Investment Trends Quarterly

Transcription

1 Second Quarter 2008 Report Vol. 4, No. 2 Spotlight on Portland Sponsored by:

2 InThisVolume Now Available! National Overview Caught in the Storm Economic Background & Investment Environment A Focus on Real Estate Cap Rate & Yield Rate Expectations Seeking Shelter from the Storm Effect on Real Estate National Market Analysis & Property Sector Highlights Sustainable Development Shapes Portland Past and Future Contributors Scope & Methodology Regional and Metro-Level Analyses Coming Soon! East Region Baltimore, Boston, Charlotte, Hartford, Norfolk, Northern New Jersey, New York City, Pittsburgh, Philadelphia, Raleigh, Richmond, Washington, D.C. South Region Atlanta, Austin, Dallas/Ft. Worth, Houston, Memphis, Miami, Nashville, New Orleans/Baton Rouge, Oklahoma City, Orlando, San Antonio, Tampa Midwest Region Chicago, Cincinnati, Cleveland, Columbus, Detroit, Indianapolis, Kansas City, Milwaukee, Minneapolis, Omaha, St. Louis, Toledo West Region Denver, Honolulu, Las Vegas, Los Angeles, Phoenix, Portland, Sacramento, Salt Lake City, San Diego, San Francisco, Seattle, Tucson

3 Foreword April 2008 Dear Readers, Property fundamentals for commercial real estate are beginning to reflect the new economic and capital market storm we find ourselves in. Vacancies are up for all property types on a national level, and as noted in the second quarter 2008 RERC/CCIM, sales volume and pricing are starting to decline. What s more, the National Association of REALTORS (NAR) forecasts that until confidence levels return, commercial real estate investment will remain as much as 40 percent below transaction levels seen in 2007, when a record $427.2 billion of commercial real estate traded hands. Despite this softening, commercial real estate is holding up reasonably well compared to other investments, and CCIM designees and candidates who responded to RERC s survey remain optimistic about this asset class. While we see a great deal of turbulence in the commercial real estate debt market, according to anecdotal information gathered at the mid-year CCIM Institute business meeting, most CCIM members are expecting only an approximate 10-percent adjustment for commercial real estate this year. Given the turmoil in the markets, return expectations are of special interests thus our special analysis on yield rates, capitalization rates, and spreads. We hope you find this, and our other analysis of the capital markets, of interest. To make this research report even more valuable to CCIM members, we encourage you to share your completed sales transactions. Here s how: At go to the Member Services category, Click on the CCIM Transactions link (you ll be prompted to enter your regular username & password), Under the Professional Profile section, click the Manage Completed Transactions link, and Enter the transaction. Thank you to all who completed and returned our surveys, communicated your transaction information, or shared reports or other details about the various property sectors and markets. We appreciate your information and insights. Sincerely, Kenneth P. Riggs, Jr., CCIM, CRE, MAI President & CEO Real Estate Research Corporation (RERC) Timothy S. Hatlestad, CCIM 2008 CCIM Institute President President, RE/MAX Commercial Investment

4 CaughtInTheStorm Few, if any, could have anticipated how much the financial markets and the economy could change over the last 12 months. The commercial real estate market had reached a new pinnacle in early 2007, with The Blackstone Group s acquisition of Equity Office Properties (EOP), plenty of cheap capital, and a belief that we were on the cusp of a new era of investing with limited downside volatility. The storm clouds then began to roll in with the subprime mortgage meltdown, followed by declining home values, sustained high oil prices, and a slowing economy. The winds began to shift, and we saw the credit markets pause as the rating agencies finally started to sound a warning. Questions arose in the financial arenas about the underlying risk of securitized pools of mortgages involving a string of investors and elements that were unknown to even the most informed. By late 2007, there was a recognized credit crisis and we knew there were rough times ahead for the U.S. economy. Once the broad debt markets seized up and the eventual buyout of Bear Stearns (fifth largest investment bank in the world) occurred, the finger-pointing began in earnest, and even the past two Federal Reserve chairmen were pulled into the fray to comment on the state of the financial markets. These are the shifting conditions that are darkening the climate in which commercial real estate finds itself. The reach of the storm is global, and there is no end in sight. Further, the ripple effect of this storm is immense, with those sitting on the front lines either gone or forever changed in the way they conduct their business or approach the financial world. However, as we have pointed out in the past, the impact on the various investments and the magnitude of the change in investment conditions depend on your perspective and where you are sitting as this storm plays out for the balance of Real Estate Research Corporation s (RERC s) view, from a commercial real estate equity standpoint, is that low-leveraged commercial real estate is doing reasonably well relative to investment alternatives, and we see the market dynamics for this style of low-leverage equity investment from a credit disruption perspective rather than a credit crisis. Although Wall Street may challenge us on this optimistic approach to a world in crisis, RERC has remained focused on commercial real estate investing from a low-leverage equity perspective, and how investors can best cope with the turbulent conditions surrounding us all. This report will lay out our perspective for commercial real estate returns as we are tested and challenged to navigate through a tempest that most of us have never seen before. Economic Background & Investment Environment The year 2007 will be remembered for the many storm clouds in our economy the global financial markets, the U.S. residential housing market, gasoline prices, and geopolitical risk, among others. While the storm clouds have been hovering over the commercial real estate arena and the turbulence has affected the debt markets, the commercial real estate low-leverage equity market has not been as negatively affected as the residential market. Although the global credit crisis ripped apart the most sophisticated leveraged structures from a financial perspective, we did not see a collapse of home prices. As can be seen in Exhibit 1, even though home prices fell around 8 percent in 2007, they were still 70 percent higher than in first quarter We recognize that then was then and now is now, but it demonstrates that the undoing of the housing market lies in the financial package and not in the Exhibit 1. Historical Housing Prices Source: National Association of REALTORS (NAR), 4q 2007.

5 fundamental value of the asset. There is clear downward home re-pricing taking place in parts of the U.S. that experienced the most speculation, and we still have some tough realities to face before the market stabilizes. This is important to keep in mind when we examine the financial side of the commercial real estate market versus the asset side. The inability of investors to sort though the financial instruments that were created over the past decade has caused them to become more risk averse, and has brought established underwriting and investment criteria back to appropriate standards that focus on the fundamental value of the asset. Getting back to basics is not a bad thing, but one should not overreact to this situation. It is important to avoid the old pendulum paradigm of swinging from a sentiment of greed to a sentiment of fear. We see this happening on a limited basis, and it tends to guide commercial real estate to spots where one needs the pendulum to swing in the opposite direction, although commercial real estate did not experience the broadbased overselling and overleveraging that we saw in the residential sector. Investors are seeing a bifurcation relative to repricing issues in commercial real estate between top-quality, low-leveraged assets, versus average-quality, high-leveraged assets (75+ percent), although each set of assets is facing some level of re-pricing. Investors have a wait-and-see attitude, given the disarray and disappointment seen in the economy and financial markets, but who can blame them? However, despite what one hears in the news, investors are not totally outof-sorts with commercial real estate. It is no surprise that we continue to see the bid/ask spread widen, as sellers are not willing to sell at a discount, and buyers are not willing to buy at the ask price, given the uncertainty in the economy and financial markets. The profound shift in the sell sentiment can be found in the historical buy, sell, or hold recommendations shown in Exhibit 2. The sell recommendation during first quarter 2003 through first quarter 2007 hovered around 8.0 on a scale of 1 to 10, indicating that it was a good time to sell (prices were viewed as strong relative to value). Today, however, the sell recommendation is about half that level, Exhibit 2. RERC Historical Buy, Sell, Hold Recommendations Rating Q 1999 Source: RERC. Buy 1Q Q 2001 Sell 1Q 2002 Hold 1Q Q Q Q Q Q 2008 indicating that it fell quickly alongside the credit market concerns and now is not a good time to sell (properties are viewed as underpriced relative to what buyers will pay). This reversal occurred right after the Blackstone/ EOP deal, which will go down in history as a major market coup and pricing velocity watermark. The message the market is sending is that commercial real estate is a good investment and the pricing is not viewed as being too far ahead of the fundamentals, especially from a risk perspective and compared to alternative investments We have noted during the last year that the market has been going through a re-pricing phase and that investor sentiment is shifting to reflect the changing nature of the clouds that exist in today s turbulent environment. This is a clear signal that the commercial real estate capital markets recognized the credit crisis and that commercial mortgage-backed securities (CMBS) are temporarily on the sidelines. Given the big picture, commercial real estate is reacting appropriately to the alarm. If it had continued with the levels of first quarter 2007 CMBS underwriting that possessed aggressive pricing of high loan-to-value ratios and high valuations, commercial real estate would have un-

