RCLCO U.S. Real Estate Chart Book MARCH 2014 Austin Los Angeles Orlando Washington, D.C.
Contents RCLCO RCLCO Outlook From the Ground Up 03 With 40 staff in four locations, RCLCO provides consulting services in the areas of Institutional Advisory Services, Urban Development, Community and Resort Development, Public Strategies, and The Real Estate Cycle 04 Management Consulting and Litigation. RCLCO is an employee-owned firm that exclusively provides consulting services. Housing 05 Office 14 Retail 19 Industrial 25 Economic and Capital Market Backdrop 30 RCLCO s Institutional Advisory Services group provides services to commercial real estate owners in the areas of: Strategic planning and investment policies Portfolio development and manager selection Portfolio analysis and monitoring i Investment analysis, target markets, and hold/sell analyses Market analysis and independent research For questions, contact: Paige Mueller, Director of Institutional Advisory Services, RCLCO, 233 Wilshire Blvd, Ste 370, Santa Monica, CA 90401, (310) 601-4919. Report Prepared by: Paige Mueller, Managing Director Dustin Young, Associate 2
RCLCO Outlook U.S. real estate markets continue to improve with generally higher occupancy and rental rates across most property types and markets. Capital continues to flow into the sector with record fundraising by REITs in 2013 and banks again lending at a pace that is faster than the number of loans that are maturing. Pricing in secondary markets has been improving at a similar pace as the primary markets since late 2011, evidence of increased risk tolerance by investors. This has also particularly benefited private equity firms and others who have been successful in raising value-addadd and opportunistic funds recently. We are encouraging clients to think through their long-term cycle strategies now while fundamentals are generally positive. Cycle strategies should set a long-term framework and action plan through which real estate firms can operate successfully during all parts of the cycle. Part of this strategy should identify key market indicators and plans that can be enacted when those indicators begin to change / appear in the market. The planshouldbeineffectduring all phases of the cycle and if it does not exist, should go into effect now as it requires some advance planning and agreement as to action plans among senior members of the firm. We have seen evidence from the last cycle that firms that had such plans in place were able to invest and sell more thoughtfully as market conditions i began to change, and thus had better performance metrics. For example, higher occupancy, rental rates, and pricing are also generating more construction, and this construction is now spreading beyond a few key markets. While this is an indication of positive demand, we are already beginning to see flattening to lower occupancy rates as a result of new supply in a few apartment markets and in D.C. and CBD New York office markets. While this is more of an exception than the rule, it is the start of a more mature phase of the market that will expand to other metro areas as the supply pipeline continues. In the capital markets, the 100 bp summer increase in 10- year treasury yields has not reversed. While mortgage rates moved in synch with interest rates in 2013, there was no noticeable increase in cap rates, likely because of the relatively wide spread that existed in 2013 between cap rates and interest rates (but is now gone). With long-term inflation expectations remaining just above 2%, we expect that 10- year treasury yields could rise by another 50-100 bp to the 3.5%-4+% range which could put upward pressure on cap rates, particularly in markets or properties with limited potential for future income growth. Thus, in addition to downward pressure onincomefromnewsupply, thecapital markets could also put downward pressure on return expectations going forward. The graphs on the following pages are designed to help firms identify key indicators that should inform their cycle plans. While westill see many interestingi investment opportunities ii from core through new development, investors should be carefully reviewing leverage and buy/sell strategies as part of their cycle planning. Paige Mueller, Director of Institutional Advisory Services 3
