National Association of REALTORS COMMERCIAL REAL ESTATE LENDING TRENDS 2016

Transcription

1 National Association of REALTORS COMMERCIAL REAL ESTATE LENDING TRENDS 2016

2 Commercial Real Estate Lending Trends NATIONAL ASSOCIATION OF REALTORS All Rights Reserved. Reproduction, reprinting or retransmission in any form is prohibited without written permission. 2

3 NATIONAL ASSOCIATION OF REALTORS 2016 OFFICERS President Tom Salomone President-Elect Bill Brown First Vice President Elizabeth Mendenhall, GRI, ABR, ABRM, CIPS, CRB, PMN Treasurer Michael McGrew, CRB, CRS Immediate Past-President Chris Polychron, CIPS, CRS, GRI Vice President Michael Labout, GRI Vice President Sherri Meadows, GRI, CIPS, CRB, PMN Chief Executive Officer Dale Stinton, CAE, CPA, CMA, RCE 3

4 CONTENTS 1 Introduction 2 Economic Overview.. 3 Commercial Real Estate. 4 Survey Highlights... 5 Survey Results: Market Environment.. Lending Environment. Appraisals.. Methodology

5 1 INTRODUCTION 5

6 INTRODUCTION GEORGE RATIU Director, Quantitative & Commercial Research Commercial real estate (CRE) notched another year of growth in 2015, favored by continued macroeconomic growth and broadening capital markets, according to the Expectations & Market Realities in Real Estate 2016: Navigating through the Crosscurrents report, released by Deloitte, the National Association of REALTORS, and Situs RERC. While global economies decelerated, leading to volatility in financial indices, U.S. gross domestic product rose, employment growth accelerated toward the tail end of the year, and housing prices reached new heights. In addition, the Federal Reserve signaled a shift in its monetary policy by raising its target funds rate, as core inflation hovered around its target of 2.0 percent. Commercial vacancy rates declined for the core property types. Availability is expected to continue contracting for office, industrial and retail properties in Vacancies for apartments are estimated to rise, due to gains in supply. Commercial rents have risen across the board, and are projected to advance this year in the 2.5 percent to 4.0 percent range. CRE sales volume continued its positive trend in 2015, with $534 billion in closed transactions, compared with $432 billion in 2014, based on data from Real Capital Analytics (RCA). Most of the transactions reported by RCA are based on data aggregated at the top end of the market above $2.5 million. In contrast to the large commercial transactions reported by RCA, commercial REALTORS managed transactions averaging $1.8 million per deal, frequently located in secondary and tertiary markets, and focused on small businesses and entrepreneurs. The 2016 Commercial Real Estate Lending Trends shines the spotlight on this significant segment of the economy a segment which tends to be somewhat obscured by reports on Class A trophy commercial properties. Lending conditions in REALTOR markets notched another year of sustainable recovery. As CRE asset prices strengthened, financing and lending conditions improved in The main sources of capital for commercial REALTORS clients remained local and regional banks, which made up 55.7 percent of funding in The incidence of failed transactions, due to lack of financing, reached a new low. REALTORS cite uncertainty from legislative and regulatory initiatives as the most relevant cause of bank capital shortage for CRE. 6

7 2 ECONOMIC OVERVIEW 7

8 COMMERCIAL REAL ESTATE LENDING TRENDS ECONOMIC OVERVIEW Gross Domestic Product Looking at macroeconomic performance through the lens of the Gross Domestic Product (GDP), U.S. economic activity grew at a moderately positive 2.4 percent in 2015, on par with the prior year. This marks the seventh year of post-recession economic growth. However, with the fourth quarter s growth notching a mere 1.4 percent gain, it also marks another year of subpar performance, considering that long-term GDP growth has averaged 3.0 percent. Nonetheless, in the context of the global economic landscape especially as illustrated by recent market gyrations the U.S. economy continued to be a comparatively bright spot. Gross domestic product had a slow start in the first quarter of 2015, with a slight 0.6 percent increase. Economic activity picked up in the second quarter, as GDP rose at an annual rate of 3.9 percent. However, financial markets gyrations predicated on the global slowdown led to lost momentum and the third quarter posted an increase of 2.0 percent Exhibit 2.1: Real GDP (% Annual Chg.) Source: NAR, BEA The changes in GDP through the year were mirrored in the pattern of business investments, which felt the impact of volatility in financial markets. Business investments typically make up percent of GDP. Spending by companies had a moderate start in 2015, but was followed by a solid 4.1 percent increase in the second quarter. The third quarter recorded slower growth, while the final quarter of 2015 witnessed a 1.9 percent decline in nonresidential fixed investments. Toward the tailend of the year companies cut back on commercial construction and equipment spending. Double-digit cuts in purchases of transportation and other equipment led to declines in overall equipment investment. Spending on industrial and information processing equipment remained bright spots. Companies also slowed their investments in intellectual property products software, R&D, along with entertainment, literary and artistic works Exhibit 2.2: Real GDP Business Investments (% Annual Chg.) Structures Equipment Intellectual Property Source: BEA International trade continued to play an increasing role in the U.S. economy. While the Great Recession clearly impacted the pace of trade, the subsequent rebound had been positive, aided for a while by a soft U.S. dollar, which drove marked growth in U.S. exports and a contraction in the balance of trade. However, in 2015, international trade felt the impact of the stronger dollar, which reached its highest point since U.S. exports rose at a modest 1.1 percent in 2015, while imports advanced 4.9 percent, keeping the balance of trade 8

