Commercial Real Estate Financing in a Dynamic Market Environment

Graduate School of Banking at Louisiana State UniversityBaton Rouge, LouisianaMay 27th – May 30th, 2019

Cal Evans

Credit Market Intelligence

Synovus Financial Corp.

calevans@synovus.com

• Synovus Financial Corp., Columbus, GA – $40B, 5 State FP

• Credit Market Intelligence– CRE Sector Research/Risk Analysis

– C&I Industry Research/Risk Analysis

– Regulatory Support

– Economics/FRB Advisory

• calevans@Synovus.com

• 706-254-0377

Hi, I’m Cal Evans

• We will break once per session for fifteen minutes

– I know you have a job and a life outside this room!

• Please turn your cell phone ringers off during class

– Vibrate is fine-if you need to take it, please quietly excuse yourself

– If your phone rings you will be loudly booed by me and the rest of the class

Before We Dive in to the Amazing World of CRE…

There Are Many More Dumb Answers than Questions!

This Could Be More Brilliant than DumbSpeaking of Questions…

• High level view of real estate financing fundamentals– Basic Concepts– Valuation– Underwriting– Capitalization Rates (So Important It Is Covered Twice)– Sector specific lending practices and trends– Economic Trends affecting CRE

• Overview on crafting a market intel program for your bank– Data resources– Supply side analysis and basic forecasting

• Overview of regulatory environment regarding CRE lending

• The end goal is to provide you with a practical education in CRE finance that combines fundamental best practices with intelligent market analysis.

Course Objectives

Let’s Get Started: Intro “Case Study”

Hold On! Ask Questions! Be Engaged!

Augment Your Daily Knowledge of Our Economic Situation:

http://www.mauldineconomics.com/subscribe

• Key weaknesses to avoid in reviewing and underwriting a real estate transaction are:

– Over-reliance on past performance

– Failure to evaluate the market and/or the long and short term economic trends of the product type or the area of development, that is, failure to recognize overbuilding in the area or asset

– Failure to assess the total financial condition of the developer by obtaining and analyzing the cash flow on all real estate projects and other contingent liabilities (contagion from other assets)

– Over-lending with too much debt against specific real estate projects

Case Study: Excerpt from My Bank’s Loan Policy

Why Are These Objectives Important?

• 2005: 150 unit Class C apartment complex sold for $2.5mm to outside of market investor group

• 2006: Proposal for low-priced condos, $69k to $85k

– As-Is Value = $2.5mm; Projected NPV Condos = $3.2mm

• 2007: Feasibility study says condos should be marketed at higher end TO PARENTS OF STUDENTS, $99k to $119k

– Value goes from $3.2mm to $4.8mm

– Half units will be redone, other half leased

– Work begins Summer 2007

American Horror Story: Multifamily

• 2008: Market tanks

– Loan is overfunded

– Developer has weak projects elsewhere

– Sales efforts continue with 50% of units finished

– 50% remain rented as apartments to construction crew

• 2009: Sales efforts stall out, bank puts on non-accrual

• 2010: Bank forecloses, starts to dispose of ORE

• 2011: Contract at $2.3mm

– Property Eventual 2011 Sales Price?

– Total Bank Loss?

American Horror Story: Now It’s Condominiums

• Reviewing the Basics

• Valuations

• Introduction to Underwriting

• Property Types, Trends, and Analysis

• Capitalization Rates

• Building a Market Intelligence Program

• Regulatory Environment

Course Outline

Commercial Real Estate Basics:Terms and Concepts

Buy This Book: Barron’s Dictionary of Real Estate Terms (Kindle)

https://www.amazon.com/Dictionary-Estate-Barrons-Business-Dictionaries-ebook/dp/B00BWX9QSG/ref=sr_1_1?s=books&ie=UTF8&qid=1488141086&sr=1-1&keywords=barrons+real+estate+dictionary

• Going-Concern Properties

• Owner-Occupied CRE

• Income Producing Real Estate (IPRE)– Core Types

• Multifamily

• Retail

• Office

• Warehouse/Industrial or Logistics

• Hotel

– Non-Core• Self-Storage

• Other Investment Property

Various Types of Commercial Real Estate

• Commercial Bank– Construction Lending

– Mini-Perm Lending

• Life Company

• Gov. Sponsored Enterprise– FNMA/FRMC or SBA

• CMBS/”Conduit” Lenders– Risk Retention Rules

• Life, GSE, and CMBS are all considered ‘permanent’ takeout sources and are generally longer term and non-recourse to borrower

Sources and Types of CRE Financing

• Very important when valuing properties

• Fee Simple– Simply, the full bundle of ownership rights. For this class it is the

Leased Fee Value + the Leasehold Value

• Leased Fee– The interest of the landlord, determined in part by the Fee paid

by tenant(s) for use of the property– Tenants can lease buildings or land (ground lease)

• Leasehold Interest– The interest of the tenant, who Holds the lease and the rights

that come with occupying the space

Types of CRE Ownership

• Appraisals

– This warrants its own special section

• Environmental Reports

– Phase I: Basic First Run Testing

– Phase II: Expanded Testing

• Feasibility Studies

• Data Services

– Will cover in detail as we discuss property types

Third Party Reporting

• Ground Lease• Traditional Lease Types

– Full Service: usually found in smaller properties

– Gross: Landlord pays taxes, maintenance, property insurance• Modified Gross: includes one or more expenses

– Net: Smaller base with pro-rata or stated $/SF of expense category• Single Net: Tenant pays stated or pro-rata of property tax• Double Net: “ property tax and property insurance• Triple Net: “ property tax, property insurance, CAM• Absolute Net: Tenant pays for every expense related to property

(rare)

Leases and Lease Structure

• LTV:% of Loan to Total Value

• Borrower’s Equity: % of project costs contributed by borrower (can be land already owned, soft costs, etc.)

