2010 National Apartment Report

Transcription

1 21 National Apartment Report To our valued clients: The worst-case scenario for the U.S. economy and financial system was averted in the Great Recession of 28-29, notwithstanding its severity. The stabilization of the global financial system ushered in greater appetite for risk and opportunistic buying reflected in the global equity market surge much faster than the most optimistic forecasts. Job cuts finally abated to reasonable levels in late 29, and several downward revisions to prior months losses were characteristic of an emerging turn in the employment cycle. As we look ahead, we still face a myriad of challenges, starting with high and rising unemployment, record consumer debt, and the eventual need to clean up the government balance sheet. Judging by the extended period of time required to recapture lost jobs after the last two recessions, companies are likely to enter expansion mode cautiously. Apartment owners and investors should be prepared for tepid job creation in 21, with the year expected to be somewhat of a staging period for an eventual acceleration in employment growth, likely in Severely high unemployment among 2- to 34-year-olds will hamper renter household formation in the short term. The sheer size of the echo-boom generation, however, only moderately smaller than the 8 million baby boomers, along with a drastic pullback in housing construction, points to strong rent growth starting in 211. It is simply a matter of time before an expanding economy releases this powerfully favorable demographic into the renter pool. Investors began positioning ahead of this macro trend in 29, concentrating their bets on quality assets in stronger metros and/or submarkets. A relatively brief period of rising cap rates gave way to multiple offers from credible buyers and cap rate compression in the upper tier of the apartment market, as positive leverage and prospects for strong income growth overtook fear. In 21, risk tolerance should gradually spill over to the broader market as an economic recovery becomes more convincing. Nevertheless, investors will continue to demand due reward for the additional risk associated with value-add deals. Conversely, visions of quality assets coming to market at fire-sale prices will continue to fade, and buyers and sellers will move closer to redefining fair value based on true assessments of quality and risk. More distress is sure to come to market, but the quality will be highly mixed as lenders avert further losses by avoiding foreclosure on performing assets and those with reasonable prospects for stabilization. The drivers of increased sales activity began to align in 29, but for extremely tight underwriting and limited debt availability outside of GSEs and some banks. Life insurance companies started to show renewed interest, but capacity limitations cap the potential for a 21 surge. Assuming government-mandated changes to Fannie Mae and Freddie Mac steer clear of their multi-family lending arms, the GSEs should remain the primary sources of financing for apartment investors. This year, more foreign investors, REITs and institutions will join private investors, who dominated acquisitions last year. Expectations for near-term weakness will be overshadowed by increased visibility on fundamentals, more reasonable cap rates and prospects for above-trend rent growth in the years to come. To assist you in planning and executing a successful investment strategy, we are pleased to present our 21 National Apartment Report. Included is our National Apartment Index (NAI), a forward-looking ranking of 44 markets based on forecast supply and demand conditions. We hope you will find this report helpful, and our investment professionals look forward to assisting you in meeting your goals. Sincerely, Harvey E. Green President and Chief Executive Officer Hessam Nadji Managing Director Research Services

2 21 National Apartment Report NATIONAL PERSPECTIVE Executive Summary... 3 National Apartment Index National Economy... 6 National Apartment Overview... 7 Capital Markets... 8 Investment Outlook... 9 MARKET OVERVIEWS Atlanta... 1 Austin Boston Charlotte Chicago Cincinnati Cleveland Columbus Dallas/Fort Worth Denver Detroit... 2 Fort Lauderdale Houston Indianapolis Jacksonville Kansas City Las Vegas Los Angeles Louisville Miami Milwaukee... 3 Minneapolis-St. Paul Statistical Summary Table New Haven New Jersey New York City Oakland Orange County Orlando Philadelphia... 4 Phoenix Portland Riverside-San Bernardino Sacramento Salt Lake City San Antonio San Diego San Francisco San Jose Seattle... 5 St. Louis Tampa Tucson Washington, D.C West Palm Beach CLIENT SERVICES National Multi Housing Group (NMHG) Marcus & Millichap Capital Corporation Research Services Contacts, Sources and Definitions Office Locations Written by John Chang, National Research Manager, and edited by Hessam Nadji, Managing Director. The Capital Markets section was coauthored by William E. Hughes, Managing Director, Marcus & Millichap Capital Corporation. Additional contributions were made by Marcus & Millichap market analysts and investment brokerage professionals nationwide. 21 Annual Report