9 COMMERCIAL REAL ESTATE LENDING TRENDS at a negative $544 billion for the year. The slowdown in exports notwithstanding, international trade proved positive for the industrial real estate sector, driving demand for space and leading to strong investor interest. employment and higher household wealth encouraged consumers to spend more on household appliances, furnishings, clothing, but also more discretionary items like recreation and recreation vehicles Exhibit 2.3: Real Net Exports (Bil Chn 2009$) Source: BEA Exhibit 2.4: Real Consumer Spending (Bil Chn 2009$) GDP Consumer Spending Source: BEA Government spending, another major GDP component, saw a modest 0.7 percent annual gain during Most of the gain came from higher spending by state and local governments, which have enjoyed rising property tax revenues. The federal government cut its spending by 0.3 percent during the year, as defense spending retrenched. Consumers continued as the main engine of economic activity in 2015, with consumer spending comprising 68.0 percent of total GDP. Consumer expenditures rose during each quarter of 2015, rising from an annual rate of 1.8 percent in the first quarter to 3.6 percent and 3.0 percent in the second and third quarters. However, the fourth quarter which includes the traditional holiday shopping season recorded a slower 2.5 percent advance. On balance, consumers spent more on a broader array of goods and services in Buoyed by declining gasoline prices which dipped to $53 per barrel by December consumers purchased more cars. Auto sales reached an annual level of 17 million vehicles by the end of the year. In addition, rising 9

10 COMMERCIAL REAL ESTATE LENDING TRENDS Housing The housing recovery led the way during With the annual pace of existing home sales above 5.0 million, housing supply shrank and hovered below its long-term equilibrium of 6 7 months. At the end of December 2015 there were 1.8 million homes available for sale, down 5.4 percent from already low levels in the prior year. Given the higher-than-usual sales pace in December, owing to the unseasonably warm weather, the measure of months supply fell to 3.9 months, one of the thinnest levels of inventory recorded in the past 15 years Exhibit 2.6: Completions & Household Formation New Housing Completions ('000s) Household Formation ('000s) Aside from an increase in sales, the steady drop in distressed properties over the past seven years coupled with underproduction of new homes has exacerbated the inventory situation. Distressed properties accounted for only 6.0 percent of total sales at the tail end of 2015, down from over 40.0 percent in Exhibit 2.5: NAR Months' Supply of Existing Homes Source: NAR The supply of new homes has averaged about 800,000 units per year since In fact, from 2009 to 2015, a total of 5.6 million single-family homes, condominiums, and apartment units were built. Over the same period, approximately 1.7 million housing units were demolished and removed from the housing stock, as they were uninhabitable or obsolete. For the period, there were a net 3.9 million housing units added to the country s stock. Source: Census Bureau Over the same period, America s population rose by over 17 million. Even accounting for an average of 2.5 persons living in one housing unit, about 7 million new homes would have been required to meet demand. In addition, the historical household formation numbers corroborate the gap in the market. Over the long-term, the U.S. economy has recorded an average of 1.5 million new households per year. The number dropped significantly during the Great Recession, but it has been moving toward its longterm trend. In turn, home prices have been rising at a healthy clip over the past few years. The price appreciation has been a boon for homeowners, boosting their wealth. In fact, household wealth tied to real estate reached $22.0 trillion in the fourth quarter of 2015, with owners equity totaling $12.5 trillion, closing in on the prior peak achieved in the early However, this has broadened the divide between homeowners and renters. For consumers who participate in real estate markets, the recovery has been positive, leading to an improved outlook. For consumers who are not participating in the markets, income is the main measure of economic wellbeing, and wages have been rising only about 2.0 percent on a yearly basis. 10

