Weak U.S. housing markets and rising unemployment at the state level are leading indicators of deteriorating commercial property loan performance, according to Fitch Ratings. As a result, Fitch expects commercial properties in the most impacted states to continue to face greater cash flow stress until the housing market and unemployment begin to show signs of recovery.

Among major property types, U.S. CMBS loans backed by multifamily, retail, and office properties are defaulting almost 30% more frequently in states most impacted by these economic factors. In contrast, hotel defaults correlate more closely to broader economic factors including GDP, consumer spending and corporate earnings.

"Though commercial loan default rates are rising nationally, properties in Florida, Michigan, Arizona, Nevada and California are proving to be particularly vulnerable," said Managing Director Eric Rothfeld. "These states represent approximately 25% of all retail, office, and multifamily loans in Fitch-rated U.S. CMBS transactions and are likely to see more rapid and material declines in performance."

Through the end of January 2009, housing prices in these states have experienced peak value declines almost 50% higher than nationwide averages, foreclosure rates almost 20% higher and local unemployment rates almost 20% higher. Although the commercial sector had remained somewhat resistant to housing market pressures through the third-quarter 2008, commercial real estate loan defaults as of the end of January 2009 increased to 1.15% from 0.43% in September 2008.

Multifamily loans in these states have a default rate of 4.1%, the highest of any property type and more than 20% above the national average. Speculative multifamily construction in these states outpaced nationwide levels and supply has not been absorbed as expected. In addition, further competition has developed from single-family homes that have entered the rental market as foreclosure rates have increased.

Retail loans in these states have a default rate of 1.2%, almost 20% above the national average. Consumers continue to face unemployment pressure and declines in real estate and equity values and have dramatically reduced their discretionary spending. Several recent large retailer bankruptcies have impacted these markets at an accelerated pace as store closings typically occur first in areas with weaker sales and overbuilding.

Office loans in these states have a default rate of 0.65%, more than 40% higher than the national average. Higher unemployment rates demonstrate the large impact of the economic recession on local businesses. Many financial services firms that supported booming housing markets in previous years have consolidated or closed. Because housing growth has not materialized as expected, these states are now faced with an oversized office infrastructure which has resulted in declining rents and increasing vacancies.

In the current economic recession, tenants are trying to re-negotiate rental rates with commercial borrowers to help reduce their own costs and maintain profitability. As market rents decline, many tenants signed to long term leases will likely be able reduce rental payments in markets where the ability to lease vacant space is significantly constrained.