Platform:Here's the next shoe to drop as a result of the bursting of the credit bubble: US commercial real estate. It won't be anywhere near as dramatic as the fallout in the residential real-estate market. But, at the same time, it won't simply be a temporary disruption in financing followed by a modest correction in pricing, which the industry is predicting, writes Steven Pearlstein

The office vacancy rate along the Dulles corridor around Washington DC has climbed to 14.2 per cent from 13 per cent in the past year, according to CoStar Group's latest data.

In markets such as Washington, New York, Boston and San Francisco, the last four years have been among the best the industry has seen - falling vacancy rates, rising rents, soaring values and a tonne of new development. But that's all about to grind to a halt as financing becomes more expensive and restrictive, the economy slows, and a slug of new inventory hits the market. "It's over," one local developer told me this week. "It was a great ride, and now it's over."

You can date the beginning of the end of the commercial real-estate bubble to February of this year, when the Blackstone Group closed on its $39 billion (€28.6 billion) purchase of Sam Zell's Equity Office Properties, the largest single commercial real-estate portfolio in the US.

Within weeks, Blackstone had sold off a chunk of the Equity Office portfolio for $18.5 billion - at even higher prices than it had paid.

In June, Tishman Speyer and Lehman Holdings offered to buy another big real-estate investment trust, Archstone-Smith, for $22 billion.

In the past few weeks, however, as lenders and investors have begun to come to their senses, the market for "commercial mortgage-backed securities" (CMBS) has virtually shut down. Those are the packages of commercial real-estate loans that are sold off in pieces to hedge funds, pension funds and other institutional investors. And without that cheap and easy financing, neither Macklowe Properties nor Tishman/Lehman have been able to secure permanent financing for their deals, putting them in an awkward position.

They are not alone. In Washington and across the country, there are reports of sales falling through or being held up by buyers seeking a lower price. And with financing costs uncertain, new deals have been put on hold.

Developers who have just completed buildings and need to convert their construction loans into permanent financing are finding that the only lenders interested in talking are banks and insurance companies, which traditionally hold their loans on their own books rather than selling them into the securities markets. These "portfolio lenders" charge higher rates and demand lower levels of debt.

All of this is likely to sort itself out within a month or two. But when it does, it will have a significant impact on prices.

In recent years, commercial real-estate prices have been driven up by buyers such as Blackstone and Tishman, who were able to bid up prices as long as CMBS lenders were offering low-rate, interest-only financing for as much as 95 per cent of the purchase price. But in the future, if the only financing available is for interest and principal loans at 75 per cent of the market value, with an interest rate a percentage point higher than before, the price that investors would be willing to pay for a building, given the same market conditions, could be 20 to 25 per cent less.

Unfortunately, market conditions are not the same as they were six months ago. As the US Federal Reserve acknowledged last week, the market turmoil is likely to cause a slowdown in economic growth and raise the risk of recession.

And in markets such as Washington, the pace at which buildings have been leasing has slowed even as a large number of new buildings are about to come on line. According to CoStar Group, office vacancy rates along the I-270 corridor have risen to 11.6 per cent from a low of 9.7 per cent a year ago. Buildings under construction will add another 5 per cent to supply over the next two years. For the moment, DC's office market remains strong, but it is hard to imagine that it will be able to absorb all the development that is slated for the next five years.

Over the past year, local real-estate types have tended to dismiss suggestions that the market is overheating. Their story was that the Washington economy is relatively immune to downturns, and a global savings glut would keep interest rates low. With a large number of low-rent leases set to expire in the next couple of years, they were counting on big spikes in rental income. However convincing that story was six months ago, it sounds a lot less convincing today.