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Commercial Sector Remains Strong Despite Housing Woes

Midway through 2007, commercial real estate markets are going strong, aided by an economy that has weathered the housing slowdown well so far and generated a fair amount of job creation. And in spite of reduced levels of home equity to draw on, consumer spending is still going strong.

On the housing slowdown front, a large part of the impact has been absorbed, in the form of buyback calls from Wall Street players that caused a number of subprime originators to go out of business, and in the tightening of underwriting standards by lenders. However, it remains to be seen what happens when adjustable-rate mortgages already in the system start resetting to higher rates. These ARMs don't form the major part of the mortgage loans made in the last few years though, and not all of them are going to default when payments start resetting upward, and it doesn't seem likely that their resetting will have a major systemic impact.

On the topic of defaults, Moody's Investors Service reports that defaults on lease payments by the largest tenants was the most common cause for putting commercial mortgages into special servicing in 2006, accounting for 37% of such loans. This is based on a universe of Moody's-rated securitized commercial mortgage loans, not including multifamily properties and manufactured home communities. Buildings in larger metropolitan areas are less likely to be impacted by tenant defaults while buildings in smaller markets with economies that are not well diversified can be impacted more by tenant defaults, the report says. According to Moody's, loans on buildings outside the larger metropolitan areas that enter special servicing are represented "at approximately twice the frequency that their total share of CMBS collateral would suggest."

And the latest commercial real estate market report from Moody's says that the limited-service hotel sector saw the greatest performance improvement of seven commercial property sectors in the first quarter. The credit rating agency reports in its second-quarter market update, based on data from the first quarter, that New York and Los Angeles are the top performing cities for commercial real estate. These two are also the largest cities represented in commercial mortgage-backed securities deals.

Of seven major property sectors the rating agency follows, five are in the highest-performing "green" category, while two (full-service hotels and suburban offices) fall in the middling "yellow" category. The overall score for commercial real estate was 72 in the first quarter, down from 73 for the fourth quarter of 2006.

The five worst-scoring U.S markets in the first quarter (with previous quarter score in parentheses) are Trenton, N.J., 33 (42); San Antonio, 41 (26); Jacksonville, Fla., 45 (49); Las Vegas, 46 (42); and Detroit, 48 (53).

The limited-service hotel group moved into green territory, while its full-service cousin barely made the yellow category. On a revenue per available room basis, revenue in the full-service hotel sector rose 6.3% compared to the first quarter of 2006. While this increase in revenue is the lowest seen in the sector for over two years, this is the first time it has "exceeded the baseline target since we began measuring it in 2004," according to Sally Gordon, a Moody's analyst/senior vice president. In the limited-service hotel sector, revenue exceeded the baseline target by 4.5%. Supply remains short and demand has slipped a bit.

The suburban office sector had a yellow score of 46, the only sector with a below-50 score. There is a mismatch between supply and demand in this sector, Moody's reports.

Also, it has some low-scoring markets that bring down the overall category score.

In the multifamily sector - which fell in the green category with a score of 80 - the relationship between new supply and demand is stable but slightly negative. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com