In the midst of what some are calling a jobless recovery, vacancy rates are also under pressure from new space delivered in the market. Some 35 million sf of new space came on the market in the first half of the year, and another 34 million feet of new construction will be delivered in the second half of the year.

Meanwhile, sublet space nationwide is estimated to have reached 150 million sf, and shadow space--space leased by companies for expansion but now sitting empty--could account for up to 5% of all unused office space.

The process of converting this vacant space to economically vacant space will stress some borrowers and will increase the downward pressure on rental rates in some markets--most notably in suburban areas. One of the more interesting twists to the current downturn is that while performance as a whole is deteriorating, investment-sales activity for office properties has been robust. Pent-up demand in the wake of Sept. 11 and an appetite for investment-grade and trophy properties have pushed down office cap rates to an eight-year low.

The apartment sector, historically considered a safe haven by real estate investors, should continue its decline through the end of the year before beginning to recover in 2003. Vacancy rates should peak at 6% to 7%, just shy of the highest levels of the last recession.

The national average vacancy rate increased a nominal 10 basis points in the second quarter to 5.8%, moderating from the 90 to 100 basis point increases in each of the previous two quarters.

With mortgage rates near all-time lows, and home ownership at record levels, apartment owners face stiff competition in attracting tenants. Overbuilding was also expected to contribute to a further softening in the market through year-end, with 80,000 new units coming online during the second half of 2002.

Despite the deteriorating factors, multifamily CMBS-loan delinquencies have remained stable during 2002, in part because borrowers built up cash-flow cushions from substantial run-ups in apartment rents from 1997 to 2000.

The hotel sector, hardest hit by the terrorist attacks of Sept. 11 and the economic downturn, continues its painful recovery. Year to date, the industry benchmark revenue per available room is down about 7%.

Barring any additional terrorist events, we anticipate a return this fall and winter to slow RevPar growth commensurate with economic recovery. Although increased domestic and leisure travel has contributed to a rebound in occupancy levels, business travel, which is linked to corporate profitability, is critical to a sustained recovery in hotel revenue growth.

Retail continues to be one of the bright spots in the commercial real estate sector and in the economy overall. The retail market is already showing some signs of overall stability, although some metropolitan areas--including Orlando and Phoenix--continue to suffer from oversupply.

Due in part to the lagging nature of the commercial real estate sector, overall commercial real estate delinquencies and foreclosures have remained at their lowest levels in more than 20 years, even as vacancies recently topped 10%--the highest level since 1994.

As we look forward to the end of the year and into 2003, this dichotomy of low delinquencies and high vacancies sends a clear warning about the direction of the market. But with loans underwritten to sustainable rents and realistic vacancy levels, and riskier loans kicked out to B-piece buyers, we believe CMBS loans can withstand substantial revenue declines without a significant increase in defaults in the coming months.

Think Tank member Ben Williams heads Wachovia Securities' fixed income division, which includes a real estate capital markets group that originated more than $3 billion in CMBS issuance last year. Williams guided the formation of Wachovia Securities' commercial real estate investment banking business over the past two years.

Brian Lancaster is a managing director and head of Wachovia Securities' real estate and CMBS Research.