6 dergone a fate similar to that of the subprime market, and we would all be suffering. Oddly, this current commercial real estate market disruption (or crisis, for those on Wall Street) is better for long-term investment prospects for commercial real estate, and provides us with a more solid investment foundation without having to suffer a broadbased market failure like the residential securitized market. However, we know that it is not over yet, and there will be casualties along the way. As shown in Exhibit 3, CCIM designees and candidates rated commercial real estate at 6.7 on a scale of 1 to 10, indicating it is a better investment relative to the alternatives of stocks, bonds, and cash. This does not come as a surprise to commercial real estate investors, but they have always been a group that was somewhat biased Exhibit 3. CCIM Respondents Rate Investments 1Q Q 2007 Commercial Real Estate Stocks Bonds Cash Source: RERC Institutional Investment Survey, 1Q toward commercial real estate. Clearly, the respondents see many clouds above, and while preparing for a storm, are establishing strategies toward safer harbor. Exhibit 4 tells what investors are facing in a world of downside volatility. The only positive realized returns during first quarter 2008 are those reflected by the National Council of Real Estate Investment Fiduciaries (NCREIF) and the National Association of Real Estate Investment Trusts (NAREIT). The 10-year treasury bonds reflect expected returns versus realized returns. NCREIF and NA- REIT show almost no capital (appreciation) return, indicating that values flattened in first quarter 2008, and we likely are entering a time of potential value adjustments or re-pricing of the underlying assets. However, while commercial real estate is not performing at a level witnessed a year ago, it is still delivering positive returns. As we head into the second quarter 2008 and beyond, we need to assess the economy and what it holds in store for commercial real estate. If a recession takes hold and unemployment increases, vacancy rates are likely to increase, rents will deteriorate, and values will be affected by these strong undercurrents. With respect to the pricing of commercial real estate, the key thing is to assess where prices have settled on a price per square foot/unit basis, and what direction capitalization rates and yield rates are heading. Exhibit 4. What Do the Financial Markets Tell Us? Compounded Annual Rates of Return as of 4/1/2008 Market Indices 1Q Year 3-Year 5-Year 10-Year 15-Year Consumer Price Index 1.16% 3.98% 3.37% 3.00% 2.79% 2.68% 10-Year Treasury Bond* 3.66% 4.38% 4.52% 4.39% 4.81% 5.34% Dow Jones Industrial Average -3.06% -0.74% 5.30% 8.94% 3.37% 8.85% NASDAQ Composite -6.75% -6.11% 3.56% 10.83% 2.39% 8.27% NYSE Composite -3.60% -5.02% 7.07% 13.21% 3.80% 8.36% S&P % -6.91% 3.86% 9.29% 1.84% 7.43% NCREIF Index 1.60% 13.56% 16.84% 15.17% 12.70% 11.29% NAREIT Index** 1.40% % 11.69% 18.34% 10.69% 11.66% *Based on Average End of Month T-Bond Rates. **Based on FTSE NAREIT US Real Estate Index Equity REITs, Total Return. Sources: Economy.com, Federal Reserve Board, BLS, NYSE, NCREIF, NAREIT, compiled by RERC.

7 A Focus on Real Estate Cap Rate and Yield Rate Expectations Exhibit 5. RERC Yield Rates vs. 10-Year Treasuries Sources: RERC, Federal Reserve. Exhibit 6. RERC Yield Rates vs. 5-Year Treasuries Sources: RERC, Federal Reserve. Exhibit 7. RERC Yield Rates vs. 10-Year Treasuries Sources: RERC, Federal Reserve. Yield Rates As a starting point in examining return expectations, it is important to focus on the spreads of commercial real estate yields (total returns) versus 10-year and 5-year treasuries rather than reviewing these returns strictly on a nominal basis. In our evaluation, we are using both 10- and 5-year durations, because the holding periods for commercial real estate have shortened from the traditional 10-year holding periods, and because the durations of average leases that create these cash flows are probably something between that of 5-year and 10-year bonds. Regardless, we can see that the spreads in 2003 in both cases were huge, which meant that commercial real estate was a very attractive risk-adjusted investment and that capital was bound to flow into this arena. As one survey respondent stated, It was a no-brainer to invest in real estate. Then the market started to aggressively bid up real estate prices to bring this spread down to its lowest level in 10 years in the first quarter Since then, we have seen yield spreads for commercial real estate reach around 450 basis points over 10-year treasuries (refer to Exhibit 5), and 550 basis points over 5-year treasuries (refer to Exhibit 6). We recognize that spreads for other financial instruments have widened much more and at a more rapid pace during this credit crisis. Since second quarter 2007, the market has been re-pricing commercial real estate risk relative to treasuries. On historical terms and given the dynamics of commercial real estate today, the spread is at least recognizing market risk vagaries. This shift in attitude is demonstrated in Exhibit 7, showing the significant upward percentage change in commercial real estate yield expectations during the second quarter 2007 from a 10-percent decline to a net upward shift of over 25 percent (-10 percent versus +15 percent). Are we there yet? Probably not across the board, but for the low-leverage, high-quality deals, we are getting close. From our vantage point, the biggest question that the market is wrestling with today is: How do you price risk for commercial real estate when there are fewer transactions to measure investor behavior?

8 Cap Rates The market tends to talk about pricing in terms of capitalization rates on a nominal basis. Cap rates are a simple performance measure and an easy metric to extract from actual transactions; however, a cap rate does not give you the full picture like a yield rate or internal rate of return (IRR) can provide. During the last few years, RERC and others have commented on this era of cap rate compression, as depicted in Exhibit 8. Since 2004, cap rates have declined by 200 basis points, much of which is attributable to spreads over treasuries, as seen in Exhibit 9. Cap rate compression has been reflecting the attractiveness of commercial real estate from an overall investment appeal perspective, a world with lower return expectations, and significantly improved transparency. Although required cap rates have increased only around 25 basis points, the spreads over treasuries have increased significantly and have incorporated more upward re-pricing for the asset class than most market observers are recognizing. Exhibit 10 shows that yields (total returns, or IRRs/discount rates) also have increased slightly more than cap rates since second quarter The spread between yields and required cap rates (refer to Exhibit 11) showed a spike during the latter part of 2007, which has settled down to a 160-basispoint spread in first quarter As with cap rate compression, we see a 200-basis-point decline in yield expectations over the past 3 years until first quarter 2007, and an increase in yield expectations from that point in time. This downward trend in yield expectations is reflecting the attractiveness of commercial real estate from an overall investment appeal (improved transparency and attractive investment) and a world with lower return expectations. *RERC Required Cap Rates are used and reported onin the RERC Real Estate Report. Exhibit 8. RERC Required Going-in Cap Rates Exhibit 9. RERC Required Going-in Cap Rates vs. 5-Year Treasuries Source: RERC. Sources: RERC, Federal Reserve. Exhibit 10. RERC Yield Rates Exhibit 11. RERC Yield Rates vs. Required Going-in Cap Rates Source: RERC. Source: RERC.

