Prices paid for income-producing properties in the United States have been shrinking for the past year and real estate observers say values still have not hit bottom. With few lenders offering more than 60% leverage, the trend is particularly troublesome for landlords who need to refinance expiring mortgages that amount to 75% or more of asset value.

The Moody's/REAL Commercial Property Price Index tracked an 11.5% drop in prices across property types from their peak in October 2007 to the end of August. Because that index only tracks repeat sales — or how much that a sold property has changed in value since the last time it traded — market-wide declines in real estate values may be even deeper, say some industry experts.

A preponderance of trophy acquisitions this year may be skewing that index to obscure an even greater decline in overall value, they argue.

With so much gloom and doom engulfing the capital markets and the economy, many owners have taken their properties off the market, hoping that leverage will return and enable buyers to meet their asking prices.

Only 1,089 U.S. office properties had sold this year through August, down 70% from a year ago, according to New York-based researcher Real Capital Analytics.

The limited number of property sales has deprived buyers and sellers of market data they need to set values for their non-trophy assets, further delaying a price correction, says Keven Lindemann, director of the real estate group at SNL Financial in Charlottesville, Va.

“You have a lot of real estate owners right now who don't know what their property is worth,” he says. “We need to start seeing some transactions so that we can establish some data points about where real estate is trading.”

Recent sales suggest that prices have dropped further since August. Consider the recent history of 1372 Broadway in New York, a 21-story office building, which at press time was under contract for sale to investor Lloyd Goldman for a reported $275 million. That's nearly 18% less than the asset's $335 million value in July 2007, when Wachovia acquired an 85% stake in the property.

“Anecdotally, I think that's very much in the ballpark for Manhattan,” says researcher Dan Fasulo, managing director of Real Capital Analytics. “There's no question that prices are off for most properties around the country.”

The Moody's/REAL index detected a 15% spike in real estate prices from the fourth quarter of 2006 through mid-year 2007, a surge that Fasulo attributes to the tremendous amount of leverage available at the time. “Now that the liquidity has dried up, that 15% of froth has been wiped out.”

Another shoe to drop?

The Moody's/REAL index shows that prices flattened at the end of this summer, and it seemed a correction had largely run its course. Don't believe it, say analysts at Real Estate Analytics LLC (REAL), which owns the Moody's/REAL index.

In a special report, analysts described the halt in price declines that occurred in July and August as “a false bottom to the market, with the potential for prices to fall much further.”

Observers say a new dynamic — softening fundamentals — is beginning to weigh on the investment market. Mounting job losses that totaled 760,000 for the year through September, bank failures, the government takeovers of Fannie Mae and Freddie Mac, and worries over what may already be a recession in the U.S. economy are driving tenants to delay commitments to new space, and many are downsizing.

The effects of a withering economy are already showing up in the office market, where the national vacancy rate rose to 14.3% in the third quarter compared with 13% a year ago, according to Grubb & Ellis.