, which has translated into higher mortgage costs for commercial borrowers. December and January brought in the highest delinquency rates ever seen, said Kristin Gannon, managing director for Goldman Sachs (NSYE: GS).

"And it's accelerating," she said. Gannon also expressed concern over the $40 billion in mortgages expected to need refinancing in the next few years.

Real estate investment trusts, also known as REITs, have been hammered: The REIT index has lost 38 percent in 2008, Gannon said.

REITs are expected to refinance as much as $14 billion in the coming years and will likely start cutting dividends or paying dividends in stock. Expect bankruptcies, she added.

"Some of the capital structures are just not sustainable," Gannon said.

Comparatively, San Diego has borne the bludgeoning well, experts noted.

With an annual growth of approximately 2 percent to 3 percent, the region is less overbuilt than Phoenix and Las Vegas, which saw year-over-year growth of 10 percent.

San Diego paces the nation in third-quarter vacancy rates in office and industrial, but performed better in retail and apartment, Greer said, referring to data from various research groups.

San Diego ranked as the seventh-best market out of 80 in retail and the third-best market out of 60 in apartment.

Even San Diego's hotel sector, which saw 77 percent vacancy in the third quarter compared to the nation's 68 percent, is still ranked seventh out of 53 markets.

Furthermore, the distressed housing drag is heavily concentrated, USD's Miller pointed out, citing data that shows 50 percent of subprime foreclosures are in one state, and 50 percent of subprime foreclosures in a given metro are in about 10 percent of the area.

In fact, Miller said, 80 percent of San Diego ZIP codes are performing better than the Case-Schiller Index.

Commercial real estate should see the bottom in most sectors within two years, Miller said. In retail, neighborhood businesses will be insulated while large chains lead the downward plunge.

Industrial will lag the other sectors. Apartments, on the other hand, will lead as housing inventory is absorbed.

"People have to live somewhere, even when they're unemployed," Miller said.

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