"We believe that valuations will rebound off the bottom and settle in for the longer term at levels 30%-40% below the market top as liquidity and investors return to the sector and property cash flows begin to recover," says Nick Levidy, managing director of Moody's, in a release. Titled "Moody's Outlook for US Commercial Real Estate and CMBS," the report predicts a slow rebound on cash flow, hand-in-hand with a growing refinancing risk on CMBS as maturities on the bonds draw nearer.

Tying in with the approaching maturation of CMBS--and what Moody's and others predict will be a steady increase in delinquencies on the securities--the Moody's report says there will be further downgrades of up to three notches for many subordinate tranches of conduit/fusion bonds issued between 2006 and 2008. However, ratings on the most senior bonds will likely stay where they are, the report says.

The report presents both base-case and stress scenarios in analyzing expected losses and ratings for conduit/fusion CMBS. Currently, average realized losses for CMBS deals issued between 2003 and '08 are currently less than 0.2%, but Moody's says that under its base case, the numbers will range from just over 2% to just under 6%, "depending on the vintage." Under the stress scenario, bonds below the original mezzanine AAA class in 2006-2008 vintage deals would be downgraded to very low speculative grade or impairment.

Last week, Moody's said its CMBS Delinquency Tracker showed the aggregate rate of delinquencies among US CMBS rose to 4.01% as of Oct. 31. The DQT, which rose 37 basis points from September's 3.64% rate, was 0.60% a year ago and 0.22% at the low point measured in July 2007.

"The October increase is in-line with the steady rise in the delinquency rate over the past five months," says Levidy. "We anticipate the rate to increase further." Along similar lines, Fitch Ratings reported on Monday that Fitch-rated CMBS loans in special servicing rose another 7.4% last month.

Levidy says in the release accompanying this week's report that cash flows on properties that have short-term lease structures, such as hotels and multifamily, "will likely hit bottom in 2010 or early 2011. The bottom for office, retail and industrial properties will take longer to form."

In the case of office, demand will continue declining as unemployment continues to rise, a trend that's expected to carry forth an increase into next year. "We expect office market fundamentals to bottom out in '11, once employment rates begin to rise and tenants determine their ultimate space needs," according to Moody's. Meanwhile, sales activity and valuations in the sector will increase as financing becomes more readily available and capital comes off the sidelines.

For retail, weak consumer spending, increasing unemployment rates and "stagnant" wage growth remain drags on demand. The ratings agency says it doesn't expect domestic consumers to return to pre-recession spending levels until employment and wage growth resumes and enough time passes for consumer confidence to rebound. "This may not occur until '11 or later."

On the other hand, Moody's notes that there have been fewer store closings this year than had been anticipated, due in large measure to retailers renegotiating leases and improving their ability to operate in underperforming locations. "Lease restructurings reduce cash flow available to service mortgage debt, but keep retail centers vibrant by reducing vacant storefronts," Moody's says.

The ratings agency says it expects vacancy rates in multifamily markets to peak within the next few months. However, rental rate growth will stall until '11 as employment and household formation return to positive growth from the recession sometime next year. Moody's also cites government programs to encourage home ownership, the recent steep decline in single-family home prices and the significant number of shadow rentals as drags on the supply-and-demand relationship in the sector.

With US RevPAR down 18% year-over-year and headed toward 2004-2005 levels, the lodging industry outlook remains negative on the whole, says Moody's. "There is significant performance differentiation in the hotel sector by location, price and destination type," according to the report.

Instant Insights /

Values Face a Long, Slow Road Back

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