• LTC:% of Loan to Total Cost of Project

• NOI: Net Operating Income

– Gross Potential Rent Less Vacancy Plus Other Income = Effective Gross Income

– Effective Gross Income – Operating Expenses = NOI

• Tenant Improvements and Leasing Commissions (TI/LC)

CRE Lending Terms

• DSCR: Debt Service Coverage Ratio

– Expressed as 1.25x, or the NOI is 1.25x the Debt Service

• Break-Even Analysis: finding point where DSCR is 1.0x

• Debt Yield: (NOI * Loan Amount), expressed as a %

– $100k NOI, $1mm Loan, 10% Debt Yield

– More on Debt Yield in Underwriting Section

– See Class Materials for Debt Yield Summary

• Recourse vs. Non-Recourse

– Guarantee Burn-Offs

CRE Lending Terms

Valuations

The Starting Point for Commercial Real Estate Lending

Link to Appraisal Institute’s Valuation Magazine:

http://www.appraisalinstitute.org/publications/valuation-magazine/

• Appraisals:

– Satan’s special tool designed to punish borrowers and lenders alike?

– Valuation estimates one notch above using a Magic 8 Ball?

– Regulatory nonsense designed to increase paperwork tenfold?

– An opinion of value made by an appraiser• Income Approach: Value to Investor

• Market Data/Sales Comparison: Purchase Same Utility

• Cost Approach: Build Same Utility

What Are Appraisals?

• BPO: Broker’s Price Opinion

• AVM: Automated Valuation Model

– ValueNet, Zillow, most residential tax valuations

• Tax Assessor Value

– Usually automated to some degree

• You should ALWAYS make your customers and banks cognizant of this to save money

• Evaluation

– Internal or External

• Review or ”Forensic” Appraisal

• What you can use varies by state, loan size, type of CRE

Other Common Types of Valuation Products

• “Market Value is the most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of the title from seller to buyer under conditions whereby:

– Buyer and seller are typically motivated

– Both parties are well informed or well advised and each acting in their own interest

– A reasonable time is allowed for exposure to market

– Payment is made in terms of cash in US Dollars or in terms of financial arrangements comparable there to; and

– The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale (refund example in sales comparables)

Market Value

• The highest and most profitable use is that legal use which is most likely to produce the greatest net return over a given period of time

• Inherent Factors in HBU:

– Time

– Location

– Utility Factors

– Government Regulations

Source: Farren, Highest and Best Use

Highest and Best Use

CRE Valuation Roller Coaster 2000-2018

• Value to an Investor, and the basis of most of our discussions from this point forward

• Direct Capitalization and Yield Analysis (Discounted Cash Flow)

• Direct Capitalization is focus in this class– NOI: Income - Expenses

• Gross Potential Rents less

• Vacancy = Effective Gross Income

• Effective Gross Income – Management Fees and

• Operating Expenses EQUALS

• NOI

• Value = NOI/Capitalization Rate– That means the current value is a function of the next 12 month’s

income

The Income Approach

Example of Income Analysis Format

• 𝑉𝑎𝑙𝑢𝑒 =𝐼1

(1+𝑦)1+

𝐼2

(1+𝑦)2+…+

𝐼𝑛

(1+𝑦)𝑛+

𝑉𝑛

(1+𝑦)𝑛

• Cash Flows are the front components

• Reversion of the property is last component

• The Reversion is simply a direct capitalization at the time of sale of property, less selling/marketing expenses

• The Cap Rate used to determine the Reversion is the Terminal Cap Rate

• The Discount Rate brings the future values to a present value

A Quick Run through Yield Analysis (DCF)

• GENERALLY, the Terminal Cap Rate is higher than the OAR due to risks that increase as time period grows

• GENERALLY, the Discount Rate is 50 to 150 bps higher than the Terminal Cap Rate

• The DCF Model will most commonly be found in properties that have yet to stabilize, subdivision analysis, and hotels

• DCF Is Not Covered on the Test, Just Be Aware of It

Yield Capitalization: DCF Model

• Income Analysis:

– Rents come from operating statement/pro forma

• Market rent comparables used to judge appropriateness

• Adjustments based on size, amenities, location, etc.