Construction Pipelines Rising Across Most Property Types Occupancy Low Occupancy Rising Occupancy Rising Occupancy High Occ. Above Average Occupancy Low Demand Improving Demand Improving Demand Improving Occupancy Flattening Occupancy Falling Occ. Flat to Down Rents Flat to Down Rents Rising Rents Rising Rents Flattening Rents Falling Rents Flat to Down No Construction Limited Construction Construction Construction Construction No Construction Suburban Office Single-Family Prime** CBD Office Multifamily Hotel Industrial Construction is well underway in apartments, prime** CBD office, and some hotel markets. While these sectors generally have high occupancy rates and rising rents, occupancies in some apartment markets and office markets such as NY and DC are starting to stabilize or decline as new supply increases. Retail* Increase Vintage Reduce Vintage New Development Reduce Opportunistic Redevelopment & Lease-Up Reduce Risk: B / Non-Core, Leverage Short-Term Leases Long-Term Leases *neighborhood h & community centers **includes New York, Washington DC, San Francisco, Seattle, Los Angeles, and Boston Source: RCLCO 4
Housing Fundamentals 5
U.S. Apartment Absorption Continues to Outpace Completions 4 th Quarter 2013 apartment vacancy was down 10 bp quarter-overquarter and 50 bp year-over-year to 4.1%. Owners have pricing power as they leverage low vacancies into rent growth for the 15 th straight quarter. Vacancies have most likely reached their cycle lows as of year-end end 2013. With projects under construction equivalent to over 2.5% of stock, vacancy may begin to creep up. The rent growth forecast below could face some downward pressure if new construction occurs faster than expected. 250 U.S. Apartment Absorption, Vacancy, Rent Growth 13% 200 10% ions) Squ uare Feet (in milli 150 100 50 8% 5% 3% 0 0% -50 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 (f)2015 (f)2016 (f) Completions Net Absorption Vacancy % Rent Growth % -3% Source: Reis, Inc.; RCLCO 6
Apartment Vacancy Historically Low Apartment vacancies remain low as most major U.S. apartment markets are experiencing lower current vacancy than their longterm (1990-present) average. The only two markets with aboveaverage vacancy are Washington, D.C., and New York, although vacancies in both markets remain low at 4.8% and 2.7%, respectively. 14% 12% LT Average Vacancy Apartment Current and Long-term Vacancy Max 10% Va acancy 8% 6% 4% 2% Current Vacancy Min 0% Atlanta Austin Chicago Green box - current vacancy < LT avg. Red box - current vacancy > LT avg. Dallas Denver District of Columbia Houston os Angeles L Miami Minneapolis New York Oran nge County Orlando Philadelphia Phoenix San Diego San Francisco San Jose Seattle Suburba an Maryland Suburb ban Virginia Petersburg Tampa-St. Un nited States NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; RCLCO 7
U.S. Apartment: Market Risk Indicator Rents continue to rise in most major apartment markets, although occupancy rates are beginning to flatten in a few markets. Due to historically high occupancy and rent levels, construction continues to be in full swing in most markets. Net Absorption % Completions % of of Stock Current* Stock Current* Quarter Quarter** Under Constr % of Stock Current* Quarter*** QoQ Occupancy Change YoY Occupancy Change QoQ Rent YoY Rent Occupancy**** Growth Growth Atlanta 0.4% 0.0% 1.4% 94.1% 0.3% 1.0% 1.0% 3.6% Austin 1.0% 1.1% 6.7% 95.5% -0.1% -0.1% 0.9% 4.2% Chicago 0.3% 0.4% 1.1% 96.3% 0.0% 0.2% 0.7% 3.1% Dallas 0.8% 0.6% 4.2% 95.1% 0.2% 0.6% 1.1% 3.7% District of Columbia 0.7% 0.7% 7.0% 95.2% 0.1% -0.4% 0.1% 1.6% Denver 0.6% 0.4% 6.5% 96.4% 0.1% 0.4% 1.0% 4.7% Houston 0.9% 0.5% 4.0% 94.0% 0.4% 1.2% 1.2% 4.3% Los Angeles 0.2% 0.2% 1.6% 96.9% 0.1% 0.2% 0.8% 2.5% Miami 0.6% 0.5% 1.8% 96.3% 0.2% 0.2% 0.5% 3.2% Minneapolis 0.6% 0.8% 2.9% 97.2% -0.1% -0.2% 1.0% 3.6% New York 0.2% 0.5% 4.9% 97.3% -0.3% -0.6% 1.8% 4.1% Orange County 0.2% 0.0% 1.9% 97.1% 0.2% 0.8% 0.5% 2.8% Orlando 0.6% 0.5% 3.8% 95.1% 0.2% 0.8% 0.9% 3.3% Philadelphia 0.5% 0.3% 1.3% 96.7% 0.3% 0.3% 0.9% 2.8% Phoenix 0.6% 0.3% 2.0% 94.9% 0.3% 0.9% 1.0% 3.5% San Diego 0.3% 0.4% 2.1% 97.4% 0.0% 0.1% 0.8% 3.5% Seattle 0.7% 1.1% 4.1% 95.4% -0.4% -0.4% 1.2% 7.1% San Francisco 0.5% 0.5% 2.4% 96.9% 0.0% 0.2% 1.9% 5.6% San Jose 0.9% 0.6% 4.4% 97.3% 0.2% 0.1% 1.1% 5.5% Suburban Maryland 0.5% 0.1% 4.6% 96.6% 0.4% 0.7% -0.5% 1.5% Suburban Virginia 0.0% 0.2% 5.3% 96.2% -0.2% -0.2% -0.1% 1.3% Tampa-St. Petersburg 0.8% 0.6% 2.2% 95.7% 0.2% 1.1% 0.9% 2.8% United States t 05% 0.5% 04% 0.4% 26% 2.6% 95.9% 9% 01% 0.1% 05% 0.5% 08% 0.8% 32% 3.2% *Current quarter defined as Q4 2013 **Completions highlighted in Red if above 0.25% of Stock ***Under Construction highlighted in Red if above 1% of Stock ****Green if above city s historical average since 1990 NOTE: Above data includes only market rate rentable apartment space NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; RCLCO 8
