7 july 2015 july 2015 sector in-depth growth towers above...

STRUCTURED FINANCE

SECTOR IN-DEPTH7 JULY 2015

TABLE OF CONTENTS

Highlights 1Moody’s/RCA CPPI 3

Overview: Sectors constituting thenational all-property index

3

Tiers 1 & 2: National, apartment andcore commercial

4

Tier 3: Core commercial sectors 5Tier 5: Major and non-major markets 6

Spotlight: Drivers of the peak-to-peakpath of commercial property prices

7

Appendix 8I: Recovery profile of CPPI indices 8II: Repeat-sales transaction volume 9III: Distressed transaction volume 10IV: Schedule of CPPI report releases 11V: Index hierarchy 12VI: Definitions 13

Moody's Related Research 14

ANALYST CONTACTS

Tad Philipp +1-212-553-1992Director of CRE [email protected]

Kevin Fagan +1 212 553 [email protected]

Keith Leung +1 212 553 6855Associate [email protected]

Nick Levidy 212-553-4595MD-Structured [email protected]

Commercial MBS - US

Moody’s/RCA CPPI: CBD Office PriceGrowth Towers Above Other Sectors -July 2015HighlightsThe Moody’s/RCA Commercial Property Price Indices (CPPI) national all-property compositeindex increased 1.3% in May. The apartment component rose by 1.3%, while the larger corecommercial component rose 1.2%. Exhibit 1 shows the index’s recent and historical trends.

Central business district (CBD) office was by far the best-performing CPPI segment over thelast three months, with prices increasing by 12.1%.

Exhibit 1

Moody’s/RCA CPPI: National All-Property Composite Index

Note: Based on data through the end of May 2015.

Sources: RCA, Moody’s Investors Service

http://www.moodys.com/viewresearchdoc.aspx?docid=PBS_1006390

MOODY'S INVESTORS SERVICE STRUCTURED FINANCE

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 7 JULY 2015 COMMERCIAL MBS - US: MOODY’S/RCA CPPI: CBD OFFICE PRICE GROWTH TOWERS ABOVE OTHER SECTORS - JULY 2015

The Moody’s/RCA CPPI measures price changes in US commercial real estate based on completed sales of the same commercial

properties over time, or the “repeat-sales” methodology1 . Below are the highlights of this month’s report, which we base ontransaction data through the end of May 2015. Exhibit 2 shows these price changes broken out by sector and market type.

» The national all-property composite index increased 1.3% in May. The apartment component increased by 1.3%, while the corecommercial component increased by 1.2% over the same time frame.

» CBD office was by far the best-performing segment over the last three months, with prices increasing by 12.1%. There has beenan abundance of capital chasing CBD office property, particularly in major markets. CBD office prices in major markets standapproximately 42% above their pre-crisis peak.

» Major-market prices exceed their November 2007 pre-crisis peak by approximately 27.4%, while non-major market prices areabout 1% below their pre-crisis peak.

» The CPPI and the National Council of Real Estate Investment Fiduciaries (NCREIF) price series use different approaches and havetaken somewhat different paths since 2000, but each has recently recorded prices above its respective pre-crisis peak. The NCREIFprice series has topped its pre-crisis peak by about 7.1%, while the CPPI has topped its pre-crisis peak by about 11.5%. The NCREIFseries experienced a 29.3% peak-to-trough decline following the financial crisis, as compared with a 40.4% peak–to-trough declineexperienced by the CPPI series.

» The Moody’s/RCA CPPI series may be more sensitive to the availability and cost of debt capital than the NCREIF series given thatmany of the CPPI observations come from transactions among private market owners involving middle market property. The rapidexpansion of commercial mortgage credit during the mid to late 2000s likely accounts for the CPPI’s higher peak. By the sametoken, the sharp contraction in commercial mortgage credit following the crisis likely accounts for the CPPI’s deeper trough.



