Presented By:

Commercial Real Estate andthe Next Downturn

Brian D. Bailey, CCIM, CRESubject Matter Expert – CRE

2018 Atlanta FedBanking Outlook Conference

The views and opinions expressed are those of the presenter and are not necessarily those of the Federal Reserve Bank of Atlanta or the Board of

Governors of the Federal Reserve System.

Property Sector• Vacancy/Occupancy• Apartment Effective

Rent Growth• Supply

Economy• National

Unemployment• State Unemployment

• Has The Downturn Started• Cyclical/Idiosyncratic Risk

Economy

Capital Markets

PropertySector

• Transactions• Cap Rates• Risk Premiums

Capital Markets

TODAY

UNEMPLOYMENT RATES

Source: Bureau of Labor Statistics, STL FRB FRED

Une

mpl

oym

ent R

ate

%

Current: As of 1/2018

Current: 8.2%Pre Crisis: 8.4%

Current: 4.1%Pre Crisis: 4.6%

STATE UNEMPLOYMENT RATES1Q 2007 – 4Q 2017 (%)

Source: Bureau of Labor Statistics, STL FRB FRED

Data 4Q/2017

Florida Georgia Tennessee Alabama Mississippi Louisiana

Une

mpl

oym

ent R

ate

%

3.3

4.14.5 4.7

5.1

3.7 3.94.3

6.6

5.1

4.4

5.1

6.6

9.1

8.18.8 8.6

7.9

6.9

8.2

11.0

9.5

7.9

9.7

0

2

4

6

8

10

12

1Q 2007 4Q 2017 1Q 2007 4Q 2017 1Q 2007 4Q 2017 1Q 2007 4Q 2017 1Q 2007 4Q 2017 1Q 2007 4Q 2017

U3 U6

COMMERCIAL REAL ESTATE

OCCUPANCY RATESCURRENT VS. 20-YEAR AVERAGE (ATL, MIAMI, NASHVILLE, NATION)

Source: AXIOMetrics, CBRE-EA, Risk Analysis Unit/Federal Reserve Bank of Atlanta

Source: AXIOMetrics, Risk Analysis Unit/Federal Reserve Bank of Atlanta

APARTMENT OCCUPANCY RATES

OccupancyRange

# ofMarkets

≤ 90% 2590% to 92% 2992% to 94% 7594% to 96% 153

≥ 96% 106

Source: AXIOMetrics, Analysis Unit/Federal Reserve Bank of Atlanta

ANNUAL EFFECTIVE RENT GROWTHASKING RENTS & CONCESSIONS

Rent Growth # of Markets

≤ 0% 540% to 2% 1092% to 4% 1124% to 6% 65

≥ 6% 48

Source: AXIOMetrics, CBRE-EA, Mueller, Risk Analysis Unit/Federal Reserve Bank of Atlanta

ChangeRange

# of Markets

≤ -3% 78-3% to 0% 1150% to 2% 662% to 4% 52

≥ 4% 77

APARTMENT EFFECTIVE RENT GROWTH & OCCUPANCYCOMBINED CHANGE

NATIONAL NEW SUPPLY VS. LONG-TERM AVERAGE20-YEAR AVERAGES VS. 2015, 2016, 2017 SUPPLY

Source: CBRE EA, Risk Analysis Unit/Federal Reserve Bank of Atlanta

75% Above Average 14%

Above Average 7%

AboveAverage

84% Below Average

Source: AXIOMetrics, CBRE-EA, Mueller, Risk Analysis Unit/Federal Reserve Bank of Atlanta

NEW SUPPLY VS. LONG-TERM AVERAGECURRENT UNDER CONSTRUCTION VS. 20-YEAR AVERAGE

Downturn Recovery Upturn Mature Downturn

Source: AXIOMetrics, CBRE-EA, CoStar, Federal Reserve, Mueller

Multifamily

OfficeWarehouse

Retail

Note: Depending upon economic conditions, indicators can remain stable or reverse

High RentGrowthin Tight Market

Rents Rapidly RiseToward New Const.

