In a grim year, nowhere have things seemed bleaker than in US residential property. But might its woes be replicated in the commercial property sector in 2008?

Median home prices sank in 2007 for the first year since the Great Depression. Things are widely expected to get worse in the next 12 months, as the leverage boom that was fuelled by inflated home values unwinds painfully, driving prices down further. Mortgage loan defaults are likely to increase sharply, while even aspiring homeowners with good credit are struggling to secure mortgages. With little sign so far that the Federal Reserve’s interest rate cuts are easing the credit squeeze, potential buyers may not find much relief in the near term, which will keep sales activity paralysed.

As banks continue to take subprime writedowns, there are concerns that their commercial mortgage investments may be next. The commercial property market has held up well but vacancy rates have stopped falling on every property type and have even risen in some segments. Commercial real estate’s implied risk, though far lower than for residential property, has doubled since August, based on trading of commercial mortgage-backed securities indices. Of the more than $3,000bn in commercial mortgages outstanding, JPMorgan now expects $52bn to be written down.

Various factors will determine the commercial property sector’s health. Consumer spending has slowed less than expected but retailers are still finding their profits pinched. And while office prices remain sky-high in many US markets because of limited supply, the amount of space available to sublet has ticked higher.

Corporate profits are likely to dictate how much commercial real estate prices slide. Analysts have already pared back their earnings projections for 2008. If the picture darkens further, commercial property is extremely vulnerable.

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