american realty advisors q1 2011

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CORE AND VALUE-ADDED REAL ESTATE INVESTING: KEY FACTO

IN EVALUATING THE RECOVERY

LOS ANGELES CHICAGO ATLANTA

Stanley Iezman

Chairman & CEO

Walter Page

Managing Director,Research & Strategy

Corporate Headquarters801 North Brand Blvd.Suite 800Glendale, CA 91203818.545.1152818.545.8460 fax

www.americanreal.com

DEMAND GROWTH

In 2010, all property typesexperienced positive netabsorption � a sharpcontrast to the declinesexperienced in 2009. Thefuel for this demand

growth has been, in part, anexpansion of employmentby 900,000 jobs for 2010.Multi-family tends to be anearly recovery property typeand, not surprisingly, itexperienced strong demand growth totaling 1.3% during the year, while industrial degrowth was minimal at only 0.1%. American�s current forecast calls for a 1.5% togain in total employment in 2011, as historically the second full year of a recovery ach

Monthly Change in U.S. Employment (in Thousands)

-1000

-800

-600

-400

-200

0

200

400

600

Jan-

08

Apr-

08

Jul-

08

Oct-

08

Jan-

09

Apr-

09

Jul-

09

Oct-

09

Jan-

10

Apr-

10

Jul-

10

Oct-

10

Temporary Census Employment

Job Trend

Source: Bureau of Labor Statistics , ARA Research

FIRST QUARTER 2011 NEWSLETTER

SIGNS OF CONTINUED RECOVERY IN TODAY�S REAL ESTATE MARKET

With the apparent upturn in the economic cycle, 2011 is showing signs of being an itime to invest in both core and value-added real estate, due in part to both an improrisk profile and significant value upside potential. In this newsletter, we will discussfactors most strongly affecting opportunities currently available to real estate inves

including:

Demand Growth Limited Supply Occupancy Gains Net Operating Income Gains Rent Upside Relative Pricing

Evaluating each of these carefully should yield key insights into the best strategies

both core and value-added real estate in an overall real estate portfolio.



INVESTING TODAY: CORE AND VALUE-ADDED REAL ESTATE P

at least 1.5% job growth, with similar growth in 2012and 2013 expected. Corresponding to employmentgains, we expect overall real estate demand to improve, with a reduction in the gap between the top-performing multi-family sector and the trailing industrial sector.

Industrial markets hardest hit by the recent recession,such as California�s Inland Empire and Phoenix, Arizona, respectively, experienced a solid 0.47% and0.95% gain in demand during the 4Q10. This is thefirst significant gain in demand that both of thesemarkets have seen in several years.

LIMITED SUPPLY

Construction of new real estate continued to fall during 2010 and is likely to reach a recessionary low in 2011.During 2010, office completions were down 73% from

2008, industrial was down 90%, retail down 82% andmulti-family completions were down 63%. As most of the demand gains will be absorbed through an increasein occupancy of existing space, growth in new supply will continue to be low and is expected to remain wellbelow historical averages for several years.

With rents below construction justification levels inmost markets, most speculative new construction willlikely be limited to multi-family in Washington D.C.,New York, and coastal California, as only these marketscan achieve at least a 6.5% to 7.5% unleveraged return

on investment cost. As a result, now is one of thtimes in the market cycle that real estate investoremove near-term supply risk from the typical concerns.

OCCUPANCY GAINS

The trend in vacancy rates is important in predthe direction and magnitude of future real returns. For core real estate, returns are typically 4% higher when vacancy rates are falling than they are rising, as there is strong relationship beoccupancy trends and net operating income (NOIhave found that, for every 1% improvement iestate occupancy rates, within two years real estatetypically grows by 2% to 3%, as increases in occunot only reduce the percentage of space not ea

rent, but also are associated with gains in rental For value investors, a positive trend in moccupancy reduces investment risks for lestrategies and should allow value investors tooccupancy-challenged value-add properties witintention to sell, upon lease-up and stabilizationthe core market demand.

