Wednesday, June 16, 2010

More Gloom: Commercial Property to Stay 40% From Peak, Pimco Says

Bloomberg News

June 16 (Bloomberg) -- U.S. commercial property values are rebounding slowly and may remain as much as 40 percent below their 2007 peak levels, Pacific Investment Management Co. said.

More than $500 billion of real estate will hit the market as lenders dispose of assets or restructure debt on properties where valuations have dropped below loan levels, keeping “general” prices down for three to five years, Newport Beach, California-based Pimco, which runs the world’s biggest bond fund, said on its website.

“Capital is clearly returning to commercial real estate, helping to stem the value decline in the sector,” Pimco said in a report based on research in 10 cities. “Optimism should be tempered, because national price indices are misleading when transactions are limited and fail to reflect the significant uncertainty around property valuations.”

High unemployment, potential re-regulation and an increased savings rate are among factors that will “lengthen the deleveraging process and suppress a recovery,” Pimco said in the report dated June 2010 and led by John Murray, commercial real estate portfolio manager.

Competitive bidding for “lower-risk trophy assets” in cities such as New York and Washington have led real estate investment trusts and private equity funds to search for acquisitions “even in challenged markets,” Pimco said. Capitalization rates declined to 2006 and 2007 levels as non-U.S. buyers also sought property.

The capitalization rate is a measure of real estate returns derived from net operating income divided by property value.

‘Deleveraging Cycle’

As regional U.S. banks are forced to recognize losses on construction loan portfolios, “the deleveraging cycle will take far longer to play out” than in previous real estate cycles, making a V-shaped recovery unlikely, the report said.

“Many assets may not return to their peak 2007 values until the 2020s,” according to Pimco.

Investors will find “attractive” real estate opportunities in the loan portfolios of troubled banks, large- loan restructurings and subordinate positions of CMBS tranches, Pimco said.

“Extreme discipline in assessing both the asset level and macroeconomic risks will be critical to making the right investment decisions,” the report said.

To contact the reporter on this story: Dan Levy in San Francisco at dlevy13@bloomberg.net .