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Commercial Property Woes Hit Pension Funds: Report

A new report finds the recent fall in commercial real estate values is beginning to affect the bottom lines of the nation’s big pension funds.

The value of U.S. commercial real estate owned by big pension funds fell five percent in the fourth quarter of 2007, twice the drop of the third quarter, according to an index from the MIT Center for Real Estate

The transaction-based index (TBI) tracks the price at which big pension funds buy and sell commercial properties, which include shopping malls, apartment complexes and office buildings. The cumulative fall since last year’s midsummer peak is now more than 7 percent.

“Pension funds are one of the significant investors in commercial real estate in the United States, both multifamily, office retail industrial properties and they're facing a challenge, the same challenges that a lot of other investors in the market are facing,” says Dr. Sam Chandon, Chief Economist at REIS, Inc.

Experts, like Chandon, blame the credit crunch, which has now bled over from the residential real estate market to the commercial market. There is simply less money available because the commercial mortgage backed securities market has slowed down so significantly over the last couple of months.

“With less money available to finance transactions, it has become more difficult to sell properties at the premium prices that we saw in early 2007,” adds Chandon.

The TBI saw tremendous growth — 64 percent — from 2004 to 2006, as the residential housing market began to wane. It then saw another 8 percent surge in the first half of 2007.

“The price decline we see so far in commercial property as reflected in the TBI may simply represent a correction of the froth that occurred in early 2007 as a result of very aggressive commercial mortgage underwriting practices,” said MIT Center for Real Estate Director David Geltner in today’s release.

Despite the surge in the index in the first half of the year, 2007 marked the weakest annual performance for the index since 1992; that was when commercial property saw its worst crash since the Great Depression.

The drop in the index, however, does not directly translate into a drop in pension fund values, and that’s because pension funds rely to a great extent on the stability of the cash flows of the properties more than price appreciation.

“What we do see for commercial properties is that rents and vacancies remain stable in most markets, cash flows net operating income remain very stable,” says Chandon. The funds do see pressure, however, from less retail spending, which could affect those funds invested heavily in the retail space.

The MIT Center’s TBI is based on prices of properties sold from the National Council of Real Estate Investment Fiduciaries (NCREIF) database, and also includes appraisal information for all of the more than 5,000 NCREIF properties.

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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