9 Seeking Shelter from the Storm It is becoming harder and harder for the U.S economy to find shelter, as conditions have changed dramatically over the past 15 months and there is no near-term relief in sight. The credit crisis continues, and the International Monetary Fund (IMF) predicts that before it is over, an overwhelming $945 billion of credit-related losses will have occurred. Oil prices have topped $120 per barrel and are still climbing, which continues to exact a heavy toll on consumers and businesses. The labor markets are succumbing to the pressure of rising costs and abating demand, with approximately 260,000 jobs lost in the first 4 months of 2008 (although this is relatively good news in the short term, when one compares this total to the 2001 recession when at times we lost 300,000 jobs per month). The 1-year expected inflation readings are approaching 5.0 percent, up from the prior month s level of around 4.5 percent, according to published reports. However devastating, our financial system and the economy have remained relatively resilient given the storms in our path, but how long can we hold on? Home prices continue to deteriorate, and a turnaround in the housing market is not on the near-term horizon. The S&P/Case-Shiller Home Price Index that measures home prices in 20 major metropolitan areas dropped 12.7 percent in February 2008 from year-ago prices, which is the largest decline in the 20-year history of the Index. Tighter lending terms for mortgages and broader weakness in the economy, particularly in the labor market, are depressing demand, and with a large inventory of unsold homes, prices are likely to fall further. The Federal Reserve has stepped up in a big way to make sure that capital is available, although more expensive in most cases. The Federal Reserve cut interest rates in late April for the seventh time in 8 months, but signaled that one of its most aggressive rate-cutting campaigns in a generation may be nearing an end. The Federal Reserve also lowered its target for the federal funds rate to 2.0 percent from 2.25 percent, bringing the cumulative reduction in interest rates since September 2007 to 3.25 percentage points. That exceeds even the aggressive rate posture set by former Federal Reserve Chairman Alan Greenspan in the first 8 months of 2001, before the economy was shocked by the terrorist attacks of September 11. The Federal Reserve indicated that while the economy remains under stress, the substantial rate cuts and other measures it has taken to provide liquidity to the financial markets have tempered the risk of a severe recession. On Wall Street, the turmoil that has devastated market conditions for the stock and bond markets now shows signs of improving. It is still too early to be certain, but there are some believers that the worst of the credit crisis may be past. Gold prices, which had surged to a record high of more than $1,000 an ounce, have dropped below $900. In addition, the global economy appears to be re-entering an era when governments are harboring more protectionist attitudes and are reasserting those views through their policies and opinions related to world trade. Once again, barriers are rising. The era of easy globalization is certainly over, says Pulitzer Prize-winning author Daniel Yergin, whose 1998 book, Commanding Heights: The Battle for the World Economy, detailed the triumph of markets over nations, starting with British deregulation under Margaret Thatcher. The power of the state is reasserting itself. Interestingly, it is U.S. consumers, although burdened with high food and gasoline costs, who may be best equipped to help stave off recession. By most accounts, approximately $110 billion will be injected into the U.S. economy this spring through the economic stimulus program. Some pundits are suggesting that how Americans spend the tax rebate checks they began receiving in early May is a good predictor of whether consumers can continue to hold

10 on during this economic storm. If consumers use most or all of their tax rebate checks for discretionary purchases, like flat-screen TVs, new furniture, or vacations, it is a sign that the economy may make it through this storm without much more damage. On the other hand, if consumers use most or all of their tax rebate checks for non-discretionary purchases like food or energy, or to pay down credit cards or other bills, consumer strength may be more at risk than anyone thought. How accurate this projection is as an indication of things to come is anyone s guess. Nor do we know how long this storm will go on. But we do know that we have often doubted the strength of the U.S. consumer in years past during the recession, after the terrorist attacks of September 11, through corporate and accounting scandals, with the war on terror, during the jobless recovery, through rising gas prices, with the housing bubble and the bursting of that bubble, the subprime lending crisis, and most recently, through the weakness in the capital and financial markets. So far, U.S. consumers have held on. We will see if they will be able to continue to do so through this current storm. According to CCIM designees and candidates, commercial real estate is the most preferred investment alternative, with cash as the second-most preferred investment vehicle. RERC maintains that as the economy, financial markets, and capital markets continue to go through troubled times, commercial real estate will remain a relatively strong investment option, given the nature of the asset and where it has been over the past year as compared to other investment prospects. First quarter 2008 commercial real estate fundamentals remained relatively steady, although vacancy rates are inching upward for office, industrial, apartment, and retail properties. As pressures from the economy and the financial markets increase, low investor confidence is keeping the volume of sales down. The considerations and analyses of yield and cap rate expectations included herein reflect much more of a risky undercurrent than one would surmise by looking at nominal returns they reflect and incorporate the dynamic changes that we have seen in the financial markets over the past year. Although some pundits would argue there has not been enough upward adjustment on these return expectations, given the global credit crisis and particularly in the CMBS debt market, RERC believes that the market is working toward figuring out the malaise but there is not enough clarity to make a confident adjustment. The message we offer from the equity commercial real estate market is that of selectivity, caution, and the need to keep a watchful eye on the rest of the financial markets. Low-leverage, high-quality commercial real estate is in a relatively positive position compared to investment alternatives. As demonstrated in Exhibit 12, commercial real estate s investment performance on a realized basis has exceeded investor expectations. However, we can clearly see that performance has changed dramatically over the past year and that it continues to deteriorate. RERC expects this trend to continue until the write-down adjustments are taken in the NCREIF Index. We are using the NCREIF Index as the basis for the realized return in this performance analysis, and we recognize the lag in data relative to the timing of capital adjustments. The impact of the credit crisis has not fully played itself out in this data. Commercial real estate will be challenged by continued storm clouds in the form of a tough economy, tighter credit standards, tougher underwriting criteria, and an uncertain world. In the end, institutional commercial real estate will weather this storm battered but in relatively good shape, but we are being pulled into market dynamics that few have ever experienced, and adjustments to our expectations will need to be made. Exhibit 12. Annualized Investment Performance 25% 20% 15% 10% 5% 0% -5% 3Q Q 2006 Sources: RERC, NCREIF. Market Equilibrium Hotels 1Q Q 2007 Apartments Retail 3Q Q 2007 Industrial Office 1Q % 20% 15% 10% 5% 0% -5%

