US commercial real estate suffered its worst annual capital return since at least 1978*, according to the IPD US Quarterly Property Indicator, which fell -23.9% in 2009, taking the total capital decline to -33.4% from December 2007 when real estate values were at their peak. Ireland was the world's worst performer with a dip of 28.9%.

While the pace of market value decline eased over the final quarter, continued cap rate pressure together with weakening rental fundamentals is curbing optimism that 2010 is the year of recovery. Cap rates softened by a further 140 basis points over the year to end 2009 at 7.1%, the highest level in six years.

Five City Analysis:In an analysis of commercial real estate in five major cities in the US, IPD shows that New York, Washington and Chicago all suffered slightly less severe market value write-downs than the broader US market. Conversely, the West Coast markets of Los Angeles and San Francisco have fallen further than the national average.

Over the entire peak-to-trough, New York has suffered a steeper re-pricing cycle than the US average, falling by 34.3%. The chart above shows the five cities annual capital return with the full peak-to-trough decline. San Francisco commercial real estate market values declined the most over the quarter (-4.1%), the year (-27.5%) as well as overall peak-to-trough (-39.4%). The city‟s cap rates are now equal to the national average (7.1%).

In the five city analysis, Washington‟s market values fell 180 basis points less than the broader US market over the full year (-22.1%) – and by 200 basis points peak-to-trough (-31.6%). The city which delivered the shallowest quarterly market value decline was Chicago (-2.1%).

“2010 in many ways is a crunch year for US commercial real estate," said Simon Fairchild, Managing Director for North America at IPD. “The 'extend and pretend' policies banks adopted last year to stave off loan-to-value covenant breaches may have curbed the tide of rising loan delinquencies in the short-term, but lenders and investors need to always retain a vigilant eye on the health of real estate fundamentals. One focus this year will be to track signs of stress in occupier markets; particularly in cities with rising vacancy rates.”

East-West Coast Divide: Over 2009, there was a distinct geographic trend in the pace of capital depreciation, with the East Coast outperforming the West Coast in all four main sectors  -- offices, retail, industrial and apartments. In addition, the East Coast delivered the lowest geographic capital decline, outperforming Mid West and the South, in retail, offices and industrials. In the apartment sector, the Mid West returned the shallowest annual capital decline.

Investment Returns:US commercial real estate income returns were robust in 2009 at 6.6%, partially offsetting the falls in value and contributing to an annual total return of -18.7%. At the sector level, the strongest performer was retail, which outperformed the all property
average by 390 basis points, returning -14.8%, while at the other end of the spectrum offices underperformed the wider market by 220 basis points, delivering -20.9%. The industrial and apartment sectors returned -20.2% and -17.0% for 2009, respectively.

Over three, five and 10 year periods, US commercial real estate has returned -4.9%, 3.3% and 6.3% per annum.

Global Comparisons:  The -23.9% 2009 market value decline in US commercial real estate compares with a -3.8% decline in the UK, buoyed by a fourth quarter rally which saw British property markets climb by a record 8.1%. The historically stable Netherlands real estate market fell by -5.6% over 2009, while the world's worst hit market, Ireland, fell -28.9%.

*This takes into account IPD‟s US data, which began in 1999, and the US NPI (National Property Index), which dates back to 1978. IPD is a London-based property index company.