Sept. 11 (Bloomberg) -- Commercial-property sales in the U.S. this year are forecast to fall to the lowest in almost two decades as the industry endures its worst slump since the savings and loan crisis of the early 1990s.

About $16 billion of office transactions will be completed by year-end, according to data compiled by Real Capital Analytics Inc., a New York research firm that has tracked deals for almost a decade. Real Capital Managing Director Dan Fasulo and Sam Chandan, chief economist of Real Estate Econometrics LLC, said that may be the lowest volume since at least 1991.

“There’s no real way to sugarcoat it,” Fasulo said in an interview. “A slowdown of this magnitude certainly hasn’t occurred since I’ve been in the business.”

The financial crisis that led to the demise of Lehman Brothers Holdings Inc. and the buyout of Merrill Lynch & Co. is curtailing commercial property lending and leading more landlords to default on loans. The scarcity of transactions is making it difficult for buyers and sellers to value properties, further delaying any potential thaw.

The default rate on commercial mortgages held by U.S. banks more than doubled in the second quarter to 2.88 percent, according to New York-based Real Estate Econometrics. It may reach 4.1 percent by year end, the highest since 1993.

That may mean more pain for banks that hold the mortgages and signal that this year’s gain in real estate investment shares may be overdone.

‘Double-Edged Sword’

The Bloomberg Office REIT Index is up 19 percent this year through yesterday, beating both the performance of the Dow Jones Industrial Average and the Standard & Poor’s 500 Index. The measure has increased largely on investor speculation that REITs, having raised more than $19 billion through August, are poised to buy distressed assets.

“It’s a double-edged sword,” said Michael Knott, senior REIT analyst for Green Street Advisors Inc. of Newport Beach, California. “If you have no deals, then it’s harder to be confident in values.”

Returns on office investments this year have been running almost 1 percent higher than for moderate-risk (Baa-rated) long- term corporate bonds, according to an Aug. 28 Green Street report. That may be tough to sustain if credit availability doesn’t ease, Knott said.

More Challenges

“You’re still looking at several years of challenges in the secured financing markets” for commercial real estate, he said. “The problem is there is going to continue to be sort of a dichotomy between the broader credit markets and the real estate credit markets. Real estate seems to be kind of a dirty word right now.”

Stifel Nicolaus analyst John Guinee and International Strategy & Investment Group’s Steve Sakwa said REITs are poised to make purchases.

SL Green Realty Corp. last month agreed to sell 485 Lexington Ave., a Manhattan office tower, and Vornado Realty Trust last week sold 1999 K St. in Washington for prices that were “surprisingly high,” Guinee said.

“Although the volume of transactions are thin, the cap rates are low and the prices are high,” Guinee said. “There’s no reason for them to significantly underperform the S&P, unless other sectors start having significant earnings gains while REITs do not.”

Return to Deals?

Investor interest in making deals may slowly return by the middle of next year, real estate services firm Jones Lang LaSalle Inc. said in a report last week.

Banks emboldened by strong second-quarter earnings are “willing to dip a toe in the water and pursue new transactions with gold-plated sponsors collateralized by top-quality real estate,” said Bart Steinfeld, managing director for real estate investment banking at Jones Lang, in a statement. “Capital is available, but it is directed toward higher returns and prime product and major markets.”

With so few transactions, buyers and sellers can’t agree on prices. That’s scuttling lenders’ ability to examine comparable transactions, or comps, to evaluate financing requests, said Douglas Durst, president of the Durst Organization, the New York property developer of One Bryant Park, the Manhattan headquarters of Bank of America Corp.

“The lack of comps is making it more difficult to get financing,” Durst said in an interview. “Comps are necessary for lenders. They use the comps to see, if they have to sell the property, what they can get for it.”

Deal Volume Falls

The volume of office sales in the second quarter was 97 percent less than the market’s peak in the first three months of 2007, according to Real Capital. That reminds some investors and analysts of the S&L crisis.

“Some of the older folks in the industry I talk to said it has a similar feel to the early ‘90s, when transaction activity went to basically zero,” Fasulo said.

The early 1990s commercial real estate recession followed overbuilding funded by savings and loan associations. When those lenders failed, the Resolution Trust Corp., a federal agency created to dissolve seized bank assets, dumped the properties at whatever prices buyers were willing to bid, often for pennies on the dollar.

This time there’s no central clearinghouse.

“We’re not forcing the banks to disgorge” distressed properties, , said Susan Wachter, professor of real estate at the University of Pennsylvania’s Wharton School in Philadelphia. “It’s a different crisis, a far worse crisis.”

Zell Buyout

Based on Real Capital’s forecast, 93 percent fewer commercial-property transactions will be completed this year than in 2007.

Just $2.1 billion of properties were sold in the second quarter, the slowest in Real Capital’s database. It was the eighth in the last nine quarters that office sales fell, going back to the start of 2007, when a record $77.617 billion of properties were traded.

The largest commercial deal was Blackstone Group LP’s $39 billion acquisition of Sam Zell’s Equity Office Properties Inc. in 2007. This year so far it’s the $590.3 million sale of Worldwide Plaza in Manhattan in July.

It took a group led by closely held George Comfort & Sons three attempts to work out the purchase of the Worldwide Plaza complex, the last of seven midtown towers sold by Deutsche Bank AG after it foreclosed on owner Harry Macklowe.

‘Stress Tests’

Bidders looked at the building’s rent roll and conducted “stress tests” to evaluate prospective returns, said Doug Harmon, senior managing director of Eastdil Secured LLC, who brokered the sale of Worldwide Plaza and 1540 Broadway in Manhattan this year. “Two years ago, people didn’t do too much stressing and transactions were accomplished on expedited time frames,” he said.

“Buildings were trading month over month at higher values, so you had to move fast if you wanted to get in the game,” he said. “You didn’t look at justifying every little thing.”

Banks remain skittish, said Chandan of Real Estate Econometrics, a New York- based research firm.

In the first five months of this year, Real Estate Econometrics found that 17 lenders including New York-based JPMorgan Chase & Co. and Bank of America of Charlotte, North Carolina, were more likely to refinance or restructure property loans for existing clients than offer new loans by a ratio of two to one. The findings were based on Treasury Department data, Chandan said.

Economic Forces

Maturing commercial property loans are high on the “worry list” of San Francisco Federal Reserve President Janet Yellen, she said in a July 28 speech to the Oregon Bankers Association.

“Our biggest concern now is with maturing loans on depreciated commercial properties,” Yellen said. “The economic forces hammering commercial property are unlikely to reverse any time soon.”

The entire real estate dynamic has shifted, said Frank Liantonio, executive vice president of Cushman’s capital markets group. Liantonio, 60, with a career that goes back to the early 1970s, said he’s been through six down cycles from the mid-1970s to the dot-com bust of the early 2000s. This is the worst, he said.

“Property is no longer controlled by the owner,” he said. “It’s controlled by the lender, and the lender in most instances doesn’t have the ability to take the charge to earnings and sell the property. That’s one reason why you’re not seeing any transactions.”

To contact the reporter on this story: David M. Levitt in New York at dlevitt@bloomberg.net.

Last Updated: September 11, 2009 16:03 EDT