Imagine a world where properties trade in all-cash deals. That certainly would simplify things, especially in light of the significant shakeout in today’s lending market. Unfortunately, reality dictates that briefcases full of money are only exchanged in the movies. Real-life buyers of commercial real estate need financing, and they already are feeling the ripple effect of the sub-prime mortgage crisis.

The question is, will those ripples build into waves with the potential to overturn the office and industrial sectors? So far, evidence points to the affirmative. Commercial investors are starting to pay a steep penalty for the collapse of the residential sector. We are seeing the beginnings of a negative trend on pricing for larger transactions because the CMBS market is functionally frozen. Lenders are tightening their standards and lowering loan-to-value ratios, which translates to lower sums that borrowers can use to finance transactions.

But, according to a recent IOREBA member survey, heavy deal volume in small and mid-size transactions continues, with buyers outnumbering sellers. However, as these buyers become unable to stretch to make aggressive offers, sellers looking to dispose of assets of all sizes may need to accept less. With less capital available on the marketplace, both buyers and sellers will face some significant headwinds going into 2008.

While there are storm clouds on the horizon with respect to the economy as a whole, the fact remains that the present market for commercial properties is fundamentally strong. In fact, the best time for owners to sell might be right now. We have seen cap rates compress to levels that were unimaginable only five years ago, so properties purchased recently can still leave sellers with a substantial capital gain.

Even though interest rates and spreads have risen in the past few months, they remain near record low, which means that buyers, especially ones that intend to occupy the building themselves, are out there. For them, it is more efficient to own a property rather than lease. Consequently, prices remain at or near the top of the market.

Buyers of investment properties are in a trickier position. The days of easy loans with little-risk premiums priced into spreads are over. The conduit loans have temporarily gone away because the number of buyers of CMBS paper has declined. At the same time, insurance companies and other financial institutions that hold the loans on their balance sheets remain competitive and have filled much of that void. The commercial mortgage market already is beginning to stabilize, and the CMBS market should recover in about six to nine months. However, the underwriting guidelines will remain conservative for the foreseeable future.

Creative investors and brokers will find that out of this turmoil are deals to be made. REITS and investors that can put their own capital at risk will benefit greatly from their lack of dependence on bank loans—and may actually do as well, if not better than, in a more stable market.

With patience, buyers may find that great deals will come to them. In one recent case, a winning bidder on a property sale was unable to close the deal because their financing became unavailable. In the end, another, initially outbid developer was able to move ahead with the purchase at a price below their original bid. Several months ago, the seller would have considered the price too low.

Additionally, some developers and high-risk investors have used high levels of exotic, short-term financing and little of their own capital for acquisitions that otherwise would not make sense. With these loans coming due in the near future, and lenders reluctant to lend as aggressively, high-leverage buyers will no longer be able to compete for properties and development opportunities. In some cases, they may be forced to sell properties in order to satisfy debt obligations.

Looking ahead, the Federal Reserve probably will not—and should not—convince lenders to loosen their standards. Even as interest rates go down and more liquidity is added, lenders will be reeling from the continued string of delinquencies, write-downs and foreclosures that caused the sub-prime collapse.

In August, the reduction in the discount rate added much-needed liquidity to the credit markets. However, this move was only a patch that allowed lenders and borrowers to maintain short-term credit facilities. The actual cut of the Fed Funds Rate in September helped push rates down, but only marginally, and long-term rates actually rose the day of the Fed easing. The decline in short-term rates has caused concern among investors about the possibility of long-term inflation and created nervousness among foreign investors over the weakening dollar.

The net effect is that we are living in volatile times, and there are big swings in the market almost every day. Practically speaking, as rates decline, spreads seem to increase by an almost equal amount. The net effect is that commercial mortgage rates seem to go up with market, but not down. It is our hope that in the coming months the market stabilizes and lenders are able to maintain the prices that they quote on deals and that transactions can be completed.

Looking forward, the New York metro area will continue to outperform most of the nation. We maintain an advantage in that demand for office and industrial space in the region is high and will remain that way for the long-term, despite tighter lending standards. Strong demand, limited supply and premium pricing will help to insulate this market somewhat from the current financing situation. Over the long term, owners cannot go wrong with properties in this area, especially in the Northern New Jersey and Manhattan markets.

The views expressed here are those of the author and not of Real Estate Media or its publications.

Hal Messer is associate vice president of NAI James E. Hanson, Hackensack, and president of the Industrial and Office Real Estate Brokers Association of the New York Metropolitan Area (IOREBA).

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