– Vacancy comes from operating statement/pro forma

• Market vacancy rates are factored in here

– Concessions

– Other Income

• Expense Analysis:

– Management Fee-even if there isn’t one technically in place

– Operating Expenses

– Replacement Reserves

• “Below the Line” Expenses: TI/LC in office, retail

NOI Analysis

𝑽𝒂𝒍𝒖𝒆 =𝑵𝒆𝒕 𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑰𝒏𝒄𝒐𝒎𝒆

𝑪𝒂𝒑𝒊𝒕𝒂𝒍𝒊𝒛𝒂𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒆

𝑪𝒂𝒑𝒊𝒕𝒂𝒍𝒊𝒛𝒂𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒆 =

𝑳𝒐𝒂𝒏 𝒕𝒐 𝑽𝒂𝒍𝒖𝒆 % ∗ 𝒀𝒊𝒆𝒍𝒅 𝒕𝒐 𝑩𝒂𝒏𝒌+

𝑬𝒒𝒖𝒊𝒕𝒚 % ∗ 𝒀𝒊𝒆𝒍𝒅 𝒕𝒐 𝑩𝒐𝒓𝒓𝒐𝒘𝒆𝒓

𝑪𝒂𝒑𝒊𝒕𝒂𝒍𝒊𝒛𝒂𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒆 is 𝑾𝒆𝒊𝒈𝒉𝒕𝒆𝒅 𝑨𝒗𝒆𝒓𝒂𝒈𝒆 of 𝑩𝒂𝒏𝒌 𝒀𝒊𝒆𝒍𝒅 and 𝒀𝒊𝒆𝒍𝒅 𝒕𝒐 𝑩𝒐𝒓𝒓𝒐𝒘𝒆𝒓

Income Approach to CRE Valuation

• Cap Rate: Weighted Average Return Bank/Owner

• Finance Source Yield

– Rate Floors

– Supply Constraints

• UW Tightening

• Concentration Mix

• Developer Yield

– Re-pricing of Risk: Higher Required Return

– Foreign Exchange: Lower Required Return

– Development Cessation/Expansion

Cap Rate Components

• Loan: 75% LTV Loan, 6% Rate, 5 year Term, 20 Year Am• Investor: 25% Equity, 12% Required Return

• The Weighted Average Problem:– Bank: 75% LTV x Mortgage Constant of 8.597% = 6.45%– Developer: 25% Equity x 12% Required Return = 3.00%– 6.45% + 3.00% = 9.45% Cap Rate

• BAND OF INVESTMENT

• Assume a Property has NOI = $25,000– $25,000/9.45% = $264,550

• There Is a Cap Rate Generator Worksheet in the Class Materials section of the GSB LSU website

Let’s Build a Cap Rate (Band of Investment)

Loan Parameters Capitalization Rate Calculations

Note Term (years) 5 Loan to Value: 75%

Amortization (years) 25 Loan Constant: 6.33%

Loan to Value 75% Return to Lender: 4.75%

Mortgage Rate 4.00%

Loan Constant % 6.33% Required Return to Investor

Equity Percentage: 25%

Capitalization Rate Determination Required Return to Investor: 10%

Return to Lender: 4.75% Return on Equity: 2.50%

Return on Equity: 2.50%

Capitalization Rate: 7.25%

Mortgage Constant:

N 300

i 0.33%

PV -1

FV N/A

Solve for PMT 0.53%

Annualized: 6.33%

Supplemental Class Materials: Cap Rate Generator

Average Investment Grade Cap Rates: All CRE 4Q08-1Q19

Data: PWC 3.2018

Net Over 2 Years Basically Zero Change

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Avg BPS Movement

RERC Southern First Tier Cap Rates: Most Applicable

Peak Loss from Cap Rate Increases in Recession

Source: PWC

• Lower % Increase in Gross Rents

• Higher Vacancies

• Higher Management Fees

• Higher % Increase in Operating Expenses

• LOWER NET OPERATING INCOME

– Divided By

• HIGHER CAPITALIZATION RATES

– Equals

• LOWER VALUES FOR COMMERCIAL REAL ESTATE

Back to the Income Approach: Recession (2020?) Example

Income Approach Value Loss Example (Commercial Properties)

150 BPS Cap Rate

Change Only

150 BPS Cap Rate Change + 10% Increase in Vacancy and Expenses

2013 2014 2015

Effective Rent $100,000 $103,143 $106,311

Operating Expense 40,000$ 41,000$ 42,025$

NOI $60,000 $62,143 $64,286

Cap Rate 7.0% 7.25% 7.5%

Value $857,143 $857,143 $857,143

Required Rent Growth: 3.14% 3.07%

Rent Growth Needed to Compensate for Cap Rise

Right Now Rent Growth > 3% Is Only for Better Markets

Assumes Annual 2.5% OER Increase, 25 bps Cap Rate Increase

2018 2019 2020

RERC 1Q19 Rent vs. Expense Growth: See an Issue?

41

• RERC 1Q19

• Development Approach

– Similar to Yield Analysis insofar as it is done over time

– Used for residential/commercial subdivisions, condo projects

– Sometimes called subdivision analysis

Other Income Approach Subtypes

• Based on the premise that an informed purchaser would pay no more for a property than the cost of acquiring a property with the same utility.

• Based upon a comparison of market data

– The other approaches utilize some form of comparison

– Income: rent comps, cap rates, vacancies, certain expenses

– Cost Approach: land, expense comparables

• The foundation of residential analysis; best with a large number of relatively homogenous sales

Sales Comparison (Market Data) Approach

The Cost Approach

• Based on the proposition that the informed purchaser would pay no more than the cost of producing a substitute property with the same utility as the subject

• Replacement vs. Reproduction– Utility– #1 Problem with Homeowners Because of:

• Contributory Value– Swimming Pools– Marble Fireplace– Storage Sheds

• What Is a Special Use Property?

