The deep freeze in the property sales market is likely to thaw in 2009. Declining real estate fundamentals are pressuring sellers while pent-up demand to move capital is forcing vulture fund managers to act.

The credit crunch removed high-leverage buyers from the market in 2007. In their absence, equity investors have pressed for higher cap rates to justify the risk of low-leverage deals while owners have largely held out for higher prices.

The impasse is evidenced by a drop in transaction volume. Just $113.8 billion in commercial assets across property types traded in the United States in the first three quarters of this year, down 71% from the volume notched a year ago, reports Real Capital Analytics.

Yet a second influence on pricing — softening fundamentals — is taking hold, says Jamie Woodwell, vice president of commercial real estate research at the Mortgage Bankers Association. The shrinking economy will impede rent growth, and in many cases result in higher vacancies and lower net operating incomes on commercial assets, eroding sellers' justification for high asking prices.

“The weakening economy is having an impact on businesses throughout the U.S., and is spilling over to commercial real estate as businesses pause before signing leases, or retail sales drop, or household formation slows down,” Woodwell says.

The credit crunch has triggered a re-pricing that will eventually bring commercial asset values down 15% to 20% from their peak in 2007, but those price declines have done little to drive sellers to the table, says Joshua Scoville, research director at Property & Portfolio Research.

In 2009, deteriorating fundamentals are expected to create cash flow problems at some properties as net operating income (NOI) becomes insufficient to cover existing debt service. Some investors will have little choice but to bring in equity partners or drop their prices.

The impact of decreasing cash flows on asset values will be smaller than the dramatic price correction wrought by the credit crunch, Scoville predicts. Even so, declining income directly affects an owner's ability to make debt payments. “It's going to have a greater impact on the owner's ability to stay afloat.”

Bruce Cohen, chief executive at Wrightwood Capital in Chicago, believes investors in some of the opportunity funds that have formed this year to purchase distressed real estate will eventually compel their advisers to start closing acquisitions or return their capital.

“The common view is that the sellers just haven't gotten the memo,” says Cohen. “Or maybe the sellers are well-heeled, well-capitalized, and don't need to sell at that distressed pricing.”