The slow recovery in the commercial mortgage market in the second half of 2011 will persist throughout 2012, with recapitalization remaining the market's biggest challenge.
Though the market slowed over the final six months of last year, commercial real estate sales activity "still grew nicely", analysts at Keefe, Bruyette & Woods said. CRE sales activity grew 55% in the second half 2011 from the year earlier.
"We believe that the biggest challenge in the market over the next several years is recapitalization, which will need to occur as underwater mortgages hit maturity," the analysts said.
They expect a more modest pace of growth in 2012 versus 2011, due partially to economic concerns and difficulty in comparable valuations. "We expect class A properties to continue to drive property sales, so the divergence between class A and distressed prices is likely to persist."
Between the peak in October 2007 and September 2011 — KBW's most recent data point — commercial property prices declined 41% to levels not seen since late 2002.
Forward Management said the CRE market bottomed out and is poised for growth, barring an unforeseen crisis or a decline in employment gains. Commercial real estate fundamentals are outperforming residential real estate, and real estate investment trusts could attract more investors in 2012, according to the investment advisory firm.
Distressed properties continue to weigh on the market as a whole.
According to Moody’s (MCO), distressed sales accounted for nearly 26% of all commercial transactions in September, the 20th straight month of more than 20% of total volume coming from distressed sales.
KBW analysts note that these sales will hang over the commercial market for several years, given a lack of significant demand for these properties.
Commercial mortgage debt grew rapidly from 2002 to 2007, hitting a annual growth peak in 2005 of 15%. However, this debt began to contract in 2009 and continued to decline through the first nine months of 2011. In the third quarter, commercial mortgage debt outstanding declined 4.5% from a year earlier with a 1% drop from the second quarter.
"We expect continued modest declines through 2012, primarily driven by write downs," KBW analysts said.