The longer the markets remain shaky, the more investors look for signs to foretell the future. A new report by Standard & Poor's reveals that the past hasn't been as rough as expected for much of the real estate industry, yet the future remains unclear.

While the outlook for the coming months is somewhat murky, commercial mortgage-backed securities (CMBS) are continuing their solid performance so far this year. The CMBS segment has joined most other real estate sectors in surprising investors with both solid returns and good fundamental performance in the first half of 2001.

Yet the picture isn't necessarily rosy for the rest of 2001, according to S&P. In a recent study of the commercial property market and CMBS, S&P determined that some weakness is beginning to show.

In the office properties segment, says S&P, the largest percentage increases in vacancy rates are occurring in regional markets that once enjoyed the most rapid rental increases, including the tech-wrecked centers such San Francisco and San Jose. In addition, many regional markets in the Northeast have also begun to show weakness, including a number of submarkets in Manhattan, central New Jersey, and Fairfield County, Conn.

Development activity also is responding to the increase in vacancy rates. Additional office, retail, and industrial development is about 10 percent to 15 percent less than the rate of development in 2000. New construction for hotels and health care facilities has been falling for about a year already, and the rate of multi-family construction has been flat for more than a year.

CMBS activity is particularly strong overseas. International CMBS activity for the second quarter was about $6.4 billion, with $5.7 billion of this occurring in Europe.

"Although the breathtaking level of issuance from Europe in the second quarter should come as no surprise, considering the large pipeline of deals available going into the period, it is somewhat surprising to see the ease with which these transactions are absorbed by the market," said Clayton Hunt, Jr., managing director of international CMBS in S&P's structured finance group.

"The depth of the investor market," he said, "is paving the way for what will surely be a new record in international CMBS issuance in 2001."

A couple of CMBS segments, however, already are showing signs of struggle forced by the economic downturn. Overall, just over 1 percent of CMBS loans were delinquent in the second quarter, a strong 8 percent increase over the first quarter.

In the hospitality market, which has seen its share of trouble thus far in 2001, full-service mid-price hotels account for the majority of delinquent hotel loans within the S&P CMBS pools.

Although hotel delinquencies, or loans more than 60 days past due, make up only 1.4 percent of CMBS-rated hotel collateral, the full-service mid-price segment represents about 55 percent of that total.

S&P blames much of the trouble in this segment on older properties and tired brands, as well as an abundance of new limited-service hotels that have opened during the past few years, according to the report. Supporting this argument is the Holiday Inn chain, which has the greatest delinquent loan balance of the hotel chains rated by S&P.

Another hard-hit segment is REOs, which are properties that have been foreclosed upon and are currently owned by the CMBS-issuing trust. REOs saw a 45 percent increase in loan delinquency in the second quarter. Two-thirds of these properties are from the lodging and healthcare industries.

There is some good news, however. S&P reports that regional malls are going strong, and commercial mortgage transactions for regional and super-regional malls remain stable.

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