Below Inflation Rent

Growth

Long Term Average Occupancy

New Construction Cost Feasible

Negative RentGrowth

OUTLOOK

CAPITAL & FINANCE

CRE TRANSACTION VOLUME

Source: Real Capital Analytics, Risk Analysis Unit/Federal Reserve Bank of AtlantaData: Q4 2017

Source: RCA, Federal Reserve Bank of AtlantaData through 4Q 2017

Cap

Rate

s %

5.62%

4%

5%

6%

7%

8%

9%

10%

10Q1 11Q1 12Q1 13Q1 14Q1 15Q1 16Q1 17Q1

Office Industrial Retail Apartment Hotel

Yield 10 Yr T (10Q1: 3.83%, 174Q: 2.40%

6.72%6.75%

8.58%

6.60%

NATIONAL CRE CAP RATESQUARTERLY AVERAGES 2010-2017

Source: RCA, Federal Reserve Bank of AtlantaData through 4Q 2017

Cap

Rate

s %

5.62%

4%

5%

6%

7%

8%

9%

10%

10Q1 11Q1 12Q1 13Q1 14Q1 15Q1 16Q1 17Q1

Office Industrial Retail Apartment Hotel

Yield 10 Yr T (10Q1: 3.83%, 174Q: 2.40%)

6.72%6.75%

8.58%

6.60%

Change Since 201010 Yr Treasury Yield -1.4%Apartment -1.2%Retail -1.5%Office -1.7%Industrial -1.4%Hotel 0.7%

NATIONAL CRE CAP RATESQUARTERLY AVERAGES 2010-2017

Source: RCA, Federal Reserve Bank of AtlantaData through 4Q 2017

0

100

200

300

400

500

600

700

800

01Q1 02Q1 03Q1 04Q1 05Q1 06Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1 13Q1 14Q1 15Q1 16Q1 17Q1

Office Industrial Retail Apartment Hotel

Basis

Poi

nts

Yield 10 Yr T = 2.4%

Hotel 555

Apt. 326

Office 412Ind. 434

Retail 395

CRE CAP RATESSPREAD ABOVE 10-YR TREASURY

Source: RCA, Federal Reserve Bank of AtlantaData through 4Q 2017

0

100

200

300

400

500

600

700

800

01Q1 02Q1 03Q1 04Q1 05Q1 06Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1 13Q1 14Q1 15Q1 16Q1 17Q1

Office Industrial Retail Apartment Hotel

Basis

Poi

nts

10 Yr T Yield = 2.4%

Hotel 555

Apt. 326

Office 412Ind. 434

Retail 395

Current vs. AverageApartment -3Retail 25Office 20Industrial 1Hotel 63

CRE CAP RATESSPREAD ABOVE 10-YR TREASURY

THE 2008 DOWNTURN

SHIFT HAPPENS

• Overbuilding• Greater Efficiency

• Amazon• Affordability

• Higher Rents• Increased Costs

• Cybersecurity

Property Sector

PropertySector

Capital Markets

RISK

• Capital Availability• Heightened Value Levels• Rising Cap Rates• Reduced Regulatory

Environment• Current Prevailing Market

Sentiment “What Can Go Wrong”

• Current LTV Environment

Capital Markets

CURRENT LEVERAGE LEVELS…A FALSE SENSE OF SECURITY?

Market participants say: “Average loan LTV = 58%. A low leverage environment equates to safety and what can go wrong.”

All else remaining equal, a 150 basis point increase in CRE Cap Rates movesthe LTV upward notably in both scenarios.

The implications may be greater for smaller markets

Current FutureNOI $100,000 $100,000Cap Rate 4.00% 5.50%Value $2,500,000 $1,818,182

($681,818)

Leverage @ 58% $1,450,000 $1,450,000

LTV Based on New Value 80%

Current FutureNOI $100,000 $100,000Cap Rate 5.50% 7.00%Value $1,818,182 $1,428,571

($389,610)

Leverage @ 58% $1,054,545 $1,054,545

LTV Based on New Value 74%

• Enhanced Market Knowledge

• Greater Due Diligence• Monitoring Changing

Dynamics• Actively Monitoring

Concentrations• Property• Geography• Tenant

Property Sector

PropertySector

Capital Markets

STRATEGIES TO MINIMIZE RISK

• Stress Testing Going-In & Exit Cap Rates

• Stress Testing LTVs Against Changing Property Values

• Asking “What Can Go Wrong”

Capital Markets