Apartment Pricing and Growth Expectations Investors continue to favor the low vacancy rates of the apartment sector, with average Class A cap rates of around 5% or lower, and some markets close to 4%. The graph below shows average Class A cap rates and average expected NOI growth for the next five years, including expected changes in occupancies and rents. While NOI growth going forward is expected to be positive, new supply is putting downward pressure on expected income growth going forward and the combination of low cap rates and moderate rent growth results in some of the lowest forward return expectations of all property types. 12% Class A Apartment Price + Growth 10% Price + Growth 8% 6% 4% 2% 0% Average Cap Rate Average Annual NOI Growth (2014-2018) Initial yield and cash flow growth over the hold period are significant contributors to unlevered total return expectations. Low cap rates should thus be accompanied by higher growth expectations. While the above graph is an incomplete view, it does provide some indications of markets that should be particularly reviewed for further insights. For example, markets with low bars in the graph above may have less growth than needed to offset lower yields, or the growth may be more backended in a 10-year hold. Conversely, markets with high bars may be positioned to experience significant growth as compared to current pricing, or may be markets that are considered to be more risky and thus justify higher expected returns. NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; CBRE; RCLCO 9
Household Formation is Outpacing Single-Family Starts 1,600,000 Single-Family Housing Starts and Household Formation 1,400,000 1,200,000 ts and Formation ns Housing Start 1,000,000 800,000 600,000 400,000 200,000 0 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Housing Starts New Households NOTE: Housing starts include single-family, townhomes, condominiums, and cooperative homes Source: Moody s Analytics; RCLCO 10
New Home Sales Continue to Improve New home sales surpassed expectations in January, up 9.6% from December and 2.2% from a year ago. New home sales are now running at the fastest pace since 2008. Existing home sales slipped in December and January, likely due to cold weather, higher mortgage rates and prices, and low inventory levels. Assuming that mortgage rates do not rise faster than expected, sales are expected to improve going forward as a result of improved job growth and household formation. 8,000,000 National Home Sales 1,600,000 7,000,000 1,400,000 6,000,000 1,200,000 Existing Home Sa ales 5,000,000 4,000,000 3,000,000 1,000,000 800,000 600,000 N ew Home Sales 2,000,000 400,000 1,000,000 200,000 0 0 01/99 01/00 01/01 01/02 01/03 01/04 01/05 01/06 01/07 01/08 01/09 01/10 01/11 01/12 01/13 01/14 Existing Home Sales (L) New Home Sales (R) Source: U.S. Census Bureau; National Association of Realtors 11
Housing Supply Is Near Stabilized Levels The inventory of homes available for sale has recovered since the downturn as a result of both fewer homes being put on the market and a higher volume of home sales. Inventory to sales ratios continue to stay near long-term stabilized levels which should help to generate demand for new homes as well as support moderate increases in home prices. 14 New and Existing Home - Months of Supply of Housing 12 10 Months Sup pply 8 6 4 2 0 Existing Home Months Supply New Home Months Supply NOTE: Home supply includes single-family, condo, and townhomes Source: NAR; RCLCO 12
Single-Family New Home Prices Recovered while Existing Prices Are Still Below Peak Levelsels New home prices were up by approximately 5% in 2013. While prices slipped recently, economists in the Wall Street Journal Consensus Survey expect home prices overall to rise by another 5% in 2014. 300,000 Home Prices 250 $ 250,000000 200,000 150,000 100,000 50,000 200 150 100 50 ndex I 0 0 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Median New Home Price Case Shiller 20 City Index Median Existing Home Price Source: U.S. Census; National Association of Realtors; S&P; Wall Street Journal 13
Office Fundamentals 14