11 Jan Aug Mar Oct May Dec Jul COMMERCIAL REAL ESTATE LENDING TRENDS Feb Sep Apr Nov Jun Jan Aug Mar Oct Jan Nov Sep Jul May Mar Jan Nov Sep Jul May Mar Jan Nov Sep Jul May Mar Jan Employment Payroll employment closed the year on a positive note, with almost 3.0 million net new jobs. Payroll employment rose at the strongest pace in the last quarter of the year, adding 837,000 new jobs. The sectors with the largest gains were in the Education & Health, Professional & Business Services, and Leisure & Hospitality industries. With employers in these sectors growing, demand for commercial properties has been on the upswing, leading to lower vacancies and improved cash flows. The unemployment rate declined from 5.6 percent in the first quarter 2015 to 5.0 percent by the close of the year. The average duration of unemployment declined from 31 weeks in the first quarter to 28 weeks by the end of Exhibit 2.7: Payroll Employment (Change, '000) As of the end of 2015, 94.1 million Americans 16 years and older were not in the labor force, of which 1.8 million were estimated to want a job; this is in addition to the 7.9 million Americans currently in the labor force but unemployed. Even as the U.S. population continues to grow and the Millennials become the largest demographic cohort, retiring Baby Boomers, and a low or contracting participation rate will likely hold back economic potential Exhibit 2.8: Labor Force Participation Rate Source: BLS Source: BLS However, it is worth pointing out that there is a cloud casting a long shadow over the employment landscape. The labor force participation rate rose from 58.0 percent in the late 1940s to over 67 percent by the early 2000s, as women entered the labor force in large numbers. The figure has been declining over the past 15 years, but the decline accelerated during the Great Recession, and reached 62.6 percent in December of 2015, the same level as seen in the late 1970s. 11

12 COMMERCIAL REAL ESTATE LENDING TRENDS Monetary Policy Markets spent the better part of last year trying to read the Federal Reserve s decision on the funds target rate. During the summer, the concern focused on the September meeting of the Federal Open Market Committee meeting, which did not result in a rate hike. Mid-December brought a muchanticipated change, ending the Fed s accommodative policy with a 25 basis point hike. Of course, since then, financial markets have been riding a wild roller coaster, leading some to question the timing of the Fed s decision Exhibit 2.9: FOMC Fed Funds Target Rate (%) Source: Federal Reserve Board Longer-dated bond yields had not moved up measurably despite the Federal Reserve rate hike. For commercial real estate investors the spread between the 10-year Treasury Note yields and cap rates remained at over 400 basis points. However, with interest rates expected to rise, commercial price appreciation is expected to moderate. Despite earlier concerns about the potential for inflation, 2015 recorded low inflationary pressure due in large part to declines in prices of gasoline and other energy products. Deflationary pressures are expected to subside in 2016, as gasoline prices will likely stabilize. In addition, with apartment rents having risen at 4.0 percent or better over the past few years, and the Owners Equivalent Rent component of the Consumer Price Index having increased at over 3.0 percent in 2015, consumer prices are projected to notch up in the short to medium term Outlook The outlook for the remainder of 2016 remains moderately positive, with GDP projected to close the year 1.5 percent higher on an annual rate. Payroll employment is expected to advance at an annual rate of 1.3 percent. With the Federal Reserve expected to continue increasing the funds target rate, U.S. inflation is expected to remain below 2.0 percent in Household formation an important driver of economic growth has been rebounding toward its long-term trend. While in 2015 household formation advanced at a rather moderate pace of 191,000 new households, we expect it to continue advancing over the next few years as Millennials currently considered the largest generational segment of the U.S. population mature and enter the workforce in larger numbers. Exhibit 2.10: U.S. Economic Outlook March Annual Growth Rate, % Real GDP Nonfarm Payroll Employment Consumer Prices Level Consumer Confidence Percent Unemployment Fed Funds Rate Month T-bill Rate Corporate Aaa Bond Yield Year Gov t Bond Year Gov t Bond Source: National Association of REALTORS 12

