Rating Agencies Expect CRE Price Decline

Two credit rating agencies report that commercial real estate indices they maintain point to a decline in commercial real estate prices.

Standard & Poor's said that October results on its S&P/GRA commercial real estate indices show that "annual returns continue to decelerate" on a national level.

The national composite index showed annual returns of 4.9%, compared to October 2006. However, this is a decline from the growth rates seen previously, according to the rating agency.

David Blitzer, managing director and chair of the index committee at S&P, noted, "There may be pockets of relative strength in certain regions. The Desert Mountain West, the Mid-Atlantic South and the Northeast all reported some improvement in their annual returns. However, these regions are still significantly below their recent double-digit growth rates, so we will need to keep an eye out to see if the decelerating trend continues in future months."

In terms of property sectors, the apartment sector gained 2% in October, compared to September 2007, but was down 0.5% compared to October 2006. This is the worst performing property sector on an annual basis.

"A few more months of data are needed to tell whether this sector is turning around or on its way to further declines," according to Mr. Blitzer.

Office properties performed best, with an annual return of 10.8%, but monthly returns were down 2.5% in October 2007, compared to September.

The retail sector was up 7.1% and the warehouse sector gained 8.7% on an annual basis.

On a geographic basis, the Desert Mountain West region was up 7.7% in October, compared to October 2006, turning in the best performance.

In the Mid-Atlantic South, annual returns were a mere 0.4%, the Midwest region gained 4%, the Northeast region was up 4.9% and the Pacific West saw a positive return of 6.9%.

Moody's Investors Service also reports that its real property price indices showed a 0.2% decline, on a monthly basis, in November. This is the second decline in the last three months.

Moody's believes that this level represents a plateau in commercial real estate valuations that may indicate a coming downturn.

"Price series often stumble along at the top, leveling off before experiencing a more consistent downward trajectory," said Sally Gordon, a Moody's senior vice president.

"Furthermore, we anticipate that at an inflection point in the market, the index would demonstrate some jumpiness, albeit with more downs than ups on a net basis," she added.

In October 2007, prices were up 1.6% after a 1.2% decline in September.

At the end of November 2007, prices were up 12.1% over the same period of 2006 and 17.5% higher than two years before.

One sign of market weakness that the rating agency sees is that the number of the repeat sales transactions that went into the indices has declined in each of the last three months.

Both the number of these transactions and their dollar volume are now below their average levels of the last three years, although not at their lowest levels for the same period.

The Moody's/REAL commercial property prices indices are based on the repeat sales of the same properties at different points in time price across the U.S.

This approach helps take care of the distortions that can occur with other commercial property value measurements such as appraisals or average prices, according to Moody's.

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