Last week's GlobeSt.com Quick Poll asked readers if thebailout is already improving CRE's outlook or if it will take timeto help the industry. Michael Gottilla, Colliers Houston &Co.'s director of research in Teaneck, talks to GlobeSt.com aboutwhy the bailout was necessary but may not halt falling marketprices.

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The commercial real estate market existed in a parallel universefor the first phase of the credit crisis. Prices kept rising evenafter Bear Stearns collapsed. Commercial real estate prices behavedas if they were impervious to the storm battering the globaleconomy. Things had been so good for so long that there certainlyappeared to be a great deal of willful neglect on the part ofmarket participants regarding the obvious linkage betweencommercial real estate and the economy. In September, when LehmanBrothers went bankrupt and AIG was forced to turn to the governmentin order to survive, the perception of invincibility wasshattered.

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Those events caused a cessation in lending that was a wake upcall for the commercial real estate industry. Commercial realestate market participants could no longer hit the snooze button.Since that time most people in the commercial real estate markethave done their best to conceal their apprehension. Regardless,they have come to the realization that they exist in the sameuniverse as everyone else. The bailout has done very little to makethat epiphany less worrisome.

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The appreciation in prices that has occurred was chiefly drivenby cap rate compression and not by gains in net income. The steadyperformance of commercial real estate, since the rebound from theS&L crisis, lowered risk premiums unreasonably. That fact,combined with the extreme proliferation of leverage, createdunrealistic prices for properties. The bailout, in concert with allthe other efforts and initiatives of the government, will makemoney available again. However, market fundamentals will determineprices. Cap rates have been squeezed to unjustifiable levels. Anadjustment from the 6% cap rate that had prevailed to an 8% caprate, a number much more in line with traditional valuations, alonewould represent a 25% decline in market prices. That adjustmentwill be made more severe when net incomes begin to reflect thenegative impact of the recession.

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The bailout was necessary and will lead to new loans forcommercial real estate. However, it will not arrest the decline inmarket prices brought on by the increased risk premium that bankswill demand when lending on properties. That increased risk premiumis reflected in higher cap rates which translate into lower prices.The price adjustment will begin as balloon payments come due onover leveraged properties, which there are no shortage of at thispoint.

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