Current Environment of Commercial Real Estate (CRE) By: Dan McDonald Date: 8/13/09 Market fundamentals continue to weaken for all commercial real estate (CRE) asset classes, with increased vacancy levels and decreases in rental rates.  The capital markets continue to struggle, with a slowdown in investment sales and purchasers remaining on the sidelines.  It is expected that demand will remain weak as long as companies continue to reduce expenses and shed employees.  The story in capital markets is the steady increase in troubled commercial assets. Distressed assets continued to increase in February 2009 to $49.2 billion, comprising 2,293 properties, with $5.7 billion of troubled assets that fell into default, foreclosure or bankruptcy, signaling possibly more trouble on the horizon. The ratio of offerings to closings remains high at five to one, resulting in further downward pressure in prices.  As a result, cap rates will likely continue to increase.  Cap rates for office alone are up 25 to 50 basis points since December overall.  The increases in cap rates have moved the fastest and highest in the secondary and tertiary markets.  The biggest challenge for purchasers and sellers is how to determine value in a falling market – whether based on cap rate, yields, borrowing cost or the expected disposition price in three to five years, depending on the purchaser’s objectives. The national office vacancy rate increased by 80 basis points from 14.7% at year-end 2008 to 15.5% in the first quarter of 2009.  The decline corresponds to a 25 million square foot decline in net absorption. Job losses continued to reduce the demand for office space nationwide.  The overall vacancy rate continued to climb, with the national suburban office vacancy rate increasing by 90 basis points to 17.1% overall, and the downtown vacancy rate increased by 70 basis points to 12.4% in the first quarter. The national U.S. industrial availability rate increased by 100 basis points from year-end 2008 to 11.5% in the first quarter of 2009, due to falling demand and few new completions.  As a result, net absorption fell to a negative 36 million square feet.  Among the top ten industrial markets, the biggest increases in availability were in Atlanta, which rose 470 basis points to 16.5%.  Demand for U.S. rental apartments remained weak in the first quarter 2009, amid sharp job losses and a glut of vacant single-family homes and condominiums for sale or rent.  The good news is the multi-housing completions are tapering off, falling to an annualized pace of 242,000 units, 50,000 below year-ago levels.  Apartment rents and revenues will still be negatively affected by rising unemployment and vacancy rates in the near term.  Indeed, it will take further major declines in new supply before the market can stabilize and turn positive.  The hotel sector, perhaps the hardest hit in commercial real estate, is struggling with significant decreases in demand and an onslaught of new supply, resulting in lower occupancies and a loss of pricing power.  Revenues per available room have declined approximately 18% to date, with some segments and geographies experiencing declines in excess of 25%.  Hotel sector cash flows have taken a significant hit, given highly leveraged operating structures.  U.S. transactions activity was down in excess of 80% for 2008 relative to 2007.