• There can be several ‘final values’, but they all take into account the different approaches used in the appraisal

• Rare are the times where the approaches are equally weighted; data availability and applicability are paramount

• As-Is Value

• As-Completed Value

• As-Stabilized Value

The Final Value in an Appraisal

Capitalization Rates

CBRE Semiannual Cap Rate Survey:

https://www.cbre.com/research-and-reports/US-Cap-Rate-Survey-H2-2018-Advance-Review

𝑪𝒂𝒑𝒊𝒕𝒂𝒍𝒊𝒛𝒂𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒆 =

𝑳𝒐𝒂𝒏 𝒕𝒐 𝑽𝒂𝒍𝒖𝒆% ∗𝑴𝒐𝒓𝒕𝒈𝒂𝒈𝒆 𝑪𝒐𝒏𝒔𝒕𝒂𝒏𝒕+

𝑬𝒒𝒖𝒊𝒕𝒚 % ∗ 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑹𝒆𝒕𝒖𝒓𝒏 𝒐𝒏 𝑬𝒒𝒖𝒊𝒕𝒚

𝑪𝒂𝒑𝒊𝒕𝒂𝒍𝒊𝒛𝒂𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒆 is 𝑾𝒆𝒊𝒈𝒉𝒕𝒆𝒅 𝑨𝒗𝒆𝒓𝒂𝒈𝒆 of 𝑹𝒆𝒕𝒖𝒓𝒏 𝒕𝒐 𝑩𝒂𝒏𝒌 and 𝑹𝒆𝒕𝒖𝒓𝒏 𝒕𝒐 𝑩𝒐𝒓𝒓𝒐𝒘𝒆𝒓

Capitalization Rate Formula for Leveraged Transaction

RERC Southern First Tier Cap Rates

2Q18 was first quarter with no cap rate declines in over two years

Cap Rates are levelling out or increasing in most sectors and markets(One Notable Exception!)

Spreads Between Caps and TNX: Risk Is Relative

259 bps

481 bps281 bps

Bond Price surge has pushed this

back out to about 325 bps

• Greater number of financing sources available

• Less deals to fund (though 2018 $ volume highest since 2015 per RCA)

• Selection Bias

• Refinance options readily available

• Competitive Effects

– As index rates have gone up, spreads have NOT favored the banks!

• 2017: Multi Construction 30 Day LIBOR (1.25%) + 325 bps = 4.50% Rate

• 2018: Multi Construction 30 Day LIBOR (2.25%) + 225 bps = 4.50% Rate

• This is a Pricing Distortion keeping cap rates down

• When liquidity starts to dry up, i.e. banks pull back, cap rates will go up.

Why Aren’t Cap Rates Escalating More Rapidly?

• Cap Rates level to mildly increasing– Warehouse/Logistics does have some room to move down

• Level Caps Because…– Banks haven’t sounded the alarm – Competition is fierce and only getting more intense– Banks can’t pass rate increase to CRE borrowers– Rate Pressure?

• Increased Caps Because…– Yield chasing shows up more in surveys (especially multifamily)– Rate Pressure?– Trade War Concerns

• Construction Costs• Lower Foreign Investment leads to lower demand• What if China escalates “trade skirmish” to full war with Treasury sales?

– General Risk

2019 Cap Rate Outlook

Underwriting CRE

A Risk Management Process and a Philosophy

Link to FDIC CRE underwriting supervisory insights:

https://www.fdic.gov/regulations/examinations/supervisory/insights/siwin07/article02_real_estate.html

• Underwriting helps to identify risks in a CRE project; it is not the elimination of risk

• Underwriting identifies risks in a CRE project and can help to mitigate those risks through loan structure

• Underwriting philosophy should be conservative and responsive to changes in market conditions and property segments

– In terms of the way CRE is used and is affected by external factors, this is probably the most dynamic era in CRE history

Underwriting Risk in CRE Lending

– Over-reliance on past performance

– Failure to evaluate the market and/or the long and short term economic trends of the product type or the area of development, that is, failure to recognize overbuilding in the area or asset

– Failure to assess the total financial condition of the developer by obtaining and analyzing the cash flow on all real estate projects and other contingent liabilities (contagion from other assets)

– Over-lending with too much debt against specific real estate projects

Look familiar? We do not want horror stories!

Underwriting Helps Us to Avoid:

• Consists of much more than quantitative analysis– Lease Review– Construction Contracts (if applicable)– Guarantees/Recourse– Equity– Project Considerations– Site Considerations– Market Conditions

• The quantitative analysis is very similar to what we covered in the Income Approach discussion

• The qualitative analysis is usually summarized in an underwriting memo or narrative analysis

CRE Underwriting

• A Multifamily lease is fairly standard– Student Housing may require parental guarantees

• Commercial lease structures:– Full Service: usually found in properties w/multiple tenants, hard

to pro rate expense

– Gross: Landlord pays taxes, maintenance, property insurance• Modified Gross: includes one or more expenses

– Net: Smaller base with pro-rata or stated $/SF of expense category• Single Net: Tenant pays stated or pro-rata of property tax

• Double Net: “ property tax and property insurance

• Triple Net: “ property tax, property insurance, CAM

• Absolute Net: Tenant pays for every expense related to property (rare)

Lease Review

• What is the lease structure?

