Analysts Grow Concerned about Prospects for CRE.

Heading into 2008, industry watchers are concerned about what impact a slowing economy might have on the commercial real estate sector.

In one sign of increased caution, Fitch Ratings is raising subordination levels on commercial mortgage-backed securities, based on the credit rating agency's view that commercial mortgage loan defaults are likely to rise.

The New York rating agency reports that for a "BBB" rating, an increase in enhancement levels of 10%-20% addresses the increased risk, while an "AAA" rated bond would require an additional subordination of 5%-10%.

The market is expecting higher commercial mortgage loan defaults, going by the spreads on the CMBX market indices (which are made up of CMBS deal tranches), the rating agency said.

However, Fitch does not expect defaults to rise as much as the level the indices appear to be anticipating. Susan Merrick, managing director and head of Fitch's CMBS group, noted, "Fitch expects loan defaults to rise given the current capital market environment, but not threefold." Robert Vrchota, a managing director in Fitch's CMBS group, said that the CMBX index is reflecting default rates that are three times historic default rates on CMBS. He believes this is because the index is also reflecting the fallout from an ongoing credit crunch.

The increase in Fitch's subordination levels is based on the rating agency's view that a slowing economy will impact commercial real estate performance. Also, the credit crunch is looking to be more extended than the rating agency expected, which could impact access to capital for commercial real estate borrowers.

Ms. Merrick expects that CMBS issuance for this year is likely to go down to a range of about $100 billion to $120 billion. According to statistics from the Commercial Mortgage Securities Association, 2007 CMBS issuance was at $223 billion. If commercial mortgage lenders don't get a chance to offload loans into the CMBS market, they are also likely to cut down on new lending activity. Loans with variable interest rates are finding fewer takers, according to Ms. Merrick.