U.S. Office Vacancy Slowly Improving Despite significant office employment growth, 4Q 2013 office vacancy was flat quarter-over-quarter at 16.9% and down by 20 bp year-over-year as tenants continue to absorb extra space and decrease space usage per worker. Office absorption is expected to outpace completions during the next three years nationally as office jobs are growing at a faster pace than employment growth overall. The slow forecast recovery masks regional differences. Poorly located or configured properties are likely to face higher obsolescence risk, while properties in prime locations are expected to experience high rent growth in the near-term as rents recover from the downturn. 200 U.S. Office Absorption, Vacancy, Rent Growth 20% 150 15% lions) uare Feet (in mil Sq 100 50 0-50 10% 5% 0% -5% -100-10% -150 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 (f)2015 (f)2016 (f) Completions Net Absorption Vacancy % Rent Growth % -15% Source: Reis, Inc.; RCLCO 15
Office Vacancy Generally Still High Most major U.S. office markets continue to experience higher current vacancy than their long-term (1990-present) average. Phoenix has the highest current vacancy rate of these major markets at 25.3%. The only two markets with below-average vacancy are Houston and NYC at 14.4% and 9.9%, respectively. 30% Office Current and Long-term Vacancy 25% Max Current Vacancy 20% Va acancy 15% 10% 5% LT Average Vacancy Min 0% Atlanta Austin Boston Green box - current vacancy < LT avg. Red box - current vacancy > LT avg. Charlotte Chicago Dallas Denver Columbia District of Houston Los Angeles Miami nneapolis Mi New York Orang ge County iladelphia Ph Phoenix San Diego Francisco San San Jose Seattle Maryland Suburban Suburba an Virginia ted States Unit NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; RCLCO 16
U.S. Office: Market Risk Indicator U.S. office occupancy remained unchanged qoq in 4Q 2013 as new supply met demand, and fell by only 20 bp yoy. The sluggish national data masks much more dynamic changes at the local level. Supply outpaced demand in New York and D.C. High growth tech and energy markets are also now experiencing significant pipelines, while other markets are generally lagging. Net Absorption % Completions % of Under Constr % of QoQ YoY of Stock Current* Quarter Stock Current* Quarter** Stock Current* Quarter*** Occupancy**** Occupancy Change Occupancy Change QoQ Rent Growth YoY Rent Growth Atlanta 0.2% 0.0% 0.4% 79.9% 0.2% 0.6% 0.5% 0.9% Austin 0.2% 0.1% 4.2% 83.7% 0.1% 0.8% 0.0% 1.8% Boston 1.2% 1.0% 2.1% 86.4% 0.3% 0.6% 1.6% 2.9% Chicago -0.1% 0.0% 0% 0.1% 81.3% 0.0% 0% -0.2% 0.7% 1.3% Charlotte 0.0% 0.0% 0.2% 82.2% 0.0% -0.5% 0.4% 1.5% Dallas 0.2% 0.0% 2.8% 77.1% 0.2% 0.5% 1.3% 2.8% District of Columbia -0.1% 0.7% 0.8% 89.7% -0.7% -1.0% 0.2% 0.5% Denver 0.2% 0.0% 1.2% 82.7% 0.2% 0.8% 0.4% 1.7% Houston 0.1% 0.3% 4.1% 85.6% -0.2% 0.0% 0.9% 3.7% Los Angeles 0.4% 0.1% 0.4% 84.5% 0.3% 0.2% 0.9% 1.7% Miami -0.3% 0.0% 0.4% 82.8% -0.3% 0.1% 0.1% 1.1% Minneapolis 0.1% 0.1% 0.0% 82.7% 0.0% 0.8% 0.1% 1.2% Northern New Jersey 0.0% 0.0% 0.0% 81.3% 0.1% 0.8% 0.4% 0.5% New York 0.4% 0.6% 1.4% 90.1% -0.2% 0.0% 1.0% 4.2% Orange County 0.7% 0.5% 0.7% 83.0% 0.3% 1.1% 1.3% 2.8% Philadelphia -0.1% 0.0% 0.3% 85.7% -0.2% 0.4% 0.3% 0.6% Phoenix 0.3% 0.0% 0.8% 74.7% 0.3% 0.5% 0.5% 1.1% San Diego 0.5% 0.0% 1.1% 84.2% 0.5% 0.6% 1.0% 2.1% Seattle -0.3% 0.0% 3.2% 85.9% -0.4% 0.3% 1.1% 3.0% San Francisco 0.3% 0.0% 3.0% 87.1% 0.4% 0.9% 0.3% 4.5% San Jose 0.5% 0.0% 4.3% 82.0% 0.6% 1.0% 1.4% 5.0% Suburban Maryland 0.1% 0.0% 1.2% 84.9% 0.1% -0.2% 0.1% 0.5% Suburban Virginia 0.3% 0.8% 1.1% 82.6% -0.4% -1.3% 0.2% 0.9% United States 0.2% 0.2% 1.2% 83.1% 0.0% 0% 0.2% 0.7% 2.2% 2% *Current quarter defined as Q4 2013 **Completions highlighted in Red if above 0.25% of Stock ***Under Construction highlighted in Red if above 1% of Stock ****Green if above market s historical average since 1990 NOTE; Above data does not include Medical Office NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; RCLCO 17
Office Pricing and Growth Expectations Pricing varies significantly by market, with cap rates well below 6% for Class A office buildings on average in prime markets such as Boston, Washington, D.C., New York, and San Francisco. The graph below shows average cap rates and average expected NOI growth for the next five years, including expected improvements in occupancies and rents. While NOI growth going forward is expected to be strong in several markets, growing construction pipelines in markets such as Washington, D.C., may limit income growth and thus return expectations. Meanwhile, supply is lagging in many secondary markets which are typically high yield / high construction markets. These may be good short-term term plays with occupancy gains likely in the near-term. 12% Class A Office Price + Growth 10% Pric ce + Growth 8% 6% 4% 2% 0% Average Cap Rate Average Annual NOI Growth (2014-2018) Initial yield and cash flow growth over the hold period are significant contributors to unlevered total return expectations. Low cap rates should thus be accompanied by higher growth expectations. While the above graph is an incomplete view, it does provide some indications of markets that should be particularly reviewed for further insights. For example, markets with low bars in the graph above may have less growth than needed to offset lower yields, or the growth may be more backended in a 10-year hold. Conversely, markets with high bars may be positioned to experience significant growth as compared to current pricing, or may be markets that are considered to be more risky and thus justify higher expected returns. NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; CBRE; RCLCO 18