• What is the length of the lease?

• Is the tenant a “Credit Tenant”?

• How are tenant improvement allowances allocated?

• If multi-tenant, how are common areas handled?

• Retail Lease Considerations:– Percentage Rent?

– Anchor Tenant or In-Line Tenant?

– Co-tenancy Clause?• This can destroy your mall, community, or strip center loan

Commercial Leases: Office, Retail, and Warehouse

• Sponsors can provide guarantees to strengthen underwriting; loans with these are called Recourse Loans

• Guarantees can “burn-off” as performance metrics are met and surpassed

• Non-Recourse Loans mean exactly that-there is no recourse to the bank regarding the borrowers, the payback is strictly tied to the performance of collateral and only the collateral can be taken back by the bank

– Generally see Non-Recourse lending in CMBS, GSE, and Life Company deals, though commercial banks will do this where competition is intense on larger deals

Guarantees: Recourse vs. Non-Recourse

• What mitigates risk in Non-Recourse loans? EQUITY!

• 1- LTV % = Equity %– Equity generally alluded to in terms of Max LTV %

• Required equity levels vary at every financing source for every property type, but for core properties max LTV %:– Multifamily: 75-80% DSCR: 1.20x

– Retail: 70-75% DSCR: 1.30x

– Office: 70-75% DSCR: 1.25x

– Warehouse: 65-75% DSCR: 1.25x

– Hotel: 60-70% DSCR: 1.35x

– These are estimates-each bank has their own matrix

Equity in CRE Loans

• If construction, CAN this project be done?

– Site Considerations

• Zoning-always use CURRENT zoning

• Utilities-many a project has been killed by cost of sewer

• Environmental Issues

• Soil Condition/Sub-soil issues

• If site OK, SHOULD this project be done?

– Can the property performance alone service the loan?

• Look at property as a Non-Recourse deal

– Market Conditions

Project Considerations

• Market conditions vary by geography and property type, and are rarely static due to CRE’s cyclical nature

• CRE property types have their own individual cycles due to the nature of the specific property type– This is perhaps the most transformative time the CRE

industry has experienced in regard to property types-we will cover this on back half of class.

• How do we judge market conditions?– Let’s step outside of our rigid analytical frameowrk and use

some common sense here…these are radical suggestions…

Market Conditions

• GO TO THE SITE OR PROPERTY AND INSPECT THE MARKET

• GO TO THE SITE OR PROPERTY AND INSPECT THE MARKET

• GO TO THE SITE OR PROPERTY AND INSPECT THE MARKET– This is the most elemental component of CRE analysis; expense it!

Judging Market Conditions

“Knowledge without mileage is B.S.”-Henry Rollins

• ASK SOMEBODY!

– Depending on the size of your bank, you may have a valuations department; ask the people who look at this all day long for a living!

• They may have market studies, appraisals, etc. and can help you identify Demand Drivers

– Get to know your external appraisers

– Get to know your Tax Assessors

– Get to know your commercial Realtors

– Data Providers (Free and Fee)

Judging Market Conditions

• Quantitative Data You Need to Know:– Rent Comparables– Sales Comparables– Capitalization Rates– Expense Comparables– Demand and Supply Indicators

• Data Providers– Free Sources I use:

• Marcus and Millichap• CBRE• Colliers International• Real Estate Center at Texas A&M• Various University and Commercial Realty Sources

Judging Market Conditions

• Paid Providers I use:– CoStar: All property types

– Axiometrics: Multifamily

– REIS: All types except hotel

– Smith Travel Research: Hotel

– Real Capital Analytics: Loan metrics, cap rates, deal volumes

– CBRE-EA: All property types plus Pipeline

– Report Services: PWC, RERC, Integra

• Most data is current or historical, but we need to be cognizant of future supply and demand– Why Future Supply Is So Important! Anderson Example

Judging Market Conditions

• Let’s Review Some Terms:– Loan to Value Percentage: LTV %

– Loan to Cost Percentage: LTC %

– Debt Service

– Debt Service Coverage Ratio: DSCR, expressed as 1.??x

– Break-Even Analysis: where DSCR = 1.0x = NOI

– Operating Statements (existing property)

– Pro Forma (borrower/developer estimate)• Basically their underwriting, usually “happier”!

• Latin: “as a matter of form”, not strict, normal

– NOI

– Debt Yield = NOI/Loan Amount, expressed as a %

CRE Underwriting: Quantitative Analysis

CRE Underwriting Example: Typical Class A Multifamily

• Cornerstone of every great work of fiction!