Moody’s/RCA CPPI2

Overview: Sectors constituting the national all-property index

Exhibit 2

Price Changes by Sector and Market Type: Value-Weighted Composite Tiers

(1) The “tier” is the hierarchical level of the index, with the national all-property CPPI defined as Tier 1. Tiers 1-3 and 5 are value-weighted composite indices. Tier 4 consists of theunderlying, “building block” indices, which we estimate as equal-weighted regressions of sector repeat sales.(2) We weigh composite indices in the Moody’s/RCA CPPI system by value, based on the segments’ long-term, 10-year rolling average dollar share of the defined composite market, ina manner similar to that for typical stock market indices, which we weigh by the market capitalization of the constituent stocks. We adjust the weights monthly according to relativereturns and rebalance them yearly. The weights here are the most recently rebalanced.(3) The office segmentation is a mezzanine-level index tier; in other words, the core commercial composite comprises both CBD and suburban segments.(4) The major markets (MM) are the six gateway metropolitan areas: Boston, Chicago, Los Angeles, New York, San Francisco and Washington, DC. For composite Tier 5, we show majorand non-major markets (NMM) as a percentage of national, for reference only. They do not contribute directly to the calculation of the national all-property composite index; however,when combined at their weighted averages, they produce the same Tier 1 result.




Tiers 1 & 2: National, apartment and core commercial

» The national all-property composite index increased 1.3% in May. The apartment component increased by 1.3%, while the corecommercial component increased by 1.2%, as Exhibit 3 shows.

» Apartment prices now exceed their pre-financial crisis peak by 29.5%, while core commercial property prices are 5.4% above peak.

Exhibit 3

Moody’s/RCA CPPI: Apartment and Core Commercial Composite Indices (1)

(1) In this report, peaks are pre-financial crisis, and troughs, post-financial crisis, for the highest tier index in a given exhibit. For example, the peak and trough dates in Exhibit 3 refer tothe peak and trough of the national all-property index, not Apartment or Core Commercial.Based on data through the end of May 2015.




Tier 3: Core Commercial Sectors

» CBD office was by far the best-performing core commercial segment over the last three months, with prices increasing by 12.1%, asshown in Exhibit 4. CBD office price growth over the last three months exceeded that of the next-best-performing core commercialsegment, suburban office, by more than 8 percentage points.

» There has been an abundance of capital chasing CBD office property, particularly in major markets. CBD office prices in majormarkets stand approximately 42% above the pre-crisis peak. The next-best-performing core commercial segment is major marketindustrial, roughly 11% above its pre-crisis peak.

» While office cap rate compression has been broad-based, it has been particularly strong in the major markets. Cap rates in most ofthe metro areas we designate major are at or near their 15-year lows.

Exhibit 4

Moody’s/RCA CPPI: Core Commercial Sector Composite Indices

Note: Based on data through end of May 2015.




Tier 5: Major and Non-Major Markets

» The 5.5% price increase in major markets over the last three months exceeds that of non-major markets by about 2 percentagepoints, as shown in Exhibit 5.

» Major-market prices exceed their November 2007 pre-crisis peak by approximately 27.4%, while non-major market prices areabout 1% below their pre-crisis peak.

Exhibit 5

Moody’s/RCA CPPI: Major Markets and Non-Majors Markets Composites





Spotlight: Moody’s/RCA CPPI and NCREIF Price Series Follow Different Approaches and Paths to Post-Crisis PeaksIn this spotlight, we align the CPPI national all-property price series with that of its NCREIF counterpart starting in Q4 2000, thecommencement of the CPPI series. We present both series in their entirety to provide a long-term perspective on the post-crisis pricedecline and recovery.

The Moody’s/RCA CPPI uses the repeat sales regression methodology to calculate price changes based on a broad set of commercialproperty sales transactions. The NCREIF prices series is derived from appraisals of properties managed on behalf of institutionalinvestors that are typically above average in quality.

While the NCREIF and CPPI price series use different approaches and have taken somewhat different paths since 2000, they haveeach recently recorded prices above their respective pre-crisis peaks. The NCREIF price series has topped its pre-crisis peak by about7.1%, while the CPPI has topped its pre-crisis peak by about 11.5%. The NCREIF series experienced a 29.3% peak-to-trough declinefollowing the financial crisis, as compared to a 40.4% decline experienced by the CPPI series. By comparison, the peak-to-troughdecline recorded by NCREIF following the savings and loan/over-building-related crisis of the late 1980s/early 1990s was approximately22.7%.

During the roughly 15-year history of the CPPI series, prices have risen by approximately 101%, or about 4.6% per year on a compoundannual basis, as Exhibit 6 shows. Over the same time frame the NCREIF series has risen by approximately 80%, or by 3.9% per year.Over its entire 37-year history the NCREIF price series has risen by nearly 350%, or by 4.1% per year.