3 21 National Apartment Report Executive Summary National Apartment Index (NAI) Washington, D.C., retained the top spot in the NAI for the second consecutive year, as ongoing government spending intended to spur the economy will fuel metrowide hiring and apartment demand. San Diego (#2) rose four places in the ranking due to expectations for resumed employment and household growth, which will support low vacancy and slightly rising rents. Many Midwestern markets performed well in the ranking in recent years due to relatively stable vacancies and rents; however, these metro areas are expected to lag as the economy recovers. Chicago (#2) fell nine spots in this year s ranking while Kansas City (#24), Cincinnati (#3) and Columbus (#31) each tumbled eight spots in the index. Markets hardest hit by the housing bubble began to rebound in the index, moving up a few spots due to anticipated stabilization in 21. Seattle (#22), Miami (#25), and Phoenix (#34) rose three, three and seven spots, respectively, in the NAI. National Economy After shedding nearly 7.2 million jobs since the onset of the recession, the U.S. employment market is expected to expand slowly in 21. While modest losses are likely in the first quarter, employers are projected to add nearly 1 million workers this year, a.75 uptick in payrolls. Unemployment, which averaged 1 percent in the fourth quarter of 29, is forecast to remain in the double digits through the end of 21 as a resumption of hiring drives job seekers to re-enter the labor force. The economy will be buoyed by government stimulus and a weak dollar, which will support exports. GDP is expected to grow by 2.5 percent to 3. percent in 21, after contracting by 2.5 percent last year. Consumer spending, which makes up approximately 7 percent of GDP, is not likely to rebound significantly due to persistent high unemployment hampering growth. Despite the doubling of the Fed s balance sheet, inflation is expected to remain fairly tame in 21. Slack in the labor markets will limit wage pressures, and low capacity utilization should keep prices largely in check. National Apartment Market Overview The worst of the erosion of occupancies is over, and a drop in construction is setting the stage for a recovery. Developers will complete 65, apartments in 21, down from 94, units last year. Vacancy is expected to decrease 3 basis points this year to 7.8 percent, following a 14 basis point spike in 29. Asking rents will decline 1.7 percent in 21, and operators will continue to trim effective rents, as the moderate drop in vacancy will not translate into pricing power yet. Effective rents are forecast to retreat 3 percent, and concessions will reach 9 percent of asking rents, compared with an average of approximately 5 percent of asking rents from 25 to 28. Unemployment among 2- to 34-year-olds started 21 more than 2 basis points higher than the overall unemployment rate and the highest figure on record since the early 198s. As the economy slowly gains steam, younger workers and recent graduates, many of whom moved in with friends and family, could begin to enter the rental market. Capital Markets While many regional banks have sharply pulled back commercial real estate lending volume, the apartment market has been supported by lending by Fannie Mae and Freddie Mac. The agencies commercial loans have been among the best performing assets in their portfolios, and the GSEs are expected to continue to be a primary lending source in 21. Many upside-down owners remain unable to refinance maturing debt, even for assets generating healthy cash flows; however, lenders are increasingly willing to extend or modify loans. Even properties with insufficient cash flows may be candidates for modifications, though additional equity contributions typically are required. The lending climate for apartments will remain constrained, and underwriting standards will be conservative in 21. Investors should expect LTVs to stay within the 55 percent to 75 percent range. Investment Outlook After dropping approximately 7 percent from the peak, investment activity began to revive modestly in the second half of 29 and should improve further in 21. Local, private buyers account for the bulk of activity, but institutions and REITs that have accumulated capital are expected to target large properties in primary markets this year. The weakness of the U.S. dollar is attracting foreign buyers. In the fourth quarter of 29, for example, the Kuwait Finance House announced plans to buy $45 million of apartment properties in the United States. Softening operating conditions contributed to stalled transaction activity through much of 29, as buyers and lenders were unsure how far property fundamentals and NOIs would slip. With the economy entering a modest recovery and most performance measurements expected to stabilize in 21, investors have more confidence in their forecasts and underwriting. 21 Annual Report page 3

4 National Apartment Index Markets with the Highest Expected 21 Employment Growth San Antonio Austin Dallas/Fort Worth Houston Salt Lake City Seattle Portland Minneapolis-St. Paul Washington, D.C. Denver United States.7% % 2. Nonfarm Employment (Y-O-Y Change) Markets with the Greatest Expected 21 Employment Losses Detroit Jacksonville West Palm Beach Tampa Fort Lauderdale Miami Cleveland Atlanta Oakland Sacramento United States %.5% 1. Nonfarm Employment (Y-O-Y Change) Vacancy Rate 1 15% 1 9% Markets with the Highest Expected 21 Vacancy Rates Jacksonville Tucson Houston Phoenix Las Vegas Atlanta Charlotte Orlando Tampa Austin United States Units (thousands) Markets with the Highest Expected 21 Completions Dallas/Fort Worth Houston Washington, D.C. New York City Seattle Austin New Jersey Denver San Antonio Phoenix 21 National Apartment Index Marcus & Millichap is pleased to present the 21 edition of the National Apartment Index (NAI). The NAI is a snapshot analysis that ranks 44 apartment markets based on a series of 12-month forward-looking supply and demand indicators. Markets are ranked based on their cumulative weighted-average scores for various indicators, including forecast employment change, vacancy, construction, housing affordability and rents. Taking into account both the predicted level and degree of change over the forecast period, the index is designed to indicate relative supply and demand conditions at the market level. Users of the index are cautioned to keep a few important points in mind. First, the NAI is not designed to predict the performance of individual investments. A carefully chosen investment in the bottom-ranked apartment market could easily outperform a poor choice in the topranked market. Second, the NAI is geared toward a short-term time horizon. Third, a market s ranking in the index can improve from one year to the next, even if its fundamentals are weakening. This is especially evident during shifts in the real estate cycle. For example, a number of markets that rose in the index will record modest vacancy increases this year, but the forecast vacancy rate in many of these areas remains well below the national average. It is also important to note that because the NAI is an ordinal index, differences in specific rankings should not be misinterpreted. For example, the top-ranked market in the index is not necessarily twice as good as the second-ranked market, nor is it 1 times better than the 1th-ranked market. Low Vacancy Markets Once Again Rise to the Top Vacancy Rate 1 Markets with the Lowest Expected 29 Vacancy Rates New York City New Haven Minneapolis-St. Paul New Jersey San Diego San Francisco Milwaukee San Jose Los Angeles Washington, D.C. United States During the past two years of job cuts, apartment fundamentals have generally performed best in established metro areas known for stability rather than rapid growth. Midwestern markets, in particular, were among those impacted the least during the recession. Some markets with traditionally high occupancy, on the other hand, fell dramatically in the 29 ranking, as concentrated job losses among professional and financial firms caused vacancy rates to nearly double in some instances while pressing significant rent declines. As renter demand firms in 21, metro areas that feature structurally low vacancy rates are expected to stabilize; these markets rose in the NAI. While forecasts for job growth caused markets such as Seattle, Denver and Phoenix to improve in this year s ranking, supply overhangs persist in these areas, and extended periods of household expansion will be required for the markets hardest hit by the recession to recover fully. page 4 21 Annual Report

