Investors have slashed commercial real estate prices by 21% from the peak of October 2007, according to the Moody's/REAL Commercial Property Price Indices, which show asset prices across property types fell in January to levels not seen since the spring of 2005. But rather than buy into a declining market, most investors are holding out for even greater discounts.

“Overall volume is terrifyingly small,” says Pete Culliney, research director at the New York-based research firm. “The state of despair in the market is almost palpable. Investors are waiting for buyers to feel comfortable making big transactions.”

Observers say asset values are sure to slip further this year as recession spoils Corporate America's appetite for space and as rental incomes decline. Half of 165 industry experts polled at a Real Estate Investment Advisory Council gathering in Atlanta last month indicated they expect commercial values to sink at least 25% — perhaps as much as 35% — from peak to trough. That means prices still need to fall further before the market hits bottom and buyers resume acquisitions.

Data in doubt

The greatest hindrance to commercial real estate investment activity in 2009 is the uncertainty that haunts every statement of asset value. With sales volume so greatly diminished, the real estate community lacks reliable data and is struggling to determine prices and gauge where real estate values are likely to bottom out.

“Everyone is looking for a strategy, but all the strategies are predicated on value,” says Woody Heller, executive managing director at real estate services firm Studley. “At the moment, no one has a clear sense of value.”

Recent deals illustrate that some sellers are swallowing bitter losses in order to shake buyers into action. In January, an institutional investor sold a 240-unit apartment complex in Mesa, Ariz. for $20 million, or 36% lower than the $31.1 million it paid for the complex as part of a portfolio acquisition in 2006, according to Real Capital Analytics.

In another example, Bircher Development repurchased a strip retail shopping center in Costa Mesa, Calif., earlier this year for $34 million, or about one-third of the $100.8 million the company received when it sold the same property in the summer of 2007.

“[Sellers] are taking significant haircuts,” says Culliney, referring to these extreme sale prices. “The haircut is not quite as dramatic on a market-wide basis, but the clippers are certainly coming out.”

Stalemate eases

Lenders and appraisers are coping with the lack of sales comparables by extracting data from distressed deals, examining tenant default risk and projecting rental incomes under various economic scenarios. Those methods may help investors gain insight into the value of their own properties.

Institutional investors, at least, are finally acknowledging that asset values must be written down to reflect buyers' increased capital costs amid the credit crunch.

Asset values measured by the NCREIF Property Index fell 9.54% in the fourth quarter from the end of the previous quarter. That's the largest quarterly decline in the index's 31-year history, according to Doug Poutasse, executive director of the National Council of Real Estate Investment Fiduciaries (NCREIF), which publishes the index.

Why the rapid change? For one, both in-house evaluators and third-party appraisers acknowledged declining values in the portfolios they assessed. The second reason is that an uncharacteristically large proportion of NCREIF members chose to appraise their holdings in the fourth quarter. Those investors provided updated values for more than 86% of the properties represented in the NCREIF Property Index, Poutasse says.

The index, which tracks asset values as well as overall real estate returns, showed an 11% drop in values for all of 2008. The index showed a much slower pattern of write-downs in the 1990s, falling just 4% in the first year of that real estate slump and continuing with incremental declines for another five years. Poutasse finds the pace of correction this time around encouraging: “That means we definitely won't be doing this for six years this time.”