Here in New York, we are seeing offerings of primarily mezzanineloans on investment grade properties. The interest reserves thatlending institutions had required of purchasers have not as yetengendered a wave of foreclosures and properties being taken backby the lending institutions as REO in their own portfolios, butthis may once again occur. Banks may not be as harsh as they werebefore, but eventually, they will have to protect their bottomlines. The question is whether the FDIC will require the lendinginstitutions to protect their balance sheets by writing down thevalue of these mortgages.

Residential and office properties have maintained their basicvalues, with some increases in rental rates for the most part,especially in New York. There has been little vacancy increasesespecially in apartment buildings subject to rent regulatoryguidelines and even with increases in operating expenses, theseproperties still generate sufficient income. Office properties willprobably show an increase in vacancies because of the failures ofLehman Brothers, Bear Stearns and others and the subletting ofexisting spaces. However, there still has been no major drop in therental rates in class A office buildings. The sector that will bemost affected is the hospitality sector, where capital for newconstruction has virtually dried up.

If these properties have maintained their intrinsic values, howdid the current crisis arise? The last few years have producedprices which we have not encountered before. Real estate normallyadjusts in 10-year cycles and investors had been anticipating acorrection which did not materialize. Prices kept escalating withcap rates as low as 3%. Investors were purchasing on the futurevalue as opposed to the present value and the lending institutionssupported this, with loans up to 90% of these projected values.Many investors purchased the properties with an eye to holding themfor a certain term and then remarketing the properties at asubstantial profit once the rent roll was increased to what theyhad calculated to be its future value. A cardinal rule of realestate is that you make your profit at the time of purchase, not atthe time of anticipated sale.