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IRVINE, CA-Residential mortgage foreclosures rose 55% during the first six months of this year, and the subprime lending problems causing those foreclosures have in turn created volatility in the commercial lending sector. The foreclosure figures appeared in a report issued Monday by locally RealtyTrac, and the impact of the subprime industry woes on the commercial lending markets appeared in a commentary from Jones Lang LaSalle.

RealtyTrac reported 925,986 foreclosure filings in the US during the first half of this year, up more than 55% from the first six months of 2006. Rick Sharga, RealtyTrac’s vice president of marketing, tells GlobeSt.com that the residential foreclosure picture “will get worse before it gets better,” primarily because a large number of risky adjustable loans are coming due this fall.

“With underwriting standards getting higher, people who might have wanted to refinance their way out of those loans won’t be able to do that,” Sharga says. He tells GlobeSt.com that whether the foreclosures will take any toll on the commercial real estate markets remains to be seen.

“What we’re looking at right now is a pretty weak residential market, compared to what seems to be a relatively healthy commercial market,” Sharga tells GlobeSt.com. “The only connection I can see, which is a little bit of a stretch, is that there are pockets of Southern California where the foreclosure issues have wiped out [mortgage-related] businesses, and with those kinds of companies going under, it might put some pressure on the office space market.”

The Jones Lang LaSalle outlook on the CMBS market, authored by JLL’s Bart Steinfeld and Jere Lucy, shares Sharga’s view that the commercial real estate fundamentals remain strong in the US. It points out that delinquency and foreclosure rates on US commercial mortgage loans “remain at historic lows.”

The JLL commentary, however, says that the “unrelenting flow of negative news” regarding the US housing market and subprime mortgages “has taken its toll on the US commercial mortgage market” in the form of rising spreads. “In contrast to the relative stability of AAA CMBS bond spreads over the last few months, AAA bonds have widened approximately 15 to 20 basis points this week,” Jones Lang LaSalle points out.

Some experts predict that spreads will widen further before volatility settles down, JLL adds. It explains that the cause of the volatility in the CMBS bond market is the “continuing fallout from the subprime residential mortgage market.”

Other factors connected with the subprime mortgage debacle include a weakening of demand from CDO buyers who represent an important segment of CMBS bond buyers. In addition, the CMBS market is still digesting “a backlog of aggressively underwritten loans originated prior to lenders’ tightening of credit underwriting standards,” JLL notes.

Citing the solid fundamentals in the commercial real estate markets, JLL emphasizes that “the underlying dynamic in spread widening and volatility in the CMBS market is the spillover of credit concern from the residential subprime mortgage market.” According to Sharga, the subprime market will continue to work out its problems for most of the remainder of this year, with the prospect of a return to more stability and a lower foreclosure rate possible some time next year.

“The whole lending industry is undergoing a fairly rigorous tightening of underwriting standards and a retrenchment of the subprime category, so you will see a weakness for a while,” Sharga says. “But once you get the risk profile normalized again, it will be a good market again.”

The 925,986 foreclosure filings that RealtyTrac reported included default notices, auction sale notices and bank repossessions on 573,397 properties nationwide. Nevada, Colorado and California posted the top foreclosure rates, with Nevada recording one foreclosure filing for every 40 households during the first half of 2007.

Colorado’s rate was one foreclosure filing for every 60 households and California’s was one for every 69 households. Other states with foreclosure rates among the top 10 included Michigan, Florida, Ohio, Georgia, Arizona, Connecticut and Indiana.

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