11 TheEffectonRealEstate Residential real estate construction remained weak while commercial real estate construction activity was mixed during first quarter 2008, according to the April 16, 2008 Beige Book. Continued slowing of residential construction was expected as the economy slowed, and is needed for the housing market to strike a better balance between supply and demand. Total construction for first quarter 2008 was $121.2 billion, down 19 percent from a year ago according to McGraw-Hill Construction. Total new construction starts were down 8 percent for March Non-residential building declined by 23 percent in March, after increasing by 36 percent in January and February. Residential building dropped by 1 percent in March. Sales of commercial real estate have been slowing and prices are seeing downward pressure in most districts, according to the April 16, 2008 Beige Book. Rental conditions are weakening in the New York, Philadelphia, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, and San Francisco districts, while conditions are steady in the Boston, Kansas City, and Dallas districts. CCIM designees and candidates rated commercial real estate as the top investment alternative compared to stocks, bonds, and cash. With the volatility in the stock market, stocks earned the lowest rating overall. On a scale of 1 to 10, with 10 being high, survey respondents gave commercial real estate a rating of 6.7, cash a rating of 5.7, bonds a rating of 4.5, and stocks a rating of 4.3. Survey respondents rated the return versus risk for commercial real estate during first quarter 2008 at 6.2 on a scale of 1 to 10, with 10 being high, nearly a full point higher than the rating for fourth quarter 2007, indicating that respondents expect a slightly higher return on commercial real estate versus the amount of risk taken. The apartment sector received a return versus risk rating of 6.8 on a scale of 1 to 10, with 10 being high, for first quarter This was the highest rating received by any of the property types covered in this report. The industrial market received the second highest rating at 5.9. The office sector was the only property type to receive a return versus risk rating below 5.0 on a Return vs. Risk scale of 1 to 10, with 10 being high, for first quarter 2008, indicating that investors believe the office sector is offering a lower return relative to risk. Commercial real estate received a slightly higher value versus price rating in first quarter 2008 than it received during fourth quarter However, at 4.8 on a scale of 1 to 10, with 10 being high, investors still believe the value of commercial properties is generally less than the price paid for them. At 5.3 on a scale of 1 to 10, with 10 being high, the hotel sector received the highest value versus price rating during first quarter The apartment and industrial sectors weren t far behind, with ratings of 5.1 each. These ratings indicate that respondents feel the value of the properties is slightly higher than the price. In first quarter 2008, both the office and retail sectors earned a value versus price rating of less than 5.0 on a scale of 1 to 10, with 10 being high, indicating that survey respondents feel the value of the property is less than the price paid. Except for the apartment sector, all property types received a higher value versus price rating than they received during fourth quarter Historical Return/Risk and Value/Price Ratings 1Q Q Q Q Q 2007 Office Indusrial Retail Apartment Hotel Overall Value vs. Price Office Indusrial Retail Apartment Hotel Overall *Ratings are based on a scale of 1 to 10, where 1 is poor and 10 is excellent. Source: RERC. 10

12 TheEffectonRealEstate With housing starts at historic lows, home foreclosures at all-time highs, increasing residential vacancy rates, and tighter restrictions on credit for those purchasing a home, the majority of first quarter 2008 survey respondents said that the apartment sector offers the greatest opportunity for investment during Survey respondents also noted that the industrial sector offers good investment opportunity due to the stable income, growing demand, and low vacancy rates associated with this property type. Many first quarter 2008 survey respondents stated that the retail sector offers the lowest investment potential as compared to the other property types. This is due in large part to the impact of the slowing economy on the retail property type. In addition to higher unemployment, increased energy costs, and inflation, the retail sector overall is overpriced and overbuilt. In Summary In first quarter 2008, CCIM designees and candidates noted that the commercial real estate market is mostly stable but it is beginning to soften. Many respondents were seeing trends such as slightly rising vacancies among all property types, flat rental rates, and a gradual increase in capitalization rates. For now, most respondents are taking a wait and see approach to commercial investment. For the most part, fundamentals for commercial real estate remained relatively steady in first quarter 2008, although vacancy rates are inching upward for office, industrial, retail, and apartment properties. Investor confidence has been declining as pressures from the economy and the financial markets increase. However, the majority of survey respondents state that there is still ample credit and interest for quality assets, but low confidence is keeping the volume of sales down. Annual Growth Rate NAR U.S. Economic Outlook: April Annual Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q Real GDP Nonfarm Payroll Employment Consumer Prices Real Disposable Income Consumer Confidence Unemployment Interest Rates, Percent Fed Funds Rate Month T-Bill Rate Prime Rate Corporate Aaa Bond Yield Year Government Bond Year Government Bond Source: Forecast produced using Macroeconomic Advisers quarterly model of the U.S. economy. figures are seasonally-adjusted annual rates. Assumptions and simulations by NAR's Dr. Lawrence Yun. 11

13 NAR Commercial Forecast (March 2008) II III IV I II III IV OFFICE Vacancy Rate (%) Net Absorption ( 000 sq. ft.) 21,202 14,766 15,414 9,179 8,690 9,468 11,193 81,183 57,265 38,530 Office Employment (thousands) 16,795 16,826 16,875 16,915 16,950 16,997 17,066 16,648 16,875 17,066 Completions ( 000 sq. ft.) 14,732 16,476 17,380 17,380 23,442 17,338 16,252 51,606 61,102 74,412 Inventory (millions sq. ft.) 3,362 3,378 3,398 3,416 3,439 3,456 3,472 3,326 3,398 3,472 Rent Growth (%) INDUSTRIAL Vacancy Rate (%) Net Absorption ( 000 sq. ft.) 35,402 29,390 19,733 32,899 33,299 33,035 35, , , ,662 Industrial Employment (thousands) 10,236 10,238 10,238 10,244 10,252 10,255 10,261 10,235 10,238 10,261 Completions ( 000 sq. ft.) 35,695 28,033 40,330 52,874 46,020 36,627 38, , , ,041 Inventory (millions sq. ft.) 12,330 12,358 12,399 12,451 12,497 12,534 12,573 12,233 12,399 12,573 Rent Growth (%) RETAIL Vacancy Rate (%) Net Absorption ( 000 sq. ft.) , ,756 6,368 6,000 5,636 10,526 11,081 24,760 Completions ( 000 sq. ft.) 8,002 7,454 5,807 6,269 6,300 3,094 4,659 28,455 29,733 20,322 Inventory (millions sq. ft.) 1,566 1,574 1,580 1,586 1,592 1,595 1,600 1,550 1,580 1,600 Rent Growth (%) MULTIFAMILY Vacancy Rate (%) Net Absorption (Units) 70,705 41, ,734 10,612 71,751 82,375 91, , , ,786 Completions (Units) 57,798 58,384 57,436 57,314 56,275 54,573 53, , , ,880 Inventory (Units in Millions) Rent Growth (%) Sources: NAR, CBRE/Torto Wheaton Research. 12

14 Snapshot of Real Estate Space and Market Performance 1 Q 2008 Vacancy Rates Source: Torto Wheaton Research. Source: Torto Wheaton Research. Source: Torto Wheaton Research. Source: Reis. Performance Indicator Recent Data Impact on Commercial Real Estate Rental Rates (RERC s surveyed rent growth expectations) Office - 3.0% to 3.2% Industrial - 2.8% to 2.9% Retail - 2.6% Apartment - 3.1% Hotel - 3.0% Rental rate expectations for first quarter 2008 for all the property types increased by 20 to 30 basis points, as compared to the previous quarter s rates. Real Estate Returns RERC s Required Returns: Office - 7.9% to 8.4% Industrial - 8.1% to 8.5% Retail - 7.8% to 8.5% Apartment - 8.2% Hotel - 9.2% NCREIF Realized Returns: Office % % Industrial % % Retail - 7.4% % Apartment - 9.6% Hotel -15.6% RERC s required return expectations for office, retail, and apartment sectors increased during first quarter Expected returns for the hotel sector decreased slightly, while those for the industrial sector remained about the same as the previous quarter. NCREIF s realized returns decreased across the board as compared to the previous quarter. Capitalization Rates RERC s Realized Cap Rates: Office - 5.6% Industrial - 6.7% Retail - 6.4% Apartment - 5.8% Hotel - 7.9% NCREIF Implied Cap Rates: Office - 4.9% - 5.6% Industrial - 5.9% - 6.2% Retail - 5.7% - 5.9% Apartment - 4.6% Hotel - 7.1% RERC s realized capitalization rates for first quarter 2008 remained steady for all property types, except for hotels, which increased 20 basis points. NCREIF s implied capitalization rates decreased slightly for all property sectors. 13