NET OPERATING INCOME GAINS

With long-term leases, real estate NOIpredominantly diversified portfolio would likely recovery in the broader economy by about 18 months. This means that while total employmen were recorded in 2010, real estate portfolios are unto experience increasing NOI before the second h2011 or even 2012. Based on prior ecorecoveries, NOI growth should then generally upward with a cumulative 15% increase in expected by 2015. Given stable market capitalirates, this would equate to a 15% gain in pro values on top of the normal income return. The

2010 Market Size SF(in millions)

Job Trends

2010

2009

2008

Multi-FamilyRetailIndustrialOffice

1.3%0.6%0.1%0.6%2010 Demand Change %

154.251.612.917.1

-58.6-5.8-253.6-39.7

-11.5105.3-68.219.5

NetAbsorption SF(in millions)

13,144.79,607.812,572.33,573.4

1.5% to 2.5%0.7%-3.5%-2.6%

2011201020092008

Real Estate Demand Fundamentals

2010 Market Size SF(in millions)

Job Trends

2010

2009

2008


1.3%0.6%0.1%0.6%2010 Demand Change %

154.251.612.917.1

-58.6-5.8-253.6-39.7

-11.5105.3-68.219.5

NetAbsorption SF(in millions)

13,144.79,607.812,572.33,573.4

1.5% to 2.5%0.7%-3.5%-2.6%

2011201020092008

Real Estate Demand Fundamentals

Source: CBRE Econometric Advisors, AxioMetrics, PPR, CoStar, Economy.com, ARA Research

Source: CBRE Econometric Advisors, PPR, CoStar, ARA Research

Completions SF(in millions)

2008

2009

2010

2011

Forecast

119.893.175.551.9

0.4%0.3%0.1%0.6%2010 Change in Supply %

25.0 to 50.020.0 to 30.05.0 to 20.010.0 to 20.0

53.932.917.521.2

145.7181.9188.579.1


Real Estate Supply Fundamentals

Completions SF(in millions)

2008

2009

2010

2011

Forecast

119.893.175.551.9

0.4%0.3%0.1%0.6%2010 Change in Supply %

25.0 to 50.020.0 to 30.05.0 to 20.010.0 to 20.0

53.932.917.521.2

145.7181.9188.579.1


Real Estate Supply Fundamentals

Occupancy

2008

2009

2010

2011

Forecast

92.5%85.7%83.7%

93.0% to94.0%

86.0% to87.0%

84.0% to85.0%

92.7%85.7%83.6%

93.4%88.2%86.0%

MRetailIndustrialOffice

Real Estate Occupancy Fundamentals

Occupancy

2008

2009

2010

2011

Forecast

92.5%85.7%83.7%

93.0% to94.0%

86.0% to87.0%

84.0% to85.0%

92.7%85.7%83.6%

93.4%88.2%86.0%

MRetailIndustrialOffice

Real Estate Occupancy Fundamentals

Source: CBRE Econometric Advisors, AxioMetrics, CoStar, ARA Research




in NOI are likely to first favor the multi-family sectordue to short lease terms, with a catch-up period for theother property types following.

RENT UPSIDE

Construction costs tend to rise with inflation over timeand real estate rental rates in the long-run tend tofollow suit. Within the office sector, the long-termtrend in effective rent growth is 2.25% (shown by thedashed red line in the adjacent chart.) Over time, officerents tend to revert to this trend encouraging new construction. This means investments timed to periodssuch as today are likely to achieve above inflation rentgrowth with office currently showing 13% to 20% rentupside to long-term trends. Similarly, our analysisshows that retail has 13% to 20% of rent upside, whilemulti-family has the lowest amount of rent upside tothe long-term trend at 5% to 10%. RELATIVE PRICING

Accounting for rent, occupancy and NOI growthpotential, property values in the NCREIF Property Index (NPI) are roughly 15% below long-term trends.Given the economy is now in recovery mode, this

favorable valuation provides investors with lessdownside risk and above-average upside potential. Value-added investment prices are currently lessaggressive than core and the upside there iscorrespondingly greater.