13 3 COMMERCIAL REAL ESTATE 13

14 COMMERCIAL REAL ESTATE Fundamentals Commercial real estate continued on an upward trajectory in 2015, building on improving fundamentals and investment momentum. In tandem with rising economic conditions, leasing strengthened during the year. Growing net absorption led to declining vacancies and accelerating rent growth. As employment gains are expected to continue into 2016, demand for commercial space is expected to advance. Professional and business services added the highest number of net new jobs in The improving employment landscape in office-using industries drove demand for office space. Almost half of office leasing activity during the year was made up of company expansions, a positive development. Even with 44.2 million square feet of new supply, office vacancy declined 40 basis points year-over-year, to the lowest level in eight years 14.7 percent by the fourth quarter. Rents for office properties rose 2.2 percent during the fourth quarter, to $31.26 per square foot, according to JLL. Retail net absorption totaled 88.3 million square feet in 2015, according to JLL. Constrained new supply in high-demand areas lowered vacancies to 5.7 percent by the last quarter of the year. Rents increased 2.1 percent during the year, to an average $15.84 per square foot. Demand for multifamily properties continued on an upward path. Renter occupied housing units totaled 42.6 million units in the fourth quarter of 2015, a 300,000 unit advance from the fourth quarter of 2014, based on U.S. Census Bureau data. National vacancy rates averaged 7.0 percent for rental housing during the fourth quarter, unchanged from the same period in Median rents for rental units averaged $850 by the end of the year. Industrial properties found favorable conditions in 2015 due to international trade and solid gains in online retail sales. National vacancies for industrial buildings dropped in the single digits during the year, leading to higher rents. Net absorption of industrial space totaled million square feet in 2015, based on data from JLL. With new supply clocking in at million square feet, availability rates declined to 6.4 percent by the fourth quarter. Industrial rents rose 5.6 percent over the year, to an average of $4.93 per square foot. With consumers keeping spending on an upward trajectory, the retail sector recorded positive demand matched by restrained supply, leading to declining vacancies and moderately growing rents. 14

15 Billions 2006Q1 2006Q4 2007Q3 2008Q2 2009Q1 2009Q4 COMMERCIAL REAL ESTATE LENDING TRENDS Q3 2011Q2 2012Q1 2012Q4 2013Q3 2014Q2 2015Q1 2015Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q4 Investments Commercial real estate (CRE) investment trends were positive in 2015, following on last year s tail winds. Sales of large CRE transactions (LCRE) over $2.5M advanced 23 percent year-over-year, totaling $534 billion, based on data from Real Capital Analytics (RCA). Investor demand for properties continued on an upward path, as economic fundamentals, broadening lending sources and capital followed returns. Prices for commercial assets reached new records, surpassing prior 2007 peaks. Based on RCA s Commercial Property Price Index, commercial prices rose 12.3 percent in 2015 compared with the previous year. Capitalization rates averaged 6.5 percent during the year across all property types, a 16 basis point decline year-over-year. $200 $150 $100 $50 $- Exhibit 3.1: CRE Sales Volume & Prices ($2.5M+) Sales Volume CPPI With global economies hitting a slow patch in 2015, U.S. property markets became an even stronger contender for cross-border investors, as well. Toptier markets in gateway cities continued as the major targets of investor activity. However, posting higher yields and strengthening economies, secondary and tertiary markets remained on the list of investor destinations during the year Source: Real Capital Analytics In comparison to the high-end deals, 82.7 percent of commercial REALTORS reported transactions below the $2.0 million threshold in Although many REALTORS participate in transactions above $2.5 million per deal, they frequently serve a segment of the commercial real estate market for which data are generally not as widely reported, which we term the small CRE transactions (SCRE) Exhibit 3.2: REALTOR CRE Markets (YoY % Chg) Sales Volume Prices Source: NAR Based on National Association of REALTORS (NAR) data for the SCRE market, sales volume increased 20.5 percent on a yearly basis in The strong increase mirrored the renewed investor interest in stabile markets and properties offering higher yields. Prices for REALTORS commercial transactions advanced 8.5 percent year-over-year, a slower pace than in LCRE transactions. The data underscore an important point about the recovery and growth in SCRE markets. The rebound in smaller markets was delayed by three years and the rate of price growth has been shallower. In 2015, inventory shortage dominated the list of concerns for SCRE markets. Cap rates averaged 7.8 percent over the year, a 40 basis point decline from Yields in SCRE markets continued to offer a premium compared with the 6.5 percent average recorded in LCRE transactions during the year. 15

16 Capital Markets Capital markets proved favorable for commercial real estate during 2015, riding the rising tide of the past two years. Major capital providers found new energy in the growing values of commercial assets and competed for deals, leading to steep acceleration in prices for some property sectors, especially apartments and CBD office buildings. The U.S. investment market totaled $6.2 trillion in 2015, with 57.3 percent of the figure comprising debt-based investment assets and the remainder accounted for by equity-based properties. On the debt side, chartered depository institutions (banks) accounted for the bulk of capital providers, with about half the total market holdings, as the wave of low interest rates continued through the end of the year. The second largest share of debt holders was represented by commercial mortgage backed securities (CMBS), collateralized debt obligations (CDOs), and other asset backed securities (ABS) holders, making up 18.0 percent of total, based on data from the Federal Reserve. Government-sponsored enterprises (GSEs) were the third largest debt holder, with 12.0 percent of total, dominating the financing in the multi-family segment. Life insurance companies continued as active participants in debt markets, accounting for 11.0 percent of the debt universe. On the equity side of CRE financing, where equity investors held $2.6 trillion in assets, private equity accounted for 43.0 percent of capital, followed by listed and non-listed REITs, which made up 32.0 percent of financing in 2015, according to Situs RERC. Pension funds, both domestic and crossborder were the third largest capital provider group, representing 14.0 percent of the equity market. The remainder was evenly distributed between groups comprised of life insurance companies, commercial banks, corporations, foreign investors and others. Exhibit 3.3: CRE Debt Universe Exhibit 3.4: CRE Equity Investments U.S. Chartered Depository Institutions CMBS, CDO, other ABS GSEs (Freddie, Fannie) Life Insurance Companies Foreign Banking Offices in U.S. Other Private Equity REITs Pension Funds Life Insurance Cos. Commercial Banks Corporations Foreign Investors Gov't, GSEs & Others Source: Federal Reserve Board Sources: Situs RERC, NAREIT, PREA, AFIRE, Prequin, Real Capital 16