5 National Apartment Index Affordability Index (U.S. = 1) Single-Family Housing Affordability Most Affordable Least Affordable Indianapolis Cleveland Detroit Cincinnati St. Louis San Jose Oakland Orange County San Francisco New York City Washington, D.C., Retains the Top Spot; San Diego Rises to #2 Fueled by government spending, Washington, D.C., will be among the first metro areas to emerge from the recession, allowing the nation s capital to maintain the top spot in this year s NAI. Despite continued inventory growth, healthy demand drivers will increase absorption, driving vacancy lower and fueling limited rent growth. San Diego (#2) rose four places in the ranking due to expectations for comparatively low vacancy and rents that will rise slightly, unlike virtually all other markets. New York City, which ended 29 as the tightest apartment market in the country, will record modest vacancy improvement this year as professional and financial services firms resume hiring. The metro jumped five places in the index to #3. Despite tight vacancy, rents in Minneapolis-St. Paul (#4) continue to contract, causing the market to slip one spot this year. Job growth in Philadelphia will lag the nation in 21, easing down the market three places to round out the top five. New Jersey ticked down one spot to #6 this year, as accelerating construction will outpace job growth, pushing vacancy higher. Payrolls in Orange County (#7) will expand for the first time since 26 and delivery of new units will slow, supporting the area s six-spot improvement in the ranking. Expectations for a vacancy uptick and further rent declines pushed down Boston four places to #8, while San Francisco advanced eight spots to #9, as relatively low housing affordability keeps its vacancy rate among the tightest nationwide. Limited additions to inventory and a forecast resumption of job growth will drive down vacancy in San Jose (#1) this year, supporting the metro s eight-spot rise in the 21 NAI. Many Midwestern markets performed well in the ranking in recent years due to relatively stable vacancies and rents. Most of these metros are expected to lag as the economy recovers and therefore fell in the NAI. Chicago (#2) dropped nine spots in this year s ranking, while Kansas City (#24), Cincinnati (#3) and Columbus (#31) each tumbled eight spots. The Texas markets are forecast to lead the country in job growth in 21, but developers will continue to deliver new units, and vacancy will remain above-average. Each of the Texas markets rose in the index, with San Antonio (#12) the top-ranked metro area in the state. While a modest recovery will take hold throughout much of the country this year, Florida s economy will remain soft, and major metro areas in the state comprise much of the bottom of the index. Steep rent declines are forecast for Fort Lauderdale (#39), West Palm Beach (#41) and Jacksonville (#44). These markets will not show a recovery in 21; however, properties in these areas could offer strong upside for less riskaverse investors who acquire assets this year. Rank Rank 9-1 MSA Change Washington, D.C. 1 1 San Diego New York City Minneapolis-St. Paul Philadelphia New Jersey Orange County Boston San Francisco San Jose Salt Lake City San Antonio Los Angeles New Haven Louisville Austin Milwaukee Oakland Portland Chicago Denver Seattle Dallas/Fort Worth Kansas City Miami St. Louis Indianapolis Houston Charlotte Cincinnati Columbus Cleveland Sacramento Phoenix Orlando Detroit Riverside-San Bernardino Tucson Fort Lauderdale Tampa 4 4 West Palm Beach Atlanta Las Vegas Jacksonville See National Apartment Index Note on page Annual Report page 5

