Beige Book: weak fundamentals sour property values.

Weak property demand, falling rents and value declines continued in commercial real estate markets across the country, according to the Federal Reserve Board's September Beige Book.

The Boston and Kansas City districts maintained steady vacancy rates, but space demand remained weak as commercial rents declined. Kansas City district contacts were also concerned that lower commercial real estate values would hinder upcoming loan renewal and refinancing activity, the Beige Book said.

In the Boston district, underwriting standards in the commercial market remained "very strict, with loan-to-value [LTV] ratios largely below 70 percent."

"Small regional banks continue to support the bulk of financing activity in the region," the Beige Book said. "Our regional banking contacts report that they have maintained a healthy balance sheet through conservative lending, and experienced higher profits this summer compared to a year ago as a result of increased market share in [commercial and residential] mortgage lending."

One Boston district contact predicted a 50 percent decline in the national commercial property value index from peak-to-trough before recovering. A Boston contact said declines in property values ranged from 30 percent to 60 percent on various downtown office buildings. A Providence, Rhode Island, contact said commercial property foreclosure sales, all originally financed through CMBS, increased as sale prices reflected 60 percent discounts from peak prices in 2007.

In a number of cases, Boston district rents fell below the level that supports debt repayment.

"In light of these conditions, delinquencies and foreclosures are expected to increase further in the coming months," the Beige Book noted.

Rents fell and vacancy rates increased in the Philadelphia and Richmond, Virginia, districts. Philadelphia contacts said commercial real estate financing remained "very difficult as secondary markets show no signs of recovery," the Beige Book said. Contacts expect nonresidential real estate leasing to remain weak into next year, with "no signs that construction will strengthen in the near future."

In Richmond, some landlords postponed property improvements to conserve cash.

"Contacts reiterated that tight credit conditions were dampening sales prospects," the Beige Book said. "Sales-price trends were difficult to detect in most markets due to a lack of activity, although prices did reportedly edge lower in Richmond and Charlotte, North Carolina. Reports of commercial foreclosures were generally scarce, although agents in Washington, D.C.; Richmond; Raleigh [North Carolina] and Charlotte reported a few instances of clients 'turning in keys.'"

The Dallas district also reported falling rents, and its contacts were concerned about a large share of commercial real estate loans up for renewal. "But for now, lenders appear to be extending the loans," the Beige Book said.

Office and industrial vacancy rates increased in many parts of the San Francisco district, and contacts said limited available financing "continued to sharply curtail construction activity and investment transactions for commercial properties."

Construction remained at very low levels, with modest improvements in public construction in the Chicago, Cleveland and Minneapolis districts.

In Cleveland, the Fed heard "numerous accounts of difficulties in obtaining financing for private-sector projects" and, in Minneapolis-St. Paul, retail vacancy reached its highest level on record and industrial absorption was at record lows.

Contractors in the Atlanta district said commercial construction will continue to decline into 2010, and a Louisville, Kentucky, contact in the St. Louis district does not expect nonresidential construction to improve until 2011.