Expectation and Market Realities in Real Estate 2013 nd Market Realities 2013

7/29/2019 Expectation and Market Realities in Real Estate 2013 nd Market Realities 2013

1/57D E L O I T T E | R E a L E T aT E R E E a R c c O R p O R a T I O n | n aT I O n a L a O c I a T I O n O F R E a LT O R

E x p E c T a T I O n & M a R k E T R E a L I T I E I n R E a L E T a T E 2 0 1 3

TURN THE PAGE

THE ECONOMY

the best of times, theworst of times.

THE CAPITAL MARKETS

Esig cotiues

THE PROPERTYMARKETS

persetive d alysis

OUTLOOK FOR 2013

The new norml


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Expectations & Market Realities in Real Estate Turn The Page

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SPONSORING FIRMS


Founded in 1931, Real Estate Research Corporation was one o the frst national frms dedicated to com-mercial real estate research, valuation, and consulting services. Today, RERC is also known or its inde-pendent fduciary services, management inormation systems, valuation management, and litigationsupport services. With its practical know-how and discipline, RERC serves as the independent fduciaryand oversees all real estate investment- and valuation-related activity o the multi-billion dollar realestate accounts or several major pension unds. In addition, RERC provides web-based portolio tech-nology solutions and valuation management or several other major unds. Further, RERC has providedairness opinions on dozens o major acquisitions totaling over $1 billion. RERCs valuation services alsohave proven rewarding to real estate owners and investors or tax appeals and expert witness testimonyin partnership disputes.

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Deloitte is a recognized leader in providing audit, tax, consulting, and fnancial advisory services to thereal estate industry. Our clients include top REITs, private equity investors, developers, property man-agers, lenders, brokerage frms, investment managers, pension unds, and leading homebuilding andengineering & construction companies. Our Real Estate Services team provides an integrated approachto assisting clients enhance property, portolio, and enterprise value. We customize our services in waysto ft the specifc needs o each player in a real estate transaction, rom owners to investment advisors,rom property management and leasing operators to insurance companies. Our multi-disciplinaryapproach allows us to provide regional, national and global services to our clients. Our real estatepractice is recognized or bringing together teams with diverse experience and knowledge to providecustomized solutions or all clients. Deloittes Real Estate Services industry sector in the United Statescomprises over 1,300 proessionals supporting real estate clients out o oces in 50 cities; key locationsinclude Atlanta, Boston, Chicago, Dallas, Denver, Houston, Los Angeles, Miami, New York, San Fran-cisco, and Washington, D.C. Deloittes global Real Estate Services industry sector includes over 4,800proessionals located in excess o 40 countries.


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selors and others. Approximately 78,000 NAR and institute aliate members specialize in commercialbrokerage and related services, and an additional 232,000 members oer commercial real estate servicesas a secondary business. e term REALTOR is a registered collective membership mark that identifes areal estate proessional who is a member o the NATIONAL ASSOCIATION o REALTORS and subscribes toits strict Code o Ethics. Working or Americas property owners, the National Association provides a acilityor proessional development, research and exchange o inormation among its members and to the publicand government or the purpose o preserving the ree enterprise system and the right to own real property.

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FOREWORD

December 2012

Dear Readers,

As we put the fnishing touches on our annual outlook report, Expectations & Market Realities in Real Estate 2013Turnthe Page, we are anxious to turn the page into a new year and a new era. ere is still much uncertainty and many challengesaheadthe European debt crisis and slowing global growth, the unsustainable debt levels and fscal policy discussions inthe U.S., a slow-growing U.S. economy and lack o job growth, and heavy reliance on monetary policy, to name a ew. We havecome to the conclusion that 2013 may not be much brighter or better than what we have been through during the past ewyears, but we look orward to putting the past behind us and getting on with it.

Although there are no guarantees and there are elements o risk with any investment, we generally agree that despite theuncertainty and challenges still ahead, commercial real estate appears to be positioned relatively well.

WeReal Estate Research Corporation (RERC), Deloitte, and the National Association of REALTORS (NAR)are pleasedto present our research, overview, and outlook to you. ank you to everyone who has contributed to this report, especiallyour researchers and data providers, economists, business associates, research survey respondents, and the many others whohave shared their insights and observations. We also thank youour clients, subscribers and membership proessionals, andconsultantsor your interest and support o this report. We hope you fnd Expectations & Market Realities in Real Estate2013Turn the Pagehelpul in reaching your investment objectives.

Sincerely,

Lawrence Yun, PhDSr. Vice President, Chie Economist


Matthew G. Kimmel, CRE, FRICS, MAIPrincipal & US Real Estate Services Leader

Deloitte Financial Advisory Services LLP

Kenneth P. Riggs, Jr., CFA, CRE, FRICSChairman & President





ACKNOWLEDGEMENTS

SPONSORIN FIRMS & CHAIRS

Matthew . Kimmel, CRE , FRICS, MAI Deloitte Financial Advisory Services LLPKenneth P. Riggs, Jr., CFA, CRE, FRICS Real Estate Research Corporation

Lawrence Yun, PhD NATIONAL ASSOCIATION OF REALTORS

CONTRIbUTIN AUTHORS

bar bush Real Estate Research Corporation

Todd J. Dunlap, MAI, MRICS, Senior Manager

Deloitte Financial Advisory Services LLP

Kenneth W. Kapecki, MAI, CRE, FRICS, Senior ManagerDeloitte Financial Advisory Services LLP

Lindsey Kuhlmann Real Estate Research Corporation

Roert Liey, Research & Analysis Deloitte Services LLPSaurah Mahajan, Research & Analysis Deloitte Services LLP

Andy J. Miller, Manager Deloitte Financial Advisory Services LLP

eorge Ratiu NATIONAL ASSOCIATION OF REALTORSSurahi Sheth, Research & Analysis Deloitte Services LLP

brian Velky, CFA Real Estate Research Corporation

Morgan Westpfahl Real Estate Research Corporation

DESIN & LAYOUT

Luke baldwin 21Fingers

Je Carr Real Estate Research Corporation

OTHER DISTINUISHED CONTRIbUTORS

Roert bach Newmark Grubb Knight FrankVictor Calanog, PhD Reis, Inc.

Ronald Johnsey Axiometrics, Inc.

Roert Mandelaum PKF Hospitality ResearchRoert M. White Real Capital Analytics

R. Mark Woodworth PKF Hospitality Research

RERC EDITORIAL bOARD

Stephen blank Urban Land Institute

David blankenship AEGON USA Realty Advisors, Inc.

Nicholas . buss INVESCO Real Estate

Susanne Cannon DePaul University - The Real Estate Centereorey Dohrmann Institutional Real Estate, Inc.

Cydney Donnell Texas A&M University

Stephen Furnary Clarion PartnersMichael ately Cornerstone Advisers

David eltner MIT Center or Real Estate

Jacques ordon LaSalle Investment Management, Inc.John Levy John B. Levy & Company

Mary Ludgin Heitman Capital Management, LLC

Dennis Martin RREEF/DB Real Estatelenn Mueller University o Denver

Scott Muldavin The Muldavin Company, Inc.

Joseph Pagliari University o Chicago

Richard Sokolov Simon Property GroupAllan Sweet AMLI Residential Properties, LLC

Charles Wurtzeach DePaul University-The Real Estate Center

Sam Zell Equity Group Investments, LLC




CONTENTS

1 | INTRODUCTION

Turn the Page..............................................................................................................................................................................................8

2 | THE CAPITAL MARKETS

Easing Continues .................................................................................................................................................................................... 20

3 | THE PROPERTY MARKETS

Perspective and Analysis ....................................................................................................................................................................... 25

4 | OUTLOOK FOR 2013 AND bEYOND

e New Normal ..................................................................................................................................................................................... 50

SPONSORIN FIRMS

................................................................................................................................................................................................................... 54




1 | INTRODUCTION

Turn the Page

When Real Estate Research Corpora-tion (RERC), Deloitte, and the NationalAssociation o REALTORS (NAR)began discussions to publish theannual Expectations & Market Reali-ties in Real Estate 2013, we hoped thatsome o the uncertainty that has domi-nated our outlook or the past ew yearswould be in decline. Instead, whatwe ound was that the economy andcapital markets appeared even moreuncertain, and that there were major

hurdles still to overcome beore inves-tors would have the clarity they havebeen wishing or.