6 National Economy (millions) Annualized Quarterly Change in GDP Decade Average Annual Growth % -5% -1 5% 1% U.S. Employment U.S. GDP 95 GDP/Employment Ratio GDP Employment 25-Year Average GDP: 3.1% 25-Year Average Employment: 1.5% 5 5 9*1** 9*1** 195s 196s 197s 198s 199s 2s 21** Muted, Choppy Recovery Expected; Elements of Surprise to the Upside Emerging Unlike previous severe economic downturns, which were typically followed by robust growth, recovery from the Great Recession will be hampered by elevated unemployment, high consumer debt and a corporate focus on profit margins. Record levels of government borrowing and stimuli also are sources of concern, as they point to higher taxes and increase the threat of inflation. These economic headwinds remain formidable and should not be underestimated. Apartment owners and investors should prepare for a muted recovery in 21, particularly when it comes to job growth. A number of positive elements have emerged, however, that make a surprise to the upside more likely than the resumption of economic contraction. For starters, low capacity utilization and high unemployment should keep inflation at bay through most, if not all, of this year, giving the Fed plenty of time before entering an aggressive tightening cycle. This should prevent a double dip, which in previous instances was largely attributable to the Fed raising interest rates too far, too fast. As the financial system moves past stabilization and bank profits continue to improve, lending will increase. This will give consumers and small- to mid-sized businesses much-needed relief from extremely tight credit conditions. In the latter part of 29, the percentage of banks tightening lending criteria slipped to the lowest point since the financial crisis began. Projected GDP growth of 2.5 percent to 3. percent in 21 could actually come in stronger due to export growth and improvement in the housing market. Normally, expansion in this range would translate into an employment gain of 1.5 percent; however, with corporate psychology likely to remain fixated on cost containment, outsourcing and part-time solutions, job growth of.75 percent to 1. percent is the more likely scenario for 21. At some point, most likely in 211, the extreme job cuts of the past 18 months will result in a shortage of workers in many industries, leading to levels of job creation that resemble real economic expansion. 21 National Economic Outlook Slow Employment Growth in 21. The recession claimed approximately 7.2 million jobs through the end of 29, including 4.1 million last year alone. Employers will begin to rehire cautiously in 21, creating approximately 1 million jobs. Growth will be concentrated in the education and health services and export-related industries. Underemployment Rate Retail Sales and Underemployment 2 15% 1 5% 1 Underemployment Rate Retail Sales, Excluding Auto & Gas 1 5% -5% in Retail Sales *** *** Through November Federal Reserve Walking a Tightrope. Through the recession, the Fed dropped interest rates to nearly zero and committed billions of dollars in aid to provide liquidity to credit markets. This year, the central bank must determine when, and how much, support should be withdrawn to avoid inflation or another recession. Credit Availability Crucial to Small Businesses. Historically, small businesses account for nearly two-thirds of job growth, and they remain a critical component of recovery. Initiatives have been proposed to raise the maximum size of Small Business Association loans and allow more banks to borrow at low rates from the Troubled Assets Relief Program. Commercial Mortgage Maturities a Wild Card. Banks deferrals of atrisk loans may be postponing inevitable writedowns as weak fundamentals challenge overleveraged properties. As potential losses accumulate, the risk of additional bank failures escalates, potentially diminishing credit availability as the recovery gains momentum. page 6 21 Annual Report

7 National Apartment Overview Worst over for Operations; Recovery to Gain Strong Momentum After 21 Apartment property fundamentals should stabilize this year after absorbing the demand shock of 29. Tepid job creation and elevated unemployment will hamper renter household formation through most of 21, delaying a more noteworthy improvement in apartment demand. Unemployment in the prime renter age cohort of 2- to 34-year-olds started the year more than 2 basis points above the overall rate and at the highest level on record since the early 198s. Additional challenges to an apartment recovery in 21 include competition from shadow rentals and the extended first-time homebuyer tax credit. By some estimates, the latter has already resulted in 35, home sales that would not have occurred otherwise. The extended forecast for apartments remains bright, supported by a pullback in construction and permitting, burn-off of excess housing inventory, receding homeownership rates, and favorable demographics. Apartment development in the years leading up to the recession fell short of historical norms, and tight credit markets have since cleared many planned projects from the pipeline. In 29, multi-family permitting declined 6 percent from the previous year, and construction deferrals doubled. The lull in development will provide owners time to fill vacant units ahead of the next construction cycle, which is unlikely to reach meaningful levels until Furthermore, apartment owners stand to benefit from echo boomers transitioning into their prime renting years, with the number of 2- to 34-year-olds projected to rise by approximately 5 million individuals in the next 1 years. 21 National Apartment Outlook Fannie Mae as Landlord. Under a new plan, Fannie Mae will permit homeowners facing foreclosure to rent their homes for as long as a year, effectively creating another layer of shadow rental stock. At the same time, the program should minimize near-term REO sales, helping to stabilize the housing market, which remains critical to an economic recovery. Completions Retreating. Developers will deliver 65, apartments in 21, down from 94, units last year. Completions in the most oversupplied housing markets, such as Phoenix and Las Vegas, will slip to the lowest levels in years. Only a few markets will register increases this year, including New York City and New Jersey, where a handful of highrises will come online. Vacancy to Drop Moderately in 21. Vacancy improvement in the second half of 21 will offset some of the weakness recorded earlier in the year. Vacancy surpassed all previous peaks in 29, increasing 14 basis points, and is forecast to end 21 at 7.8 percent, a net decline of 3 basis points. to Lag. Fierce competition for renters will persist even after vacancy starts to subside, keeping downward pressure on rents. In 21, asking and effective rents are expected to slip 1.7 percent and 3. percent, respectively. Owners will begin to see some pricing power in the second half of the year, particularly in lower vacancy markets that had significant rent adjustments in 29. Demographics Favor Student Housing. Forecasts of an expanding college-aged population and rising post-secondary enrollment bode well for student housing over the next several years. Student housing outperformed traditional apartments in 29, with vacancy remaining in the 7. percent to 7.5 percent range. This trend should continue through 21 as development in this segment slows by more than 5 percent. Average Effective Rent Units Completed (thousands) Vacancy Rate Revenue per Unit Apartment Rent and Vacancy Trends $1, $9 $8 $7 $ Effective Rent Vacancy Rate 1 9% Vacancy Rate Apartment Completions 85 Units Completed Completions as a Percentage of Inventory *1** Unemployment in the Prime Renter Demographic 2 Vacancy Rate Unemployment Rate - Ages * 15% 1 9% Apartment Revenue and Concessions $95 $9 $85 $8 $ Revenue per Unit Concessions as a Percentage of Asking Rents 1 9% *1** Inventory as a % of Completions Unemployment Rate - Ages 2-34 Concessions as a % of Asking Rents 21 Annual Report page 7

