August 20, 2010

U.S. Commercial And Residential

Property Markets May Have Seen
The Worst Of Their Slumps
Primary Credit Analyst:
David M Zuber, New York (1) 212-438-1125; david_zuber@standardandpoors.com

www.standardandpoors.com/ratingsdirect 1
816374 | 300998467
U.S. Commercial And Residential Property
Markets May Have Seen The Worst Of Their
Slumps
The slump in the U.S. commercial property market didn't quite plumb the depths of the downturn in residential real
estate, but although we see signs that home prices are nearing the bottom, commercial real estate could fall further.

Despite a surge in foreclosures in the U.S. commercial real estate market, there were fewer defaults in commercial
mortgage-backed securities (CMBS) than Standard & Poor's Ratings Services originally expected. We still see
fundamentals in the market declining—if at a slower pace—and we might see more delinquencies in CMBS. In the
first quarter of 2010, foreclosures totaled $3.6 billion, the most since 2001 and 48% higher than in the fourth
quarter of last year.

At the same time, we've seen some CMBS issuance—a fraction of the peak in 2007, but already exceeding 2009's
total—with most deals involving less-risky, lower-leveraged loans in pools that are much smaller.

As the U.S. economic recession spurred job losses and store closings, the commercial property market suffered sharp
reductions in construction and steep decreases in prices. But although prices tumbled 39% from their peak—an even
bigger drop than we saw in residential real estate—this was tempered because there aren't as many commercial
mortgages as there are residential loans. In addition, loan-to-value (LTV) ratios in the commercial market weren't as
high as those in the residential sector as lenders learned from the drubbing they took in the late 1980s.

"The problem is severe but not quite as bad as in the residential market, and at this point it doesn't look quite as
bad as we thought it might be," Standard & Poor's Chief Economist David Wyss sais. "There's a more normal
pattern in CMBS and commercial real estate because commercial real estate has always a very cyclical business, and
this has been a really bad cycle."

Although lenders' losses haven't been as severe in commercial real estate as they have in the residential markets,
small and midsize banks have been hurt most because they made the bulk of construction loans and held the
mortgages on strip malls and suburban office parks, where prices have dropped more than in city commercial space.
Still, we believe new issuance of CMBS is unlikely to return in earnest until fundamentals in the commercial
property markets stabilize further.

"People are reluctant to lend if they think property values are going to keep going down," said Standard & Poor's
Managing Director James Palmisano. "It becomes really hard for lenders to make loans and for investors to buy
pools of CMBS if they don't really know what's going to happen with those loans."

The dearth of a CMBS market leaves lenders without an effective hedging mechanism, Mr. Palmisano said, adding
that there aren't enough CMBS transactions in the market for issuers to index their loan pools against.

Meanwhile, Standard & Poor's has seen some issuance in residential mortgage-backed securities, mostly so-called
re-REMICs, which are resecuritized real estate mortgage investment conduits that are collateralized by classes from
other structured transactions. This comes as the U.S. residential market faces the withdrawal of recent government
support, mainly in the form of tax rebates on home purchases. We expect to see some drop-off in purchases, but
"the hope is that withdrawal of government support is coming at a time when the economy has enough strength

Standard & Poor’s | RatingsDirect on the Global Credit Portal | August 20, 2010 2
816374 | 300998467
 U.S. Commercial And Residential Property Markets May Have Seen The Worst Of Their Slumps

behind it to grow without the crutch," Mr. Wyss said. "We hope that that's the case, but we're not sure of it."

"Given current interest rates, given current home prices, housing is pretty affordable now," he added. "Markets
seemed to have calmed down, you can get loans, and I think that will keep the housing market strong because
people have to live somewhere."

The decline in homebuilding and, thus, the drop in excess supply of houses we saw a few years back could help to
solidify the rebound. "But that doesn't mean we're not going to have a setback," Mr. Wyss said.

Although Standard & Poor's maintains a negative outlook on public real estate investment trusts (REITs) as
fundamentals in the market continue to deteriorate somewhat, our stance is moderating. "REITs have got access to
capital, and most of the property sectors are approaching a trough from a fundamental standpoint," says Standard
& Poor's Managing Director Lisa Sarajian. "But if this recovery is a head fake, we might have companies shifting
from defense to offense prematurely and using up some of their precious liquidity too quickly."

In our view, most REITs have core portfolios that will continue to deteriorate, and in past cycles, a residential
rebound augured a return in demand in the commercial sector, though that is less likely to happen this cycle.

"There is a silver lining to that, perhaps, because supply is not as big an issue this cycle," Ms. Sarajian said. "And
because there are still constraints on financing new construction, as the market recovers REITs do have access to
capital and could be in the driver's seat in terms of taking advantage of the development opportunities that surface."

Amid diminished demand for new strip malls, office buildings, and the like, companies with well-positioned
portfolios will probably benefit, in our view, in what could be an active year for debt sales by REITs and
homebuilders. After a six-month dearth of issuance leading up to March of last year—during which there was no
issuance by REITs—Standard & Poor's rated $9 billion in REIT debt from June to December 2009, and sellers
matched that amount in first half of 2010. REITs are using much of this debt to build war chests to take advantage
of opportunities that arise.

"But the market has been so volatile and the recovery, at least from our perspective, wobbly, we're not operating
under the assumption that that window will stay open," Ms. Sarajian said. "There's the potential that it gets
slammed shut again."

www.standardandpoors.com/ratingsdirect 3
816374 | 300998467
Copyright ( c ) 2010 by Standard & Poor’s Financial Services LLC (S&P), a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.
No content (including ratings, credit-related analyses and data, model, software or other application or output therefrom) or any part thereof (Content) may be modified,
reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of S&P. The Content
shall not be used for any unlawful or unauthorized purposes. S&P, its affiliates, and any third-party providers, as well as their directors, officers, shareholders, employees or
agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or
omissions, regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is
provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF
MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING
WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any
party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without
limitation, lost income or lost profits and opportunity costs) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact or
recommendations to purchase, hold, or sell any securities or to make any investment decisions. S&P assumes no obligation to update the Content following publication in any
form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or
clients when making investment and other business decisions. S&P's opinions and analyses do not address the suitability of any security. S&P does not act as a fiduciary or
an investment advisor. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or
independent verification of any information it receives.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result,
certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the
confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain credit-related analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right
to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and
www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party
redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

Standard & Poor’s | RatingsDirect on the Global Credit Portal | August 20, 2010 4
816374 | 300998467