Commercial real estate prices have taken a dive of 32.8% from a year ago, and 40% from two years ago, a new report by Moody’s/REAL Commercial Property Price Indices shows. Most surprising is the steep plunge in prices for apartments, once considered the golden sector and the property type least damaged by recession and the nation’s credit crisis.

The special report from Moody’s Investors Service issued this week shows particular weakness in the Florida apartment market and in the San Francisco office market. Declines occurred across four major property types: multifamily, industrial, office and retail. Hotels were not included.

“Given how bad things are, there’s really no reason to sell unless you’ve got a gun to your head,” says Joe Franzetti, managing director at Cohen Financial, a Chicago-based mortgage banking firm.

“A seller has to be highly motivated today for a couple of reasons. They either have to get out of an obligation, or they’ve had a fund and it’s run its course and it’s time to sell the asset because it’s a turnaround situation.”

After a 40% drop in prices, many borrowers have no equity left in their properties, says Franzetti. Their stark choices are to sell at today’s depressed values or wait it out and sell when the market recovers. In many cases, the property has already passed from the borrower’s hands to the lender, who must make a choice on whether to take a haircut on the asset.

The most recent transaction figures show a 32.1% price decline for apartments from two years earlier, and that figure is expected to climb closer toward the 40.3% aggregate for all four property types in next month’s report, according to Moody’s analyst Connie Petruzziello.

“Multifamily has been hit hardest, and we’re seeing it also in our delinquency rate.” Moody’s also compiles a CMBS loan delinquency report that tracks the multifamily, office, industrial, and industrial sectors. In September, the multifamily delinquency rate for commercial mortgage-backed securities (CMBS) loans at least 60 days past due reached 6.09%, compared with just 1.47% just a year earlier.

“We’ve really seen multifamily skyrocket [in delinquencies]. That’s pretty much what we look for to see which property type is doing the worst,” says Petruzziello. Right behind multifamily is the hotel sector, with a delinquency rate of about 5%, the analyst says.

One reason some apartment markets, such as Miami, Phoenix and Las Vegas are faring worse today is the amount of speculation that occurred in transactions taking place two years ago at the height of the market. The timing of the deteriorating market was different for each sector.

“All real estate is struggling with valuation drops, but on a relative basis multifamily is healthier than most thanks to the constant and strong presence of Fannie Mae and Freddie Mac,” says Doug Bibby, president of the Washington, D.C.-based National Multi Housing Council, which represents apartment communities.

Multifamily occupancies and rents rely on job growth, so it’s hard to predict a recovery or price stabilization for 2010, says Bibby. “Drops in valuations are always problematic, especially of this magnitude because they essentially wipe out the equity in the deal.”

NMHC sees signs of heavy bidding for core assets in strong markets, offering hope that the bid-ask spread between borrowers and sellers will contract, he says. That could bring more capital to apartment transactions.

Although commercial real estate prices declined 40.3% nationally from two years ago through August, across geographic regions the greatest drop occurred in the South, which recorded a 48.7% decline. Apartments in Florida were singled out for their 48.3% price drop over the same period.

While the commercial real estate industry is still bleeding financially, the bleeding is not as severe as it was a month ago. One positive note is that transaction prices across all property types declined 3% month-over-month in August 2009 compared with 5.1% July, and the improvement was even more striking than transaction prices reported in May.

“While we saw over 8% declines in the month of May, this month we’re seeing declines in the 3% range. So we’re seeing the rate of decline slowing down,” says Petruzziello. “That’s an encouraging sign.”

Still, the 40.3% decline from two years ago was greater than the 37.5% drop recorded last month from two years earlier. And the upcoming November report is likely to show a still more dismal two-year gap, since it is closer to the peak of transaction prices reached in October 2007.

Although it’s a difficult pill for many owners to swallow, today’s transaction prices may indeed reflect the real value of their properties, particularly if they must sell in the current market.

“It’s very hard to say whether a property has an intrinsic value that’s greater than where the market is today. The fact of the matter is, if you have to sell, this is where the market is today. And right now, it’s severely depressed,” says Franzetti of Cohen Financial. If the owner can hang on to the asset, its price could rise, however.

Delinquency rate may not deter lenders

Accompanying the plunge in values is a sharp rise in delinquency rates. However, rising delinquency rates, such as those shown in Moody’s newly released CMBS delinquency tracker for October, do not necessarily persuade a lender to stop providing loans, says Franzetti.

“The only thing anybody will lend on today is a performing asset. So what you have to look at in terms of any particular project is making sure you’ve got a sustainable and underwritable cash flow.”

Cohen Financial has been beset with requests for help with refinancing and restructuring, as well with new mortgage requests. “If you have a new project coming in to be financed, just because another project is delinquent doesn’t necessarily scare the lender because he’s underwriting the given project he’s looking at.”

Although the specific request will be decided on its merit, the financial climate does affect the market. “The rising delinquency rates just make everybody a little bit nervous because that’ll put further pressure on prices as more properties end up in the distressed bucket.”

One aspect of the current lending market is that mezzanine loans have in many ways become a casualty of the decline in prices and values, says Franzetti. “An existing mezzanine loan on a [first] loan that was made two years ago — that’s probably dead.” If a loan was taken out at an 80% to 90% loan-to-value two years ago and the value has steeply eroded, there’s no value left for the mezzanine holder.

“What happens is the first mortgage lender is the one essentially in control at that point. They’re the only ones that have any skin left in the game.”

Distress sales climb to 25% of market

The falling prices show another trend in today’s commercial real estate marketplace — the rising tide of distress sales. Distress sales currently represent about 25% of transactions, a sharp increase from 18% last month and 13% the month before, says Neal Elkin, president of Real Capital Analytics LLC (REAL), who oversaw the creation of the Moody’s/REAL index.

“We’re now in a situation where there’s negative equity with these assets. And that’s forcing a lot more of the distress sales because the current owners can’t come up with the additional equity,” says Elkin.

The volume of transactions has picked up, which is a positive trend, he says. However, in the meantime, prices are still falling. And with loans coming due, that is bad news for borrowers. “What’s undeniable is the extent of refinancing pressure that’s going to come to bear in the commercial real estate space.”