Alt hough a ew questions have beenansweredthe Federal Reserve hasinitiated a third round o quantita-tive easing and has extended thetime rame or keeping the ederalunds rates low to mid-2015, and theNovember elections are overotheruncertainties remain. It appears thatthe political gridlock we have had orthe past couple years will continue,at least to some degree, and we won-der i calmer heads will prevail. Sloweconomic growth, weak job growth,and unsustainable debt levels arehere or the oreseeable uture and wequestion i any industry can provide ameaningul boost to growth. Tax bur-dens and expenses o the new health-care legislation are beginning to beelt, and new banking regulations areon the rise. e credit crisis in Europe

has spread and the U.S. is beginningto eel the eects through lower exportgrowth, all while the challenges in theMiddle East are intensiying

I there is one thing investors appearready to doperhaps even anxiousto doit is to turn the page on thepast ew years. In general, investorswant to put the past behind t hem, and

although they may not know exactlywhere they are going, they know wherethey have been and that they do notwant to return there. ey know whatthey are dealing with, they realize thatthis situation will be with the nation or

the oreseeable uture, and they needto make adjustments in order to maxi-mize commercial real estate invest-ment perormance and yield in thiskind o environment. We believe thatmuch o the critical research and anal-ysis needed to do just that is providedin our new outlook report: Expecta-tions & Market Realities in Real Estate2013Turn the Page.

In this irst chapter to our annuareport, we take a look at the economy as the investment environmentin which people invest. The outlookis or a continued slow recoverywith modest economic grow th over

the next ew years and or slow jobgrowth to continue. It is expectedthat once businesses get used tothe new tax increases, that businessspending (including hiring) mayincrease. In addition, it appears thatthe residential real estate market isinally starting to stabilize, and wemay inally begin to see positivegrowth in this sector.




e capital markets take center stagein Chapter 2, as we look at the demandor commercial real estate as an invest-ment alternative, as well as the avail-ability and discipline o capital orinvesting in this asset class. Both debt

and equity committed to commercialreal estate investment are discussed.

Chapter 3 oers our highlights andexpectations or the fve major prop-erty sectorsthe oce, industrial,retail, apartment, and hotel markets.Our analysis examines volume, pric-ing, capitalization rates, vacancy/occupancy rates, absorption and com-pletions, and rental rates/revenues oreach o the property sectors.

Our fnal chapter contains our collec-tive analysis o the investment envi-ronment, the capital markets, and theproperty markets as we present ouroutlook or commercial real estate or2013 and beyond.

The Economy

In providing an economic outlook or2013, one is reminded o the amousquote rom Charles Dickens in A Taleo Two Cities: It was the best o times,it was the worst o times.

at statement could be an apt sum-mary o current economic conditions.e stock market has bounced backspectacularly rom the low point o2009, nearly doubling in value, yet thenumber o new small business start-ups remains very low. Housing aord-ability is at the lowest level on record,accompanied by exceptionally low

deault rates by recent homebuyers, yetthe number o homeowners who are ina negative equity position (underwa-ter) still remains near unprecedentedhighs. Over 4 million net new jobshave been created in the past 3 years,yet the number o people unemployedremains high. e mixed economicdata on balance point to an economicoutlook that is positive but mediocre,

with signifcant positive or negativepotential in either direction. e eco-nomic outlook is very dicult to pre-dict, given that unresolved political

and policy issues can have a majorimpact on any economic orecast.

OVERVIEW

e NAR orecast or gross domesticproduct (GDP) is or constant dollargrowth or 2012 in the neighborhood o2.1 percent, then rising modestly to 2.5

percent in 2013. When viewing quarterlygrowth fgures rom the Bureau o Eco-nomic Analysis (BEA), the economy hasdecelerated, rom a strong growth rate o

4.1 percent in ourth quarter 2011 to 2.0percent, 1.3 percent, and 2.0 percent inthe each o the subsequent quarters.

is weakening o economic activitywas cited as a key reason or the Federal Reserves publicly-stated com-mitment to keep the ultra-low interest rate policy initiated in 2008 (seeExhibit 1-1) until mid-2015, including

0

2

4

6

8

Jan20

12

Jan20

11

Jan20

10

Jan20

09

Jan20

08

Jan20

07

Jan20

06

Jan20

05

Jan20

04

Jan20

03

Jan20

02

Jan20

01

Jan20

00

Percent

Exhibit 1-1. Federal Open Market Committee Federal Funds Target Rate

oures: Federl Reserve Bord, ver alytis, Otober 12, 2012.




the additional purchases o mortgage-backed securities, in order to urtherstimulate the housing sector. Inter-estingly, it has been the recovery othe housing markets, albeit modest,that appears to have been preventing

the U.S. economy rom slipping into anew recession. e Federal Reservesvery aggressive commitment to keepultra-low interest rates may be partlyin response to a likely fscal policy con-traction in the near term.

The high budget deicit (see Exhibit1-2) will likely need to be addressedby a combination o governmentspending cuts and revenue increasesas part o a long-term budget deal. Ingeneral, though such measures bring

short-term downward pressureson economic growth, longer-termgrowth prospects should improverom the implementation o poli-cies that resolve concerns over thedeicit and public debt. Any budgetdeal, however, is unlikely to takeplace until deep into 2013, with someshort-term patch o kicking the candown the road being the most likely

action rom Congress during the nearterm. Otherwise, most economistsboth nationally and at NARbelievethat the iscal cli o sudden sharp

sequestration and high taxes wouldquickly shave-o close to 3 perceno GDP and plunge the economy backinto job-cutting recessionary condi-tions. These orecasts are thereorebased on the assumption that theU.S. will somehow muddle throughthe variety o political deals to avoida recession.

DP DETAILS AND DRIVERS

To some observers, current economicconditions suggest that the U.S. may beapproaching a recession, although thisview is inconsistent with recent GDPdata. Economists defne a recession asa prolonged period o declining out-

put, with two consecutive quarters odecline in the GDP normally qualiy-ing as a recession. e act o the mat-ter, however, is that as shown in Exhibi1-3, the U.S. GDP has expanded or 12straight quarters, according to theBEA. e latest growth rate o 1.3 per-cent in second quarter 2012, was verysluggish and well below the 3-percenhistoric average annual growth rate.

-1,600

-1,200

-800

-400

0

400

Jan20

12

Jan20

11

Jan20

10

Jan20

09

Jan20

08

Jan20

07

Jan20

06

Jan20

05

Jan20

04

Jan20

03

Jan20

02

Jan20

01

Jan20

00

$

Billions

Exhibit 1-2. Federal Surplus and Defcit (12-month moving total)

oures: U.. Tresury, ver alytis, Ot. 12, 2012.

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

2Q201

2

2Q2011

2Q201

0

2Q200

9

2Q2008

2Q200

7

PercentChange

Exhibit 1-3. Real GDP Growth

oures: BEa, ver alytis, Otober 12, 2012.




Nonetheless, the economy is stillproducing more output and creatingadditional jobs. The low point or jobswas in early 2010, as reported by theBureau o Labor Statistics (BLS) anddemonstrated in Exhibit 1-4, when

there were 8 million ewer peoplework ing compa red to just two yea rsprior. But since the low point, t he U.S.economy has added 4.3 million netnew jobs as o September 2012. TheU.S. economy is still down rom thepeak in jobs, but is well o the bot-tom and is continuing to add jobswith each passing month.

Further, when examining each o thecomponents that make up the GDP, it isdicult to see how the economy could

sink back into a recession at this time.e behavior o each o the major com-ponents, which are discussed in moredetail in the ollowing paragraphs,suggests urther economic expansion.

Consumer Spending

First, as shown in Exhibit 1-5, con-sumer spending has moved into posi-tive territory over the past two yearsand will likely continue to be positivedue to rising aggregate income becauseo job creation and big wealth gains inthe stock market. Even housing wealthis slowly making gains, rising by $730billion since the end o 2011, accord-ing to the Federal Reserve. By year-end 2012, home prices will likely haveshown some modest single-digit gainsnationally, while some ast-recoveringmarkets like Phoenix and Miami willlikely have shown double-digit rates oprice appreciation. A higher housingwealth eect is a lso likely to help con-

sumers open their wallets.

In addition, home price increases willlikely urther diminish the rate o dis-tressed property sales with each pass-ing quarter. e so-called shadowinventorythose homes not on themarket but where mortgages have notbeen paid or 3 months or morehasalso trended down, urther raising the

prospects o strong price appreciation.In act, the economist panel to Te WallStreet Journal (o which NAR is a par-ticipant) has raised its consensus home

price outlook to 3.3 percent growth in2012 and another 3.3 percent in 2013rom a orecast o essentially no pricegrowth earlier this year.

128,000

130,000

132,000

134,000

136,000

138,000

140,000

Jan20

12

Jan20

11

Jan20

10

Jan20

09

Jan20

08

Jan20

07

Jan20

06

Jan20

05

Jan20

04

Jan20

03

Jan20

02

Jan20

01

Jan20

00

Thousands

Exhibit 1-4. Total Nonarm Employees

oures: BL, Otober 12, 2012.

