As if investors didn’t have enough to worry about, a new danger is brewing that the country’s most bearish investment newsletter says could roil the financial markets. In brief, it sees an accelerated national downturn in commercial real estate.

The associate editor of the Safe Money Report newsletter in Jupiter, Fla., Michael Larson, citing what he says are growing signs that this sector will be the next shoe to drop, is making a compelling argument that investors who have put their money to work in such related areas as construction, real estate investment trusts, and financial companies involved in lending to commercial real estate businesses face a new wave of losses.

“The downturn in commercial real estate shouldn’t be as bad as what we’ve seen in residential real estate, but it should be bad enough,” he tells me.

The Federal Reserve also takes note of the risks, having reported that banks are starting to take write-downs on commercial mortgage-backed securities. Furthermore, the Fed notes that delinquencies on commercial real estate loans surged in the fourth quarter of 2007 to 2.71%, the highest level since the fourth quarter of 1996, and more than double the year earlier’s 1.32%.

One of the early voices to flash warnings of impending risks in the residential area, Mr. Larson argues that commercial real estate developers unfortunately committed the same financial blunders as their counterparts in the housing sector. In brief, they borrowed too much money in an easy lending environment while factoring in excessively optimistic projections for rent growth, and assuming vacancy rates would forever hug their historic lows.

With the economy slumping, however, and many new subdivisions turning into overnight ghost towns, Mr. Larson observes that the immediate result has been near-empty strip malls, vacant storefronts, and deserted office parks. Underscoring the weakness in the retail sector, he points to a recent survey of 22 leading chains by CoStar, a provider of commercial real estate information, that shows they are now closing or planning to close more than 2,000 stores. That cutback, Mr. Larson says, is going to send vacancy rates much higher and drive rents lower.

In a nutshell, he says, “companies that own commercial real estate are on the ropes as the value of their properties begins to fall.” He further predicts companies that develop, sell, and manage commercial buildings are going to suffer severe earnings declines.

Adding to the woes, Moody’s Investors Service is already projecting a 15% to 20% drop in commercial real estate prices over the next few years. Given a rising number of telling signs of increased weakness, Mr. Larson says he feels that Moody’s is understating the speed and depth of the decline. Among those signs:

• Private, nonresidential construction spending dropped in February for the third consecutive month after posting gains in prior months of between 1% and 2%.

• February billings, according to the American Institute of Architects, dropped 8.9%, the biggest monthly decline since September 2001. That signals a further drop in construction spending.

• In this year’s first quarter, Manhattan experienced the lowest level of sales since 2005; the quarter also showed a 91% drop in year-over-year transaction volume.

“There may be a diamond in the rough, but I would avoid all real estate investment trusts: ditto anything related to commercial construction,” Mr. Larson says.

He notes that investors in commercial mortgage-backed securities are already getting their heads handed to them on platters as fear of rising delinquencies and default rates gut the value of their portfolios. The evidence is the extra interest premium investors are demanding on triple-A rated CMBS bonds compared to Treasuries — it has exploded to a hefty 3.4% from a mere 0.74% a year ago.

Mr. Larson figures the most effective way “to profit from this mess” is an exchange-traded fund, the UltraShort Real Estate ProShares, which is designed to rise 20% for each 10% decline in the Dow Jones U.S. Real Estate Index.

As for residential real estate, Mr. Larson takes strong issue with those brokerages pushing investors to buy some beaten-up housing-related stocks. It’s “too soon,” he says. A lot of excess inventory and tightening lending standards suggest the potential for further declines in housing prices, Mr. Larson says. He added: “I think you’re talking about dead money for at least the remainder of the year because any housing recovery is likely to be a lengthy, drawn-out process.” As for government action to help revitalize housing, Mr. Larson hastens to point out that “there is a risk such efforts might fail.”

dandordan@aol.com