The Moody’s/RCA CPPI series may be more sensitive to the availability and cost of debt capital than the NCREIF series given that manyof the CPPI observations come from transactions among private market owners involving middle market property. The rapid expansionof commercial mortgage credit during the mid to late 2000s, including CMBS originations in excess of $200 billion at the peak, likelyaccounts for the CPPI’s higher peak. By the same token, the sharp contraction in commercial mortgage credit following the crisis,including CMBS originations collapsing to zero post crisis, likely accounts for the CPPI’s deeper trough.

Exhibit 6

Moody’s/RCA CPPI and NCREIF Commercial Price Series

Sources: RCA, Moody’s Investors Service, NCREIF



Appendix

I: Recovery profile of CPPI indicesExhibit 7 ranks the primary 20 CPPI indices by the percentage of the nominal peak-to-trough price decline recovered.

» The national all-property index stands 11.5% above its pre-crisis peak. All sectors have recovered at least 60% of their peak-to-trough loss.

» Major market apartment prices have had the strongest recovery, with prices more than 50 percentage points above their pre-crisispeak. Apartment prices have benefitted from strong underlying fundamentals and abundant liquidity.

Exhibit 7

Summary: Moody’s/RCA CPPI Sub-Indices Peak-to-Trough Detail (1)

(1) Peaks are pre-crisis (2007-08), and trough are, post-crisis (2009-10).(2) We calculate “percentage peak-to-trough loss recovered” as the ratio of the current-minus-trough value divided by the peak-minus-trough value. For example, if the peak-to-troughloss was 50%, and the price is currently 10% below peak values, we calculate: (90-50)/(100-50) = 40/50 = 80% of the loss recovered.Note: Based on data through the end of October 2014.




II: Repeat-sales transaction volume

Exhibit 8

Moody’s/RCA CPPI: Three-Month Rolling Volume by Count



Exhibit 9

Moody’s/RCA CPPI: Three-Month Rolling Volume by Dollar





III: Distressed transaction volume

Exhibit 10

Moody’s/RCA CPPI – Three-Month Rolling Distressed Share of Market Types by Count



Exhibit 11

Moody’s/RCA CPPI: Three-Month Rolling Distressed Share of Property Types by Count





IV: Schedule of CPPI report releasesThe Moody’s/RCA CPPI is based on repeat-sales transactions that take place any time throughout the month, two calendar monthsprior to the current report. For example, the July CPPI report covers repeat sales on or before the final day of May; we process the datafrom these transactions through the end of June.

The CPPI allows for “backward” revisions and incorporates new data we receive subsequent to publishing; thus, future indices willreflect adjustments from additional transaction data.

CPPI releases take place the second week of each month. Reporting for the Tier 4 “building block” indices is quarterly; we include thesedata in the February, May, August and November reports.



V: Index hierarchy

CONSTRUCTION OF THE CPPI SUITEWe calculate the CPPI suite with a repeat-sales regression methodology using a “two-stage annual to monthly frequency

conversion” (ATM) technique3 . ATM enhances accuracy and versatility, given the comparatively small datasets typical of commercialreal estate transactions.

The first step in the process is to generate the most granular underlying indices in the index suite possible, which we have labeled Tier4 in the exhibit below. Tier 4 indices are equal-weighted, meaning each verified repeat sale constitutes the same contribution to theindex calculations. The higher-tier indices, Tiers 1 through 3, are based on value-weighted roll-ups of the underlying indices. The valueweighting of Tiers 1 to 3 is similar to that in a buy-and-hold portfolio in which each component is weighted annually by the dollar share

of total stock outstanding.4

The CPPI methodology makes advantageous use of both equal- and value-weighting. Equal weighting at the underlying/Tier 4 levelis important, primarily to prevent any single property sale or small market segment from skewing the CRE market picture. The value-weighted roll-up of the underlying/Tier 4 indices to the higher Tier 1-3 levels appropriately allows a market segment to influencecomposite indices in correct proportion to its market share of dollar-based transaction volume.

Exhibit 12

Moody’s/RCA CPPI Suite: Hierarchy of Composite Indices

Note: Office, Hotel and Tier 5 are for information only and are not included in the national composite roll-up.




VI: Definitions

Building Block Indices These indices, also referred to as “Tier 4” (see Exhibit 13), are the most granular of the CPPI suite, grouped bymarket type (major or non-major) and property type. They are constructed from equal weighting of repeat-salestransactions. They are reported quarterly.

