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   Risks in the Commercial Real Estate Market

The fear factor is probably the biggest single risk going forward. As long as healthy companies and individuals are afraid to deploy their capital, the return to economic recovery will be dampened. Exaggerated and misinformed stories of doom and gloom have dominated the media which has further exasperated and extended the current market cycle.

Based on analysis of the Federal Reserves Flow of Funds it is estimated that business and consumers have stockpiled 70% of the gross domestic product (GDP). Once investors become confident that there will not be further significant declines in prices the stage is set for the commercial real estate market to revive.

Areas of housing busts will be slower to recover because of the number of overleveraged home owners and an over supply of commercial properties built to serve now struggling housing developments. Examples would be Las Vegas, Jacksonville, Phoenix, West Palm Beach, Tampa, Fort Lauderdale, Miami, Atlanta, and Sacramento

Housing plays a major role in consumer confidence. Currently there are over 9 million homes for sale out of a housing stock of 130 million making for a high vacancy factor and continued downward pressure on housing prices. It is estimated that by 2011 roughly half of the mortgage holders of single family homes will owe more than their homes are worth. Because of these factors housing prices are expected to decline another 10% to 15% in 2010 meaning the "bottom" for housing will not be reached until late 2010 or sometime in 2011.

The anticipated avalanche of foreclosed commercial properties will be avoided as long as the current policy of "extend and pretend" remains in place. The risk is that lenders will continue to be hesitant to loan and investors will remain on the sideline waiting for the dam to break.

The alternative to "extend and pretend" is to force lenders into a "foreclose and dispose" modality. Such a policy would succeed in clearing bank's books of questionable loans. The problem with this policy as practiced in the 1990s is that it will most likely lead to the closure of numerous additional lenders potentially costing the taxpayer hundreds of billions of additional dollars. The political and economic backlash could be significant making a change to "foreclose and dispose" policy less likely.

The social policies that created much of the current economic difficulties (lending to unqualified borrows who have little to no "skin in the game") are still being encouraged by the FHA in the housing market as it has become the subprime lender of choice. These policies, if not checked, are creating the prospective of additional government bailouts further burdening the taxpayer and the economy.

Borrowers with securitized debt are at higher risk of foreclosure because of the complexity of their loans making it difficult if not impossible to renegotiate and do successful workouts for their properties and loans.

If the economy fails to recover and job growth does not return the erosion in rents and demand for commercial property could return. In numerous markets the erosion of rents appears to be bottoming out and absorption rates are picking up. Click on Investor Prospective and Positive Market Factors for more information.

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