As noted within MBA’s Data Book, during the third quarter, while continuing to feel the pressure the credit crunch, commercial/multifamily real estate began to show signs of being affected by the slowing of the broader economy.

“For more than a year, we have been faced with the question of whether commercial real estate would be the next shoe to drop,” said Jamie Woodwell, Vice President of Commercial Real Estate Research for MBA.  “The weakening economy, in concert with the ongoing credit crunch, is demonstrating that commercial/multifamily is not entirely immune to the impacts felt by the residential market.”

As noted within the Data Book, property fundamentals showed a slowdown in leasing activity.  Property sales and mortgage originations showed the impact of economic uncertainty, shifting investor expectations and the continued capital markets malaise while mortgage investment levels were depressed by the capital constraints of traditional investors and headline risks associated with holding “mortgage-related” assets.  All the above factors resulted in a deterioration of commercial/multifamily mortgage performance.

BROAD ECONOMIC ANALYSIS

According to the dominant gauge of economic growth, the annualized percentage change in real gross real domestic product (GDP), the U.S. economy shrank in the third quarter.  The rate of decline, 0.5 percent, was relatively modest, but all expectations are that the fourth quarter numbers will show a more significant decline.  (MBA’s December economic forecast is predicting a decline of 5.2 percent in the fourth quarter of 2008 and a further decline of 3.7 percent in the first quarter of 2009).  While the major drag on the economy over the past two years has been the decline of the single-family housing market, a major drop in personal consumer expenditures pulled GDP growth 2.7 percent below where it otherwise would have been, dwarfing the previous single-family market impacts.

Employment growth is following a similar course.  Approximately 1.9 million jobs have been lost between November 2007 and November 2008.  The majority of those have been goods producing jobs – led by manufacturing and construction jobs – but recent months have seen a surge in losses among service-producing industries.  And the trend is worsening; while 600,000 jobs were lost during the third quarter, 533,000 jobs were lost in November alone.

PROPERTY MARKETS

The economic slowdown has begun to have an impact on demand for commercial real estate.  Despite relatively modest new construction activity, the slowdown in job growth, retail sales and other aspects of the economy has led to lower demand for commercial space and to declines in net absorption of space.  As a result, supply is outpacing demand.  Nationally, asking rents fell in the third quarter for office and retail space.  Rents were flat for industrial space and up slightly for apartments and vacancy rates increased for each of the major property types.

Not surprisingly, commercial property sales have also stalled.  On a dollar basis, commercial property sales through the first three quarters of 2008 were 67 percent lower than for the same period in 2007.  While part of the large percentage fall off can be attributed to the extraordinary volumes seen in the first half of 2007, sales volume in the third quarter was the lowest since 2003’s third quarter. 

Hand-in-hand with the slowdown in transactions is a surprising stability in reported cap rates.  Cap rates for commercial properties rose slightly in the third quarter, but not by the levels most anticipated.  A disinclination by owners to sell properties that are still generating income and meeting debt services is a likely reason why.  But prices have been coming down.  Among the major price indices for commercial properties, all show prices down from their peaks, although by varying degrees.  The S&P/GRA index shows prices down 2 percent from its peak, the Moody’s/REAL index is down 9 percent from its peak, and the NCREIF TBI index is down 12 percent from its peak. 

It’s important to note that while commercial real estate has been getting a great deal of attention related to the pricing pressure it is experiencing, the price declines seen so far are only a fraction of what’s been seen in other investments, including the prices of single-family homes, the Dow Jones Industrial Average or the price of crude oil.

MORTGAGE DEBT OUTSTANDING

In the third quarter of 2008, for the first time since the mid-1990s, commercial/multifamily mortgage debt outstanding declined meaning that the volume of new originations is not keeping pace with the rate at which mortgages are paying-off and paying down..  The level of decline was relatively modest at –0.1percent.  The government-sponsored enterprises and Ginnie Mae increased their holdings of multifamily mortgages by $14 billion and finance companies and life insurance companies each increased their holdings by $2 billion, but commercial banks and thrifts reduced their holdings of commercial/multifamily mortgages by $9 billion and the CMBS market decreased its holdings by $13 billion. 

At the same time, stress on commercial/multifamily mortgages has continued to rise from the historic lows of the last couple of years.  Delinquency rates remain low by historical standards, but the pressure – from the weakening economy and the continued credit crunch – is building.  30+ day delinquency rates on CMBS loans rose from 0.53 percent to 0.63 percent over the third quarter and 90+ day delinquency rates for commercial/multifamily mortgages held by banks and thrifts rose from 1.18 percent to 1.38 percent.  The rise is quite small when compared to what has been seen in single-family and construction loans.  In addition, the absolute levels, thus far, have remained well within expectations.  (Among more than 35,000 loans held by life insurance companies, only 36 were 60+ days delinquent at the end of the third quarter).  That said, the economic and credit market stress cannot help but be felt in commercial/multifamily mortgage performance.

“Even with the expected degradation of loan performance, the pricing of CMBS bonds continues to puzzle most observers,” added Woodwell. “Spreads on AAA CMBS rose to levels more than 12 times where they were just a year earlier.  In recent weeks they have regained some of that widening, but current spreads remain well wide even of the levels seen at the end of the third quarter.  No new CMBS were issued in the third quarter, and as loans continue to pay-down and pay-off, the overall level of CMBS outstanding continues to drop.  At the end of the quarter, $800 billion was outstanding, compared to $821 billion at the end of 2007.”

REAL ESTATE FINANCE MARKET

The slight decrease in holdings of commercial/multifamily mortgages belies the dramatic decrease in originations activity.  The slowdown in sales transactions and refinancing volume means that investors are not experiencing the same runoff – through pay-downs and pay-offs – that they were a year ago.  As a result, much less new product is required to maintain an investor’s level of holdings.  Even so, while mortgage debt outstanding shrank by just 0.1 percent in the third quarter, origination volumes were 53 percent lower than last year’s third quarter and 11 percent lower than the second quarter.  Originations for CMBS conduits, commercial banks and life insurance companies all fell over the year.  Multifamily originations for Fannie Mae and Freddie Mac increased.

To view the report, please visit: http://www.mortgagebankers.org/ResearchandForecasts/ProductsandSurveys/quarterlydatabook.htm

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The Mortgage Bankers Association (MBA) is the national association representing the real estate finance industry, an industry that employs more than 280,000 people in virtually every community in the country. Headquartered in Washington, D.C., the association works to ensure the continued strength of the nation's residential and commercial real estate markets; to expand homeownership and extend access to affordable housing to all Americans. MBA promotes fair and ethical lending practices and fosters professional excellence among real estate finance employees through a wide range of educational programs and a variety of publications. Its membership of over 2,200 companies includes all elements of real estate finance: mortgage companies, mortgage brokers, commercial banks, thrifts, Wall Street conduits, life insurance companies and others in the mortgage lending field. For additional information, visit MBA's Web site:  www.mortgagebankers.org.