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Need to delever will be ‘undoing’ of many property owners

A combination of deteriorating fundamentals, lower property values and constrained capital markets will prove a “tall order” for many US investors, according to PREI. However, the firm says the speed of the current downturn could mark the start of ‘cautious optimism’ about US real estate.

A perfect storm of deteriorating fundamentals, lower property prices and a need to delever amid tight capital markets will prove to be the “undoing” of many US property investors, Prudential Real Estate Investors has warned.

The Parsippany, New Jersey-based investment firm said that while “cautious optimism” had replaced the “doom-and-gloom” sentiments of last year, the recapitalisation of the commercial real estate industry would be a “major issue for years” to come.

In its quarterly market report, PREI said though the industry could take hope from the fact that asset values were repricing much faster than in previous downturns.

During the 1990s, the firm said, the National Council of Real Estate Fiduciaries (NCREIF) property index took 24 quarters to reach bottom, with values falling 32 percent. As of the end of June though, the NCREIF index had declined 24.5 percent in just five quarters.

“The pace of the falling values will come as little comfort to investors who have exposure to the asset class, but the sooner asset values reach bottom, the sooner they can begin to position themselves to take advantage of opportunities that may arise as a result of the distress,” the US report said.

PREI added that “if history is any guide”, investors who “buy assets or originate debt at or near the bottom of the cycle will be rewarded”.

Reviewing US capital markets, PREI said commercial banks and life insurance companies had largely retreated from originating new loans, with life companies expected to write just $10.4 billion of mortgages in 2009 – the lowest level since 1992. Commercial banks have also reduced originations by 50 percent or more, PREI said, largely in part to rising delinquency rates in their existing portfolios.

As investors deal with constrained capital markets, fundamentals are deteriorating, with little, if any, improvement expected over the next 12 to 18 months.  “The overriding fact is that there can be no substantial recovery until the dismal employment situation turns around.”

With 6.5 million jobs lost since December 2007 and another 2 million more job losses expected in the next 10 months, PREI said “the downturn has already wiped out nine years’ worth of job growth”.