Fitch: Declining U.S. Office Fundamentals Offset RE Rebound Benefits.

Business Editors

NEW YORK--(BUSINESS WIRE)--Feb. 23, 2004

Based on data from the close of third-quarter 2003, Fitch Ratings today updated its Property Market Metric (PMM) scores. The Fitch PMM scores, which assign a volatility risk ranking to five major property types in more than 375 markets throughout the United States, range from 1 to 5, with Volatility Group 1 (VG 1) demonstrating the least volatility and VG 5 the highest. As expected, PMM scores in primary markets demonstrate less volatility than secondary markets, with the average PMM scores for both primary and secondary markets, 2.76 and 3.46, respectively, essentially unchanged since last reported. Nonetheless, there have been significant patterns of change within each of the different property types. The previous PMM update was based on year-end 2002 data.

"One thing has become clear in looking for patterns in the changed scores," said Mary O'Rourke, senior director, Fitch Ratings. "Texas, the third largest contributor of CMBS collateral behind California and New York, falls well behind in both the average primary and secondary PMM scores when compared to other states that make significant contributions to CMBS, and the increased volatility of Texas markets is demonstrated across all property types."

The average primary market PMM score for California, New York, New Jersey, Florida, and Virginia, five of the six largest contributors, is 2.65, while it is 3.32 for Texas. In secondary markets, the average for those states is 3.28; for Texas it is 4.07. Whereas overall secondary market PMM scores improved in those five other states since last reported, Texas secondary market scores increased in volatility by 79 basis points.

The Apartment Sector: O'Rourke noted that while the average PMM score for multifamily primary markets improved slightly by 22 basis points, the average score in secondary markets declined by 16 basis points. 'In fact, the only primary multifamily market to show a decline was Riverside, CA, which changed to VG 3 from its previous score of VG 2 at the last reporting.'

Seven multifamily primary markets improved enough to move up into the next highest category, and both Honolulu and Pittsburgh moved from VG 2 to VG 1, the highest group. The average PMM score in primary markets was 2.35 with no primary markets scoring below VG 3. In secondary markets, the average multifamily PMM score was 3.0, the best of any property sector. No secondary markets scored below VG 4. O'Rourke noted that sixteen of the 54 multifamily secondary markets that showed increased volatility were in Texas, while ten of the fourteen secondary markets where volatility lessened were on the East Coast.

The Hotel Sector: Within the hotel sector several primary markets showed improvement significant enough to lift them out of the VG 5 category, most notably Denver, Hartford, and Las Vegas, but most markets remained unchanged. Major markets such as San Francisco, Boston, New York, Fort Lauderdale, Honolulu, and New Orleans remain in the VG 5 category. Los Angeles, as well as all the other California primary hotel markets, with the exception of Riverside, remains in the VG 4 category. Riverside is the only primary California hotel market with a score of VG 3. Hotel properties continue to have the most volatile fundamentals: they make up 42.3% of all VG 4 and VG 5 scores.

The Office Sector: While continuing to show an above-average overall PMM score of 2.85 in the primary markets, the downward pressure of the recent recession is becoming more evident in the office sector. When compared to the previous score, the overall primary office market score worsened by 17 basis points. Two new markets, however, Riverside, CA, and Norfolk, VA, joined Sacramento, Washington DC, and the Nassau-Suffolk NY market in the VG 1 category. Milwaukee slipped from VG 1 to VG 2.

The most significant change in the primary office sector occurred in the six primary Northern New Jersey markets: all six moved from the highest category, VG1, to VG 3, a rare 'two-bucket' shift in PMM scores. An analysis of the data indicates that while at VG 1 in the previous reporting, those markets were very close to the cusp of VG 2. After three more quarters of data, those markets are now in the higher end of the VG 3 category, close to the cusp of the bottom end of VG 2. Northern New Jersey, like Boston, has experienced the trifecta of woes: declining rents, high vacancy, and new supply.

Alone, Austin remains at the bottom of the primary office market category, the only primary office market still in VG 5. Denver, formerly at VG 5, rose to VG 4. West Palm Beach, as well as Texas primary markets Dallas, Ft. Worth, Houston, and San Antonio, remain unchanged at VG 4, and are now in the company of a number of markets that declined to VG 4 from VG 3: San Jose, Phoenix, Atlanta, Boston, Minneapolis, and Charlotte.

The Retail Sector: Retail markets continue to present the least volatile scores, with 28 of 62 markets achieving VG 1. In primary markets, the average retail PMM is 2.05. In fact, all but eight markets have VG scores at VG 3 or higher. Raleigh NC recently joined the VG 4 group, which now includes the five principal Texas retail markets, plus Denver, and New Orleans. On a regional basis, CA retail appears very strong, with Oakland, Orange County, Riverside, and San Jose in VG 1 and San Francisco, Sacramento, and San Diego at VG 2, a decline for San Diego from VG 1 at last reporting. Los Angeles and Ventura are VG 3.

The Warehouse Sector: There has been very little change in the overall volatility in the warehouse sector. The widespread durability of the sector can best be observed in noting there is only a single primary warehouse market, Austin, in the VG 4 group and none in VG 5, and that the eight primary warehouse markets in the VG 1 category are in eight different states: Oakland, Washington DC, Jacksonville, Honolulu, Chicago, New Orleans, New York, and Cleveland. Several important warehouse markets, notably Chicago, Indianapolis, and Orlando have all shown improvement.

Expectations: "While Fitch expects both the primary and secondary office markets will continue to experience greater volatility as a result of the economic stress brought on by declining rents and high vacancies, the overall picture emerging for other property types is that of reduced volatility and stabilization," noted O'Rourke.

Fitch Ratings' Property Market Metric (PMM) scale, a proprietary system for measuring the historical and current volatility of five major real estate property types in interaction with specific real estate markets, is available to subscribers at 'www.fitchratings.com'. The PMM scores are used in Fitch's CMBS rating model to account for market risks.