8 Capital Markets Multi-Family Mortgage Debt Outstanding Other, 5% Life Insurance Companies, Savings Institutions, 7% State & Local Governments, Commercial Mortgage Delinquency Rates Delinquency Rate Maturing Balance (billions) Rate CMBS, CDO & Other ABS, 1 5% 1% 4Q 97 4Q 98 4Q 99 CMBS (3+ days and REO) Life Companies (6+ days) Fannie Mae (6+ days) Freddie Mac (6+ days) Banks & Thrifts (9+ days) 4Q 4Q 1 4Q 2 4Q 3 4Q Q 5 GSEs & Ginnie Mae, 3 Commercial Banks, 2 4Q 6 4Q 7 4Q 3Q 8 9 Estimated Multi-Family Debt Maturities by Vintage $1 $75 $5 $25 $ Pre All-in Rates Range-Bound, Despite Fluctuating 1-Year Treasury Yield 27 1-Year Treasury Yield Fannie Mae All-in Rate (Tier 2) GSE Lending Remains a Lifeline as Tight Capital Markets Stifle Sales Activity Apartments will maintain a financing advantage over other property types in 21 due to the availability of debt from Fannie Mae and Freddie Mac. The GSEs account for almost 6 percent of new multi-family mortgage originations, followed by banks. Generally constrained lending, however, will keep sales and refinancing below normal levels despite some improvement over 29. Agency lending should persist at a healthy pace in 21, assuming government-mandated changes steer clear of their multi-family lending arms. Furthermore, Freddie Mac s Capital Markets Execution program holds promise as a viable source of liquidity, following the securitization of $2 billion of debt in 29. Nonetheless, traditional CMBS issuance remains limited despite government programs such as TALF and PPIP, and is unlikely to be a major source of financing in 21. This presents the greatest challenge for deals over $15 million, an issue exacerbated by a pullback in lending by life insurance companies. Though a handful of life insurers have showed renewed interest in lending, capacity limitations dampen expectations for a 21 surge. Aside from the GSEs, local and regional banks will account for the greatest share of apartment financing this year, focusing on smaller, low-risk deals in primary markets with strong sponsors. Delinquency rates continue to rise, though increases vary by lender type. Fannie Mae and Freddie Mac, which account for 38 percent of apartment debt outstanding, boast sub-1 percent delinquency due to conservative underwriting through the boom. The CMBS sector, on the other hand, has recorded rapid increases in its apartment delinquency rate, which closed 29 at an estimated 9 percent. CMBS debt originated between 25 and 27 presents the most risk and includes many large loans underwritten on optimistic rent/ occupancy projections that failed to materialize. In addition, prices were at or near peak levels during this period, and high-leverage loans were prevalent. Many risky CMBS loans will mature between 21 and 212, though recent tax-law changes granting special servicers greater loan modification flexibility may alleviate some default risk. An increase in defaults could prove most problematic for commercial banks, which account for one-fourth of outstanding multi-family debt. Banking risks are well-recognized, however, and government efforts to prevent another financial shock remain likely. 21 Capital Markets Outlook Long-Term Rates Low. The 1-year Treasury yield increased in 29 but remains low by historical standards, due partly to government Treasury purchases last year. Moderate economic growth and tame inflation should prevent a major run-up in yields in 21. Mortgage Rates Relatively Stable. Lenders will continue quoting all-in rates instead of spreads, limiting fluctuations. Fannie Mae s all-in rate is currently equivalent to late-28 levels, when the 1-year was 1 basis points lower. Lenders Opt for Extensions over Near-Term Losses. Many upside-down owners remain unable to refinance maturing debt, even for assets generating healthy cash flows; however, lenders are increasingly amicable to extensions/modifications. Even properties with insufficient incomes may be candidates for modifications, though equity contributions are typically required. Seller/Assumable Financing Critical as Lending Remains Constrained. More than half of all commercial real estate deals involved seller and/ or assumable financing in 29. As balance sheets heal, caution and risk aversion will continue to dominate lending decisions. Investors should expect LTVs to remain in the 55 percent to 75 percent range. page 8 21 Annual Report