• Depending on your bank size, you may do $5mm CRE loans or $50mm CRE loans

• The loan amount isn’t important here

• The project size isn’t important here

• The ratios, percentages, and methodology are important

Willing Suspension of Disbelief

• Class A Multifamily (the nice stuff)– Secondary Market– 282 Units– Property has been appraised at $36mm

• Property size/value doesn’t matter here actually, U/W is fundamentally the same whether it is 50 or 500 units

• Loan Terms (limits found in your bank’s loan policy)– Max LTV: 80%– Min DSCR: 1.20x– Term: 5 Years (CMBS, Life, GSE could be 10)– Amortization: 30 Years– Target Debt Yield: 10% (this may not be in your policy)

• Indicates a $28.8mm Max Loan• 3.25% normal rate• 6% stress rate at 30 year am = debt service constant 7.195%

OK, Let’s Start with Some Project Details…

• Borrower’s Pro Forma– Generally is most optimistic outlook

• Appraisal Income Approach– Reflects market assumptions (vacancy, expenses) and rents

• Fully Stressed Scenario– In this case:

• 10% discount on all revenues• No credit for “premium rents”• 10% vacancy or market rate, whichever is greater

• Breakeven Scenario

• Compare Non-stressed Rate and Stressed Rate Numbers

Varying Underwriting Scenarios

BORROWER PROFORMA APPRAISAL REVENUES DISCOUNTED 10%

$/Unit $/SF $/Unit $/SF $/Unit $/SF

INCOME: $1,314 / unit $1.29 / sf $1,314 / unit $1.29 / sf $1,183 / unit $1.16 / sf

GROSS POTENTIAL BASE

RENT: $4,448,316 $15,774 $15.51 $4,448,316 $15,774 $15.51 $4,003,484 $14,197 $13.96

Less: Physical Vacancy $292,327 6.00% $1.02 $355,865 7.50% $1.24 $427,188 10.00% $1.49

Less: Bad Debt / Concessions $0 0.00% $0.00 $0 0.00% $0.00 $0 0.00% $0.00

Less: Mgm't / Model Units $0 0.00% $0.00 $0 0.00% $0.00 $0 0.00% $0.00

Total Economic Vacancy * ($292,327) -6.00% ($1.02) ($355,865) -7.50% ($1.24) ($427,188) -10.00% ($1.49)

PREMIUM RENTS $125,586 $445 $0.44 $0 $0 $0.00 $0 $0 $0.00

OTHER INCOME $298,215 $1,058 $1.04 $325,264 $1,153 $1.13 $268,394 $952 $0.94

EFFECTIVE GROSS

INCOME $4,579,790 $16,240 $15.97 $4,417,715 $15,666 $15.40 $3,844,690 $13,634 $13.40

EXPENSES:

Management Fees ** $228,984 5.00% $0.80 $132,531 3.00% $0.46 $192,234 5.00% $0.67

Administrative $24,816 $88 $0.09 $51,849 $184 $0.18 $24,816 $88 $0.09

Advertising $38,070 $135 $0.13 $59,257 $210 $0.21 $38,070 $135 $0.13

Payroll $338,400 $1,200 $1.18 $296,278 $1,051 $1.03 $338,400 $1,200 $1.18

Contract Services $25,380 $90 $0.09 $88,884 $315 $0.31 $25,380 $90 $0.09

Utilities $211,500 $750 $0.74 $222,208 $788 $0.77 $211,500 $750 $0.74

Insurance $74,730 $265 $0.26 $51,849 $184 $0.18 $74,730 $265 $0.26

Repairs & Maintenance $115,620 $410 $0.40 $88,884 $315 $0.31 $115,620 $410 $0.40

Ground Rent $0 $0 $0.00 $0 $0 $0.00 $0 $0 $0.00

Real Estate Taxes $448,380 $1,590 $1.56 $525,243 $1,863 $1.83 $448,380 $1,590 $1.56

Other Expenses $0 $0 $0.00 $0 $0 $0.00 $0 $0 $0.00

TOTAL OPERATING EXPENSES $1,505,880 $5,340 $5.25 $1,516,983 $5,379 $5.29 $1,469,130 $5,210 $5.12

Replacement Reserve $70,500 $250 $0.25 $59,257 $210 $0.21 $70,500 $250 $0.25

TOTAL EXPENSES & REP. RESERVE $1,576,380 $5,590 $5.50 $1,576,240 $5,590 $5.50 $1,539,630 $5,460 $5.37

NOI AFTER REP. RESERVE $3,003,410 $10,650 $10.47 $2,841,475 $10,076 $9.91 $2,305,059 $8,174 $8.04

STRESSED DEBT SERVICE $1,504,108 $5,334 $5.24 $1,504,108 $5,334 $5.24 $1,504,108 $5,334 $5.24

Net Cash Flow $1,499,302 $5,317 $5.23 $1,337,367 4742.44 4.66 $800,952 2840.25 2.79

STRESSED DSCR 2.00 1.89 1.53

EXPENSE RATIO (net of R/Rsrvs) 32.9% 34.3% 38.2%

DSCR BASED ON PRIME @ 3.25% 2.00 1.89 1.53

10.4%Debt Yield 9.9%Debt Yield 8.0%Debt Yield

Underwriting without Rate Stress

BORROWER PROFORMA APPRAISAL

$/Unit $/SF $/Unit $/SF

INCOME: $1,314 / unit $1.29 / sf $1,314 / unit $1.29 / sf

GROSS POTENTIAL BASE

RENT: $4,448,316 $15,774 $15.51 $4,448,316 $15,774 $15.51

Less: Physical Vacancy $292,327 6.00% $1.02 $355,865 7.50% $1.24

Less: Bad Debt / Concessions $0 0.00% $0.00 $0 0.00% $0.00

Less: Mgm't / Model Units $0 0.00% $0.00 $0 0.00% $0.00

Total Economic Vacancy * ($292,327) -6.00% ($1.02) ($355,865) -7.50% ($1.24)