Retail Fundamentals 19
Retail Formats Continue to Change Retail sales growth remains positive overall and is finally beginning to generate demand for new retail space. However, the retail sector continues to evolve in light of growing competition from e- commerce and changing retail platforms as evidenced by the recent closure or sale of large grocers in some markets. While top malls continue to maintain high occupancy and rental growth, department store closures in non-strategic locations by key anchors such as JC Penney and Sears are also an indication of the struggling department store segment, and likely evolution of Class B/C malls into uses with lower sales volumes. 25% Retail Sales Growth 1993-2013 20% 15% 10% 5% 0% -5% -10% -15% Warehouse Clubs + Superstores Grocery Dept Stores Ex Discount Discount Dept Stores GAFO* E-Commerce *GAFO = general apparel, furniture, and other mall-type stores NOTE: 2013 YTD data is through November Source: U.S. Census; ICSC; RCLCO 20
U.S. Retail Absorption Positive The retail sector is slowly gaining momentum with 2013 demand up by 8% from 2012 levels and at the highest level since 2007, although still well below the pace of the past decade. Neighborhood and Community Center (N/C) vacancy fell by 10 bp qoq and 30 bp yoy to 10.4% in 4Q 2013 with rents up by 0.5% qoq. 60 U.S. Retail Absorption, Vacancy, Rent Growth 12% 45 9% millions) Square Feet (in 30 15 0 6% 3% 0% -15-3% -30 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 (f)2015 (f)2016 (f) Completions Net Absorption Vacancy % Rent Growth % -6% Source: Reis, Inc.; RCLCO 21
Retail Vacancy Generally Still High All of the major U.S. retail markets are experiencing higher current vacancy than their long-term (1990-present) average except for Houston. Atlanta and Orlando are above their long-term averages by the widest margins, while Miami and Southern California retail markets are only slightly less occupied than normal. Occupancies should continue to improve given the limited construction pipeline. 25% Retail Current and Long-term Vacancy Current Vacancy 20% Max Vacanc cy 15% 10% 5% Min LT Average Vacancy 0% Atlan nta go Chica Green box - current vacancy < LT avg. Red box - current vacancy > LT avg. las Dall Denv ver ton Houst les Los Angel Mia ami Minneapo olis Orange Coun nty do Orlan Phoen nix go San Die ttle Seat tes United Stat NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; RCLCO 22
U.S. Retail: Market Risk Indicator The retail sector is slowly improving with rising occupancy and rental rates. While occupancy is still generally lower than long-term average rates, new construction is beginning to pick up, particularly in markets such as Chicago, Dallas, Los Angeles, and Orange County. Net Absorption % of Stock Current* Quarter Completions % of Stock Current* Quarter** Under Constr % of Stock Current* Quarter*** QoQ Occupancy Change YoY Occupancy Change QoQ Rent YoY Rent Occupancy**** Growth Growth Atlanta 0.4% 0.2% 0.1% 86.3% 0.2% 0.6% 0.1% 1.0% Chicago 0.3% 0.0% 1.4% 89.1% 0.3% 0.6% 0.6% 1.4% Dallas 0.6% 0.0% 1.1% 87.2% 0.6% 1.0% 0.4% 1.8% Denver 0.5% 0.0% 0% 0.0% 0% 88.8% 8% 0.5% 0.8% 1.0% 2.4% Houston 0.0% 0.1% 0.4% 87.9% -0.1% 0.3% 0.6% 2.5% Los Angeles 0.4% 0.3% 1.4% 94.0% 0.1% 0.2% 0.4% 1.6% Miami 0.0% 0.0% 0.5% 92.9% 0.0% 0.0% 0.3% 1.0% Minneapolis -0.3% 0.0% 0.5% 88.8% -0.3% 0.3% 0.8% 2.7% Orange County 0.1% 0.0% 1.0% 94.5% 0.1% 0.1% 0.6% 2.0% Orlando 0.5% 0.2% 0.6% 87.7% 0.4% 1.6% 0.9% 2.9% Phoenix 0.3% 0.0% 0.0% 89.4% 0.3% 1.0% 0.7% 1.2% San Diego 0.0% 0.2% 0.7% 93.6% -0.2% -0.1% 0.7% 2.2% Seattle 1.1% 1.3% 0.2% 93.1% -0.1% 0.1% 0.5% 2.0% United States 0.2% 0.1% 0.7% 89.6% 0.1% 0.3% 0.5% 1.4% *Current quarter defined as Q4 2013 **Completions highlighted in Red if above 0.25% of Stock ***Under Construction highlighted in Red if above 1% of Stock ****Green if above city s historical average since 1990 NOTE: Above data includes only Neighborhood/Community centers; does NOT include power centers, regional malls, or lifestyle retail centers NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; RCLCO 23