15 Source: Bureau of Economic Analysis. Gross domestic product (GDP) increased at an annual rate of 0.6 percent during first quarter Although GDP was not negative, as is required in the traditional definition of a recession, the National Bureau of Economic Research (NBER) determines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. Source: Federal Reserve. The Federal Open Market Committee (FOMC) lowered the federal funds rate and the discount rate by 25 basis points, on April 30, Economic activity remains weak according to the FOMC, and inflation is still a concern. The last time the federal funds rate was this low was in November Source: Bureau of Labor Statistics. The unemployment rate has been climbing during the last year, settling at a seasonallyadjusted rate of 5.1 percent in March Nonfarm payroll contracted during first quarter 2008, falling by 80,000 during March, primarily in construction, manufacturing, and employment services. Continued increases in unemployment indicate that commercial real estate vacancies may be on the rise. Source: Federal Reserve. The manufacturing utilization rate dropped for the fourth consecutive month. Although the rate has been on an upward trend since the 2001 recession, it began declining in July 2007, ending at 78.6 percent in March Industrial production slowed during first quarter 2008, with the decline attributable to the decline in motor vehicles and parts manufacturing. Source: Bureau of Labor Statistics. Consumer Price Index (CPI) inflation increased by 0.3 percent in March 2008, while consumer prices for the first quarter increased at a seasonally-adjusted annual rate of 3.1 percent, as compared to the 4.1 percent for all of 2007, according to the Bureau of Labor Statistics. The largest increases in consumer prices came from food and energy, which are contributing greatly to lower consumer confidence overall. Source: Census Bureau. Consumer spending appears to be slowing. Retail sales increased 2.0 percent year-overyear in March 2008 as compared to an increase of 2.9 percent in February. The March increase was the lowest year-to-year increase since October Retail sales peaked in November 2007, and have been declining since then, due mostly to decreased sales by furniture and home furnishing stores, building material and garden equipment/supplies dealers, and motor vehicle and parts dealers. 14

16 Source: The Conference Board. Consumer confidence has dropped significantly since July The Consumer Confidence Index stood at 64.5 in March 2008, lower than it has been at any time during the last 5 years. The declining housing market, increasing energy costs, financial market instability, and job losses are taking their toll, with declining consumer confidence and slower spending expected to eventually affect the the hotel and retail property sectors. Source: Census Bureau. New residential construction was down sharply by 11.9 percent, or 947,000 units, in March The downward trend in construction started after peaking in January While all of the regions also posted declines for March, the largest decline in new residential construction ocurred in the Midwest region at 21.4 percent. Source: S&P. The Standard & Poor (S&P) 500 peaked in October 2007, and declined until starting to increase again in March Source: NAR. Approximately 4.93 million existing homes were sold in March 2008, a decline of 19.8 percent on an annualized basis from year-ago sales. The peak for existing home sales was 7.35 million units in June Now that the financial market has tightened the standards on home loans, it is harder to qualify for mortgages. In addition, buyers are wary of purchasing homes that may continue to decrease in value. Source: NAR. The Commercial Leading Indicator (CLI) fell by 0.4 percent to during fourth quarter This is the second consecutive decrease after the index reached its historical high of 120.7, suggesting a slowdown for commercial real estate in the coming months. The index factors in 13 variables affecting commercial real estate, such as unemployment, retail sales, and the NAREIT Price Index. Source: NAR. The median sales price of existing single-family homes increased slightly in March 2008 to $198,200. Despite the increase, single-family home prices are down approximately 8.3 percent from a year earlier. The West region was the only area in the U.S. to see a price decrease in March, due largely to the increased number of foreclosures in that area, which usually sell at a discounted price and tend to bring down the value of other for sale homes in the area. 15

17 Commercial Real Estate Index Eases in Fourth Quarter The latest reading of the Commercial Leading Indicator (CLI) for Brokerage Activity suggests reduced business opportunities for commercial real estate practitioners in the months ahead, reports Lawrence Yun, chief economist for the National Association of REALTORS (NAR). The CLI slipped 0.4 percent to an index of in the fourth quarter from a reading of in the third quarter, but remains 0.1 above the fourth quarter of 2006 when it stood at This is the second straight quarterly dip after reaching a record of in the second quarter of The index showed nine consecutive quarterly gains prior to these declines; NAR s track of the index dates back to The decline in the index implies that commercial activity, as measured by net absorption and the completion of new commercial buildings, is likely to contract moderately over the next six to nine months, which is consistent with an expectation for slower overall economic expansion in upcoming quarters, Yun said. Rising unemployment insurance claims and falling durable goods shipments were the key factors in lowering the CLI, but a weaker rate of return on investment as measured by the National Association of Real Estate Investment Trust (NAREIT) Price Index was also a factor. The only positive contributors to the index were growth in wholesale and retail trade, and rising personal income. The latest data imply that investment in private nonresidential structures, which rose a solid 13.2 percent in 2007 according to a preliminary GDP estimate, could show only minimal growth or even decline in 2008, Yun said. REALTOR members who specialize in office and industrial properties indicated in a separate survey that they anticipate a measurably lower level of business activity in the upcoming quarters. The commercial leading indicator is a tool to assess market behavior in the major commercial real estate sectors. The index incorporates 13 variables that reflect future commercial real estate activity, weighted appropriately to produce a single indicator of future market performance, and is designed to provide early signals of turning points between expansions and slowdowns in commercial real estate. The 13 series in the index are industrial production, the NAREIT Price Index, the National Council of Real Estate Investment Fiduciaries (NCREIF) total return, personal income minus transfer payments, jobs in financial activities, jobs in professional business service, jobs in temporary help, jobs in retail trade, jobs in wholesale trade, initial claims for unemployment insurance, manufacturers durable goods shipment, wholesale merchant sales, and retail sales and food service. Nearly 140,000 NAR members offer commercial services, and 73,000 of those are currently members of the REALTORS Commercial Alliance, NAR s commercial division. This information is reproduced in part from the March 2008 Commercial Real Estate Outlook, a newsletter published by the REALTORS Commercial Alliance and with their permission. Time Period 2007 NAR Commercial Forecast (March 2008) Commercial Leading Indicator % Change from 1 Quarter Ago % Change from 1 Year Ago 4Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Source: NAR Commercial Leading Indicators Source: NAR. 16

18 NationalMarketAnalysis National Transaction Breakdown (4/1/07-3/31/08) Office Industrial Retail Apartment Hotel < $2 Million Volume (Mil) $2,757 $4,386 $4,809 $2,483 $169 Size Weighted Avg. ($ per sf/unit) $98 $56 $93 $56,231 $25,725 Price Weighted Avg. ($ per sf/unit) $135 $88 $135 $77,450 $32,441 Median ($ per sf/unit) $100 $63 $92 $60,667 $27,273 $2 - $5 Million Volume (Mil) $5,384 $7,596 $8,452 $5,909 $1,489 Size Weighted Avg. ($ per sf/unit) $133 $64 $143 $67,450 $39,915 Price Weighted Avg. ($ per sf/unit) $200 $107 $251 $112,958 $52,156 Median ($ per sf/unit) $173 $85 $219 $92,582 $42,546 > $5 Million Volume (Mil) $157,273 $39,444 $46,654 $69,844 $57,580 Size Weighted Avg. ($ per sf/unit) $254 $79 $176 $106,620 $191,307 Price Weighted Avg. ($ per sf/unit) $407 $134 $303 $177,141 $501,945 Median ($ per sf/unit) $200 $91 $188 $100,766 $114,372 All Transactions Volume (Mil) $165,414 $51,426 $59,915 $78,236 $59,238 Size Weighted Avg. ($ per sf/unit) $240 $74 $159 $99,431 $171,778 Price Weighted Avg. ($ per sf/unit) $396 $126 $282 $169,129 $489,300 Median ($ per sf/unit) $152 $75 $135 $83,333 $103,488 Capitalization Rates (All Transactions) Range (%) Weighted Avg. (%) Median (%) Source: RERC. Investment Conditions Ratings * - 1Q Q Q Q Q Q 2007 Office Industrial Retail Apartment Hotel *Ratings are averages based on responses to surveys from CCIM designees and candidates for first quarter