PREMIUM RENTS $125,586 $445 $0.44 $0 $0 $0.00

OTHER INCOME $298,215 $1,058 $1.04 $325,264 $1,153 $1.13

EFFECTIVE GROSS INCOME $4,579,790 $16,240 $15.97 $4,417,715 $15,666 $15.40

EXPENSES:

Management Fees ** $228,984 5.00% $0.80 $132,531 3.00% $0.46

Administrative $24,816 $88 $0.09 $51,849 $184 $0.18

Advertising $38,070 $135 $0.13 $59,257 $210 $0.21

Payroll $338,400 $1,200 $1.18 $296,278 $1,051 $1.03

Contract Services $25,380 $90 $0.09 $88,884 $315 $0.31

Utilities $211,500 $750 $0.74 $222,208 $788 $0.77

Insurance $74,730 $265 $0.26 $51,849 $184 $0.18

Repairs & Maintenance $115,620 $410 $0.40 $88,884 $315 $0.31

Ground Rent $0 $0 $0.00 $0 $0 $0.00

Real Estate Taxes $448,380 $1,590 $1.56 $525,243 $1,863 $1.83

Other Expenses $0 $0 $0.00 $0 $0 $0.00

TOTAL OPERATING EXPENSES $1,505,880 $5,340 $5.25 $1,516,983 $5,379 $5.29

Replacement Reserve $70,500 $250 $0.25 $59,257 $210 $0.21

TOTAL EXPENSES & REP. RESERVE $1,576,380 $5,590 $5.50 $1,576,240 $5,590 $5.50

NOI AFTER REP. RESERVE $3,003,410 $10,650 $10.47 $2,841,475 $10,076 $9.91

STRESSED DEBT SERVICE $2,072,047 $7,348 $7.22 $2,072,047 $7,348 $7.22

Net Cash Flow $931,363 $3,303 $3.25 $769,428 2728.47 2.68

STRESSED DSCR 1.45 1.37

EXPENSE RATIO (net of R/Rsrvs) 32.9% 34.3%

DSCR BASED ON PRIME @ 3.25% 2.00 1.89

10.4%Debt Yield 9.9%Debt Yield

Borrower Pro Forma and Appraisal: Stressed Example

BREAKEVEN

REVENUES DISCOUNTED 10% REVENUES DISCOUNTED 16%

$/Unit $/SF $/Unit $/SF

INCOME: $1,183 / unit $1.16 / sf $1,109 / unit $1.09 / sf

GROSS POTENTIAL BASE

RENT: $4,003,484 $14,197 $13.96 $3,754,379 $13,313 $13.09

Less: Physical Vacancy $427,188 10.00% $1.49 $400,607 10.67% $1.40

Less: Bad Debt / Concessions $0 0.00% $0.00 $0 0.00% $0.00

Less: Mgm't / Model Units $0 0.00% $0.00 $0 0.00% $0.00

Total Economic Vacancy * ($427,188) -10.00% ($1.49) ($400,607) -10.67% ($1.40)

PREMIUM RENTS $0 $0 $0.00 $0 $0 $0.00

OTHER INCOME $268,394 $952 $0.94 $251,693 $893 $0.88

EFFECTIVE GROSS INCOME $3,844,690 $13,634 $13.40 $3,605,465 $12,785 $12.57

EXPENSES:

Management Fees ** $192,234 5.00% $0.67 $180,273 5.00% $0.63

Administrative $24,816 $88 $0.09 $24,816 $88 $0.09

Advertising $38,070 $135 $0.13 $38,070 $135 $0.13

Payroll $338,400 $1,200 $1.18 $338,400 $1,200 $1.18

Contract Services $25,380 $90 $0.09 $25,380 $90 $0.09

Utilities $211,500 $750 $0.74 $211,500 $750 $0.74

Insurance $74,730 $265 $0.26 $74,730 $265 $0.26

Repairs & Maintenance $115,620 $410 $0.40 $115,620 $410 $0.40

Ground Rent $0 $0 $0.00 $0 $0 $0.00

Real Estate Taxes $448,380 $1,590 $1.56 $448,380 $1,590 $1.56

Other Expenses $0 $0 $0.00 $0 $0 $0.00

TOTAL OPERATING EXPENSES $1,469,130 $5,210 $5.12 $1,457,169 $5,167 $5.08

Replacement Reserve $70,500 $250 $0.25 $70,500 $250 $0.25

TOTAL EXPENSES & REP. RESERVE $1,539,630 $5,460 $5.37 $1,527,669 $5,417 $5.33

NOI AFTER REP. RESERVE $2,305,059 $8,174 $8.04 $2,077,796 $7,368 $7.24

STRESSED DEBT SERVICE $2,072,047 $7,348 $7.22 $2,072,047 $7,348 $7.22

Net Cash Flow $233,013 826.29 0.81 $5,749 20.39 0.02

STRESSED DSCR 1.11 1.00

EXPENSE RATIO (net of R/Rsrvs) 38.2% 40.4%

DSCR BASED ON PRIME @ 3.25% 1.53 1.38

8.0%Debt Yield 7.2%Debt Yield

Fully Stressed Scenario and Breakeven Analysis

• Debt Yield = NOI/Loan Amount

• Borrower Pro Forma: $3,003,410/$28.8mm = 10.4%

• Appraisal: $2,841,475/$28.8mm = 9.9%

• Fully Stressed: $2,305,059/$28.8mm = 8.0%

• Breakeven: $2,077,796/$28.8mm = 7.2%

Let’s Talk About Debt Yield: Supplemental Materials

Debt Yield is the ‘en vogue’ CRE lending metric because it cut throughs the BS and gives

a quick read on ability to service the debt.