-6

-4

-2

0

2

4

6

2Q2012

2Q201

1

2Q2010

2Q200

9

2Q200

8

PercentChange

Exhibit 1-5. Real Personal Consumption Expenditures

oures: BEa, ver alytis, Otober 12, 2012




Business Investment

Secondly, business investmentspending will likely be positivebecause corporations have an abun-dance o cash on their balance

sheets. According to the BEA and asshown in Exhibit 1-6, ater-tax cor-porate proits reached a record higho $1.58 trillion in 2011, and proitslook to be even higher in 2012. Bycomparison, proits had peaked at$1.1 tril lion in t he pre-recession yearo 2006.

Banks also appear to have plenty ocash reserves to lend or increasedbusiness spending, although vari-ous regulatory uncertainties are

causing banks to be extra cautious.Another part o the investment out-look is related to housing, which ismore ormally deined as residentialinvestment. According to the BEA,housing investment grew by 20.5percent in irst quarter 2012 and 8.5percent in second quarter 2012, asdemonstrated in Exhibit 1-7. Withthe broader measure o overall GDP

growth at under 2 percent, the highsingle-digit a nd double-digit pace oexpansion in the housing sector isimpressive.

-40

-20

0

20

40

2Q201

2

2Q201

1

2Q201

0

2Q200

9

2Q200

8

PercentChange

Exhibit 1-7. Real Private Residential Investment


900

1,000

1,100

1,200

1,300

1,400

1,500

1,600

1,700

1,800

1,900

2,000

3Q2012

1Q201

2

3Q2011

1Q201

1

3Q201

0

1Q201

0

3Q200

9

1Q2009

3Q200

8

1Q2008

3Q200

7

1Q200

7

$

Billions

Private Nonresidential Fixed Investment

Corporate Profits

Exhibit 1-6. Private Nonresidential Fixed Investment

oures: BEa, ver alytis, august 28, 2012.




In addition, the value o owner-occupied real estate has increasedduring the irst and second quarterso 2012 as residential prices recover,as shown in Exhibit 1-8. Improve-ments in homeowner balance sheets

as a result o increasing home pricesshould lead to continued economicimprovement.

Further, big publicly-listed com-panies appear to have, as statedpreviously, plenty o cash, andnon-residential ixed investmentis increasing. However, given thealready depressed activity conront-ing small business, spending in thatsector appears to have nowhere to gobut up (see Exhibit 1-9).

Government Spending

ird, ederal government spending islikely to continue to be a positive con-tributor to economic growth over theshort term. Spending on inrastructureor buying a helicopter or tank typicallyresults in people working and in addi-tional income generation. e debate

over the ederal budget currentlyocuses on the rate o uture increasesin spendingnot the actual cuttingo current expenditures. It is unlikely

that the ederal budget will declinemuch in terms o overall expendituresgiven that the bulk o expenditures arerequired by and fxed by law.

16,000

17,000

18,000

19,000

20,000

21,000

22,000

2Q2012

2Q2011

2Q2010

2Q2009

2Q2008

$

Billions

Exhibit 1-8. Owner-occupied Real Estate Values

oures: Federl Reserve Bord, ver alytis, Otober 12, 2012.

-30

-20

-10

0

10

20

2Q201

2

2Q2011

2Q201

0

2Q2009

2Q200

8

PercentChange

Exhibit 1-9. Nonresidential Fixed Investment





Due to signifcant budgetary pressures,particularly at state and local levelswhere the annual balancing o the bud-get is mandatory, state and local gov-ernment spending has trended lowerin recent years (see Exhibit 1-10). All

else being equal, declines in govern-ment spending typically mean lowereconomic activity, and laid o govern-ment workers and contractors will haveless money to spend. Although therehave been signifcant cutbacks at thestate level and some modest decreasesin contractors at the ederal level, thedegree o negativity has diminished (seeExhibit 1-11), which suggests that GDPwill probably not be negatively aectedby continued government cutbacksgoing orward. In addition, an improved

budget situation may raise the conf-dence o bond investors, and therebymay help provide attractive low interestrates or those private consumers andbusinesses in need o borrowing.

International Trade

e ourth component o GDP is inter-national trade. Exports have been ris-ing robustly, but so have imports. elong-standing U.S. trade defcit willlikely continue, based on the trendlines in Exhibit 1-12 (next page), butwil l likely neither measurably widennor contract, so the impact on GDPgrowth will likely be neutral. Giventhe economic troubles in Europe, agreater level o international trade hasoccurred with Asia and with our directneighbors, Canada and Mexico.

THE OUTLOOK

It is hard to oresee how the two maincomponents o GDPconsumer andbusiness expenditurescan retrenchmuch urther. ereore, the NARorecast is or U.S. GDP to continue toexpand, albeit at the somewhat subparrate o 2.1 percent in 2012 beore pick-ing up speed to 2.5 percent in 2013. esub-par growt h rate suggests that ina-tion and wage demands will not get out

o hand. e labor productivity gainsater several years o expansion tendto be normal or below average, so theGDP growth will directly translate into

job gains. As such, job gains o around1.5 million in 2012, ollowed by a morereasonable pace o 2.0 to 2.5 millionjobs in 2013, appear likely.

-6

-4

-2

0

2

4

6

8

3Q201

2

3Q201

1

3Q201

0

3Q2009

3Q200

8

PercentChange

Exhibit 1-10. Real State and Local Government Consumption Expenditures & Gross Investment


0

2

4

6

8

10

12

Jan20

12

Jan20

11

Jan20

10

Jan20

09

Jan20

08

Jan20

07

Jan20

06

Jan20

05

Jan20

04

Jan20

03

Jan20

02

Jan20

01

Jan20

00

$T

rillions

Exhibit 1-11. Total Federal Debt

oures: U.. Tresury, ver alytis, Otober 12, 2012.




A caveat to the NAR orecast is thatit assumes there will be an agree-ment by Congress and the WhiteHouse about taxes and spending. Ino new budget passes, then sizableautomatic government spending cuts

to domestic and deense programswould be mandated. T his, a long withthe recent tax increases, means thatthe dollar amount taken out o theeconomy is estimated by NAR to beequivalent to 3 percent o GDP. Apotential 3-percent GDP subtractionon an economy that is growing at lessthan 2 percent could put the economyinto a recession.

Employment

The economy has added jobs ornearly three years, and this trendwill likely cont inue in the upcom-ing years based on the GDP growthorecast. However, all is not well withjob market conditions. There are sti ll12.1 million jobless people lookingor work, o which 4.8 million havebeen without work or more than sixmonths, according to the BLS (see

Exh ibit 1-13). In the past, even duringa recession, the number o long-termunemployed people rarely reachedabove 2 million.

Furthermore, there has been heateddebate over the unemployment ratefgure, which declined to under 8 per-cent despite sluggish economic con-ditions. Surely job creation has ledto lower unemployment, but anotherreason or the decline in employmentin recent years has been due to a sharpdrop in labor orce participation rate(A person has to be in the labor orce tobe ocially counted as unemployedand a person returning to school oron disability benefts will not countas unemployed, even though this per-son may have had a job in the past.)Had the labor orce participation rateremained near 66 percent or betteras had been the case a decade earlierthen the unemployment rate would

be above 10 percent, rather than atthe BLS ocial fgure o 7.8 percent inSeptember 2012.

A better measure o the health o thejob market may not be the unemploy-ment rate but the employment rate,which can be defned as the numbero working adults among the adulpopulation. Based on this measure, the

800

1,200

1,600

2,000

2,400

2,800

Imports

Exports

2Q201

2

2Q201

1

2Q201

0

2Q200

9

2Q200

8

2Q2007

2Q200

6

2Q200

5

2Q200

4

2Q200

3

2Q200

2

2Q2001

2Q2000

$

Billions

Exhibit 1-12. Imports and Exports o Goods and Services (4-quarter moving average)


0

2,000

4,000

6,000

8,000

Sept

201

2

Sept

201

1

Sept

201

0

Sept

200

9

Sept

200

8

Sept

200

7

Sept

200

6

Sept

200

5

Sept

200

4

Sept

200

3

Sept

200

2

Thousands

Exhibit 1-13. Civilians Unemployed or 27 Weeks or Longer

oures:BL, ver alytis, Otober 12, 2012.




employment rate has been stuck at 58percent or several consecutive yearswithout any measurable improvement(see Exhibit 1-14).