19 NationalOfficePropertySector CCIM designees and candidates who responded to RERC s survey rated investment conditions for the office market at 5.1 on a scale of 1 to 10, with 10 being high, for first quarter This is a decline from the previous quarter s rating, and is the lowest rating this quarter among the five property types covered in the survey. According to RERC s recent sales transaction analysis, average prices for office properties decreased slightly during first quarter 2008, while average and median capitalization rates remained stable. For the second consecutive quarter, survey respondents rated the office sector the lowest among the major property types for both return versus risk as well as value versus price, indicating that the return on office property investment generally is less than the amount of risk taken, and that the value of office space is less than the price of the property. RERC Weighted Average Capitalization Rate 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% East South Midwest West National 1Q07 2Q07 3Q07 4Q07 1Q08 According to Torto Wheaton Research, the overall vacancy rate for the office sector increased to 12.9 percent during first quarter In addition, overall net absorption of office space in first quarter 2008 was the lowest posted since CCIM members who responded to RERC s survey noted that office vacancies are increasing in most areas and that the office market, particularly the suburban office market, is still very soft. However, opportunities are available in the future, with one respondent advising investors to hold cash and wait for risk/reward and value/price corrections in all property types; office will concede first. Medical office space is in demand, regardless of region, and in some of the southern metros (Dallas, San Antonio, New Orleans/Baton Rouge, Memphis, etc.), office space is in high demand with rent growth continuing. $350 $300 $250 $200 $150 RERC Size-Weighted Average PPSF West Midwest South East National $700 $600 $500 $400 $300 $200 RERC Price-Weighted Average PPSF West Midwest South East National $100 1Q07 2Q07 3Q07 4Q07 1Q08 $100 1Q07 2Q07 3Q07 4Q07 1Q08 18

20 NationalIndustrialPropertySector RERC Weighted Average Capitalization Rate 8.0% 7.5% 7.0% 6.5% 6.0% East 1Q07 South 2Q07 Midwest 3Q07 West 4Q07 National 1Q08 CCIM designees and candidates who responded to RERC s survey rated investment conditions for the industrial sector at 5.9 on a scale of 1 to 10, with 10 being high. This was significantly higher than last quarter s rating, and indicates increased confidence in the investment potential of industrial properties overall. RERC s first quarter 2008 sales transaction analysis indicates that like the other major property types, the sales volume of industrial property declined from the previous quarter. However, average sale prices per square foot of industrial space increased slightly, and average realized capitalization rates remained stable. Respondents to RERC s survey rated return versus risk for industrial properties at 5.9, indicating that the return on industrial property is slightly more than the amount of risk involved in investment. Respondents rated value versus price of industrial property at 5.1, indicating that the value of the investment is about the same as the price. According to Torto Wheaton Research, the average availability rate for the industrial sector increased to 9.8 percent during first quarter 2008 from 9.4 percent in fourth quarter Additionally, net absorption of industrial space was -11 million square feet, the least amount of space absorbed in about 5 years. The industrial warehouse and flex sectors are favored by many CCIM respondents, particularly in the port cities and in metros with access to highways and rail. There is a premium being placed on industrial properties with great locations, reported one survey respondent. Another respondent noted that industrial remains a preferred investment, as it is traditionally overvalued, but consistently underserved. RERC Size-Weighted Average PPSF RERC Price-Weighted Average PPSF $120 $90 West Midwest South East National $180 $160 $140 $120 West Midwest South East National $60 $100 $80 $60 $30 1Q07 2Q07 3Q07 4Q07 1Q08 $40 1Q07 2Q07 3Q07 4Q07 1Q08 19

21 NationalRetailPropertySector CCIM Institute designees and candidates who responded to RERC s survey rated investment conditions for the retail sector at 5.4 on a scale of 1 to 10, with 10 being high, for first quarter 2008, slightly higher than the previous quarter s rating. RERC s weighted average capitalization rate and the median capitalization rate for retail properties during first quarter 2008 remained stable. According to RERC s analysis of recent retail sales, national transaction volume decreased notably in first quarter 2008 from fourth quarter 2007 volume. The availability rate for the retail sector increased to 9.2 percent, according to Torto Wheaton Research. Although the retail sector s return versus risk and price versus value ratings increased for first quarter 2008 over the prior quarter s rating, the value vs. price rating increased to only 4.8 on a scale of 1 to 10, with 10 being high, indicating that the value of retail properties is generally still less than the price listed. RERC Weighted Average Capitalization Rate 7.50% 7.25% 7.00% 6.75% 6.50% 6.25% 6.00% East South Midwest West National 1Q07 2Q07 3Q07 4Q07 1Q08 Although retail space remains in demand in a few metros mentioned in RERC s survey, low consumer confidence and spending, a fear of unemployment, and higher gasoline prices are taking a toll on this property type in most regions. Interestingly, although discount store retail sales seem to be increasing and higher-end shopping is starting to slow in most areas, one Dallas/ Ft. Worth CCIM respondent reminded investors to expect the high-end shops to experience a good year because the people making good money will shop and flaunt. $225 $200 $175 $150 $125 RERC Size-Weighted Average PPSF West South National Midwest East $400 West National Midwest $350 $300 $250 $200 $150 RERC Price-Weighted Average PPSF South East $100 1Q07 2Q07 3Q07 4Q07 1Q08 $100 1Q07 2Q07 3Q07 4Q07 1Q08 20

22 NationalApartmentPropertySector CCIM designees and candidates rated investment conditions for the apartment sector at 7.0 on a scale of 1 to 10, with 10 being high, for first quarter This rating was similar to last quarter s rating, and remained the highest score when compared to the other major property sectors. The first quarter 2008 weighted average capitalization rate for the apartment sector showed no change over fourth quarter However, during the past year, the average capitalization rate for the apartment sector increased 60 basis points. Total apartment transaction volume decreased notably during the past 2 quarters, although both the size- and priceweighted average prices per apartment unit declined only slightly during first quarter Average vacancy in the apartment sector increased to 5.9 percent in first quarter 2008, according to Reis, Inc. This increase in vacancy can be attributed in part to seasonality in the apartment cycles. RERC Weighted Average Capitalization Rate 7.5% 6.5% East South Midwest West National Respondents to the first quarter 2008 survey rated the return versus risk for apartments higher than any of the major property sectors tracked by RERC. The apartment rating for value versus price decreased to 5.1, a significant decline from last quarter s rating, and indicating a lower level of investor confidence in the value of apartments when weighed against their price. 5.5% 4.5% 3.5% 1Q07 2Q07 3Q07 4Q07 1Q08 CCIM members who responded to RERC s survey generally expect apartments to be a good investment opportunity due to tighter restrictions on credit for homebuyers and because in good economic times or bad, people still have to have somewhere to live. There have been some reports of overpricing of this property type among speculators. $175,000 $150,000 $125,000 $100,000 $75,000 RERC Size-Weighted Average PPU West South National Midwest East $250,000 $200,000 $150,000 $100,000 RERC Price-Weighted Average PPU West Midwest South East National $50,000 1Q07 2Q07 3Q07 4Q07 1Q08 $50,000 1Q07 2Q07 3Q07 4Q07 1Q08 21

