Commercial and multifamily real estate is working through a market transition against the backdrop of a wobbly economy, rising inflation and a global credit crunch. All in all, the asset class is holding up pretty well despite challenging conditions. The year 2007 will be remembered for the many difficulties in the U.S. economy- slow growth and the fear of a recession, the subprime lending imbroglio and the bursting of the U.S. housing market bubble-along with difficulties in the global financial markets. Although these issues have continued into this year, 2008 has brought its own set of problems to the mix-record-high gasoline prices, climbing food prices and slow employment growth, to name a few. * This is the environment in which commercial real estate finds itself, and the fear remains that what has happened to the residential market may also happen in the commercial market. * Real Estate Research Corporation (RERC) expects continued repricing to occur in the commercial property market (as it has in the residential market). And while the credit crisis has affected the debt markets for commercial real estate (as it has with the residential market), the commercial real estate (low-leverage) equity market has not been impacted to the degree anticipated by investors, and we do not expect it to go the way of the residential market. However, we still have some tough realities to face before the market stabilizes.

This is important to keep in mind when we examine the financial side of the commercial real estate market versus the asset side.

The inability of investors to sort through the financial instruments that were created over the past decade has caused them to become more risk-averse. That has brought established underwriting and investment criteria back to appropriate standards that focus on the fundamental value of the asset. Getting back to basics is not a bad thing, but one should not over-react to this situation out of fear.

Figure 1 Current RERC Barometer

Is now a good time to buy, sell or hold?

Figure 2 RERC Historical Buy, Sell, Hold Recommendations

Figure 3 Availability and Discipline of Capital

What is the current availability and discipline of capital?

Investors are seeing a bifurcation relative to repricing issues in commercial real estate between top-quality, low-leveraged assets versus average-quality, high-leveraged assets (75plus percent), although each set of assets is facing some level of repricing.

RERC's first-quarter 2008 investor survey shows that currently there is a wait-and-see attitude with a "hold" recommendation of 7.2 based on a scale of e to 10 (see Figure i) for investment sentiment. Further, given the first-quarter disarray and disappointment seen in the economy and financial markets, the "buy" recommendation of 5.0 versus a "sell" recommendation of 3.9 disputes the view that investors are totally out of sorts with commercial real estate.

(NOTE: It is important to point out that the RERC investor survey reflects the view of large institutional buyers for higher-quality properties.)

It is no surprise that we are continuing to see the bid/ask spread widen, as sellers are not willing to sell at a discount, and buyers are not willing to buy at the ask price, given the uncertainty in the economy and financial markets.

The profound shift in the sell sentiment can be found in the historical buy, sell or hold recommendations shown in Figure 2. The sell recommendation during first-quarter 20x33 through first- quarter 2007 hovered around 8.0 on a scale of e to 10, indicating that it was a good time to sell (prices were viewed as strong relative to value). In first-quarter 2008, however, the sell recommendation was 3.9-about half that level-indicating that it fell quickly when credit market concerns entered the picture, and now is not a good time to sell (properties are viewed as underpriced relative to what buyers will pay).

This dramatic reversal in sentiment occurred right after The Blackstone Group purchased Equity Office Properties Trust-the nation's largest publicly held office building owner and manager, with a total office portfolio consisting of interests in 580 office buildings in 16 states and the District of Columbia-for approximately $36 billion. The deal will go down in history as a pricing-velocity watermark.

During the last year, the market has been going through a repricing phase, and investment sentiment is shifting to reflect the changes that exist in today's turbulent environment. This is captured and measured in the availability and discipline of capital readings reflected in our survey. The survey found a slightly-below- average current capital availability rating of 4.7 on a scale of 1 to 10, while the discipline score registers at 7.0, which is very high on a relative basis (see Figure 3). Commercial real estate has not seen this crossover of the discipline of capital versus the availability of capital since early 2001, when we were in the last recession (see Figure 4).

If the industry had continued with the levels of first-quarter 2007 commercial mortgage-backed securities (CMBS) underwriting that possessed aggressive pricing of high loan-to-value (LTV) ratios and high valuations, commercial real estate would have undergone a fate similar to that of the subprime market. But because it didn't, the current situation is better for long-term investment prospects for commercial real estate, and provides us with a more solid investment foundation without having to suffer a broad-based market failure like the residential securitized market.

Figure 4 Historical Availability and Discipline of Capital

Figure 5 Investment Ratings

Figure 6 What Do the Financial Markets Tell Us?

However, we also know there will be more casualties before everything is sorted out.