Despite the dispute over which mea-

sure best reects real world job marketconditions, there are more jobs todaythan one year ago, and more jobs oneyear ago compared to two years ago (seeExhibit 1-15). e demand or commer-cial real estate space is derived not romthe unemployment rate or the employ-ment rate, but rom total jobs. Accord-ing to surveys o individual companiesby the BLS concerning the number oemployees on company payrolls, therehave been 4.3 million payroll jobs cre-ated rom the low point o employment

in 2010. Looking at a dierent measureo jobsthe monthly household surveywhich simply asks people i they have ajobthere were an additional 4.1 mil-lion net new jobs.

Another measure o improving job mar-ket conditions is the quit rate. Quittinga job is oten a sign that better oppor-tunities are popping up elsewhere.

Ater all, America is oten reerred toas the land o opportunity, wherenew businesses get created and suc-ceed. (Technology/Internet companies

-1,000

-750

-500

-250

0

250

500

Sept

201

2

Sept

201

1

Sept

201

0

Sept

200

9

Sept

200

8

Sept

200

7

Sept

200

6

Sept

200

5

Thousands

Exhibit 1-15. Net New Payroll Jobs in Private Industries

oures: BL, ver alytis, Otober 12, 2012.

58

59

60

61

62

63

64

Sept

201

2

Sept

201

1

Sept

201

0

Sept

200

9

Sept

200

8

Sept

200

7

Sept

200

6

Sept

200

5

Sept

200

4

Sept

200

3

Sept

200

2

Percent

Exhibit 1-14. Employment Rate

oures: BL, ver alytis, Otober 12, 2012




would likely not be what they are todayi employees had not quit their priorjobs to go work there).

When the fre rate (involuntary termi-nation) rises, it is a symptom o declin-

ing economic activity. However, whenthe quit rate (a voluntary action) rises,as shown in Exhibit 1-16, the economyis generally expanding. Fortunately thequit rate is slowly making a comeback,even though quitting still remainswell below the level commensuratewith healthy economic conditions.

A major impact o the high unemploy-ment rate (even though jobs are beingcreated) is that wages are barely ris-ing. According to the BLS, the average

hourly wage rose by only 1.4 percentrom one year ago to September 2012(see Exhibit 1-17), one o the lowestincreases in modern history.

Ination

e Federal Reserve has announcedthat it is willing to tolerate a higherination rate in order to bring the

unemployment rate down. Its primarytool or providing an economic stimu-lus is Quantitative Easing, the creationo additional fnancial liquidity through

the Federal Reserves monetization obonds (popularly denoted as printingmoney). Generally printing money canlead to a higher ination rate, but so ar

1,600

2,000

2,400

2,800

3,200

3,600

Aug2012

Aug20

11

Aug20

10

Aug2009

Aug20

08

Aug20

07

Aug2006

Aug20

05

Aug20

04

Aug2003

Aug20

02

Aug20

01

Thousands

Exhibit 1-16. Total Quits

oures: BL, ver alytis, etember 11, 2012.

0.75

1.50

2.25

3.00

3.75

4.50

Sept

201

2

Sept

201

1

Sept

201

0

Sept

200

9

Sept

200

8

Sept

200

7

Sept

200

6

Sept

200

5

Sept

200

4

Sept

200

3

Sept

200

2

Sept

200

1

Sept

200

0

PercentChangeYear-to-Year

Exhibit 1-17. Average Hourly Earnings





ination is well maintained, as shownin Exhibit 1-18. e latest increase inthe Consumer Price Index was only 1.7percent, according to the BLS. Inationis likely to trend a little higher next yearbased on recent rises in energy prices

and their subsequent impact on otherprices. In act, the Federal Reserve maybe willing to let ination rise to 4 per-cent or even 5 percent, so long as coreination (all items less ood and energy)stays near 3 percent.

Despite the current non-threateningination rate, recent increases in apart-ment rents should raise concerns.Apartment rent is the biggest weight inthe overall consumer price index. Fur-thermore, several private sector mea-

surements on rents (such as apartmentrent data rom Reis, Inc.) show an evenaster rent growth than the ocial rentfgures rom the BLS (see Exhibit 1-19on next page). I, at some point, inationwere to get out o hand, then the lon-ger-dated interest rates will likely haveto rise. e bond market typically willprice bonds downwards to compensateor the loss in the purchasing power omoney. Rents could easily acceleratebecause o the rising rental population.

As to interest rates, there does notappear to be room or urther down-ward movement. e change in inter-est rates ultimately will likely be inonly one direction, and thats up. Inde-pendent o the Federal Reserves policy

on short-term ederal unds rate deter-mination, the Federal Reserve does notdirectly control the longer-dated bondyields. e 10-year Treasury is likely tohave already touched the absolute bot-tom, and will likely be steadily inchingup. From the current yield o 1.5 per-cent, NAR orecasts the 10-year Trea-sury yield to increase to 2.2 percent bythe end o 2013. Somewhat higher ratesare likely to prevail in 2014 and 2015.Commercial practitioners thereoreneed to be very mindul o the outlook

or interest rates, as many commerciareal estate loans are priced o 10-yearTreasury rates.

CONCLUSIONS AND

ECONOMIC OUTLOOKe U.S. economic outlook suggests aslowly improving economy as the U.Smuddles through the remnants romthe Great Recession. e ederal bud-getary situationtaxes, expenditures

-4

-2

0

2

4

6

Core Inflation Rate: All Items Less Food and Energy

CPI Inflation

Aug2012

Aug20

11

Aug20

10

Aug2009

Aug20

08

Aug20

07

Aug2006

Aug20

05

Aug20

04

Aug2003

Aug20

02

Aug20

01


Exhibit 1-18. Core Ination Rate: All Items Less Food and Energy





priorities, and objectivesstill needs tobe resolved, and the short-run impactso the resolution process may slow eco-nomic expansion. Consumer balancesheets, as related to debt levels and homeequity, appear to still be in the rebuilding

process, with consumers more cautiousin their spending than in the past andcontributing to the slowing o the currentspeed o economic growth. e uture othe euro and the resolution o economicproblems in a variety o European coun-tries continue to cloud the economic hori-zon. Finally, consumer confdence stilldoes not appear to have recovered romthe impact o the Great Recession.e problems still acing the economywil l likely require time or resolu-

tion as confdence increases, balancesheets build, and ederal fscal issuesare resolved. Accordingly, or the nextseveral years and as shown in Exhibit1-20, the outlook is or a slow ex pansiono the economy.

Exhibit 1-20. U.S. Economic Outlook (October 2012)

oures: naR, BEa, BL, coferee Bord, Federl Reser ve, U.. Tresury, The Wll treet Jourl, Moodys, ver alytis, Otober 2012.

2011 2011 2012 2012 2012 2012 2013 2013 2013 2013 Annual

Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2010 2011 2012 2013

U.S. Economy History Forecast History Forecast

Annual Growth Rate

Real GDP 1.3 4.1 2.0 1.3 2.0 1.7 3.0 3.0 3.0 3.4 2.4 1.8 2.1 2.5

Nonfarm Payroll Employment 1.2 1.4 1.5 1.3 1.4 1.0 1.6 1.9 2.6 2.2 -0.7 1.2 1.4 1.6

Consumer Prices 3.1 1.3 2.5 0.8 2.0 2.6 3.1 2.7 3.4 3.0 1.6 3.1 2.1 2.7

Consumer Condence 50 54 68 65 65 68 73 78 85 88 54 58 67 81

Percent

Unemployment 9.1 8.7 8.3 8.2 8.1 8.1 8.1 8.0 7.8 7.6 9.6 8.9 8.1 7.9

Interest Rates, Percent

Fed Funds Rate 0.1 0.1 0.1 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.1 0.1 0.1

3-Month T-Bill Rate 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.1 0.1 0.1 0.2

Prime Rate 3.3 3.3 3.3 3.3 3.3 3.1 3.2 3.3 3.4 3.4 3.3 3.1 3.1 3.1

Corporate Aaa Bond Yield 4.5 3.9 3.9 3.8 3.5 4.1 4.2 4.1 4.3 0 4.9 4.6 3.9 4.3

10-Year Government Bond 2.4 2.0 2.0 1.8 1.7 1.9 2.0 2.0 2.2 2.4 3.2 2.8 1.9 2.2

30-Year Government Bond 3.7 3.0 3.1 2.9 2.8 3.1 3.1 3.1 3.4 3.6 4.3 3.9 3.0 3.3

-1

0

1

2

3

4

5

Aug2012

Aug20

11

Aug20

10

Aug2009

Aug20

08

Aug20

07

Aug2006

Aug20

05

Aug20

04

Aug2003

Aug20

02

Aug20

01


Exhibit 1-19. CPI-U: Rent o Primary Residence

oures: BL, ver alytis, Ot. 12, 2012.

