The volume of commercial mortgage loans due for refinancing in 2008 has not placed a strain on the market’s limited capacity so far, but as the volume rises beginning later this year, delinquencies are likely to go up. As of mid-July, more than $7 billion in CMBS loans will be eligible for refinancing in 16 to 18 months.

During a Reis second-quarter capital markets briefing teleconference on August 27, Sam Chandan, the New York-based research firm’s chief economist, noted that as more of these mortgages come due for refinancing, more delinquencies are likely unless credit markets ease or additional sources of credit are identified.

“In an adverse feedback loop involving perceptions of risk and credit extension, credit will then tighten further and asset prices will decline in the face of distressed sales. In selected markets, particularly in those where competition among lending sources resulted in aggressive underwriting, negative asset bubbles may emerge,” Chandan said.

Delinquencies and defaults on commercial property are now transitioning from those tied to property-related idiosyncrasies to more “systematic causal drivers” related to the assumptions built into the structure of the debt.

The assumptions are based not so much on property cash flow or appraisal value as much as they are based on expectations made at the point of origination about credit market conditions at the point of loan maturity and the “amenability of lenders” to refinance maturing debt at terms similar to the original financing, according to Chandan.

In the meantime, credit markets have changed and those assumptions are no longer valid. Therefore, the challenge for commercial mortgage risk management — in contrast to the challenge on the residential mortgage side — is the capacity to proactively identify where problems might come up, not just on the level of a market or a particular type of mortgage, but at the level of the loan and the property itself.

The challenge is to find out where, in hindsight, the assumptions made in the boom years fail to pass muster. “Our ability to undertake this exercise while delinquency and default rates remain low and before the volume of maturing loans spikes provides the window of opportunity, which if fully leveraged, will allow us to keep both shoes on our feet,” Chandan pointed out.

The data suggests that we are in the middle of the credit tightening cycle, rather than at the end, according to Reis.

In the second quarter, transaction volume, based on transactions of $2 million or more across retail, multifamily, industrial and office, stood at $33.2 billion, down from $40.5 billion in the first quarter.

Including portfolio sales, transaction volume added up to more than $79 billion in the first half of 2008. Based on an annualized $160 billion, this represents a drop of 66% from 2007 transaction activity and is on par with transaction levels last seen in 2004. While the slowdown from the market peak is dramatic, the current trend shows that the pace of the slowdown has moderated.