Expect CMBS defaults to rise through the end of 2004, warns Fitch Ratings. The rating agency predicts that the cumulative U.S. default rate will reach 5% by the end of the year —an average annual CMBS default rate of 1%.

Fitch is particularly concerned about the retail sector, in which the tapping of home equity appreciation (the source of much consumer spending) is expected to diminish along with low interest rates. "With the prospect of rising mortgage rates, the retail sector will no longer be able to rely on homeowner refinancing as a sustainable source of income," says Mary O'Rourke, senior director at Fitch. "Declining sales will ultimately cause increased CMBS defaults, particularly among large chain retailers focused on discretionary retail expenditures such as home furnishings and appliances."

Multifamily also may experience rising default rates, with overbuilding a central concern. Markets such as Dallas, Las Vegas and Atlanta will suffer from high vacancies and defaults as new construction outpaces the forecasted population increase, according to O’Rourke.

In the office sector, little improvement is occurring. Defaults in 2003 totaled $512.7 million, up from $168.4 million in 2002. The only positive sign is a slow but steady absorption of sublet space. Still, Fitch is concerned that the economic recovery isn’t producing an increase in jobs in the office-using sectors. "Until that happens," says O'Rourke, "office loans in CMBS transactions are going to continue to default."

Finally, the hotel sector endured a rough 2003 with slightly more than $1 billion in defaults. Fitch sees declining default rates here, although, the hotel sector is still very vulnerable to geopolitical events.