Average of annual data and percent ch ange ofte n do not equate to quarterly average s of percent chan ges. NAR .




2 | THE CAPITAL MARKETS

Easing Continues

As we turn the page on 2012, some othe uncertainty that has been domi-nating the investment environmentand capital markets during the pastcouple years is f nally being addressed.e election is over, and there appearsto be some sense o how the electorateviews the role o government and thedirection we might go. A third round oquantitative easing (QE3) is underway,and Federal Reserve Chairman Ber-nanke has stated that the ederal unds

rate will remain low until mid-2015, atleast. ere is still uncertainty, particu-larly regarding this nations unsustain-ably high debt levels, the debt crisis inEurope, and weak GDP growth in theU.S. and worldwide, but there are hopesor addressing the mandated spendingcuts in the U.S. beore the possibility oplunging into a new recession. Signif-cant challenges remain, but as notedin the previous chapter o this report,there are signs o some slight improve-ment, particularly in t he housing mar-ket, as we look to 2013.

CAPITAL AVAILAbILITYAND DISCIPLINE

Although many investors have spentmuch o 2012 ocused on sae haveninvestments, requirements or higherreturns, along with recent doses oeasing by central banks, are drawingmany investors into riskier strategies.

For the most part, the capital marketsare willing to support such strategies,and lending continues to expand.

Accordi ng to RERCs institutionalinvestment survey respondents andas measured on a scale o 1 to 10, with10 being highest, there has been moreavailable capital than disciplinesince third quarter 2010. However,

as demonstrated in Exhibit 2-1, theavailability and the discipline o cap-ital are once again becoming moreclosely aligned, as the availability ocapital declines and the disciplineo capital increases (capital becomesmore select ive).

As or where investors are placingcapital, RERCs institutional invest-ment survey respondents rated com-mercial real estate as the top invest-ment alternative, giving it a rating o6.8 on a scale o 1 to 10, with 10 beinghighest, during second quarter 2012

1

2

3

4

5

6

7

8

9

10

Discipline

Availability

2Q201

2

2Q201

1

2Q201

0

2Q200

9

2Q200

8

2Q2007

2Q200

6

2Q2005

2Q200

4

2Q2003

Rating

Exhibit 2-1. Historical Availability and Discipline o Capital

Rtigs re bsed o sle of 1 to 10, with 10 beig highest.oure: RERc, 2q 2012.




In comparison, stocks received a rat-ing o 5.2, cash received a rating o3.9, and bonds were rated at 3.5. His-torically, these ratings have uctuatedsomewhat rom quarter to quarter,however commercial real estate has

continued to earn some o the highestmarks rom institutional investors.

e perceived saety o commercial realestate and the potential returns avail-able with this asset class have been par-ticularly attractive to investors duringthe past ew years o extreme volatility.Despite record-high sales or high-qual-ity commercial properties in some othe top markets like New York City, SanFrancisco, and Washington, DC, alongwith increasing sales o good quality

properties in the secondary and tertiarymarkets in 2012, uncertainty contin-ues to undermine investor confdence.Although investment in commercialreal estate is increasing, as noted withbuy-sell-hold scores above 6 on a scaleo 1 to 10, with 10 being highest, there isenough uncertainty that many inves-tors continue to sit on their hands andhold (see Exhibit 2-2), creating a stale-mate between many buyers and sellers.

COMMERCIAL REALESTATE LENDIN

Increasing investor demand, enhancedundamentals, and improving com-mercial real estate loan perormancecontinue to drive lending, especiallyor Class A properties. In the frst hal o2012, banks continued to ease under-writ ing standards and increase com-mercial mortgage originations, whilelie insurance companies and govern-

ment-sponsored entities (GSEs) ledoverall originations, according to theMortgage Bankers Association (MBA).However, weak perormance by com-mercial mortgage-backed securities(CMBS), high debt maturities (at least$1.7 trillion o commercial real estatedebt will mature between 2012 and2016, according to Trepp, LLC), andconcerns over stricter provisions under

the DoddFrank Wall Street Reformand Consumer Protection ActandBaselIIIcontinue to pose risks or the com-mercial real estate debt markets.

Tight lending is generally a more signif-cant challenge or investors o smallerproperties, and according to NAR, allprojections o the commercial real estaterecovery are based on continued and/or increasing credit availability. Giventhat the implementation o the Dodd-Frank Wall Street Reform and Consumer

Protection Actaects smaller banks to amuch greater degree than larger banks(estimates provided by the AmericanBankers Association show that the costo regulatory compliance as a share ooperating expenses is oten approxi-

mately 2 times greater or small banksthan or large banks), fnancing posesthe biggest single risk or investors ocommercial properties under $2.5 mil-lion. is is critical, when taking intoaccount that local banks and regionalbanks provide more than 40 percent othe fnancing or investors, per results othe third quarter 2012 REALORS 2012Commercial Lending Survey.

Even so, commercial real estate loanoriginations or larger commerciaproperties, which are the primaryocus o this report, have been risingIn second quarter 2012, commercial/multiamily mortgage origination val-ues were 25 percent higher than sec-ond quarter 2011 levels, and 39 percenthigher than frst quarter 2012, as lieinsurance companies, governmenagencies, and banks competed orcommercial real loans (especially orcore properties), stated the MBA in the

1

2

3

4

5

6

7

8

9

10

Hold

Sell

Buy

2Q201

2

2Q201

1

2Q201

0

2Q200

9

2Q2008

2Q200

7

2Q200

6

2Q200

5

2Q200

4

2Q200

3

Rating

Exhibit 2-2. RERC Historical Buy, Sell, Hold Recommendations

Rtigs re bsed o sle of 1 to 10, with 10 beig highest.oure: RERc, 2q 2012.




Q2 2012 Commercial Real Estate/Mul-

tifamily Finance Quarterly Databook.Second quarter 2012 originations orcommercial banks were up 58 percentrom second quarter 2011, and up 50percent or Fannie Mae and Freddie

Mac. Second quarter 2012 originationswere up 16 percent or CMBS conduitsrom second quarter 2011, and up 10percent or lie insurance companies.

According to the Federal Reserve Flowof Funds, fxed-income lender com-position was slightly less in 2012 (seeExhibit 2-3) than it was at the sametime in 2011 ($3.04 trillion in Septem-ber 2012 versus $3.15 trillion in Sep-tember 2011).

Among propert y types, the retai l sec-tor reported the highest growth inmortgage originations56 percentyear-over-year, w ith an index value o253.0 in second quarter 2012, versus avalue o 162.0 in second quarter 2011.(e Commercial/Multiamily Mort-gage Bankers Originations Index isbased on a quarterly average o 100 in2001.) Mortgage originations or hotelproperties were next highest, with anincrease o 22 percent, ollowed by a19-percent increase or multiamilyproperties and a 15-percent increaseor oce properties. In contrast, theMBA reported a 5-percent decrease inoriginations or industrial properties.

However, the CMBS recovery hascontinued to slow since second hal2011, driven by the sovereign debtcrisis and increased economic uncer-tainty. ere continues to be signif-cant biurcation in the market, aswell-located and leased properties

have strong access to debt capital,while other properties fnd it dicultto source fnancing. MBA expectscommercial mortgage originations toincrease by 6.6 percent year over yearto $244.0 billion through 2013.

With higher commercial propertyprices and increased refnancingoptions, the industry is fnally seeing

progress in lenders ocusing on per-manent resolutions to distressed loansversus modifcations/extensions. Forinstance, between second quarter2011 and second quarter 2012, nearly78.5 percent o the total distress work-outs (or $47.7 billion) were resolutions,

while the remaining were restructur-ings (see Exhibit 2-4), according to RealCapital Analytics. Credit conditionsremain strict or the broader commercial real estate market (including orconstruction loans), despite easing orprime properties during the past year.

U.S. Chartered DepositoryInstitutions

47%

CMBS, CDO andother ABS

18%

Life InsuranceCompanies

11%

Foreign Banking Ocesin U.S.

1%

Govt. Sponsored Entities

18% Other5%

Fixed Income Markets - $3.04 Trillion

Lender Composition

Exhibit 2-3. Fixed-Income Lender Composition

oure: Federl Reser ve Flow of Fuds, etember 2012.

0

10

20

30

40

50

60

70

2Q201

2

4Q201

1

2Q201

1

4Q201

0

2Q201

0

4Q2009

2Q200

9

4Q200

8

2Q2008

$

Billions

Restructured/Extended

Resolved/Liquidated

Exhibit 2-4. Loan Resolution Versus Restructuring

note: Dt ertis to trilig 12-moth totl.oure: Rel citl aly tis, august 2012.




