By the end of 2007 as the credit crunch spread to all corners of the capital market; the downward re-pricing of commercial real estate assets had begun. The transparent nature of the UK market has been quick to reflect this. In New York, the initial impact of the credit crunch resulted in a curtailment of sales activity, with the volume of investment sales markedly down in the last quarter of 2007 from the same period in 2006. In most other regional markets, the pace of investment activity had not been as aggressive, so the slowdown was not as dramatic. Nevertheless, it did start in these other markets and will surely continue for at least the first half of 2008.

The actual property operating fundamentals, however, continued to perform quite well throughout 2007. In New York, for example, the amount of leasing activity and the net absorption of space did slip in 2007from the levels in 2006, but both remained positive. Avery low vacancy rate was maintained and there was continued upward pressure on rents. In virtually every major market around the world, vacancy rates were low and rental growth remained in force.

Global economic growth sustained itself in 2007, but major shifts in relative strength were clearly apparent. High oil, metals, and agricultural prices along with the foreign trade deficit were draining growth from the US economy. Europe and Japan began to be impacted by the same factors. The net exporters in Asia and the commodity producers in other parts of the world prospered.

It appears that the property market operating fundamentals in 2008 are likely to follow a similar cycle. In 2008, vacancy rates could move upwards in many US and European office markets, while prime rents are likely to grow at a slower rate, or may even fall in some markets.

While the broad contours of property performance in 2008 are fairly apparent to most, it is, however, extremely difficult to quantify the precise dimensions of the cycle. The global economy and as a result the property markets are sailing into a storm in 2008. This tempest, however, was not anticipated by the forecasters or the captains of industry, even as the winds started to blow. More troubling, they are still uncertain about what caused the storm, its length, how widespread it will be, or its severity.

The collapse of the US subprime residential mortgage market has been held largely accountable, but the eventual losses in the US subprime mortgage market are expected to total $200 billion, a very small portion of the equity and reserve base of the global financial system. The protracted credit crunch has to be the result of some broader event, like the re-pricing of risk, and the credit and capital markets are still sorting out what will be the equilibrium risk adjusted yields. As a result, there has to be some legitimate ambivalence about both the operating performance and the market valuation of real estate assets during the next year.

Read the full Knight Frank report below:

Global Real Estate Annual Market Review and Forecast 2008 PDF

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