INVESTMENT REVIEW:The market may have another 10 per cent to fall before bottoming out but even more important is how long it will stay at the bottom, writes JACK FAGAN

COMMERCIAL PROPERTY is experiencing its worst crisis in decades.With prime capital values already down by 30 to 35 per cent, some property advisers contend that the market has another 10 per cent to fall before there can be any prospect of it bottoming out. Even more important is the question of how long it will stay at the bottom.

The answers to these questions may well emerge in the new year once the Government's guarantee of the Irish banking system and plans to recapitalise individual banks has been completed.

The property market cannot function without credit facilities - as we have seen over the past year. In that time, the entire commercial property market has been devastated by the liquidity crisis.

Turnover in the investment sector has dropped from almost €2 billion to a little over €300 million. Development sites have fallen in value by up to 40 per cent in cities and by up to 60 per cent in the provinces. Plans by the major banks and leading professional bodies to relocate to ever bigger office developments in Dublin have been shelved indefinitely.

Several new shopping facilities have been put on ice because of the uncertainty over financing and the reluctance of anchor tenants to make commitments at a time when consumer sentiment is declining. Sales of pubs and hotels have virtually stopped in response to the credit crunch and the fall off in business.

Some agents are suggesting that the overall turnover in 2008 will be as high as €500 million by including the €101 million sale of the Gaiety Centre on South King Street and the second phase of The Park in Carrickmines for €96 million. However, both deals were signed off at the end of 2007.

Confirmation of the battering the market has taken will come shortly from the reputable London-based research company IPD when it reports the worst performance for three decades. Retail capital values alone are likely to be down by at least 35 per cent by year end.

Equally disappointing is the fact that overall returns from the commercial market will be down by around 30 per cent when the Christmas holidays are called.

The long overdue readjustment in development site values has obviously left quite a few developers and investors badly exposed.

It has also undermined confidence in some of the lending banks which have been reluctant to acknowledge that they funded a vast number of overvalued sites. A new set of market dynamics comes into play on site values when house prices are falling and there is no demand for commercial buildings.

With the banks now finally au fait with the real value of these sites, they are unlikely to embark on a spate of forced sales for the simple reason that, even if there are buyers out there for some of them, the credit lines have been severed.

It is only when the first-time buyers can get mortgages and small businesses secure working capital that the system will begin to work again. Then the banks should be able to offer restructured loans on problem sites or move loans from one borrower to another whom they believe is in a better position to carry out a development.

While most attention has focussed on the troublesome development sites, the immense problems created by falling values has impacted on a much broader range of investors, some of them small players, others in the medium range and more at the top end of the international investment market.

Ireland is not the only market to have seen a dramatic fall in values. The old axiom that property is a long term play no longer holds good when values are continuously slipping and rents are falling behind expectations. The once thriving business of raising mezzanine finance is no longer an option because of the substantial number of small and medium-sized investors who have taken a drubbing as a result of much reduced site values and the unlikely prospect that many of these developments will ever proceed.

With capital values falling fastest in the Irish retail sector over the past year, some of those who invested heavily in new shopping centres have seen their stakes implode. A number of the shopping centres opened over the past few years are struggling to keep their head above water and face an uncertain future if the cutback in consumer spending is prolonged by a lengthy recession.

The prospects for some of the new retail parks look even more dire, simply because there are too many of them and some of them don't serve a sufficiently large population. A few of these parks, either in the pipeline or under construction, may not open for some time because of the reluctance of multiple traders to make long term commitments when consumer spending is on the decline and the threat of a recession seems more likely each day.

No one expects that the lavish borrowing of the boom years will return for a considerable time but, with governments now guaranteeing their banking systems and putting the banks under pressure to inject more liquidity, there is some hope that confidence could be gradually restored to the market before the end of 2009.

And with yields on prime investment properties steadily drifting out and interest rates set to fall further early in the new year, buildings on the high streets may well have a renewed appeal to cash-rich individuals.

Marks Spencer has been one of the first to acknowledge that Grafton Street values have fallen by offering the new Tommy Hilfiger store for sale at around €30 million. At that price it would show a yield of 5.25 per cent compared to the 2.5 per cent agreed a year ago on the superior River Island and Wallis buildings also on Grafton Street.

Investment values in the UK adjusted quite rapidly towards the end of 2007 but have been slow to fall into line here. Several institutions have been discreetly looking for offers on Dublin city centre buildings in recent weeks and, while some of them would settle for yields of 5 per cent-plus, others still have not accepted that values have fallen so dramatically.

Royal Liver, which may be tempted to sell off some of its high street properties, values its portfolio once a year in December and is still apparently going by the old book value. Fear not, the penny will drop one of these days. With investment funds so tight and banks drastically reducing the loan-to-value ratio, real buying power in the investment market has been seriously eroded.

For the first time in many years, buyers are reluctant to pitch for Grafton Street buildings where rent reviews are still outstanding or where there are any doubts about the strength of the covenant. "Buyers want certainty on several fronts and, with a greater choice of buildings now available on Grafton Street, they can pick and choose," says an agent acting for one of the institutions.

The tradition of paying a deposit on signing a contract and making it subject to a bank loan offer has also been discontinued because of the increasing tendency by vendors to pitch for the deposit if the transaction is not completed. Sean O'Neill, head of investments at DTZ Sherry FitzGerald, says the traditional view of property - rent pays down debt and equity is built up through debt reduction - was coming back into focus again. Property must now pay for itself from day one with returns based on assumptions on rental growth now heavily discounted. It's back to basics.