CBD “Central business district” is the center of business activity in a metro area, characterized by a high density of

commercial real estate. Composite Indices These indices, also referred to as Tiers 1, 2, 3 and 5 (see Exhibit 13), are constructed from the value-weighted

average returns of the building block indices or lower-tier composite indices. Value-weighting is based on the long-term, 10-year rolling average dollar share of the defined composite market, adjusted monthly according to relativereturns and rebalanced yearly. Composite indices are reported monthly.

Distressed Transactions Transactions classified as distressed are those in which the property was previously in foreclosure, REO or

bankruptcy, or the debt financing was restructured or delinquent in any way. Only arms-length transactions areincluded in the CPPI. Therefore, the transfer of a property from a defaulted borrower to a lender is excluded,whereas the subsequent sale of the property by the lender will typically be included and classified as distressed. Forfurther information, the RCA “Troubled Assets Methodology” is available upon request.

Full-Service Hotel A hotel is likely to be classified as full-service if it satisfies these conditions: has room service and has an on-site

restaurant. Limited-Service Hotel A hotel is likely to be classified as limited-service if it satisfies these conditions: does not have room service, does

not have an on-site restaurant or does not have a concierge. Major Markets (MM) The six metros we define as “major” (Boston, Chicago, Los Angeles, New York, San Francisco and Washington,

DC) are gateway markets with unique price performance and the ability to attract capital, and they representapproximately half of the RCA repeat-sales on a dollar basis.

Non-major Markets (NMM) All markets other than those classified as “major.” Repeat-Sale A transaction where the prior sale of the same property is known. Tiers The CPPI is a hierarchical suite of composite indices rolled up from 10 underlying, “building block” indices. Tier

1 is the national, all-property composite index. Tier 2 consists of the apartment index and roll-up of the corecommercial sector indices. Tier 3 consists of the individual commercial sector indices. Tier 4 is the “building block”indices. Tier 5 is a standalone roll-up of transactions in major and non-major markets.



Moody's Related ResearchBelow are links to publications from Moody’s related to the indices and underlying trends:

CPPI related:

» US CMBS: Moody's to Publish State-of-the-Art Commercial Property Price Indices , May 2012 (SF285594)

» Supplemental data:

- Moody's/RCA CPPI (Public Excel supplement)

- Moody's/RCA CPPI (Subscription Excel supplement)

» Prior month’s report: Moody's/RCA CPPI: National All-Property Price Index Tops Pre-crisis Peak by 10% , June 2015

Commercial real estate related:

» US CMBS: Moody's Delinquency Tracker , June 2015

» CMBS: Red – Yellow – Green® Update, Fourth-Quarter 2014 Assessment of U.S. Property Markets , April 2015

» US CMBS Loss Severities, Q1 2015 Update , June 2015

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of thisreport and that more recent reports may be available. All research may not be available to all clients.

Moody’s publishes a weekly summary of structured finance credit, ratings and methodologies, available to all registered users of ourwebsite, at www.moodys.com/SFQuickCheck .

http://www.moodys.com/viewresearchdoc.aspx?docid=PBS_SF285594



https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_SF409360

https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_SF411924






Endnotes1 More information about the index, including the 2012 Moody's/RCA CPPI announcement paper , is available in reports we cite in the “Moody’s Related

Research” section at the end of this report and at www.moodys.com/cmbs .

2 Refer to definitions section of this report for explanation of “tier” components of the CPPI.

3 Historical data for these indices are available in Excel format here . Data on the 10 building block indices are available to Moody’s or RCA subscribers here. Repeat sales indices, including the CPPI, are subject to backwards revision, particularly for the most recent periods and for the indices with the fewestnumber of repeat sale observations. We have elected not to employ smoothing techniques in order to maximize information content. The most recentreturns tend to be more volatile than earlier results and should be interpreted cautiously. Over time, the range of reported returns for a given period tendsto stabilize as more data bridging that period becomes available.

4 More information about the index, including the 2012 Moody's/RCA CPPI announcement paper , is available in reports we cite in the “Moody’s RelatedResearch” section at the end of this report and at www.moodys.com/cmbs .

5 For the CPPI, the annual weighting of the index segments is based on a 10-year rolling average share. Most actively traded commercial properties typicallyturn over within 10 years; thus, we infer that the 10-year rolling average of total trading volume as Real Capital Analytics tracks it is an appropriate proxyfor the relative value of the outstanding stock of the corresponding sub-index properties.


http://www.moodys.com/cmbs




http://www.moodys.com/cmbs



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