SAN FRANCISCO — The weather outside last Thursday was frightful as a howling storm ravaged the Bay Area, causing power outages and widespread wind damage. Inside the San Francisco Marriott the forecast for the commercial real estate industry wasn’t quite as grim, but attendees of the annual convention of the National Association of Real Estate Investment Trusts (NAREIT) were told to expect more stormy days ahead.

Kenneth Rosen, economist and chairman of Berkely, Calif.-based Lend Lease Rosen Real Estate Securities, said that there is a 60% chance that the U.S. economy will enter into a full-blown recession in 2003.

The good news is that REITs continue to hold their own vs. the broader equities market. Even so, emphasized Rosen, REITs are "insulated but not immune" to volatility. "REITs are the least bad place to be right now. The next two months will see a substantial REIT rally," Rosen predicted.

But the economist is quick to point out that the economy is displaying signs of a split personality, which impacts commercial real estate. While consumer spending, single-family housing, home mortgages, defense spending and healthcare are in recovery, other sectors such as business investment (venture capital), telecom, technology, state governments and the airline industry are all in recession.

The determining factor will be job growth, which gives Rosen reason for concern. He believes that another round of corporate layoffs could easily send the economy into a serious tailspin.

"Consumer confidence is weak, and the current unemployment rate is 5.7%. The economy isn’t fundamentally sound, and we have a period of prolonged weakness ahead," he said.

In the face of eroding real estate fundamentals, mass layoffs and the looming threat of war in the Middle East, there are few who believe that the REIT market will remain unscathed.

Rosen, who was featured on a panel with Torto Wheaton Research principal Raymond Torto, said that October was a very bad month for the REIT sector.

"Next year we will continue to see declining fundamentals. Still, I see dividends safe for 80% of all REITs in 2003," Rosen said.

Meanwhile, Torto identified a few troubled areas where high office vacancy rates and negative job growth have paralyzed the commercial real estate market.

In San Francisco, the office vacancy rate is nearly 20%. The employment rate has fallen to 1998 levels, according to Rosen.

"The next three to five years will be a long period of stagnation for San Francisco. The apartment sector will recover if we stop building," said Rosen.

But one silver lining is Southern California, which is experiencing strong job growth.

Torto emphasized that "perspective" on the market is crucial, or else bad news can snowball into dire forecasts. The national office vacancy level of 16.2 % recorded during the third quarter of this year is at the same level it was in the third quarter of 1994, according to Torto, which is when the office market was just beginning to recover.

The question, then, is whether the economic rebound will be what he called a "jobless recovery."

If the labor market is as weak as it was back in the early 1990s, the consequences could be devastating. In March of 1990, at the start of the last recession, the unemployment rate was hovering at 5.2%. The Bureau of Labor Statistics pegged unemployment at 5.7% at the close of last month.

The term "jobless recovery" was coined after the recession in the early 1990s, when 115,000 jobs were cut during the first five months of recovery. It took two years for the job count to once again reach pre-recession levels.

By analyzing charts from previous markets, Torto hypothesized that on average 18 months pass between the peak and the trough of the market. If this turns out to be true, the market should not expect to peak again until 2004 at the earliest, provided that it bottoms out early next year.

Torto expects San Francisco and Boston to struggle the most over the next few years, especially if new office construction supply accelerates in either market.

Rosen reminded the attendees that office space accounts for only 30% of the U.S real estate sector as a whole and that it’s not a bellwether for all property types. "Retail is very strong right now," emphasized Rosen.

Negative outlooks were hardly isolated to the economist panel. Speakers at other NAREIT sessions expressed pessimism about the immediate economic future. One consolation appears to be that REITs historically have performed well in down markets.

While uncertainty abounds about how REITs will perform as an asset class over the next few quarters, it is clear how popular they’ve become in this age of corrupt research and skewed earnings reports.

Steven Roth, chairman and CEO of New York-based Vornado Realty Trust, joked during the morning session that when TV character Tony Soprano’s wife Carmela starts talking about REITs on the popular Sunday-night drama, "you know the business has come a long way."

"Asset by asset, this business is understandable and the financial reporting is transparent here," said Roth.

As one analyst pointed out, the inclusion of REITs in the pop-culture vernacular might suggest that REIT performance has peaked, at least for now.