Although the current commercial real estate cycle has seen relative supply restraint compared with previous cycles, that won’t be enough to bail the industry out of a deep recession, which is causing demand to fall off more than expected.

During a media briefing on the 2009 outlook for commercial real estate in New York last week, Michael Giliberto, a JP Morgan senior real estate portfolio manager, said considering that real estate lags the economy, even after the economy picks up later this year, rents in all the major commercial real estate property sectors will be down about 6% by December 2009.

While JP Morgan expects all property types to be hard hit, Giliberto predicts that retail properties are likely to face a protracted reversal as consumers stop taking on additional debt and try to manage existing debt. “A huge hammering is going on in the consumer discretionary sector,” according to Giliberto.

Commercial real estate prices have been falling since the end of 2007 and were down about 12% through the third quarter of 2008. JP Morgan forecasts a decline of 15% to 20% for the average commercial real estate asset in the major property sectors from the peak of the cycle to its bottom of this cycle, as investors hike up return requirements. Some assets could even see prices drop of 30% to 40%.

As commercial real estate begins to feel the impact of falling valuations, there will be more scope for special servicers to modify loans, said Alan Todd, JP Morgan’s head of commercial mortgage-backed securities (CMBS) research. “All else being equal, if someone has already refinanced there’s potential that they will put their hands in the air,” he says.

And as more loans end up in special servicing, there is bound to be an impact on the performance of CMBS, depending on the size of the loan and how long it is in special servicing. JP JP Morgan expects than on average securitized loans issued in 2006 and 2007 will see about a 7% loss, impacting CMBS securities rated ‘A’ and below.

Todd anticipates greater possibility for refinancing risk starting in 2010, considering that five-year loans comprise about 40% of the loans coming due in 2010 to 2012. This would include loans originated in 2006 and 2007, a period of extreme market exuberance.

On the real estate investment trust (REIT) side, the JP Morgan equity REIT team believes that Wall Street’s REIT earnings estimates are 6% too high. The team expects cash flow growth on REIT stocks will be down 1% to 2% in 2009. There is not much growth prospect to attract growth investors to the stocks, while more value-oriented investors could see them as being too high priced.