The increase in loan workouts accom-panied by improved property unda-mentals has reduced the number ocommercial loan delinquencies atcommercial banks5.0 percent insecond quarter 2012 compared to 7.1

percent a year earlier, according tothe Federal Reser ve. However, slowerrecovery in non-prime markets pro-vides signi icant challenges or the$1.7 tril lion in commercial real estatedebt maturities due between 2012and 2016, as shown in Exhibit 2-5. Othe debt maturing through 2016, 29.0percent is estimated to be under-water, accord ing to Trepp, LLC, andis a signiicant barrier to recovery.In addition, high CMBS delinquen-cies (9.0 percent as o second quarter

2012, according to MBA) remain aconcern.

It is generally believed that prospectsor a broad commercial real estatemarket recovery are being delayed dueto tepid CMBS issuance and increasedcaution toward loan originations andrefnancing or non-trophy assetsin secondary and tertiary markets. Inaddition, the Dodd-Frank Wall StreetReform and Consumer Protection Act

and Basel III provisions on enhancedrisk-retention requirements or CMBSand higher capital charges on bankcommercial real estate loans will l ikelylead to increased origination and secu-ritization costs and stricter eligibilitycriteriaactors that may limit lend-ing, increase debt cost, and result in afnancing gap in the U.S. commercialreal estate markets.

While increasing bank leniency andimproved undamentals have likely

helped revive the commercial realestate market, the high level o matur-ing debt remains a signifcant barrierto recovery. Additional oreclosuresare a possibility. Lenders ocus onpermanent loan resolutions throughpre-oreclosure sales will likely pro-vide opportunities or investors toacquire overleveraged properties atattractive prices.

0

50

100

150

200

250

300

350

400

450

2020

2019

2018

2017

2016

2015

2014

2013

2012

$

Billions

Life Co.sCMBSBanks Other

$1.7 Trillion

Exhibit 2-5. Debt Maturities by Lender Type

oure: Tre, LLc, august 2012.

0

10

20

30

40

50

60

2012

YTD

2011

2010

2009

2008

2007

2006

2005

2004

2003

$

Billions

Secondary DebtSecondary EquityIPO

Exhibit 2-6. U.S. REIT Fundraising

*YTD reresets dt through august 2012oure: naREIT, etember 2012




REITS AND PRIVATEEUITY REAL ESTATE

Real estate investment trusts (REITs)have been strong perormers in thecommercial real estate recovery, given

their relatively easy access to capital,high acquisition activity, and stronginvestment returns compared to tra-ditional asset classes. However, pri-vate equity real estate has had a com-paratively slower recovery, as investorshave remained cautious during theseuncertain economic times.

REITs continue to take advantage o eas-ier access to capital as leverage (reducedto 35.6 percent in June 2012 rom 39.8percent at the start o 2011, according to

the National Association o Real EstateInvestment Trusts [NAREIT]). Fund-raising by REITs is returning to custom-ary levels (see Exhibit 2-6 on previouspage). In addition, REITs have utilizedthe surplus capital or acquisitions (netacquisitions o $7.0 billion in the frsthal o 2012 versus $5.3 billion in the frsthal o 2011, per Real Capital Analytics).

Fundraising or private equity real estate,though slow, as shown in Exhibit 2-7, isreocusing on traditional areas such ascore and opportunistic strategies, with46.0 percent and 35.0 percent o investors,respectively, planning to invest in theseunds over the next 12 months, accord-ing to Preqin, a leading source o marketresearch or the alternative assets indus-try. While there is plenty o capital ($78.5billion) to target commercial real estate inthe U.S., deployment continues to be slowdue to the economic uncertainty.

Public REITs continue to outperorm

other asset classes (see Exhibit 2-8), withyear-to-date returns o 20.4 percent as oSeptember 2012, according to NAREIT,as investors seek portolio diversifcationand strong ination-hedged returns.In 2011, private equity unds posted anaverage internal rate o return (IRR) o12.1 percent in comparison to 15.5 per-cent in 2010, according to omson OneAnalytics. During the pre-recession

period, private equity real estate undsreported an average IRR o 21.7 percentduring the period 2003 to 2007.

REITs access to equity and debt capi-tal appears to continue to avorablyposition them to acquire properties(including distressed properties) andthus appears to make commercial realestate a compelling asset class rom aninvestment perspective. In addition,private equity real estate investments

in secondary and tertiary markets canpotentially help to revive the broadercommercial real estate market. How-ever, given the minimal developmenactivity and the expected slowdownin operating undamentals, sustainedoutperormance may be challengedInvestors in REITs and private equityreal estate may be increasingly drawnto invest in Asia, selected Europeannations, and emerging markets insearch o growth and higher returns.

0

20

40

60

80

100

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

$

Billions

Exhibit 2-7. U.S. Private Equity Real Estate Fundraising

oure: preqi, etember 2012.

*YTD is s of etember 12, 2012. **ncREIF 2012 dt is s of Jue 30, 2012.oure: naREIT, etember 2012.

Asset Class FY07 FY08 FY09 FY10 FY11FY12

YTD*

Public REIT (All REIT Index) -17.8 -37.3 27.5 27.6 7.3 20.4

NASDAQ 9.8 -40.5 43.9 16.9 -1.8 19.5

S&P 500 5.5 -37.0 26.5 15.1 2.1 16.0

Russell 2000 -1.6 -33.8 27.2 26.9 -4.2 15.2

DJIA 6.4 -33.8 18.8 11.0 5.5 9.1

Private Real Estate (NCREIF

Property Index)**15.9 -6.5 -16.9 12.6 14.3 5.3

Exhibit 2-8. Comparative Perormance by Asset Class




3 | THE PROPERTY MARKETS

Perspective and Analysis

e stabilizing trends which devel-oped in the commercial real estatemarkets during 2011 have been matur-ing in 2012. Although macroeconomicgrowth remained weak in the U.S.and the global economy, the recover-ing equity markets and historicallylow interest rates helped bolster com-mercial real estate returns. e over-all investment trends in commercialproperties during the frst hal o 2012mirrored those in the frst six months

o 2011. Sales volume advanced, capi-talization rates continued to compress,and portolio transactions provided asolid highlight during the period.

As shown in Exhibit 3-1, sales o majorproperties rose 4 percent in the frst halo 2012, reaching $108.8 billion across7,590 transactions, according to RealCapital Analytics. Following the 2011trend, the pace o sales slowed duringsecond quarter 2012, as economic un-damentals took a deep breath in antici-pation o looming legislative, regula-tory, and election outcomes. Portoliotransactions totaled $23.2 billion overthe period, with the Simon PropertyGroups acquisition o the Mills Prop-erty Portolio 2012 taking the top spot.Retail transactions made up our o thetop fve portolio transactions.

In terms o yearly growth, the apart-ment sector showed the strongestperormance, with sales jumping 23

percent in the frst hal o 2012, total-ing $28.6 billion. Riding in the wakeo apartment growth, the volume odevelopment site salesespecially orapartment constructionjumped 67percent year-over-year, to $4.9 billion,according to Real Capital Analytics.

In a sign o growing investor opti-mism in the frst hal o 2012, sales in

$0

$20

$40

$60

$80

$100

$120

$140

$160

2Q201

2

4Q2011

2Q201

1

4Q2010

2Q201

0

4Q200

9

2Q200

9

4Q200

8

2Q200

8

4Q200

7

2Q2007

4Q200

6

2Q200

6

4Q200

5

2Q200

5

4Q200

4

2Q200

4

4Q200

3

2Q200

3

4Q2002

2Q200

2

4Q2001

Billions

Retail

Oce

Industrial

Hotel

Apartment

Exhibit 3-1. Commercial Property Volume

oure: Rel citl aly tis, July 2012.




secondary and tertiary markets postednoticeable gains rom 2011. By com-parison, transaction volume in mosto the major metro areas was at ornegative in the frst hal o 2012, as thesupply o properties and willing sell-

ers dwindled. However, major metroscontinued to command price premi-ums or available properties, even assecondary and tertiary markets oeredmore attractive yields.

During the frst hal o 2012, there were27 markets which exceeded $1.0 billionin commercial sales, according to RealCapital Analytics. In addition, at leastseven more markets are likely to crossthat threshold by year-end 2012. etop three spots remained unchanged

rom 2011, with Manhattan, Los Ange-les, and Chicago closing $9.9 billion,$6.5 billion, and $5.2 billion in sales,respectively. Rounding out the topfve were San Francisco, which posted$4.4 billion in sales, and Dallas, withtransactions totaling $3.9 billion. Asinvestors ound deals in secondaryand tertiary markets more appealing,the strongest year-over-year percent-age gains were recorded in Baltimore,Charlotte, Nashville, and Austin.