23 NationalHotelPropertySector RERC Weighted Average Capitalization Rate 9.5% 9.0% East South Midwest West National Over the past year, the investment conditions ratings for the hotel sector has been consistently declining. The first quarter 2008 rating was 5.9 on a scale of 1 to 10, with 10 being high, and although this rating was slightly lower than the previous quarter, it tied with the industrial sector for the second highest rating given to any of the property sectors tracked by RERC. With consumer confidence down and gasoline prices up, the first quarter 2008 average hotel occupancy rate declined to 64.7 percent, 3.7 percent lower than the year-ago average rate, according to Smith Travel Research. Revenue per available room (RevPAR) was $70.89, essentially unchanged from the same time one year ago. RERC s first quarter 2008 average capitalization rate was 7.9 percent, 20 basis points higher than the previous quarter s rate. Survey respondents rated first quarter 2008 return versus risk for hotel properties at 5.6 on a scale of 1 to 10, with 10 being high, indicating that the sector offers slightly more return when compared to the amount of risk involved in the investment. They also gave the sector a value versus price rating of 5.3, indicating that the sector represents slightly more value when compared to the price paid for hotel assets. 8.5% 8.0% 7.5% 7.0% 1Q07 2Q07 3Q07 4Q07 1Q08 Low consumer spending and high gasoline prices, along with reduced business travel due to budget cutbacks, are a double-blow to this property type. One CCIM respondent to RERC s survey noted, There are a lot of hospitality-related projects on the drawing boards right now. Investors should do their homework, know where everyone else is going, and do their math a few times determining absorption. $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 RERC Size-Weighted Average PPU 1Q07 West Midwest South East 2Q07 3Q07 National 4Q07 1Q08 $950,000 $850,000 $750,000 $650,000 $550,000 $450,000 $350,000 $250,000 $150,000 $50,000 RERC Price-Weighted Average PPU West National Midwest South East 1Q07 2Q07 3Q07 4Q07 1Q08 22

24 Sustainable Development Shapes Portland s Past and Future By Edward M. Bury, APR Long known as one of the nation s most progressive urban centers, metropolitan Portland--Oregon s largest city and the fourth largest city on the West Coast--practiced sustainable development, incorporated strict land use guidelines, and promoted ecologically sound building practices decades before it became fashionable. Today, the market of 2.2 million remains at the vanguard of how to go green. Portland developers and planners even export knowledge and expertise to other markets. Gerding-Edlen Development Company, for example, had tremendous success converting a defunct five-block property into the thriving Brewery Blocks mixed-use development. Portland experts are applying design and construction principles to new properties in Los Angeles and San Diego. Clearly, city fathers and business leaders have taken tremendous steps forward to keep run-away growth in check and preserve the scenic beauty of the Willamette Valley and surrounding region, with its nearby snowcapped mountain peaks, forests and rivers. In the city limits, the outdoors and quality of life are exemplified by the city s 5,000-acre Forest Park, the largest natural urban forest reserve in the nation, and numerous other parks and gardens. The Columbia River Gorge and Mt. Hood, world-class outdoor wonders, are a short drive away. And, Portland is the headquarters for such outdoor-oriented companies like Nike and Columbia sportswear. But strong development laws and green initiatives also have drawbacks. Portland s development controls and dedication to preserving the natural environment have made it much more challenging and expensive for new properties to be constructed or renovated, and for businesses wanting to grow. Also, controls have led to a shortage of housing, and they may be a factor in curbing job growth; job growth in 2007 was 1.2 percent, a drop from 2.4 percent the previous year, and the unemployment rate 23

25 at year-end 2007 was 4.9 percent, slightly above the national average. Despite pressures to relax guidelines, Portland remains steadfast on sustainability. Consider: In order to reduce urban sprawl, Portland operates on an 84-yearold, single-use zoning practice where land is zoned for a single use. This policy, which greatly reduces development of mixed-use properties, is under scrutiny; proponents of growth believe urban boundaries should be expanded to accommodate new development. All new commercial properties must be built to meet the Leadership in Energy and Environmental Design (LEED) silver rating from the U.S. Green Buildings Council. To meet these standards, buildings must reach specified criteria for sustainability, water and energy efficiency, materials and resources selection, indoor environment quality, and design innovation. This year, the City Council will debate a feebate system, which will provide financial incentives for developments that exceed or match high-level green building standards. Even with these challenging regulations, a wide range of large-scale development has taken place in Portland, and there are many properties under development. One of the most visible and successful redevelopment projects is the Pearl District, a onetime undesirable concentration of light manufacturing and warehouse buildings converted during the late 1990s into Portland s hippest district for galleries, boutiques, restaurants, and living. Green living is exemplified by the 937 Condominiums, a luxury 16-story, 114-unit property that will be LEED-gold certified once completed. Featuring a 4,000-square-foot rooftop garden, condo prices will range from $2.1 million to $328,000. Portland has been very successful in developing buildings that are on the leading edge of sustainability, said T.J. Newby, CCIM, vice president of Integrated Corporate Property Services, LLC, of Portland. One reason is that developers and institutions such as Portland State University engage directly with the community. An innovative cooperative program with Portland State University has helped Portland Transaction Breakdown (4/1/07-3/31/08) Office Industrial Retail Apartment Hotel < $5 Million Volume (Mil) $67 $89 $53 $170 $12 Size Weighted Avg. $140 $83 $160 $63,736 $52,257 Price Weighted Avg. $179 $102 $229 $71,101 $60,135 Median $148 $84 $152 $65,878 $56,959 > $5 Million Volume (Mil) $1,102 $422 $314 $836 $242 Size Weighted Avg. $233 $95 $134 $113,242 $105,934 Price Weighted Avg. $303 $122 $156 $137,254 $114,018 Median $175 $97 $148 $94,753 $92,026 All Transactions Volume (Mil) $1,169 $510 $367 $1,007 $253 Size Weighted Avg. $225 $93 $137 $100,089 $101,093 Price Weighted Avg. $295 $119 $167 $126,062 $111,506 Median $161 $87 $150 $74,974 $91,219 Capitalization Rates (All Transactions) Weighted Average Median Source: RERC. 24

26 keep new construction and redevelopment projects on track, she noted. And, with good reason: Portland State is the largest land owner downtown, with 4 million square feet of space spread out over 44 city blocks, and the University s Center for Real Estate has a 30-year history of educating future urban planners and developers. Newby pointed out another benefit of Portland s urban growth boundary it helped insulate the market from office overbuilding during the dot-com bust of the late 1990s and the recent economic slowdown caused by the sub-prime fallout. Today, Newby said, downtown Portland has a lot of cranes in the air at office construction sites. According to a market report from Portland State University, the downtown market can absorb from 400,000 to 500,000 square feet of new office construction by 2009 without causing a spike in vacancy rates. New Class A office rents would range from $33 to $35 per square foot. Given the housing shortage, investors have targeted Portland for apartment properties. Earlier this year, the 245- unit Wyatt apartments sold for $111.5 million, or $455,000 per apartment, and a tower at the Harrison complex sold for $45 million, or $245,000 per unit. Both properties were sold to California-based companies. Still, concern over how much land can be developed to meet market needs remains a concern. Most major markets plan for future development; the general standard is to have a 20-year supply of industrial land available to promote economic development. Economic theory suggests that for every base employment or traded sector job, another 2.8 jobs are created within that community. Portland effectively has less than a 5-year supply of industrial land available, and most of that is in small parcels, Newby said. There is strong demand for industrial properties, and that is driving land prices and lease rates up. Warehouse and flex industrial availability in the metropolitan area is under 7.5 percent, with warehouse monthly lease rates at $45 per square foot and rising. Portland s uber growth boundary won t be expanding anytime soon, Newby says. Metro and regional planners are not expected to publish recommendations for urban growth boundary expansion until sometime after In the meantime, industrial land prices start at $7.50 per square foot and warehouses are transacting around $100 per square foot. 25

