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The other real estate shoe that dropped

Unlike in the last recession, retail is tanking, and it is taking the market for commercial property with it.

Sometimes, signs are open to interpretation. Empty storefronts and vacant offices do not always mean trouble.

But these days, things seem very clear: Commercial real estate in the Philadelphia region, and just about everywhere else, has taken a nasty hit from the economy. And the signs - For Rent, Space Available, For Sale - are abundant and widely distributed among the retail, office, multifamily-residential, and hotel segments of the market.

"Commercial real estate continues to lag and will do so for a period, further eroding values," said Steven A. Wechsler, president of the National Association of Real Estate Investment Trusts (REITs), whose members own and/or manage shopping malls, office buildings, and other properties nationwide.

REITs, which Wechsler said make up the first 10 percent "of the $6 trillion commercial iceberg," hit their peak on Feb. 7, 2007, and, by the time they had stopped declining on March 6 of this year had lost 75 percent of that value.

But, he noted, "REITs are leveraged, so that decline is greatly magnified."

Some parts of the country have been hit harder than others. Retail, which depends heavily on spending in the residential market, has faltered, and "the vacancy rate is following the unemployment rate," said Jamie Woodwell, an economist with the Mortgage Bankers Association in Washington.

By contrast, Woodwell said, the last recession, in 2001 after the dot.com bubble burst, "was mild, and retail spending continued."

Locally, the commercial sector has not suffered as badly as it has in other metropolitan areas. In Phoenix, for example, signs offering space appear every few yards along major thoroughfares.

In its local forecast for 2009, commercial real estate firm CB Richard Ellis Group Inc. maintained an upbeat outlook, even as the recession deepened nationally and unemployment here, as elsewhere, grew to levels not seen since the early 1980s.

That forecast was based on the same market fundamentals Mark Zandi of Moody's Economy.com points to as buffering the effects of the housing downturn here: a diverse economy not dominated by a single industry.

But the downturn's effect is quite obvious in multifamily housing. Empty lots with faded signs announce condo projects that will never be built: Marina Towers, the Chantry, Old City 205.

Though the level of multifamily mortgage debt outstanding has changed little in several quarters, the Mortgage Bankers Association's Woodwell said, "it should not come as a surprise that commercial and multifamily mortgage-delinquency rates are under pressure as well."

At the end of the first quarter, delinquency rates for many investor groups rose to levels higher than those seen during the 2001 recession, Woodwell said. Current trends are likely to push delinquency rates higher.

Multifamily rental properties are being affected by several forces. Demand is influenced by unemployment, foreclosures and fears of purchasing single-family houses or condos, said National Association of Home Builders economist Bernard Markstein.

"At the same time, the supply of multifamily rental units is up as new product [homes and condos] comes on the market and as older, unsold properties are offered as rentals," Markstein said.

Overall, observers and economists say, the commercial sector will be, like the housing market, slow to recover.

"As is characteristic of a turning point in the economy, the incoming indicators are a mixed bag, and it is getting harder . . . to beat expectations," said IHS Global Insight Inc. chief U.S. economist Nigel Gault.

"Up to now, indicators have mostly pointed to an economy contracting, but less sharply than before," Gault said. "As we move into the second half of the year, indicators should increasingly point to growth."

That is especially true in nonresidential-construction spending, which probably rose in the second quarter, he said. But the gains are narrowly based in oil refining and power generation, and are unsustainable.

"The trend for commercial construction such as retail developments, offices, and hotels remains downward," Gault said.

In its 2009 forecast, CB Richard Ellis reported that retail activity had decelerated, evident in the decreased leasing, sales, and construction of all major property types. Tighter capital markets were limiting retail expansion plans and slowing development in the region.

In the hotel segment, as many as one in five U.S. hotel loans may default through 2010 as the recession means companies are spending less on travel and perks, according to University of California economist Kenneth Rosen.

Office-vacancy rates are up in major cities, even as fewer offices are being built.

In the second quarter locally, the office market saw the direct vacancy rate increase to 13.6 percent, from 13.4 percent in the first quarter, GVA Smith Mack, of Wayne, reported Thursday. (Direct vacancy rates include empty space currently available, but not space that is on the market but currently occupied or under construction.)

Overall, rental rates dropped 21 cents in the second quarter to $22.52 a square foot, which reflects landlords' willingness to lower rates to maintain existing tenants as well as attract new creditworthy tenants, GVA Smith Mack reported.