Sacramento's economy will lag the nation into recovery, as California state budget shortfalls and a soft housing market hinder its progress. Employment growth will resume this year, though, a welcome turnaround after losing a combined 86,000 jobs in 2008 and 2009. During 2010, local Employment will rise by 0.7% with the addition of 5,300 jobs, 30 basis points shy of the US job growth forecast. Despite this small step in the right direction, the unemployment rate will remain well above average in the near term. As of mid-2010, local unemployment had fallen from its peak in the first quarter, but at 12%, it remained approximately 200 basis points above the US figure.

In addition to elevated joblessness, Sacramento continues to face challenges stemming from the housing crash, with the metro area registering one of the higher foreclosure rates in the nation. Local home prices have declined more than 50% from peak levels of late 2005 and could slip farther if government programs aimed at curtailing foreclosures fall short, resulting in more deeply discounted bank-owned inventory and hampering the onset of a sustainable growth cycle.

While far-reaching suburban submarkets have been more severely affected by the housing downturn and recession, no area or property sector has been completely immune to deteriorating commercial real estate fundamentals or rising distress. As of early July, approximately $1. 7 billion of local commercial real estate was considered troubled, placing Sacramento in the mid-tier when scaled to size and compared to other markets nationwide. Lodging properties account for the largest share of distressed dollar volume in the metro area, totaling $490 million and comprising 29% of the total.

This segment also posts the highest CMBS delinquency rate of nearly 30%. Extended Stay America properties dominate the list of troubled assets in this segment, but this brand has encountered debt problems nationally, not just at the local level.

Following the hospitality sector, retail accounts for the most distress, with roughly 20% of the total. Outlying retail submarkets, such as Citrus Heights/Orangevale/Natomas and Rancho Cordoval US Route SOl Folsom, where developers followed rooftops, have been particularly hard hit, with vacancy rates ranging from 12.5% to 15.5%, compared to the mid- 11 % range metro-wide. The presence of significant newer shopping center supply and severe housing market weakness in these areas will continue to weigh on fundamentals, keeping pressure on shopping-center vacancy rates and pushing more property owners into distressed situations. In 2009, metro-wide shopping-center sales nearly stalled, but a greater number of properties should trade this year as more owners adjust their price expectations to meet market realities. This should, in turn, help with property price discovery and attract more buyers to the local retail market as the year progresses. Investors with long-term horizons may consider shopping centers in outlying areas, which will likely require sizable price discounting to clear the market. By acquiring these properties at today's comparatively low prices, new owners should have the advantage of being able to lease space at highly competitive rates when a turnaround in retailer demand eventually occurs.

Job losses and increased competition from shadow-rental stock have driven apartment vacancy up 200 basis points since the onset of the recession to 7.1 %. This is the highest rate on record since at least 1980 and has encouraged owners to cut rents and offer significant concessions, contributing to more distressed situations. Despite weak apartment fundamentals, investment activity has picked up in recent months, a trend expected to persist as buyers acquire distressed and REO assets at reduced prices. Year to date, 40% of all apartment properties sold have closed at less than $50,000 per unit, compared to 14% in 2009 and just 6% in both 2007 and 2008. Most of the delinquent loans in the Sacramento market are backed by older properties ofless than 100 units, with the average age around 30 years, also a contributing factor to the below-average pricing

for distressed apartment deals. Nonetheless, the disposition of troubled assets marks a crucial step in establishing a pricing floor and should ultimately give way to stronger buyer demand for stabilized properties.

Relatively few office properties have completed foreclosure, but more will likely emerge in the coming months as fundamentals weaken further. The metro-wide vacancy rate currently hovers around 21 %, and approximately 10% of the CMBS office debt outstanding has a debt service-coverage ratio of less than 1.0x, suggesting more trouble ahead. While banks remain hesitant to reclaim properties in the current climate, opting instead for loan modifications, more owners have brought troubled properties to market. During the past year, distressed office building sales accounted for 15% of all transactions in the property sector, up from just 5% in the previous 12-month period, suggesting more banks and distressed owners have adjusted pricing to clear the market. The Roseville/ Rocklin sub market currently registers the metro's highest office vacancy rate of more than 30% and contains an outsized share of distressed assets. Since 2000, developers have delivered 4.1 million square feet of new office to the submarket, one-third of the metro- wide total. In addition to above-average vacancy, tenants have signed leases at rents reminiscent of the last recession, making it difficult for owners to cover debt-service obligations and increasing the likelihood of more distress ahead. Opportunistic investors will circle the area for discounted properties, though fundamentals will lag the metro in a recovery due to the high volume of vacant space that needs to be absorbed before rents stabilize.

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