Moody's: Tempered Optimism for Commercial Real Estate

All major commercial property types were either stable and in strong condition, or showed slight improvement, based on data gathered through the third quarter of 2002, according to Sally Gordon, the principal author of Moody's Investors Service's "Commercial Mortgage Backed Securities: Red-Yellow-Green Update" released earlier this month.

This signals either continued stability or early signs of economic recovery from the down part of the real estate cycle

And while there is optimism,

Ms. Gordon, also a vice president and senior credit officer with Moody's, cautioned that "one of the problems that the capital markets, in general, are facing are more uncertainties from more sources in this economic recovery than are typical in the business cycle.

"Specifically, there is more uncertainty about war and what kind of war. How long will it be and so on. Usually, when an economy is about to recover, you are simply looking at the industry, interest rates, inventory buildup, manufacturing flows and so on. This time, we have enormous wild cards that are not just business issues."

Putting aside the wild cards, the Moody's update showed a number of conditions expected to positively impact the commercial markets.

The update, referring to data ending the third quarter of 2002, said the market segments driven more by the consumer side of the economy - multifamily and shopping centers - remained healthy.

"Even if the consumer sector were to weaken from current activity levels (referring to the third quarter of 2002), both shopping centers and apartments have some margin to absorb a bit of a challenge," said the update.

In the update, markets are described in traffic colors: red (0-33 - under stress), yellow (34-66 - warrants monitoring), and green (67-100 - not under imminent stress).

The neighborhood and community shopping centers had the highest score of the major property types at 88, and were the only asset class with a score in the "greenest-green" category of the matrix.

The multifamily sector was also green with a score of 76. According to the update, the sector is likely to benefit from several factors including some expected leveling off in the increase in homeownership rates.

The update said, "Nudging the ownership rate further from 68% to 69% will be more difficult than pushing it from 66% to 67%, as marketing efforts and borrower-friendly programs run up against increasingly marginal borrowers."

Ms. Gordon explained, "Over the last several years, there has been a nice steady upswing in homeownership rates. Part of that is because the agencies, Fannie Mae and Freddie Mac, have had some rather aggressive policies in making mortgages more available to borrowers that have been kind of marginal.

"The farther you get into those marginal borrowers, the more difficult it is to lend. Any continuing penetration will be much slower. That said, if the increase in homeownership slows down or just flattens out, then that helps out apartments because some of those people are either going to stay in apartments or go back to apartments."

The national office market, driven by the corporate side of the economy, fared less favorably than the multifamily sector.

This category's score rose slightly in the third quarter of 2002, moving to 50 from 46, having also moved up in the previous quarter to 46 from 40.

Moody's said, "For the third quarter of 2002, the national vacancy rate was 16.1%, up from 12.9% in the third quarter of 2001. However, the pace of deterioration (was) slowing, as evidenced by a much smaller increase in the vacancy of only 0.4% from (the second quarter of 2002)."

Faring slightly better than the office market was the industrial market with a score of 58 in the third quarter of 2002, moving from 52 in the previous quarter. Vacancy was almost stabilized, with a shallow increase to 10.9% in the third quarter from 10.8% in the third quarter.

The hotel sector had the lowest score of all the property types at 32, though it was a marked improvement from zero, which was the sector's score for the sector for the 2002.

New York, NY; Long Island, NY; Norfolk, Va.; Northern New Jersey; and Riverside, Ca., emerged as the markets with the best showing overall in the third quarter. And Denver; Austin; Baltimore; Stamford, Conn.; and St. Louis had the worst showing for the period.

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