Trepp LLC released a report in March that suggested loan losses were continuing to mount this was due in large part to new appraisals on properties transferred to loan servicers. The optimism experienced during the CMBS boom has been replaced by more realism as values are continuing to decline in many markets.

The Westin O'Hare Hotel in Chicago, for example, was originally valued at $131 million, but the most recent appraisal came in at $33.9 million, a decline of more than 74%.

Yet lodging is not the only sector seeing massive value declines. Just look at the Tallahassee Mall in Florida, which posted more than a 79% drop in value. The office sector is also suffering. New York City's 119 West 40th St., for instance, experienced a decline of more than 52%.

Trepps report showed that hotels have been hardest hit, with delinquency rates north of 15% through February. The research firm is forecasting a tsunami in the office market as owners continue to struggle with decreasing rents, increased concessions and declining occupancy. The conclusions were bleak, with most estimates pinning 2010 as the year we start to hit bottom.

With the Federal Reserve, Federal Deposit Insurance Corp. and major lenders working hard to restructure loans rather than foreclose, the availability of distressed assets seems low. Where properties are available, they typically suffer from some fundamental issues that likely resulted in the distress. Developments that were stopped before completion or had yet to achieve stabilized occupancy before the economic downturn are two types that come to mind.

At the Akerman Real Estate Summit held in Miami recently, participants were polled about the issues facing the real estate industry. More than 79% of respondents said the top concern was availability of credit and refinancing challenges. The next biggest issue, with 44%, was the inventory of distressed real estate held by lenders and its corresponding downward pressure on values. This is clearly more of a residential issue today, but it could foreshadow the commercial real estate markets as well.

There is some evidence that the tide is beginning to turn. Receivers are putting assets on the market, and the volume of transactions is picking up. So far, most of the properties being traded in the distressed arena are smaller retail assets, many of which are single-tenant or smaller strip centers valued under $10 million, according to reports from Real Capital Analytics and CB Richard Ellis.

Goldman Sachs is estimating that 7% of commercial mortgages will eventually become toxic. This doesn't sound insurmountable, but when you consider that the banks have booked losses of only 2.5% of such loans so far, it's clear that the future is murky at best Lenders are working very hard at restructuring existing loans, hoping to avoid toxic assets and the eventual hit to their reserves. But with an increasing number of loans coming due over the next couple of years, without major shifts in the economy and confidence, lenders may be forced to accept reality. If this happens, the market could be flooded with distressed assets and opportunities for a positive relationship between risk and reward may begin to appear. Investors and appraisers need to keep a close eye on the markets. There could be big swings coming in the availability of distressed real estate, and once the levy created by restructuring is breached, the flood of toxic assets could have devastating impacts on property values.

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Is the Worst of the Cycle Still Far Ahead of Us?

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