Magazine article Mortgage Banking

Subprime Mortgage Decline Will Impact Commercial Real Estate

Magazine article Mortgage Banking

Subprime Mortgage Decline Will Impact Commercial Real Estate

Article excerpt

Look for the current decline in the housing market and the deteriorating subprime mortgage market in particular to impact the commercial real estate sector and the overall economy, according to a report by Boston-based Property & Portfolio Research Inc. (PPR).

The PPR report, The Deteriorating Subprime Mortgage Market: Impact on the Economy and Commercial Real Estate, noted that the drag from the weakening U.S. housing market has impacted economic growth as residential investment sank 19 percent in the fourth quarter of 2006, shaving about a point off of gross domestic product (GDP) growth, which was lackluster at 2.2 percent, said PPR.

However, the decline in residential investment was solely a byproduct of affordability issues, leading to slowing home sales and ultimately deterring new construction.

"Any prolonged weakness in the housing market is not good news for economic growth. It will certainly curb future increases in consumer spending, which has recently accounted for about 70 percent of GDP, and force the U.S. to rely on business investment to keep the economy expanding," noted the PPR report. "The bad news is that we expect the weakness in consumer spending to continue in the near term."

The downward drag of falling housing prices on land values is feeding into commercial real estate values in some metro areas. PPR noted that drivers in the run-up of commercial real estate values include higher land and construction costs, partly due to the increased appetite for housing.

"It was not unheard of for industrial developers to realize a larger return on their land holdings by selling to residential builders than by building new warehouses. However, the pressure on these costs is now being released," said PPR. "Areas suffering the most material drop in home prices will also experience declining land prices and, ultimately, lower replacement costs."

In the retail sector, expect upward-trending vacancies to curb rent and income growth. At the same time, a more challenging retail environment will likely cause investors to demand wider risk premiums, and the upward pressure on cap rates will be compounded by any increase in Treasury rates, according to PPR.

The macro trends may disguise some of the underlying currents in the retail market. The weakness in the housing market is generally confined to lower-income households. …

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