STRATEGIES FOR VALUE INVESTORS

At this stage of the market cycle, the increase in moccupancy rates should allow value investors to r

gains by purchasing occupancy-challenged properstable markets and selling these properties uponup into the core space demand. It is significantly to lease up an occupancy-challenged property when demand is generally increasing than whecontracting or when the market faces meaningfuconstruction. Based on recent NCREIF data,occupancy-challenged properties may now be pria 28% discount to highly-occupied core propersignificantly greater discount than the typical discount to core observed in more normal m

conditions.

Significant Upside Potential in Property Values

100

125150

175200

225

250275

300

4Q78 4Q82 4Q86 4Q90 4Q94 4Q98 4Q02 4Q06 4 I n d e x O f P r o p e r t y V a l u e = 1

0 0 a

o f 4 Q 7 8

Index of Property Values

Long-Term Value Trend

Source: NCREIF, ARA Research

About 15% in Value-Upside to

Long-Term Trend

Office Rent versus Completions

0

20

40

60

80

100

120

140

1988 1993 1998 2003 2008 2013

C o m p l e t i o n s M S F

$15

$20

$25

$30

$35

$40

G r o s s E f f e c t i v e R e n t P S

Completions

Gross Effective Rent

Long-Term Rent Trend

Source: CBRE Econometric Advisors, CoStar, ARA Resea rch

% Discount For Occupancy-

Challenged Buildings*

-28%

-19%

-30%

-25%

-20%

-15%

-10%

-5%

0%

3Q10 and 4Q10

Occupancy Discount

Long-Term Average

Discount

Source: NCREIF, ARA Research*Above data reflects occupancy for NFI-ODCE property types that inclu

office, industrial and retail properties with occupancy rates of 80% aunder versus those with 90% or higher occupancy rates.




© 2011 American Realty Advisors®

. All Rights Reserved. Printed in-house.

For more information regarding American Realty Advisors®, please contact:

Jay Butterfield, CFA Managing Director,

Fund/Separate Account Operations801 North Brand Boulevard, Suite 800

Glendale, CA 91203

Phone: (818) 545-1152

Fax: (818) [email protected] www.americanreal.com

This newsletter is for your information only; is not intended to be relied on to many investment decisions, and is neither an offer to sell nor a solicitation of an offbuy any securities or financial instruments. The information in this newsletterbeen obtained or derived from sources believed by American Realty Advisors treliable but American does not represent that this information is accuratcomplete. Any opinions or estimates contained in this newsletter represent

judgment of American at the time this newsletter was prepared and are subjechange without notice. Models used in any analysis may be proprietary, makingresults difficult for any third party to reproduce. Past performance of any referenced in this newsletter in connection with any particular strategy should no

taken as an indicator of future results of such strategies. It is importanunderstand that investments of the type referenced in this newsletter pose the poten

for loss of capital over any time period.

This newsletter should be considered confidential and may not be reproduced in wor in part, and may not be circulated or redelivered to any person without the pwritten consent of American.

Forward-Looking Statements: This newsletter may contain forward-loostatements within the meaning of the federal securities laws. Forward-loostatements are statements that do not represent historical facts and are based onbeliefs, assumptions made by us, and information currently available to us. Forwlooking statements in this newsletter are based on our current expectations as ofdate of this newsletter, which could change or not materialize as expected. Acresults may differ materially due to a variety of uncertainties and risk fac

Except as required by law, we assume no obligation to update any such forwlooking statements.

CONCLUSION

If a recovery in the economy is now firmly in-place, with several years of improving real estate occupaexpected, investment returns from real estate are likely to be above average. Specifically, during periods of rioccupancy rates, core investments have averaged 3% to 4% higher returns than in periods of falling occupaLikewise for value investors, the 28% average discount between value and core properties offers invessignificant value upside if they can buy in the value market and eventually sell in the stabilized core real esmarket. Based on the history of past economic cycles, the window of opportunity for making a real einvestment in today�s market is quite favorable.

american realty advisors q1 2011

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