17 Lending The lending landscape in large commercial real estate (LCRE) markets broadened further in 2015, compared with the prior five years, as sources of funding actively competed for deals. Based on RCA data, CMBS originators accounted for 21.0 percent of lending at the high end of the market. Government-sponsored enterprises (GSEs) were the second largest source of lending, with 18.0 percent of total transactions, followed by national banks, which comprised 16.0 percent of deals. Regional and local banks made up 15.0 percent of total volume, while life insurance companies accounted for 12.0 percent. Financial institutions, international banks and private investors rounded-up the funding sources, with 10.0 percent, 7.0 percent and 2.0 percent, respectively, of total sales Exhibit 3.5: RCA Lending Sources ($2.5M+) Pvt/Other Reg'l/Local Bank Nat'l Bank Int'l Bank Insurance Gov't Agency Financial CMBS Source: Real Capital Analytics Based on NAR s 2016 survey data, capital markets display a fundamentally different landscape. Local and community banks were the largest lending group in REALTORS commercial markets in 2015, accounting for 31.0 percent of transactions. Local and community banks maintained market share from 2014, when they made up 32.0 percent of the market. The second largest capital source in 2015 were regional banks, which captured 25.0 percent of REALTORS commercial deals, on par with the previous year. Private investors were the third main capital providers, accounting for 12.0 percent of deals during National banks came in fourth place, with 8.0 percent market share. The Small Business Administration and credit unions shared an equal proportion, with 6.0 percent of the market each. Life insurance companies were much less active in REALTOR markets, representing 3.0 percent of deals, while CMBS conduits accounted for only 2.0 percent of funding, tied with REITs. Public companies and international banks made up about 1.0 percent of all sales Exhibit 3.6: REALTOR CRE Lending Sources Small Business Administration REITs Regional Banks Public Cos. Private Investors Other National Banks Local/Comm. Banks Life Insurance Cos. International banks Credit Unions CMBS Source: NAR The lending survey highlights the marked differences in the LCRE markets versus the SCRE markets. Debt financing represents a much-larger portion of capital in SCRE markets, whereas LCRE deals benefit from significant equity contributions. For regional and community banks which account for 56.0 percent of all capital in REALTOR markets compliance costs stemming from financial 17

18 Lending, continued regulations have made a stronger impact on available capital for CRE deals. With higher costs of compliance and higher capital reserve requirements for CRE loans, regional and community banks have been more cautious in their lending during 2015, resulting in tightening of capital, a reversal of the trend since In 2015, 33.0 percent of REALTORS reported tightening lending conditions, compared with 22.0 percent in 2014 and 28.0 percent in Exhibit 3.7: Does Bank Capital for CRE Remain Obstacle to Sales? 41% 59% Yes No Exhibit 3.8: Causes of Insufficient Bank Capital for CRE Lending: Other, please specify Global economic uncertainty U.S. Economic uncertainty Inability of banks to dispose of distressed assets New/proposed US legislative and regulatory initiatives Regulatory uncertainty for financial institutions Slow-down in pooling/packaging of CMBS Reduced NOI, property values, and equity Source: NAR In addition, 59.0 percent of REALTORS reported that insufficient bank capital remains an obstacle to sales in SCRE markets. The main reason comes from new and proposed legislative and regulatory initiatives Dodd-Frank, lease accounting, carried interest, etc. which were cited by 25.0 percent of respondents. Another 17.0 percent indicated that regulatory uncertainty for financial institutions was an important barrier to bank lending for CRE projects, tied with U.S. economic uncertainty. The third main reason was a combination of reduced net operating income, reduced property values and equity. 18

