The perfect storm rippling over to real estate.(FINANCIAL VIEWS)(Essay)

Commentary

The first haft of 2008 has seen erosion in economic fundamentals. While some argue that the economy still is not in a recession, consumers and businesses and government budgets are all feeling the pressure of a contraction. Indeed, there is little positive news to suggest a near-term turnaround in economic fundamentals. Rather than debate whether there is a recession, attention is more properly focused on how deep the contraction will be and how long it will last.

Many of those who were in the "it-will-be-fine-by-2009" camp have tempered their predictions and are now expecting further erosion in market fundamentals and a delayed recovery. While some are more optimistic, the general consensus among emerging economic signals suggests the economy is in for a difficult period.

Given the financial stress many households are facing, the debates on the economy and what to do about the housing crisis, high and sticky gasoline prices, and the rising costs of food and other essentials are likely to catch the attention of voters. As election campaigns get into full swing, the economy is likely to move to center stage. Debates will occur on the national stage, as well as on many local stages as jurisdictions struggle with declining revenue streams. Unfortunately, there are no easy solutions as the economy continues to wind down.

On the real estate front, the housing market certainly has more problems in front of it as the sector contracts to find the bottom of the inflection point. The commercial real estate market is faring somewhat better, although tightened credit, weakening employment, rising costs, and rekindled interest in risk taking is forcing many on the defensive.

Clearly, the heyday of the housing and commercial market is behind us, with many challenges ahead. The positive news is the commercial market has been able to avoid a major collapse due to the absence of industry-wide overbuilding, voluntary curtailment of new construction, and continued appetite for product-albeit more selective-among institutional investors. However, the commercial sector will not escape the economic downturn unscathed. In particular, market values will face downward pressure as capitalization rates rise to reflect higher risk premiums and a return to longer-term averages. In addition, investors facing refinancing of bullet (balloon) loans and buyers dependent on new financing will face added scrutiny. In addition to tighter underwriting standards, many borrowers will be forced to accept recourse loans, turning back the pages to the times where lenders originated loans for their portfolios rather than for securitized offerings.

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