Neighborhood/Community Retail Pricing and Growth Expectations Pricing variation by geographic market in retail is not as differentiated as in other property types, as retail yields vary more by property type and strength of the location and retailers. The graph below shows average cap rates and average expected NOI growth for the next five years, including expected improvements in occupancies and rents. NOI growth for most markets is expected to be moderate as retail occupancies and rents did not fall in the downturn as much as some property types, and also reflects reluctance of retailers to increase space needs amid strong e-commerce competition. 12% Neighborhood/Community Retail Price + Growth 10% Pric ce + Growth 8% 6% 4% 2% 0% Average Cap Rate Average Annual NOI Growth (2014-2018) Initial yield and cash flow growth over the hold period are significant contributors to unlevered total return expectations. Low cap rates should thus be accompanied by higher growth expectations. While the above graph is an incomplete view, it does provide some indications of markets that should be particularly reviewed for further insights. For example, markets with low bars in the graph above may have less growth than needed to offset lower yields, or the growth may be more backended in a 10-year hold. Conversely, markets with high bars may be positioned to experience significant growth as compared to current pricing, or may be markets that are considered to be more risky and thus justify higher expected returns. NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; CBRE; RCLCO 24
Industrial Fundamentals 25
U.S. Industrial Absorption Remains Strong Industrial absorption returned quickly after the downturn and has remained near the peak levels of the previous cycle, helped in large part by demand from e-commerce users. Vacancy rates have improved from previous peak levels, dropping to under 10% in the previous quarter. Rent growth is expected to continue to be positive, although the supply pipeline is rising in several markets. 150 U.S. Industrial Absorption, Vacancy, Rent Growth 15% 100 10% Square Feet (in millions) 50 0-50 5% 0% -5% -100 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 (f)2015 (f)2016 (f) Completions Net Absorption Vacancy % Rent Growth % -10% Source: Reis, Inc.; RCLCO 26
Industrial Vacancy Falling Most major U.S. industrial markets are experiencing slightly lower current vacancy than their long-term (1990-present) average, which represents a change from just a year ago, when vacancies were higher than their historical average. New construction has started to pick up, but is not keeping pace with demand in most markets, so vacancy continues to fall. 30% Max Industrial Current and Long-term Vacancy 25% Current Vacancy 20% Vacancy 15% 10% 5% 0% Min LT Average Vacancy Atlanta Baltimore Boston Cen ntral New Jersey Green box - current vacancy < LT avg. Red box - current vacancy > LT avg. Chicago Dallas Denver Fort Lauderdale Houston Indianapolis Los Angeles Memphis Miami North hern New Jersey Oa akland-east Bay Orange County Phoenix ardino/riverside San Bern San Diego San Francisco Seattle United States NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; RCLCO 27
U.S. Warehouse: Market Risk Indicator While rental levels continue to improve in most major warehouse markets and vacancy remains in check, supply pipelines are rising, particularly for e-commerce companies that are competing for retail dollars. Given the quick construction times and sparse pre-leasing of new industrial construction, occupancy rates can begin weakening when new supply is delivered. Demand has been high in both highgrowth local markets as well as some big distribution markets such as Dallas. Net Absorption % Completions % Under Constr QoQ YoY of Stock Current* of Stock Current* % of Stock Occupancy Occupancy QoQ Rent YoY Rent Year Quarter** Current*** Occupancy**** Change Change Growth Growth Atlanta 0.2% 0.1% 0.5% 85.6% 0.2% 0.6% 1.3% 2.9% Baltimore -0.3% 0.0% 1.3% 89.6% -0.4% 0.9% 0.0% 1.3% Boston 0.2% 0.0% 0.0% 89.1% 0.2% 0.3% 0.2% 0.6% Central New Jersey 0.2% 0.3% 0.9% 89.4% 0.0% 0.0% 0.0% 0.9% Chicago 0.4% 0.1% 0.3% 85.9% 0.3% 1.0% 1.3% 2.9% Dallas 0.5% 0.8% 3.1% 86.7% -0.1% 0.6% 0.8% 2.5% Denver 0.4% 0.4% 0.4% 90.3% 0.1% 0.8% 0.9% 1.8% Fort Lauderdale 0.3% 0.8% 0.4% 89.7% -0.4% 0.0% 0.9% 1.8% Houston 02% 0.2% 03% 0.3% 17% 1.7% 91.7% -0.1% 06% 0.6% 09% 0.9% 42% 4.2% Indianapolis -0.2% 0.0% 0.7% 89.1% -0.2% 0.0% -0.6% 