To get a sense of just how nervous real estate investors are, consider CB Richard Ellis Group Inc.


The world's largest real estate services firm not only soundly beat Wall Street expectations with its second quarter earnings but doubled its 2007 guidance.


But all that apparently amounts to little. Investors have punished the stock, which is off nearly 40 percent in the last two months.


Though the El Segundo company is highly diversified, at its core it's a commercial brokerage, and the fear these days justified or not is that the commercial real estate sector won't escape the larger market downturn spurred by the collapse of subprime lending and the stagnant housing market.


"I think what has taken place with the residential side and the subprime has impacted the sentiment of lenders on the commercial side but there really is limited linkage between residential and commercial space," said Chief Financial Officer Ken Kay.


Limited or not, over the past two weeks at least three analysts have downgraded the company and shares have continued sliding, closing at $25.52 on Sept. 13. As recently as July 19 the shares reached a high of $41.57.


Though a majority of analysts covering the firm still rate it a buy, the most recent hit came early last week when Goldman Sachs analyst Jonathan Habermann downgraded the company along with two real estate investment trusts from "buy" to "neutral."


Even as he wrote that "growth prospects for the company's leading global platform remain positive," Habermann concluded that the tightening of credit terms would likely reduce the company's volume of sales transactions.


Though the company does everything from managing property, to investing in real estate, to developing projects, commissions on brokered commercial real estate sales generated 31 percent of second quarter revenue.


"We believe that the shares could continue to be choppy in the near term," wrote Habermann, who expects the company to see a 15 percent decline in investment sales revenue next year.


Big acquisition

Kay maintains that the fears are overblown, and the debt market where mortgages are securitized and resold is not as volatile in commercial real estate as it is on the residential side.


"There is still a lot of active trading taking place in the marketplace. There are still traditional players that are still participating," Kay said, even though he acknowledged "the cost of leveraging is a bit higher or transactions take longer."


Will Marks, an analyst for JMP Securities LLC, said that he agrees that the commercial market will not experience much more than a short-term decline once initial fears over a wider real estate meltdown subside.


"There is too much money chasing commercial real estate for transaction levels to not pick up perhaps not to first-half 2007 levels but to still strong levels," said Marks, who rates the company a "strong buy."


Though rents are starting to relax in some markets, occupancy rates are high nationwide and there remains a strong demand for space. Moreover, the company, which has expanded into international markets, is seeing a boost from overseas business.


In the second quarter that ended June 30, CB Richard Ellis saw revenue rise more than 70 percent to $331 million in Europe, the Middle East and Africa, and nearly 40 percent to $122 million in the Asia Pacific region. But the company may not be geographically diversified enough.


JP Morgan analyst Michael Fox, who reiterated his "overweight" rating on the company in his last research note, acknowledged that a risk for investors was its continued relatively high exposure in the high-priced New York and California real estate markets "Leaving it vulnerable to the local economic and political conditions."


Another big issue for the company is its $2.2 billion acquisition of Trammell Crow Co. in December. The acquisition boosted the company's property management and development arms, but some question whether the costs of paying off the transaction will slow long-term growth.


"As a company continues to grow, there are things that can slow it down," said Michael Arnold, a managing principal at Newmark Knight Frank, the largest privately held real estate company in the world. Arnold spent about five years as a commercial broker with CB Richard Ellis Group in the 1990s.


Moving forward

However, Kay called the acquisition of Trammell Crow "very opportune" for the company with a "tremendous amount of benefits."


"It affords us a tremendous amount of revenue-generating sources going forward," he said.


Indeed, in the second quarter, the Trammel Crow unit accounted for a majority of the company's revenue growth in the United States and other parts of the Americas.


"CB is generating so much cash flow it will pay off the debt associated with that transaction very quickly. I have no doubt about that transaction," Marks said.


Habermann outlines a scenario in which the credit markets deteriorate further, depressing the commercial real estate market for a prolonged period. However, Habermann believes that a "middle of the road" situation is more likely.


For this to occur, the Fed would have to keep interest rates low, something that last week appeared more likely as fears of a recession grew on bad jobs reports and other news.


Kay agreed that interest rates will be critical in determining commercial real estate deal volume, a major revenue driver for the company.


"Only time will tell," he said. "It is a function of what the Fed does and perception in the marketplace. Generally the fundamentals in the marketplace are still pretty solid. The underlying economy, growth in jobs and fundamentals supporting the capital markets are very sound."

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