Most survey respondents believe the housing market will be unstable for at least 12 more months. In fact, only 14 percent of investors say the housing market will stabilize within the next few months.

Housing starts fell 2.6 percent in August to 1.3 million as the downswing in the housing market continued, according to the U.S. Commerce Department. Starts were down 19.1 percent from a year earlier, falling to the lowest level in 12 years. In August, existing inventory reached the highest level since February 1988 with an inventory-sales ratio of 9.8 months, according to the Mortgage Bankers Association (MBA).

Figure 3: Click to see larger image

Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, believes that the bottom of the housing downturn could arrive during the second half of 2008 or even later.

That’s not good news for the U.S. economy, especially when you consider that prior to the recent downturn in housing, there were 10 prior housing declines during the postwar period and all but two of them were followed by a recession. (The exceptions were the housing declines in 1950 and 1966 when major increases in defense spending helped keep the economy afloat.)

In fact, the outlook for U.S. growth has deteriorated due to the weak housing market and increasing concerns of defaults on subprime mortgages. RREEF Research is forecasting economic growth of just 1.8 percent in 2007, and 2.2 percent in 2008 compared to 2.9 percent in 2006 and 3.1 percent in 2005. Consumer spending is expected to drop from 2.8 percent this year to 2.3 percent in 2008, and unemployment is expected to rise from 4.6 percent to 5.1 percent.

“There is no doubt that the economy is more vulnerable to any additional disruptions after the credit-tightening that has occurred,” says Hessam Nadji, senior vice president and managing director of Marcus & Millichap Research Services.  “We don’t believe the housing downturn has bottomed, and that will be a drag on the economy

well into 2008. However, strength elsewhere, particularly corporate balance sheets, profits, business investments and exports should result in a slowdown rather than a recession.”

FINANCING WORRIES

Still, there are ongoing concerns about the credit markets for both residential and commercial real estate. In fact, availability of financing is the top concern for respondents in this year’s survey. Last year, only 16 percent of respondents were worried about it – more were concerned about the economy and cost of building materials.

Six out of 10 respondents say debt financing will be harder to get over the next 12 months, which compares to just 35 percent in 2006 (see figure 4). And they have every right to be spooked by what’s happened in the capital markets.

Figure 4: Click to view larger image

“There’s a global liquidity crisis in all asset classes that is going to make financing much more difficult,” Tokarski says.

In mid-summer, the CMBS market all but shut down as bond buyers exited the market, leaving billions of dollars’ worth of CMBS paper in “warehouses” and forcing many borrowers to pursue debt financing from portfolio lenders including life insurance companies. At their worst, CMBS spreads had widened to swaps plus 70 basis points for 10-year triple-A bonds, while triple-B- spreads widened to swaps plus 425 basis points.

“I would describe the capital markets’ adjustment to commercial real estate as an overreaction to the residential subprime issue,” Green says, adding that he expects the capital markets to settle down and spreads to decline eventually. “But they will not go back to their pre-July 2007 conditions.”

Before the subprime meltdown and subsequent credit crisis, $136.7 billion of CMBS loans were originated during the first half of 2007, an increase of 55 percent from the same period in 2006, according to MBA.

As of early October, CMBS lenders were still working through much of the warehoused paper. But only $10 billion worth of CMBS bonds were priced in September, less than half of the $26 billion that was initially projected, according to RBS Greenwich

Capital, one of the world’s largest CMBS issuers.

Many of the deals that were slated for September were expected to come to market in October, pushing projected issuance to $34.2 billion. If no other deals come to market in 2007, domestic issuance will total $245.4 billion, or 21 percent above 2006’s total, according to RBS Greenwich Capital. The firm initially projected 2007 issuance at $290 billion.

Fortunately, there are signs that the CMBS market is calming down. Fixed-rate CMBS spreads tightened in early October, with triple-A spreads reaching swaps plus 55 basis points. The tightened spreads, along with lower interest rates, mean investors’ cost of debt has decreased.

“By the beginning of the second quarter 2008, I think the upheaval in the credit markets will work its way out, but the stricter underwriting will be here to stay,” says R. Craig Butchenhart, president of NorthMarq Capital Inc., one of the largest mortgage banking firms in the nation.

In fact, underwriting standards today are much more conservative than they were in 2006 and early 2007. Ratings agencies Fitch Ratings and Moody’s Investors Service both issued reports earlier this year indicating that conduit lenders had become too aggressive in their underwriting and loan terms, putting CMBS investors at risk.

“Over the last five years, anyone who could breathe could get a loan and could buy real estate,” Tokarski says, adding that investors are going to have a much harder time raising debt and equity in today’s market.

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