1.2% Los Angeles 0.1% 0.0% 0.0% 92.7% 0.1% 0.6% 0.7% 2.7% Memphis 0.3% 0.2% 0.5% 83.8% 0.1% 0.7% 0.9% 3.2% Miami 0.2% 0.0% 0.7% 92.5% 0.2% 0.4% 0.3% 1.6% Oakland-East Bay 0.6% 0.2% 0.5% 89.7% 0.5% 1.1% 1.1% 2.4% Orange County 01% 0.1% 02% 0.2% 00% 0.0% 91.4% 00% 0.0% 07% 0.7% 03% 0.3% 12% 1.2% Phoenix 0.7% 0.7% 1.0% 82.9% 0.2% -0.5% 1.5% 2.1% San Bernardino/Riverside 0.1% 0.2% 0.9% 89.4% -0.1% 0.6% 1.0% 4.3% San Diego -0.3% 0.0% 0.2% 89.0% -0.2% 0.4% -0.1% 0.1% San Francisco 0.7% 0.0% 0.0% 91.6% 0.7% 1.4% 0.5% 1.4% Seattle 0.2% 0.0% 0.3% 91.1% 0.2% 1.0% 0.3% 1.5% United States 0.2% 0.2% 0.6% 88.4% 0.0% 0.5% 0.5% 1.6% *Current quarter defined as Q4 2013 **Completions highlighted in Red if above 0.25% of Stock ***Under Construction highlighted in Red if above 1% of Stock ****Green if above city s historical average since 1990 NOTE: Above data includes only Warehouse s; does NOT include other industrial buildings NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely l defined d real estate t markets. Source: Reis, Inc.; CoStar; RCLCO 28
Industrial Pricing and Growth Expectations Pricing varies significantly by market, with cap rates below 6% on average in port-oriented markets such as Los Angeles and Miami. The graph below shows average cap rates and average expected NOI growth for the next five years, including expected improvements in occupancies and rents. West Coast cap rates are generally lower, but are not always accompanied by higher expected cash flow growth. Pricing in the big five distribution markets (ATL, DAL, NNJ, CHI, and RIV) is split, with Riverside and Northern New Jersey at low cap rates and the other three moderately priced. 12% Industrial Price + Growth 10% Price + Growth 8% 6% 4% 2% 0% Average Cap Rate Average Annual NOI Growth (2014-2018) Initial yield and cash flow growth over the hold period are significant contributors to unlevered total return expectations. Low cap rates should thus be accompanied by higher growth expectations. While the above graph is an incomplete view, it does provide some indications of markets that should be particularly reviewed for further insights. For example, markets with low bars in the graph above may have less growth than needed to offset lower yields, or the growth may be more backended in a 10-year hold. Conversely, markets with high bars may be positioned to experience significant growth as compared to current pricing, or may be markets that are considered to be more risky and thus justify higher expected returns. NOTE: The markets in the above chart are not necessarily MSAs or central cities, but are loosely defined real estate markets. Source: Reis, Inc.; CBRE; RCLCO 29
Economic and Capital Market Backdrop 30
Widespread Economic Growth Our economic Hot Spot map measures short-term historic and forecast economic and job growth as well as structural factors such as income and the proportion and growth of the working population. Economic growth is currently widespread, with particularly high growth in technology and energy markets. Parts of the Midwest and Northeast are still struggling, although markets such as Minneapolis, Indianapolis and Nashville rank highly. Source: BLS; RCLCO 31
Interest Rates and Inflation Remain Subdued 10-year treasury yields continue to remain just under 3% and approximately 100 bp higher than the low in mid 2013. Both actual and expected inflation remain low, which combined with recent slowing in the housing market are giving the Fed some room to delay monetary tightening. While unemployment fell to 6.6% in January, labor force participation rates are 300 bp lower than in 2007. Our estimates indicate another 50 to 100 bps+ increase in 10-year treasury yields is likely just to return to normalized real rates. The question is when and how quickly this will happen. Cap rates are expected to be less volatile, and are unlikely to face significant pressure until treasury yields surpass 3.5%. 8% Nominal Interest Rates and Inflation 2000-2013 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% -3% 3 Mo. LIBOR CPI 10 Yr. Treasury Expected Inflation Source: BLS; Federal Reserve, www.fedprimerate.com; RCLCO 32
Lending Standards Easing Banks continue to loosen commercial real estate lending standards following improving occupancy and rental rates. 100% Net % of Banks Tightening Lending Standards 80% 60% 40% 20% 0% -20% -40% Source: Federal Reserve; RCLCO 33