9 Investment Outlook The Tale of Two Markets: Frenzy over Quality, Low Tolerance for Risk Investment strategies will change course in 21 as the buyer-anticipated wave of distressed properties comes out as a trickle. Prices have fallen, however, and with the economy starting a slow recovery, buyers and sellers expectations will begin to align, sparking sales activity. While some troubled assets will enter the market in the coming quarters, lenders will continue to extend loans and renegotiate terms rather than reclaim properties, particularly in light of relaxed FDIC guidelines regarding markdowns of underperforming loans. Lenders ultimately will have to act on nonperforming loans, though this will likely occur in stages over the next few years as banks balance sheets improve to the point where losses can be absorbed. Bottoming fundamentals and further evidence of a shortage of quality assets offered at truly distressed prices will move more buyers off the sidelines in 21. Average Price per Unit (thousands) Apartment Price and Cap Rate Trends $12 $9 $6 $3 $ 1 Average Price per Unit Average Cap Rate 9% 7% Average Cap Rate 5% * Sales velocity dropped more than 5 percent last year, but activity began to improve modestly in the fourth quarter and will continue to gain momentum in 21. Average prices have fallen approximately 25 percent from the peak, but the trend varies by quality. A recent frenzy of buyer demand has resulted in multiple offers and cap rate compression for quality assets in stronger markets. This trend will persist as investors look long term and position themselves ahead of the recovery. REITs have successfully raised capital and are re-entering the market, targeting large complexes in primary metros, while institutions and syndicates are expected to step up activity as well. Among smaller private buyers, local investors will drive sales activity, as lenders continue to show a clear preference for investors with experience managing properties in their home markets. Following advances of 1 basis points or more last year, cap rates will tick higher this year primarily among lower-tier properties and in secondary and tertiary metros. 21 Investment Outlook Stabilizing Fundamentals Support Investment. Weak operating conditions contributed to stalled sales activity through much of 29, as buyers and lenders were unsure how far property fundamentals and NOIs would slip. With the economy entering a recovery and most performance measurements expected to stabilize in 21, investors have more confidence in their forecasts and underwriting. A sharper-than-anticipated rise in long-term interest rates, however, would pose a major risk to pricing and cap rates. Busted Condos, Stalled Developments Attracting Buyers. While the number of distressed properties hitting the market remains far below expectations, opportunistic buyers are finding deep discounts in projects that encountered difficulties in the recession and conversions that were initiated just prior to the market s bust. The bulk of these deals are occurring in Las Vegas, Phoenix and Florida. Declining Dollar Driving Foreign Interest. By the end of 29, the U.S. dollar had fallen more than 1 percent against foreign currencies. A favorable exchange rate could peak foreign interest, particularly in gateway markets such as New York City, Washington, D.C., Miami, San Francisco and Los Angeles. In the fourth quarter, the Kuwait Finance House announced plans to purchase $45 million of U.S. apartment assets. Job Cuts Drive College Enrollment. One byproduct of elevated unemployment is rising college enrollment, which is spurring demand for student housing. Cap rates for student housing increased 5 basis points in 29, while the average price rose 5 percent. Both measurements outperformed those for traditional apartments. U.S. Apartment Transactions by Quarter Total Transactions (thousands) Average Cap Rate Percent of Sales Volume * Re-Pricing of Risk Reflected in Apartment Cap Rate Trends by Market 9% 7% 5% 1 75% 5 25% 4 Primary Secondary Tertiary U.S. Apartment Buyer Composition Other Public Sales $5 million and greater Private Institutional Equity Fund Foreign 9* ** * Estimate ** Through September 21 Annual Report page 9

10 Atlanta Down 3 Places 21 Rank: Rank: 39 Units (thousands) Despite Limited Construction Activity, Shadow Stock Weighing on Operations D espite a considerable decline in multi-family development activity, still soft employment generated demand and competition from shadow inventory will push vacancy near record levels this year. Indeed, completions in 21 are expected to total the fewest number of units in 15 years. Moreover, about 8 percent of this year s deliveries will come online in the North DeKalb submarket, isolating the effects of new inventory on metrowide conditions. While pressures from new development throughout the rest of the market will ease, competition from shadow inventory continues to affect unit demand. More than 2 percent of apartments were converted to condos since 23, and many are now competing as rentals. Also, as of the end of last year, homes available for-rent totaled an additional.7 of rental inventory. As a result, effective rents are projected to recede this year as owners increase concessions in response to shadow competition. Ongoing operational challenges in 21 should create additional buying opportunities for Atlanta apartment investors. Rising vacancy and increased expenses will continue to mitigate cash flows and push more assets into distress, especially properties purchased at aggressive pro forma underwriting near the market peak. As a result, cap rates, which currently average in the high-7 percent to low-8 percent range, will tick higher and may begin to narrow the pricing disconnect between buyers and sellers. Investment activity will center largely on distressed properties this year. Bank-owned assets in the Southwest, Austell and Stonecreek/Clarkston areas, in particular, may offer near-term discount opportunities, which would provide longer-term upside to investors willing to assume added operational risk. $7 $6 $5 $4 $ * Market Outlook 21 NAI Rank: 42, Down 3 Places. One of the nation s highest vacancy rates and continuing job losses placed Atlanta down three spots in this year s NAI. Employment Forecast: Total employment in Atlanta will decrease by 4, positions in 21, a.2 percent loss. Last year, employers cut 15, jobs from payrolls. Construction Forecast: This year, developers are slated to bring online 1,5 units, a.4 percent addition to inventory but down significantly from the 3,6 units delivered in 29. Over the past five years, completions have averaged 4,9 units annually. Vacancy Forecast: The average vacancy rate is projected to rise 3 basis points in 21 to 11.6 percent. Last year, vacancy increased 1 basis points. Rent Forecast: Asking rents are expected to decline 3 percent this year to $8 per month, and effective rents are projected to drop 3.5 percent to $78 per month. In 29, asking rents slipped 4.3 percent, while effective rents fell 4.4 percent. Investment Forecast: Owners will continue to retain properties in areas with steady renter demand, including the core North Fulton County, Buckhead and Midtown submarkets. Opportunities to purchase distressed assets will remain, however, allowing some buyers to take on greater risk. Market Forecast Employment:. Construction: 5 Vacancy: 3 bps Asking Rents: 3. page 1 21 Annual Report