19 4 SURVEY HIGHLIGHTS 19

20 SURVEY RESULTS: Highlights 61% of respondents closed deals in 2015 REALTORS closed an average of 8 commercial transactions 94% of sales were valued at or below $5 million Cash comprised 26% of all transactions 61% of transactions had financing with LTV equal to or higher than 7 17% of respondents had international clients/investors Sales composition: - Office CBD: 8% - Office Suburban: 12% - Industrial Warehouse: 14% - Industrial Flex: 8% - Multi-family: 15% - Retail Strip Center: 12% - Retail Mall: 2% - Land: 18% - Hotel: 2% - Other: 8% Net operating income (NOI) of sold/leased properties increased in 57% of markets over the past eight years Lending conditions tightened for 33% of respondents and eased in 31% of respondents markets Failed sales due solely to appraised values declined from 22% in 2014 to 17% in Top sources of capital: - Local/community banks: 31% - Regional banks: 25% - Private investors: 12% - National banks ( Big four ): 8% - Small Business Administration: 6% - Credit unions : 6% - Life insurance companies: 3% - REITs: 2% - CMBS: 2% - Public companies: 1% - International banks: 0.7% 27% used the Small Business Administration refinance program 4 of sales failed due to lack of financing - Loan underwriting standards caused 54% of financing failures - caused by appraisals/valuation - 12% due to financing availability 15% of deals failed to secure re-financing, compared with 5 in the 2012 report Debt-to-service coverage ratio (DSCR) was % of respondents find insufficient CRE bank capital due to: - Legislative/regulatory initiatives: 25% - Financial regulatory uncertainty: 17% - U.S. Economic uncertainty: 17% - Reduced NOI, values & equity: 13% - Disposition of distressed assets: 7% - Global economic uncertainty: 7% - Pooling/packaging of CMBS: 4% The main reasons for failed sales due to appraisals: - NOI (Net Operating Income): 31% - Economic obsolescence: 15% - Deteriorated property financials: 14% - Location obsolescence: 13% - Zoning: 7% - Environmental conditions: 5% - Lack of energy efficiency: 2% 20

21 5 SURVEY RESULTS 21

22 SURVEY RESULTS Market Environment During 2015, 61.0 percent of REALTORS who responded to the survey completed a commercial real estate sale. Respondents reported that they closed an average of eight sale transactions during the year. The majority of REALTORS 94.0 percent reported average transaction values below $5.0 million Exhibit 5.1: Closed Sales During the Year Yes No N/A The survey data indicates that 18.0 percent of sales comprised land transactions, the largest share of all property types. Multifamily properties were the second most transacted property type, accounting for 15.0 percent of all deals, followed by industrial warehouses, at 14.0 percent. Suburban offices and strip retail centers made up an equal share of transactions 12.0 percent. REALTORS reported that 17.0 percent of transactions involved international clients or investors. The measure has been consistent over the past five years. We are hopeful for an above normal CRE in the Phoenix Metro area with large numbers of small business openings already showing for Availability of additional lending capital would increase activity as we push into our next expansion of single family housing bringing increased CRE activity into the expanding areas. - Arizona My transactions are never in California as the cap rates are too low in my state... my investors go out of state. - California Rents are high so it's understandable that Lenders want 5 down if the rental market changes they could end up with owners struggling to repay the debt. - California Exhibit 5.2: Transactions by Property Type Office: CBD Office: Suburban Industrial: Warehouse Industrial: Flex Multi-family Retail: Strip Center Retail: Mall Land Hotel Other, please specify 5% 1 15% Exhibit 5.3: Sales to International Clients/Investors Yes No

23 Market Environment I work around the country and find differences in all the markets, mainly due to demand not appraisals. - Illinois Good properties, well maintained and well managed, well leased are not having any issues with availability of capital, appraisals, or LTV issues (cap rates). It s the junk some people are putting out there to slide off into someone else's portfolio that is having a problem, and brokers are looking for someone to blame. Buyers are not stupid. - Kentucky I see that buyers ask for a higher cap rate than the market will provide. - Montana My answers may be regional and not applicable nationally. However, a serious employment issue exists, skilled and unskilled, and many industrial factories than used to employ people are now nothing more than distribution centers, employing 5 people: 4 forklift operators and 1 warehouse manager! - Ohio Exhibit 5.4: Change in net operating income ($/SF) of properties sold/leased from 4th quarter of 2007 to 4th quarter of 2015 Decreased 5-75% Decreased 4-49% Decreased 35% - 39% Decreased 3-34% Decreased 25% - 29% Decreased - 24% Decreased 1-19% No Change Increased 1-15% Increased 5% - 9% Increased 1% - 4% Exhibit 5.5: Expectations for Cap Rate Movement in Next 2-3 Years 4 10 Office CBD Office Suburban Industrial Distribution/Warehouse Industrial Flex Retail: Mall Retail: Neighborhood Shopping Center Retail: Strip Center Apartment: Market-Oriented Apartment: Affordable Apartment: Student Housing Hotel Land Lower by more than 100 bps Lower by bps Lower by 1-49 bps Same Higher 1-49 bps Higher bps Higher by over 100 bps 23