Lending Improving, but Lagging g the Improvement in Property Values Net lending volumes are rising as property values improve. Despite the recent rise in interest rates, we expect lending to continue to increase as a result of improving occupancy and rental rates which should help boost prices and sales volumes. $400 Commercial Net Debt Investment and Values 30% $300 24% t Investment (in billions) Net Debt $200 $100 $0 -$100 -$200 -$300 18% 12% 6% 0% (6%) (12%) (18%) (24%) in Commercial RE Values % Change -$400 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 (30%) Net Debt Investment - Commercial / MF RE (L) Commercial RE Values (R) Source: Federal Reserve; NCREIF; RCLCO 34
Deleveraging g has Ended In 2009 to 2012, more loans were issued than matured. The trend is finally reversing in 2013. GSEs, including Fannie Mae and Freddie Mac, public debt markets, banks and life insurance companies, are net positive lenders. U.S. Commercial RE Debt Markets - Net Capital Flows - Annually 1985-2012 $400 $300 $80 $60 U.S. Commercial RE Debt Markets - Net Capital Flows - Quarterly $ in billions $200 $100 $0 -$100 $ in billions $40 $20 $0 -$20 -$40 -$200 -$300 -$60 -$80 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 CMBS Unsecured REIT Debt Commercial Banks/Savings Life Insurance Companies Pension Funds Other GSEs CMBS Unsecured REIT Debt Commercial Banks/Savings Life Insurance Companies Pension Funds Other GSEs *2013 is through Q3 Source: Federal Reserve; NAREIT; RCLCO 35
Fundraising in Domestic and Higher Risk Vehicles Capital Concentrated with Private Equity Managers United States RE Fundraising Perc cent of Capital Rais sed/ Under Management 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2004* 2008 2012 No. of Funds 200 150 100 50 0 120 100 80 60 40 20 0 $ in billions Real Estate Managers Private Equity REITs Investment Banks No. of Funds Aggregate Capital Raised ($bn) Dry Powder by Region* International (Non-U.S.) RE Fundraising $ in billions $200 $150 $100 $50 $0 No. of Funds 200 180 160 140 120 100 80 60 40 20 0 45 40 35 30 25 20 15 10 5 0 $ in billions Europe Rest of World US *Private equity cash reserves held to fund future obligations Source: Preqin; RCLCO No. of Funds Aggregate Capital Raised ($bn) 36
REIT Offerings At All-Time High REIT capital raising reached an all-time high in 2013, surpassing even 2012 levels, with a noticeable rise in IPOs. Prices overall came close to reaching the all-time high, but are now recovering from the summer downturn which occurred in conjunction with a fast rise in treasuries. Nevertheless, some REITs are currently trading at all-time high prices. 90,000 U.S. Historical REIT Offerings 12% U.S. REIT Market 700 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 10% 8% 6% 4% 2% 600 500 400 300 200 100 0 0% 0 IPO Secondary Equity Preferred Equity Unsecured Debt Secured Debt Dividend Yield (L) 10 Yr Treasury (L) Price Index (R) Source: SNL; NAREIT; RCLCO 37
CMBS Market Slowly Recovers The CMBS market continues to recover, albeit slowly, with improvements in both issuance and pricing. After spiking in the summer, CMBS spreads have moved downward again, reflecting generally positive property fundamentals. CMBS issuance is expected to approach $90 million in 2014. U.S. CMBS Issuance U.S. CMBS Spread to Treasuries 250 900 800 200 700 600 $ in billions 150 100 500 400 300 200 50 100 0 /11 /11 /11 /11 /11 /11 /12 /12 /12 /12 /12 /12 /13 /13 /13 /13 /13 /13 /14 0 01/07/ 03/07/ 05/07/ 07/07/ 09/07/ 11/07/ 01/07/ 03/07/ 05/07/ 07/07/ 09/07/ 11/07/ 01/07/ 03/07/ 05/07/ 07/07/ 09/07/ 11/07/ 01/07/ 10yr Sr AAA AA A BBB+ BBB BBB- Source: CRE Finance Council; JP Morgan; ULI; RCLCO 38
Retail Leads Returns Hotels, not surprisingly, were the hardest-hit sector during the downturn of 2008-2009, but perhaps the most surprising asset class is retail, having not dropped as precipitously during the downturn and maintaining solid growth during the rebound. This is primarily a reflection of Class A malls in the database. 35% NCREIF Total Returns 25% 15% 5% -5% -15% -25% Hotel Apartment Retail Industrial Office Source: NCREIF; RCLCO 39
Price Recovery Focused in Major Markets While major markets have consistently sold at a premium to nonmajor markets since the turn of the cycle, most of the outperformance occurred right before and after the downturn. Secondary market prices have been moving in line with the major markets since late 2011, evidence of investor higher risk tolerance and willingness to undertake leasing risk as the markets improve. Moody's/RCA CPPI Index Moody's/RCA CPPI Index 225 4% 200 2% 175 150 125 QoQ Grow wth 0% -2% 100-4% 75-6% National All-Property Major Markets Major Markets Non-Major Markets Non-Major Markets Source: RCA; Moody s Analytics; RCLCO 40
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