11 Up 4 Places 21 Rank: Rank: 2 Austin Job Growth Driving In-Migration, Fueling Apartment Demand In Austin, the robust employment growth that supported one of the healthiest local economies prior to the recent downturn is anticipated to resume in the coming months, attracting job seekers from areas deeply maligned by the recession. A recovery in the global economy will be particularly beneficial for Austin firms, as technology sales in emerging markets will revive the local manufacturing sector, which has declined by 15 percent since peaking in 27. As a result, apartment demand is expected to increase as 21 progresses, supported by a boost in household formation. Effective rents will fall, however, as the influx of construction that artificially buoyed rents last year dissipates and operators offer concessions to fill vacant units. In fact, operators of some smaller properties that rely on high occupancy to maintain revenues have led the way, recording doubledigit rent declines in an attempt to lure tenants. Many investors are expected to remain on the sidelines in the first half of the year as the impact of distressed assets on valuations materializes. Transactions in the early months of 21 will likely consist of well-located complexes with assumable debt or assets priced to cash flow on a relatively short time horizon. Velocity will accelerate as the year progresses and the expectations gap narrows, while properties with forthcoming debt maturities will come on the market at attractive prices. Average cap rates in the metro are projected to approach the 9 percent range this year. Wellcapitalized buyers may be able to acquire distressed assets with cap rates significantly higher, though deferred maintenance could become a greater concern within these deals. Units (thousands) Market Outlook 21 NAI Rank: 16, Up 4 Places. Austin s four-spot rise in the ranking is due a forecast for the second-strongest employment growth in the country for 21. Employment Forecast: The rate of job growth is anticipated to gain steam as 21 progresses. Companies are forecast to expand local payrolls at a 2.5 percent clip this year with the addition of 19, positions. In 29, total employment contracted by 6, jobs. 1 Asking Rents Effective Rents Construction Forecast: A sharp reduction in development activity is expected in 21 as 2,5 units come online, significantly below the 7,9 apartments that were delivered last year. Vacancy Forecast: Population gains and job growth will fuel a 2.1 percent increase in apartment demand this year, resulting in a 4 basis point improvement in vacancy to 1.6 percent. Rent Forecast: Asking rents are forecast to rise.6 percent in 21 to $849 per month while effective rents retreat.7 percent to $752 per month. Three years of concession burn-off will be lost by year end. Investment Forecast: In the Round Rock/Georgetown submarket, owners attempting to sell high-vacancy assets will offer significant leasing incentives to push occupancy above 85 percent in order to expand financing options for buyers. As fundamentals in the area stabilize in 211, buyers should be able to realize above-average returns by raising rents. - 6 $7 $6 $5 $4 $ * 1** * Market Forecast Employment: 2.5% Construction: 6 Vacancy: 4 bps Asking Rents:. 21 Annual Report page 11

12 Boston Down 4 Places 21 Rank: 8 29 Rank: Performance Steady in Core Areas; Suburban Locations Face Challenges Despite a slowdown in construction activity, soft tenant demand and competition from shadow rental inventory will continue to weigh on Boston apartment operations this year. Demand-side fundamentals are expected to remain weak in 21, as increased worker productivity in the manufacturing and professional and business services sectors will limit payroll expansion, and most new jobs will come from the education and health services industry. Also competing with apartments are single-family homes being rented out by investors. This trend is prevalent in suburban areas outside of the city that recorded above-average for-sale inventory growth in previous years. Elsewhere, properties in core submarkets within Route 128 will experience high demand from renters, keeping near-term operations steady. Units (thousands) * 1** 7% 5% Investment activity will pick up this year as seasoned investors re-enter the market in search of distressed properties and buy-and-hold investors target stabilized assets. Local buyers may continue to focus on distress and leverage operational efficiencies by investing in complexes that are failing to meet cash flow requirements, particularly in tertiary submarkets. Investor demand also will remain elevated for properties in core areas such as Brookline and Cambridge due to steady operations. Cap rates in these close-in submarkets average in the high-6 percent to low-7 percent range, up slightly from the start of 29. Initial yields in the suburbs, meanwhile, average in the 9 percent to 1 percent range and will likely rise modestly this year as a result of additional distress and softer investor demand. $15 $12 $9 $6 $ * Market Outlook 21 NAI Rank: 8, Down 4 Places. Boston ranked near the top in most of the index measurements, keeping the metro in the top 1 of the NAI this year. Employment Forecast: Job cuts at the beginning of the year will give way to employment growth of 22, positions in 21, or.9 percent, following the elimination of 56, workers last year. The education and health services sector is forecast to create approximately 12, jobs. Construction Forecast: Builders are expected to complete 1, apartment units this year, adding.5 percent to stock. In 29, around 3,3 units entered the market. The majority of the projects scheduled for delivery are located in suburban submarkets, including the South Shore/ Route 128 South and Mystic River North/Route 128 areas. Vacancy Forecast: Vacancy is projected to rise 2 basis points to 6.8 percent in 21, after increasing 6 basis points last year. Rent Forecast: Asking rents are expected to fall 3.1 percent this year to $1,619 per month, while effective rents are forecast to drop 3.4 percent to $1,518 per month. In 29, asking rents declined 4.1 percent, and effective rents receded 5 percent. Investment Forecast: Transaction velocity will remain steady in close-in submarkets, although cap rates will trend upward due to expectations for greater expenses. Distressed sales could increase in the suburbs as higher vacancy rates adversely impact cash flows. Market Forecast Employment:.9% Construction: 7 Vacancy: 2 bps Asking Rents: 3.1% page Annual Report

