US Commercial Real Estate Values Go South

The Moodys/Real National All Property Index dropped 0.6% in February compared to January of this year. In addition, the index is about 21% lower than a year ago, and about 18% lower than two years ago.

This index tracks the change in sale prices for different property types based on sales of the same assets over time. The index is a good measure of where commercial property prices are going. The largest year over year price drop (February 2009 vs. February 2008) was reported in industrial, 13.9% decrease; followed by apartments, 13.6% decrease; office, 13.5% decrease; and retail, 8.5% decrease.  Also, according to the report, sales volumes in February were down 67% from the year ago period and most of the sales(90%) were for assets under $15 million.

Some conclusions that can be inferred from this data:

• Commercial property prices continue to fall, which could put many owners who bought at the height of the boom underwater on their mortgages.
• There will be a continued rise in loan defaults - owners who have lostequity are more likely to walk away from their properties or sell at heavily discounted prices.
• Lower dollar deals are getting done vs. large transactions; financingfor smaller properties is easier, which should make price drops in this class >$15 million, less severe.
• With financing still scarce and fundamentals going south, expect pricesto continue falling. Expect fewer transactions as owners are reluctant to take losses.
• Wait for more price drops before buying commercial real estate; whenbuying, focus on the larger, higher growth markets. According to the Moody’s report, y/y price drops were significantly lower in the top 10 MSAs for all major property types (apartments, industrial, office, and retail).
• We still favor REITs with assets in supply constrained, urban markets,where values and rents will continue to hold up better. A couple of companies we have buys on are Avalon Bay (AVB) for apartments and Regency Centers (REG), a strip mall owner. Despite declining property values across these sectors, both companies are still trading below the value of their assets.

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