24 Lending Environment The majority of sales were financed in 2015, as cash comprised 26.0 percent of all deals, a smaller proportion than in Bank financing, in particular, was an important source of capital for commercial transactions, comprising 64.0 percent of capital. Local and community banks played a central role, with 31.0 percent of the market, followed by regional banks, at 25.0 percent. National and international banks accounted for a combined 9.0 percent of capital. Lending conditions took a step back during the year, according to survey respondents. Over a third of respondents indicated that lending conditions experienced tightening. This change marked a shift from the trend of the prior five years Exhibit 5.7: Average Loan-to-Value for CRE Transactions Other 10 Cash 5 55% 65% 7 75% 85% Exhibit 5.6: Change in Lending Conditions over Past Year Eased Significantly Eased Somewhat Not Changed Tightened Somewhat Tightened Significantly National lenders have best rates, but are way too conservative. They are not lending even for well capitalized deals. - Wisconsin Many commercial real estate properties are sold at the cap rate of below 7%. To obtain an LTV loan at 5% interest for 10 to 15 years, loan will have a debt service of equal or greater than NOI. That has to change soon! - Texas The regulatory environment is making the development and acquisition business much harder for individuals and small to medium players to compete against REITs and institutional investors. Reporting requirements, fees, legal costs related to transaction size have significant impact on the yields for smaller investments. - Texas Commercial loans above $1 million are available. Commercial loans below $1 million are difficult because they are not handled directly by commercial loan officers. Lack of experience results in a fits and starts application process with seemingly reluctant commitment and closing process. It is easier to get a large loan done than a smaller loan. - Vermont 24

25 Lending Environment 10 4 Exhibit 5.8: Percent of REALTORS Reporting Failed Sales Transaction Due to Lack of Financing N/A Dodd-Frank has forced lending institutions to look ONLY at a business s bottom line for income and only add back in depreciation, which for LLCs and Sole proprietors makes it almost impossible to get them financing for anything! - Missouri Smaller, local banks still are able to make a quicker commitment to borrowers. - New York Lending problems are due to lack of quality borrowers, not lack of capital by lending institutions. - Oregon No Yes Exhibit 5.9: Reasons for Lack of Financing 2016 Other Appraisal/valuation Loan underwriting/lender requirements Financing availability Local Banks are getting it done right now. Large banks only want large deals. They are no longer interested in small business - Oregon Lending is still difficult unless it is an owner occupied building or has long term leases in place. - Pennsylvania The Dodd-Frank act is the one greatest hindrance to the commercial real estate market activity in the US today. The Act constricts business and should be eliminated. - Colorado 10 Exhibit 5.10: Percent of REALTORS Reporting Failed Re-Financing Transaction 10 Exhibit 5.11: Reasons for Lack of Re- Financing Funding Other (please specify) 4 No Yes 4 Appraisal/valuation Loan underwriting/lender requirements Financing availability 25

26 Lending Environment SBA takes way too long, often limited knowledge of fine grain local circumstances, clients often must be able to move on their situation quickly or lose their opportunity. Thus there is a need for an 'Entrepreneurial Warehouse' brain-trust to educate, groom and promote new entrepreneurs how to get started quickly and smoothly. - Pennsylvania Private Lenders and Hard Money Lenders lend money to Investors and they should not be restricted by the Dodd Frank Act. Commercial banks are limited to Amounts and certain numbers of properties a person can hold. - Arizona Seems lenders are having difficulties lending, especially to small and medium businesses. - Arizona Need further training of FDIC and OTC regulators on the nuances of commercial real estate including understanding obsolescence, effects of changing buying trends, retail uses, etc. - California The big banks are running freely and need to be refocused. Since they were given the second wave of funds they have been out to close the market to all but themselves and stay in control. - California 10 4 Exhibit 5.12: Involved in CRE Transaction supported by SBA Loan Exhibit 5.13: If answered "No to SBA Loan, the reason was Did not know the program existed Burdensome application and reporting requirements Due to past SBA experiences Client had other source(s) of financing Other, please specify 8% 6% 9% 21% 56% N/A No Yes There is a concern that the regulatory environment is very restrictive. Some commercial lenders have expressed that they are having problems getting loans approved. - California The ongoing evolution of lending regulations will, over time, change lenders from using their judgement and relying on the numbers. Regional lenders won't be able to compete - national lenders will continue to be out of touch. Here on the Delmarva - that's exactly opposite of what we need to grow our economy and the next generation of leaders. - Maryland 26