13 Up 4 Places 21 Rank: Rank: 33 Charlotte Investment Activity Centering on Pockets of Stability North and South of Uptown In Charlotte, a sharp decline in construction activity will help to temper the projected rise in vacancy this year, although homes and condos turned for-rent will offer strong competition to apartments in some submarkets. Completions will decrease 68 percent in 21, adding a minimal.4 percent to stock. Much of the new supply will come online near transportation arterials in expanding residential and commercial areas north of Uptown, such as the Harris Boulevard/Mallard Creek Church Road submarket. Above-average tenant demand, however, will keep vacancy in this area near 9 percent this year. In the Uptown submarket, competition from shadow stock, primarily condos employed as rentals, will cause vacancy to trend higher. Area vacancy levels typically remain range near 5 percent, but the added competition is expected to push vacancy to the high-8 percent range by year end. As a result, concessions in the submarket could push higher by nearly 1 basis points this year to 15 percent of asking rents. Apartment sales activity in Charlotte will remain limited in the near term due to investors lingering concerns over the fundamental stability of the local market. As expectations for rising expenses and vacancy rates further widen the value disconnect between buyers and sellers, cap rates will trend higher, with investors underwriting for potential declines in operating revenues. Buyers will likely target properties in areas near employment and residential hubs south of Uptown, such as Ballantyne and Fairview North, as renter demand remains high in these submarkets. Longer-term upside, meanwhile, may exist in apartment assets north of the downtown area. Residential growth in these locations continues to be steady due to ongoing business and commercial expansions associated with the North Carolina Research Campus in Kannapolis. 21 Market Outlook Units (thousands) NAI Rank: 29, Up 4 Places. A forecast for resumed payroll expansion in 21 pushed up Charlotte four places in this year s index. Employment Forecast: Employers are expected to add 8, positions to Charlotte head counts this year, a 1 percent increase. In 29, instability in the banking industry contributed to the elimination of 4, jobs. - Construction Forecast: Completions will slow to approximately 1,2 apartments in 21, down from about 3,8 units last year. Over the past five years, additions have averaged 1,5 rentals annually. Vacancy Forecast: Vacancy is expected to rise 3 basis points to 11.5 percent this year. In 29, vacancy increased 3 basis points due to job losses and a spike in apartment deliveries. Rent Forecast: Asking rents are projected to reach $742 per month in 21, a 2.5 percent drop from last year, while effective rents will fall 3 percent to $657 per month. In 29, asking rents decreased 4.6 percent, and effective rents receded 5.4 percent. Investment Forecast: In 21, investors may focus more on stabilized assets in areas with steady renter demand, such as Ballantyne and the Concord/Kannapolis submarkets, in an attempt to mitigate short-term investment risk. - 6 $1 $75 $5 $25 $ * 1** * Market Forecast Employment: 1. Construction: 6 Vacancy: 3 bps Asking Rents: 2.5% 21 Annual Report page 13

14 Chicago Down 9 Places 21 Rank: 2 29 Rank: 11 Units (thousands) % 5% Syndicates and Nontraditional Buyers Set to Accelerate Activity While employment in the Chicago metro will rebound this year, apartment operating fundamentals will remain soft, especially in the suburbs, where pronounced payroll cuts have dragged on renter demand. Construction activity will slow in 21, though a considerable shadow rental inventory continues to pose a threat, particularly in the South Loop. Other submarkets, however, will show signs of strength this year. Apartments on the Northside will get a boost from a large young-professional cohort, while the eastern Oak Park submarket will benefit from comparatively low rents, as well as its proximity to employment corridors and arterial routes. These factors should also contribute to further vacancy improvements in the O Hare submarket through 21. Investment activity will likely be driven by local buyers this year, particularly in the city, where a number of assets have been discounted due to softened conditions and cap rates that have climbed into the mid-7 percent range. Deals involving out-of-state buyers will remain limited, as many of these investors are targeting metros where prices have declined considerably. Newly formed syndicates consisting of long-term owners who are divesting assets and pooling cash also will continue to emerge and seek out distressed properties in areas with broken condo projects, including neighborhoods in the South and West loops. Nontraditional buyers will reenter the market to take advantage of price reductions in submarkets such as Downers Grove and Glenview/Evanston, as initial yields in the suburbs are projected to approach 9 percent this year. Asking Rents Effective Rents 21 Market Outlook - 21 NAI Rank: 2, Down 9 Places. Continued inventory growth and a modest vacancy increase caused Chicago s nine-spot drop in the ranking. Employment Forecast: With the local labor market recovering later this year, employers are expected to add a total of 32, positions in 21, a.7 percent gain. - $9 $8 $7 $6 $ * Construction Forecast: Developers are projected to complete 1,23 apartment units by year end, increasing stock by.3 percent. Approximately 7 percent of the new units will be located in city submarkets. Vacancy Forecast: Driven by decreased renter demand in the suburbs, metrowide vacancy is forecast to reach 7.3 percent this year, 3 basis points higher than at the close of 29. Rent Forecast: Asking rents will end 21 at $1,1 per month, down 2.2 percent from last year, while effective rents will drop 2.7 percent to $925 per month. Investment Forecast: Buyers with short timelines will likely target assets on the Northside, as the opportunity to increase rents in the coming years is greatest in the area due to stable demand. Investors with longterm hold strategies may seek properties on the Westside, where prices are lower, but a recovery may be a couple of years away. Market Forecast Employment:.7% Construction: 4 Vacancy: 3 bps Asking Rents: 2. page Annual Report