Commercial Property Goes South

We highlight Avalon Bay (AVB - Analyst Report) and Regency Centers (REG - Analyst Report).

Commercial Real Estate Values Go South

The Moodys/Real National All Property Index dropped 0.6% in February compared to January of this year. In addition, the index is about 21% lower than a year ago, and about 18% lower than two years ago.

This index tracks the change in sale prices for different property types based on sales of the same assets over time. The index is a good measure of where commercial property prices are going. The largest year over year price drop (February 2009 vs. February 2008) was reported in industrial, 13.9% decrease; followed by apartments, 13.6% decrease; office, 13.5% decrease; and retail, 8.5% decrease. Also, according to the report, sales volumes in February were down 67% from the year ago period and most of the sales(90%) were for assets under $15 million.

Some conclusions that can be inferred from this data:

Commercial property prices continue to fall, which could put many owners who bought at the height of the boom underwater on their mortgages.
There will be a continued rise in loan defaults -- owners who have lostequity are more likely to walk away from their properties or sell at heavily discounted prices.
Lower dollar deals are getting done vs. large transactions; financingfor smaller properties is easier, which should make price drops in this class >$15 million, less severe.
With financing still scarce and fundamentals going south, expect pricesto continue falling. Expect fewer transactions as owners are reluctant to take losses.
Wait for more price drops before buying commercial real estate; whenbuying, focus on the larger, higher growth markets. According to the Moody's report, y/y price drops were significantly lower in the top 10 MSAs for all major property types (apartments, industrial, office, and retail).
We still favor REITs with assets in supply constrained, urban markets,where values and rents will continue to hold up better. A couple of companies we have buys on are Avalon Bay (AVB - Analyst Report) for apartments and Regency Centers (REG - Analyst Report), a strip mall owner. Despite declining property values across these sectors, both companies are still trading below the value of their assets.