27 Appraisals Appraisals for commercial transactions notched improvement in The incidence of failed sales due solely to appraised values declined from 22.0 percent in 2014 to 17.0 percent in The main culprit for low appraisals is reduced net operating income (NOI), which was cited by 31.0 percent of REALTORS. Economic obsolescence and deteriorating property finances were the second and third reasons for appraisal issues. Location obsolescence and zoning were reported as problems by 13.0 percent and 7.0 percent of respondents, respectively. There is a dramatic problem with how regional and national banks hire appraisers. There is no opportunity for proper selection by bank employees in the cities where the appraisals are being performed, often leading to hiring geographically incompetent individuals. - California Exhibit 5.14: Percent of REALTORS Reporting Transaction Failures Due to Appraised Value Exhibit 5.15: Main Reasons for Appraisal Problems Other Lack of energy efficiency No Yes Environmental conditions (air quality, contamination) Zoning Since in my state, lenders have to use an appraiser from a "pool", the appraiser most of the time does not know the area or product type. - Illinois The problem is lenders are concerned about finding the cheapest appraisal, which leads to lower quality work. Encourage quality and be willing to pay a little more for good work. - Indiana Location obsolescence Economic obsolescence Deteriorating fiscal issues with property NOI (Net Operating Income) Exhibit 5.16: Mezzanine Debt Required Due to Appraised Value Lower than Price Lending Officers are not allowed to select appraiser, so the lending officer and appraiser are disconnected. That regulatory requirement is hurting the tertiary commercial markets and hindering small business acquisition of real estate. - Tennessee 4 No Yes

28 Appraisals REALTORS reported that most appraisers are unfamiliar with local markets and property types. Only 17.0 percent indicated that appraisers are Always familiar, while 65.0 percent indicated Sometimes. Familiarity with the property type displayed a similar picture, with 63.0 percent of respondents stating that appraisers are Sometimes familiar, while 27.0 percent reported that appraisers are Always familiar. There was a cloud casting a longer shadow over the appraisal situation 60.0 percent of REALTORS reported that lenders generally seek quality appraisers who are familiar with the local market and property types. That means that two-in-five transactions are appraised by someone who may not be familiar with the market or the property type. It seems that the appraisal process is flawed. We have out of area appraisers picking from a pool of local appraisal opportunities though they are not in the least qualified to do appraisals in the those areas. For example, appraisers from Annapolis or Baltimore or Salisbury take on appraisal jobs in areas which are over an hour or two drive away from their home offices. They have to see the contract before they can give a value. What's the point of the appraisal if they are allowed to see the contract price and then can make the price appraisal fit that price? It's so ridiculous and wrong. - Maryland There is NO shortage of appraisers at this time. If there is a shortage in the future, it will be because our fees are so low we cannot afford to hire trainees. I stopped doing AMC work after the crash. Now I no longer need mortgage work so it is on the "back burner". They increased requirements and liability, but NOT the fees. So good-bye AMCs! - Virginia Appraisers are generally aware of the market they serve however are restricted by Federal guidelines that are now outdated. - Washington Exhibit 5.17: How Familiar Are Appraisers with the Market? Not sure; N/A Never Rarely Sometimes Always Exhibit 5.18: How Familiar Are Appraisers with the Property Type? Not sure; N/A Never Rarely Sometimes Always Exhibit 5.19: Do Lenders Seek Appraisers Familiar with Market and Property Type? No Yes 28

29 Methodology of NAR s 2016 CRE Lending Survey Within the framework of improving market conditions, the National Association of REALTORS conducted a national survey of commercial real estate members, focused on lending conditions. In February and March of 2015, NAR invited a random sample of 65,420 REALTORS with an interest in commercial real estate to fill out an online survey. A total of 1,241 responses were received for an overall response rate of 1.9 percent. 29

30 The National Association of REALTORS, The Voice for Real Estate, is America s largest trade association, representing over 1.1 million members, including NAR s institutes, societies and councils, involved in all aspects of the real estate industry. NAR membership includes brokers, salespeople, property managers, appraisers, counselors and others engaged in both residential and commercial real estate. The term REALTOR is a registered collective membership mark that identifies a real estate professional who is a member of the National Association of REALTORS and subscribes to its strict Code of Ethics. Working for America's property owners, the National Association provides a facility for professional development, research and exchange of information among its members and to the public and government for the purpose of preserving the free enterprise system and the right to own real property. NATIONAL ASSOCIATION OF REALTORS RESEARCH DIVISION The Mission of the National Association of REALTORS Research Division is to collect and disseminate timely, accurate and comprehensive real estate data and to conduct economic analysis in order to inform and engage members, consumers, and policy makers and the media in a professional and accessible manner. To find out about other products from NAR s Research Division, visit NATIONAL ASSOCIATION OF REALTORS RESEARCH DIVISION 500 New Jersey Avenue, NW Washington, DC

31 Commercial Real Estate Lending Trends 2016