Prices or commercial assets advanced3 percent in 2012, with oce proper-ties posting yearly gains o 12 percent,according to Real Capital Analy tics (seeExhibit 3-2). Driven by renewed porto-lio activity, the retail sector saw pricesrise 8 percent to an average o $343 persquare oot. Industrial and hotel prop-erties recorded positive price gains o 7and 4 percent, respectively.

Based on Real Capital Analytics

data, average cap rates declined 18basis points in the frst hal o 2012to a national average o 6.9 percent.As shown in Exhibit 3-3, apartmentsoered the lowest yields, at 6.2 percent,ollowed by oce properties, at 7.1 per-cent. Retail caps declined 26 percent ona yearly basis, to an average o 7.3 per-cent in 2012. Industrial and hotel prop-erty cap rates were each 7.8 percent.

Due to the large volume o mortgagematurities in 2012, distressed salescontinued to play a role in the mar-ket. However, the volume o distressedproperty sales slowed in the frst hal o

2012. According to Real Capital Analyt-ics, distressed properties accounted or12 percent o total sales in the frst halo 2012, compared with 15 percent aver-aged during 2011.

5%

6%

7%

8%

9%

10%

11%

2Q2012

4Q201

1

2Q201

1

4Q201

0

2Q201

0

4Q200

9

2Q200

9

4Q2008

2Q200

8

4Q2007

2Q200

7

4Q200

6

2Q200

6

4Q200

5

2Q200

5

4Q200

4

2Q200

4

4Q200

3

2Q2003

4Q200

2

2Q2002

4Q200

1

Retail

Oce

Industrial

Apartment

Exhibit 3-3. Cap Rates Continue to Compress

oure: Rel citl aly tis, July 2012.

75

100

125

150

175

200

July

2012

July

2011

July

2010

July

2009

July

2008

July

2007

July

2006

July

2005

July

2004

July

2003

July

2002

July

2001

Industrial

Apartment

Retail

Oce

Index

Exhibit 3-2. Property Prices Increased in 2012

oures: Moodys Ivestors ervie, Rel citl alytis (Moodys/Rca cppI ), etember 2012.




As depicted in Ex hibit 3-4, total out-standing commercial distress prop-erty sales amounted to $169 billionby mid-2012, a 6-percent declinerom 2011. The largest share o this$76.6 billionwas in the oice and

apartment sectors. However, thepace o workouts has been quicken-ing, reaching 55 percent by mid-2012.The rate o resolutions varies acrossproperty types, rom a high o 59 per-cent or apartments to a low o 40 per-cent or land and other commercialproperties.

Nationally, the majority o commercialmarkets had work-out rates exceeding50 percent, according to Real CapitalAnalytics. e exceptions were Detroit,

Indianapolis, Philadelphia, PalmBeach, Las Vegas, the Inland Empire,and Sacramento. CMBS loans made up48 percent o total outstanding distressin 2012, at $82.0 billion, ollowed bydomestic banks, with $39.7 billion introubled assets. e recovery rates oroutstanding balances (beore ees andcosts) or both entities have been tiedat 66 percent, in line with the nationalaverage o 67 percent.

With equity markets moving in a vola-tilei upwardtrend during 2012,investors remained interested in thealternative provided by commercialreal estate investments. Private inves-tors made up 41 percent o acquisitionsin the frst hal o 2012, based on RealCapital Analytics data. Furthermore,with $45.7 billion in transactions infrst hal 2012, private investors upped

their commercial purchases by 40 per-cent on a year-over-year basis.

Institutional and equity unds providedthe second largest driver or acquisi-tions in frst hal 2012, accounting or 28percent o the total. REITs were the thirdlargest group o buyers in the commer-cial markets, with $16.7 billion o acqui-sitions. Lehman Brothers Holdings ledthe group o most active buyers, with$8.8 billion in acquisitions, ollowed byBlackstone Group and Simon PropertyGroup, with $6.2 billion and $4.2 bil-lion, respectively. International inves-tors curtailed their buying in the U.S.

markets in frst hal 2012 compared tothe frst hal o 2011. According to ReaCapital Analytics, cross-border invest-ment accounted or 8 percent o totasales volume during the period, with$8.8 billion in transactions.

e steadily upward trends in invest-ments ollowed the broader improve-ment in commercial undamentalsWhile employment growth slowed as2012 wore on, the underlying macro-economic indicators remained posi-tive. In turn, demand or commerciaproperties advanced, with net absorption or all property types posting positive fgures. In concert, the supply onew commercial space remained con-strained by tight fnancial underwrit-

ing standards, leading to decliningvacancies and rising rents.

Building on the broad market stabilization o 2011, commercial reaestate remained a viable alternativeto equity securities or investors seek-ing growth during the economic andpolitical uncertainties that continuedthroughout 2012.

$0

$50

$100

$150

$200

$250

$300

$350

$400

2Q2012

4Q201

1

2Q201

1

4Q201

0

2Q201

0

4Q200

9

2Q200

9

4Q2008

2Q200

8

Troubled

REO

Restructured

Resolved

Billions

Exhibit 3-4. Distressed Property Sales Start to Decline

oure: Rel itl alytis, July 2012.




THE OFFICE MARKET

Market Overview

Following broader macroeconomictrends, the oce sector posted a solid

frst quarter 2012 perormance, butslowed by the midpoint o the year. Inthe frst hal o 2012, transaction vol-ume advanced 7.0 percent, accordingto Real Capital Analytics, and capi-talization rates declined by 25 basispoints. Sales volume totaled $29.2billion in the frst six months o 2012,compared to $27.2 billion in the frstsix months o 2011, as shown in Exhibit3-A1. Portolio sales provided a boost tooce sales in 2012, rising 50.0 percenton a yearly basis, and reaching $5.3 bil-

lion in transactions. Cap rates main-tained their downward trend, reaching7.1 percent in the second quarter, asshown in Exhibit 3-A2.

e slower pace o overall sales vol-ume in second quarter 2012 can beattributed largely to an 18.0-percentdecline in sales o central business dis-trict (CBD) buildings. While oce salesvolume or CBD properties reached

$16.3 billion in the frst six months othe year, sales o suburban proper-ties accounted or $12.9 billion overthe same period, as reported by RealCapital Analytics. e pace o sales orCBD space rose 7.0 percent in the frsthal o 2012 over frst-hal 2011 sales,while suburban oce sales advanced

5.0 percent in the frst hal o 2012. Caprates declined 40 basis points or CBDoce properties and 5 basis pointsor suburban oce properties. Withinvestor demand continuing to ocuson quality properties, pricing or ocebuildings rose 12.0 percent on a yearlybasis, averaging $245 per square oot inthe frst hal o 2012. CBD oce build-ings continued to command a pricepremium, averaging $405 per squareoot, compared with $184 per squareoot paid or suburban spaces. Withstrong economies and undamentalsthe Washington, DC, and Manhattanmarkets led the feld in pricing andyields. Oce cap rates averaged 5.3percent in Washington, DC, and 5.0percent in Manhattan. Average pricesper square oot were also elevated a$536 in Washington, DC, and $453 inManhattan. Other markets command

ing higher prices were consistent withprior yearsSan Francisco, SeattleBoston, and San Jose. (However, pricesbegan to soten during third quar-ter 2012, as lower-quality propertiesentered the sales stream.)

During the frst hal o the year, ninemajor markets posted transactionsexceeding the $1 billion mark in oce

VolumeinBillions

Average$/Sq.Ft.

$0

$10

$20

$30

$40

$50

$60

$70

$80

Volume

2Q201

2

1Q201

2

4Q201

1

3Q2011

2Q2011

1Q201

1

4Q201

0

3Q201

0

2Q201

0

1Q201

0

4Q200

9

3Q2009

2Q2009

1Q200

9

4Q200

8

3Q200

8

2Q200

8

1Q200

8

4Q200

7

3Q2007

2Q200

7

1Q200

7

4Q200

6

3Q200

6$100

$150

$200

$250

$300

$350

Price $/SF

Exhibit 3-A1. Oce Property Volume and Pricing

oure: Rel citl aly tis, 2q 2012.

