The most common question I've been asked lately is: "So, what's happening

to real estate values?" One may point out that an office building in New York City recently sold for a price higher than expected, after vigorous bidding among several potential buyers. Others suggest that the increase in commercial mortgage delinquencies is alarmingly high and growing, presaging a dire fall in prices because the extend-and-pretend philosophy of many banks will not survive the onslaught of loan defaults.

The answer, as so often the case, is: "It depends:' It depends on the type of property, its location, the status of its financing (e.g., loan maturity, current debt service coverage ratio or loan to value), the owner's financial circumstances, property-specific facts such as the financial health of major tenants, and the type of buyer likely to be interested in acquiring the asset. To simplify the analysis process, I've created a continuum along which property types seem likely to fall these days.

At the top end of the spectrum is a handful of class A office properties. They are fully leased to credit-worthy tenants, located in desirable cities such as New York City, Washington, DC and San Francisco, and have sold at relatively high prices and low cap rates. Interestingly, these prices were achieved in spite of the dearth of sales and, in a number of these markets, the underlying fundamentals such as rents and vacancies are either continuing to worsen or maintaining unfavorable levels. Buyers are typically international or private high-net worth investors.

Money center banks are lending on these properties, albeit with underwriting standards more stringent than those of the bubble period.

Multifamily, in the next tier, is a very different property type. In many parts of the country, good-quality, rent-stabilized residential properties are selling well, particularly to local investors

who receive loans from community or regional banks. Cap rates are somewhat higher than they were at the peak of the market, but not so high that the sales qualify as distressed. The relatively low price of these assets means that a large pool of investors sees them as affordable and may consider them a better way to preserve and grow capital than buying stocks on Wall Street. A few regions, however, are not participating in this trend, including areas with economies that are severely depressed, such as Detroit, as well as those that are still digging out from the overbuilding frenzy, such as Phoenix or Las Vegas.

The properties and transactions in the middle of the continuum vary widely as to type but fall into the category of assets affected by the policy of extend and pretend that is dominating the real estate industry. So many investors and lenders have been busy restructuring and refinancing existing assets rather than acquiring and financing new properties that the sheer volume of these transactions has become a distraction from the normal business of buying and selling. This means that the markets for property types in many locations are effectively treading water and not making any real progress. These markets are bumping along the bottom.

Finally, the tail end of the continuum is marked by a relatively small number of distressed sales. A distressed sale is caused by a combination of events, including a lender's unwillingness to renew a mature loan that is likely to default. This usually happens when the loan is not only larger than the value of the property but also has cash flow too low to support debt service (even with interest rates at historic lows) and a borrower who is unwilling or unable to make up the difference. Distressed properties are either foreclosed on by the lender or sold by the owner, usually with the lender's agreement, at depressed prices. Another, sometimes milder, form of distress is the sale by an owner of a property so that the mortgage loan can be paid off. The resulting decrease in debt may allow the owner to remain in compliance with or return to compliance with various debt-level covenants. Despite predictions, there has not yet been a flood of transactions. All these stages on the continuum share certain common elements. Most of the sales are of single properties, not portfolios, and many of the buyers are new to the market. The lack of sales volume has also made it difficult for valuation professionals to arrive at convincing market value estimates. The result of this, ironically, is that there are relatively few sales at any point along the continuum.

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