27 RERC~CCIM Advisory Board Members B.K. Allen, CCIM B.K. Allen Real Estate Potomac Falls, Virginia Todd Clarke, CCIM New Mexico Apartments Albuquerque, New Mexico Wayne D Amico, CCIM Property Politics Essex, Connecticut Paul Fetscher, CCIM Great American Brokerage Long Beach, New York Stephen Furnary ING Clarion Partners New York, New York Breck Hanson LaSalle Bank, N.A. Chicago, Illinois Charles Lowrey Prudential Investment Management Services Parsippany, New Jersey Dennis Martin RREEF/DB Real Estate New York, New York Jeff Lyon, CCIM GVA Kidder Mathews Seattle, Washington Buzz McCoy Buzz McCoy Associates, Inc. Los Angeles, California Tom Nordstrom, CCIM AEGON USA Realty Advisors, Inc. Cedar Rapids, Iowa Art Pasquerella Berwind Property Group, Inc. Philadelphia, Pennsylvania Duncan Patterson, CCIM Patterson-Woods Associates Greenville, Delaware Gary M. Ralston, CCIM, SIOR, SRS, CPM, CRE Florida Retail Development, LLC Winter Park, Florida Cynthia Shelton, CCIM Colliers Arnold Orlando, Florida Frank Simpson, CCIM The Simpson Company Gainesville, Georgia Richard Sokolov Simon Property Group Indianapolis, Indiana John Stone, CCIM John M. Stone Company Dallas, Texas Dewey Struble, CCIM Sperry Van Ness Reno, Nevada Julien Studley Julien Studley, Inc. New York, New York Allan Sweet AMLI Residential Properties Trust Chicago, Illinois Garry Weiss, CCIM First Industrial Realty Trust Chicago, Illinois Sam Zell Equity Group Investments Chicago, Illinois Copyright Notice for RERC~CCIM All rights reserved. No part of this publication may be reproduced, duplicated, or copied in any form, including electronic forwarding or copying, xerography, microfilm, or other methods, or incorporated into any information retrieval system, without the written permission of RERC and the CCIM Institute. RERC Editorial Staff Publisher Kenneth P. Riggs, Jr. CFA, CRE, FRICS, MAI, CCIM Editor-in-Chief Barb Bush Lead Analyst Brian Velky Research Analysts Greg Philipp Cliff Carlson Morgan Even Design Editor Michelle Houlgrave Data Management Ben Neil Daniel Warner Production Committee Terri Cotter Scott Hamerlinck Research Assistants Alicia Brown Charles Gohr Jeffrey Harms David Kelly Herinomena Rakotoarivelo Steven Schlange Anthony Tholkes CCIM Institute President Timothy S. Hatlestad, CCIM President-Elect Charles McClure, CCIM, CRE First Vice President Richard E. Juge, CCIM, SIOR Chief Executive Officer Jonathan Salk Director of Public Relations Edward M. Bury, APR CCIM Member Services Committee Steve Moriera, CCIM, Chairman Brent Case, CCIM, Vice Chairman Immediate Past Chairman CCIM Member Services Committee Nick Miner, CCIM Liason CCIM Member Services Committee Frank Simpson, CCIM 26

28 Acknowledgements The RERC/CCIM is produced by Real Estate Research Corporation (RERC) in association with and for members of the CCIM Institute. The RERC/CCIM Investment Trends is sponsored by the REALTORS Commercial Alliance of the National Association of REALTORS. Real Estate Research Corporation Founded more than 75 years ago, Real Estate Research Corporation (RERC) was the nation s first independent real estate firm that specialized in both real estate research and analysis. Recognized as a pioneer in the art of real estate management and for monitoring key sectors of the economy that influence the real estate industry, RERC has retained its place as one of the industry s leading real estate investment trends analysts through the publication of such reports as Expectations & Market Realities in Real Estate and the RERC Real Estate Report. Today, RERC is known for its research publications and market studies, commercial property valuations, complex consulting assignments, portfolio management and technology services, independent fiduciary services, and corporate advisory services. The CCIM Institute The CCIM Institute, headquartered in Chicago, confers the Certified Commercial Investment Member designation through an extensive curriculum of 200 classroom hours in addition to professional experience requirements. CCIMs are recognized experts in commercial real estate brokerage, leasing, asset management, valuation, and investment analysis, and form a business network encompassing more than 1,000 markets throughout North America, Europe, Asia and the Caribbean. There currently are more than 8,600 CCIM designees, with an additional 8,200 professionals pursuing the designation. CCIM Institute is an affiliate of the National Association of REALTORS. Visit REALTORS Commercial Alliance of the National Association of REALTORS NAR President Richard F. Dick Gaylord CRS, CRB, GRI, CIPS NAR Executive Vice President/CEO Dale A. Stinton RCA Committee Representative Patricia A. Nooney CCIM, CPM, SIOR NAR Vice President of Commercial Real Estate Jan M. Hope REALTORS Commercial Alliance of the National Association of REALTORS The REALTORS Commercial Alliance (RCA) is the commercial division of the National Association of REALTORS (NAR) that connects commercial real estate professionals and exchanges valuable information that contributes to their success. RCA in partnership with NAR s commercial affiliates -- CCIM Institute, the Counselors of Real Estate (CRE), the Institute of Real Estate Management (IREM), the REALTORS Land Institute (RLI), and the Society of Industrial and Office REALTORS (SIOR) -- is dedicated to collaboration with and building on the strengths of each affiliate entity to benefit the real estate industry. RCA works to serve the needs of members, and to shape and unify the commercial real estate industry through valuable products and services, technology initiatives, public policy advocacy, education, and research. 27

29 RealEstateResearchCorporation Founded in 1931, Real Estate Research Corporation is one of the longest-serving and most recognized national firms devoted to real property research, valuation, real estate consulting, independent fiduciary services, and portfolio services. Explore our services... Specialized Research Independent Fiduciary Services Fairness Opinions Litigation Support Consulting Portfolio Services Commercial Valuation Financial Risk Management Market Research & Analysis Appraisal Management Services Independent To ensure objectivity and independence, RERC does not engage in any activity that may conflict with the best interests of our clients. As an impartial observer of the markets, RERC is able to collect and synthesize data and commentary unavailable to less independent organizations. Unique RERC brings unique and diverse skills to solving complex real estate issues. RERC s innovative approach to problem solving is fostered by the diverse education and professional backgrounds of our team members. Expertise RERC s expertise originates from a national presence and perspective, coupled with local market knowledge gained through the completion of hundreds of engagements annually in every major market. Our clients have found that RERC is relationshiporiented, focusing first and foremost on our clients and customers needs, and delivering the highest quality products and services. RERC is an SEC-registered advisor. Leadership Kenneth P. Riggs, Jr. CFA, CRE, FRICS, MAI, CCIM President & CEO Jules H. Marling, III, CRE, FRICS, MAI Partner & Senior Vice President Del H. Kendall, CRE, MAI Partner & Senior Vice President Donald A. Burns, CRE, FRICS, MAI Partner & Senior Vice President Austin D. MacMullan, MAI, CCIM Partner & Senior Vice President Gregory P. Kendall, CRE, MAI Partner & Senior Vice President Standard Publications RERC Real Estate Report RERC/CCIM Expectations & Market Realities in Real Estate Real Estate Research Corporation 980 North Michigan Avenue, Suite 1110 Chicago, IL Phone: Fax: Offices located throughout the U.S., with headquarters in Chicago 28

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