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

Avg. Cap Rate

2Q201

2

1Q2012

4Q201

1

3Q201

1

2Q2011

1Q201

1

4Q201

0

3Q201

0

2Q201

0

1Q201

0

4Q200

9

3Q200

9

2Q2009

1Q200

9

4Q200

8

3Q2008

2Q200

8

1Q200

8

4Q200

7

3Q200

7

2Q2007

1Q200

7

4Q200

6

3Q200

6

Percent

Exhibit 3-A2. Average Oce Property Capitalization Rates

oure: Rel citl aly tis, 2q 2012.




transactions. Manhattan retained thetop spot, with $5.0 billion in sales. SanFrancisco passed last years numbertwoWashington, DC,with $2.4 bil-lion in oce transactions. Washington,DC, rounded out the top three, with

$1.7 billion in sales. e other metroswith oce transactions exceeding $1billion were Chicago, Boston, Dallas,Denver, Los Angeles, and Seattle. Inaddition, several markets appear likelyto cross the $1 billion threshold by yearend, including Charlotte, Houston,Phoenix, and San Jose.

In a notable twist, the frst hal o theyear was also marked by diminishingoers in major metros, which droveinvestors into secondary and tertiary

markets. e volume o oce sales inmajor metros declined 4.0 percent inthe frst hal o the year, while the vol-ume in secondary markets notched up16.0 percent, and the sales volume intertiary markets jumped 90.0 percent,per Real Capital Analytics. Secondaryand tertiary markets with strong unda-mentals oered better investor returns.Yields or oce properties averaged 7.7percent in secondary markets and 7.8percent in tertiary markets, noticeablyhigher than the 6.3 percent ound inmajor metros. Several inland marketsrecorded sharp increases in sales overthe frst six months o 2012, althoughmany were rom previously low levels.Memphis oce sales rose 3,604.0 per-cent year-over-year, ollowed by Hart-ord, where oce sales were up 1,587percent, Indianapolis, with oce salesup 737 percent, and Charlotte withoce sales up 704 percent.

Following an upward curve o con-

tinued improvement, oce distressmoderated in the frst hal o 2012.Cumulative oce distress totaled$43.6 billion, ater workouts. Much othe outstanding distress was concen-trated in maturing CMBS loans. Newoce distress in second quarter 2012reached $2.6 billion, the lowest levelsince the frst part o 2008. Resolu-tions reached 57.0 percent or troubled

oce properties, with the Northeastposting the strongest rate o workouts,at 70.0 percent o worked out distress.Much o the distress in Manhattan,Washington, DC, and San Franciscowas resolved. On the other hand, mar-kets with weaker undamentalsLasVegas, Orlando, Atlanta, Sacramento,

Indianapolisstill maintained resolu-tion rates below 35.0 percent.

Investor Composition

With stabilizing undamentals andincreased investor demand, the ocelandscape remained competitive inthe frst hal o 2012. Institutional/equity investors returned in orce tothe market, purchasing $11.2 billion ooce buildings in the frst hal o theyear, a 46.0-percent increase year-over-year. Private investors, as the second

largest group o investors, accountedor 28.0 percent o the market, with $8.4billion in purchases. Meanwhile, international investors made up 13 percento the market, snapping up $4.0 billionin oce properties. REIT oce invest-ment volume dropped to $3.3 billion, a40.0-percent yearly decline rom 2011

Users and other investors made up 10.0percent o the market, mirroring lastyears fgures.

Oce Market Fundamentals(courtesy of Reis, Inc. and Newmark Grubb

Knight Frank)

e incipient recovery o the oce sec-tor, sluggish as it is, took a breather insecond quarter 2012. National vacancies remained at 17.2 percent, as shownin Ex hibit 3-A3, though occupied stockincreased by more than 4.0 million

Vaca

ncyRate(%)

RentalRate

($/

Sq.Ft.)

0

5

10

15

20

25

Combined Vacancy Rates

Suburban Vacancy Rates

CBD Vacancy Rates

2013

F

2011

2009

2007

2005

2003

18

20

22

24

26

28

30

32

34

Class B Rental RatesClass A Rental Rates

Exhibit 3-A3. Oce Property Vacancy and Asking Rental Rates

oure: newmr rubb kight Fr, 2q 2012.




square eet. is slowdown in vacancyimprovement came amidst a decelera-tion in hiring, GDP growth that camein below expectations, and increaseduncertainty regarding domestic andinternational political issues that

threaten to plunge the U.S. into anotherrecession.

e reasons or the weak oce sec-tor recovery are not hard to fnd; chieamong them is the disappointing rateo job creation. e U.S. labor markethas recovered about hal o the 8.8million jobs lost to the Great Reces-sion. Oce-using jobsinormation,proessional and business services,and fnancehave done slightly bet-ter, recovering about three-quarters

o the lost jobs, but the rate o growthhas not been enough to fll the spacethat was emptied due to layos anddownsizings. As a result, about 100million square eet o shadow spaceremains on the marketleased butunoccupied. As the underlying leasesgradually reach their term, most othe space is returned to the pool odirect vacant space, which keeps thevacancy rate rom al ling as ast as itwould in a normal recovery.

Despite economic growth wellbelow expectations, the oce sectorabsorbed over 10 million square eeto space over the frst six months o2012, and second quarter 2012 marksthe sixth consecutive quarterly gain inoccupied space. Still, given the ongoingragil ity o the national labor market, itis not surprising that oce leasing hasslowed down. ere was a signifcantpullback in hiring during April andMay 2012. Moreover, a substantial por-

tion o the jobs being created are not inthe oce-using sectors o the economyand thereore do not create demand oroce space.

National asking and eective rentboth grew by 0.3 percent during sec-ond quarter 2012. But this represents aslowdown rom the 0.5 percent and 0.6percent growth rates that asking and

eective rents achieved, respectively,during frst quarter 2012. Annual gainso 1.6 percent and 2.0 percent, respec-tively, are virtually unchanged, andremain eeble. e anemic labor mar-ket recovery is translating into lev-els o demand that are insucient toincrease rents in a meaningul man-ner. Rents appear to remain stuck atlevels last seen in 2007, and 5-yearleases coming due in 2012 run the risko being signed at equivalent or evenlower rent levels, exerting a dilutiveeect on landlord incomes.

e average asking rental rate or ClassA space rose by 0.7 percent, ending theyear at $31.38 per square oot (gross).Class B space trailed with an increase o0.2 percent. CBD markets, particularly24-hour downtowns such as San Fran-cisco, Seattle, and New York, recordedsolid leasing demand as companies

consolidated in downtown locations,seeking access to mass transit or theiremployees and environments attrac-tive to the younger knowledge-workersthey seek to hire.

Oce markets powered by the tech-nology and energy industries per-ormed well in 2012. Austin, Texas, ledall large markets, having added more

than two and one-hal times as manyjobs as it lost to the Great RecessionHouston, Dallas-Fort Worth, San Antonio, and Oklahoma City, all with strongenergy sectors, also have recovered althe jobs lost to the recession, and thensome. On the East Coast, New YorkCity, Washington, DC, and Pittsburghhave recovered all their lost jobs, whiletech-ueled markets including Boston, San Jose, and San Francisco areapproaching their ormer peaks. eseimpressive employment growth rateshave shown up in oce market metricssuch as vacancy and absorption, witheach o these markets outpacing theU.S. recovery.

Supply growth in the oce sectorremains muted. During second quar-ter 2012, only about 1.6 million squareeet o oce space were completedthe equivalent o one large oce

building in New York. is representsthe lowest quarterly level since ReisInc. began tracking quarterly ocemarket data in 1999. Nonethelessdemand or space during the quar-ter was so weak that, even with suchlittle supply being delivered, the leveo absorption observed during thequarter was insucient to generate avacancy rate decline.




ough it has not been smooth orsteady, the slow recovery in the ocesector continued during the secondquarter. Unortunately, the pace oimprovement in undamentals contin-ues to reect the state o the economy,

particularly the anemic growth inthe job market. Given the heighteneduncertainty that the economy aces,organizations are proceeding cau-tiously. Until this uncertainty abates,recovery in oce leasing, i any, willlikely be muted and underwhelming.Nonetheless, the oce sector appearslikely to continue to recover during thelatter hal o 2012, though it will likelybe a recovery that isnt too strong.

Outlook

Unortunately, the 2013 outlook orthe oce market sounds like a bro-ken record. With GDP expected to beat or slightly below 2.0 percent, thelabor market will likely continue toadd jobs at a rate o 150,000 to 175,000per month, probably enough to createpositive absorption in the oce marketbut unlikely to create enough veloc-ity to generate upward momentum inrental rates (see historical absorptionin Exhibit 3-A4). It appears that thevacancy rate will decline around 1.2percentage points, ending the year at16.0 percent. is is still above the equi-librium vacancy rate o 13.0 percent to14.0 percent, where landlords and ten-ants have roug

Documents

Expectation and Market Realities in Real Estate 2013 nd Market Realities 2013