Anecdotally, 7.2% seems to be the failure line for multifamily, 7.8% for other property types.

Supplemental Class Materials: Debt Yield Explanation

• Underwriting for other property types (except hotel) is not fundamentally different than the previous example for multifamily properties

• In the next section, we will cover the core property types and I will cover brief examples of underwriting for retail/office and hotel

• We have covered a lot of concepts

• Congratulations, we are mostly done with the technical part of the class!

– Great Time to Ask Review Questions

Underwriting for Other Property Types

Core Property Sectors and Subtypes

Characteristics, Market Trends, and Analysis

MultifamilySubtypes, Quality, and Specialty DivisionsClasses and Masses: How Much Is Too Much?

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https://www.axiometrics.com/resources/axio-media/?type=Blog

• I hope you have an idea, because we just underwrote an example and you have probably lived or do live in an apartment or condominium!– Defined as a residential structure with more than one dwelling unit in

the same building

– We are concerned with 5 or more units, not du/tri/quadplexes in this class, and will focus on traditional apartments

What Is Multifamily Housing

• High Rise: – generally urban, major metros, > 6 stories

• Garden: – Generally suburban/rural, literally tenants have access to lawn area, usually

two stories

• Mid-Rise:– Generally suburban, three floor walk-ups to five floor elevator access

• Townhouse:– Two or more floor units that are connected via party walls

• Student Housing:– Public or private housing for advanced education students located near or

on a campus

• Affordable (Workforce) Housing:– Public and/or private effort at affordable housing in community through tax

credits, government guarantees, median rent comparisons, etc.

Multifamily Subtypes

• Class A – Professionally managed (regional or national management companies), and

– Strong potential for specialized take-out sources

– In well-positioned markets with strong demand drivers (universities, medical campuses, employment centers, etc.)

• Class B– Usually 10+ years old (could be newer in smaller tertiary markets)

– Good quality construction conforming to current trends but inferior to premier projects located in primary markets

– Good location in primary market or superior location in secondary or tertiary markets

– Usually professionally managed

• Class C– Usually 20+ years old

– Property exhibits deferred maintenance and requires extensive renovation. In some cases, the property may be well-maintained but exhibits functional or economic obsolescence

– Less desirable location

– Managed locally

Multifamily Quality Types

Multifamily Demand Composition

• Top Ranked Millennials: Stay Mobile

Small Footprint

• Empty Nesters: Downsize/Relocate

• Mid-Pack Millennials/Gen X: Income Constrained

Debt Constrained

• Non-College Millennial/Gen X: Income Constrained

• Some College Millennial/Gen X: Income Constrained

Debt Constrained

Millennial Achievers!

All we hear about in the news!

1) Take the Tech Job in Austin or Finance in Nashville

2) Rent an Apartment Because:

* Maintain Flexibility

* Maintain Mobility

* Can’t Afford Downtown Yet

* Too Busy to Fix Things!

3) Rent a Nice Apartment Because:

* Employer Paid Student Loans

Baby Boomer Demand for Multifamily

Source: PWC

Median Millennials/Gen X 25-44 Years Old

Millennials: 25-34 Year Olds

• Real Wage Growth (2012 $):

• 2000: $59,000

• 2014: $51,000

• Home Ownership Rate:

• 2004: 49%

• 2014: 41%

Generation X: 35-44 Year Olds

• Real Wage Growth (2012 $):

• 2000: $72,000

• 2014: $64,000

• Home Ownership Rate:

• 2004: 65%

• 2014: 60%

Feasibility of Mortgage with Student Debt?

Qualified Mortgages/UW:

43% Max Debt to Income

NAR Estimate Age 21-30:

Car Loan, CC, Stu Loan = 30%

Who Can Afford the Down Payment?

70% Increase in # of Borrowers from ‘05

(est. 22mm->44mm)

70% Increase in Average Balance per Borrower from ‘05

(est. $15k->$37k)

$1.5T of Student Debt in 2018

14% Student Loans > 90 Days30%+ Once Deferred are

Removed

UGA Survey: Four Millennials Who Can Afford a Down Payment

LSU Survey: A Millennial Who Can Afford a Down Payment

30 Year Mortgage Rates 1970-Current

If you were born here…

…all you know is sub 5%!

$33,090

15%

25%

35%

45%

55%

65%

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

65+

Mean Income, 2017 $ Long Term Avg Mean Income, 2017 $ Propensity to Rent %

65 and Up Mean Income and Propensity to Rent

• Source: U.S. Census Bureau, Current Population Survey/Housing Vacancy Survey, April 25, 2019

Age Group

2013-2018 Change in

Propensity to Rent

2013-2017 Change in Mean Income, 2017 $

Under 35 0.8% 12.6%

35-44 1.3% -7.2%

45-54 3.9% 6.8%

55-64 5.1% 4.2%

65+ 12.0% 5.7%

Boomer Rental Base Driving Growth

Labor Force Participation Rate 60+:2008: 21%2019: 25%

Boomers are either forced to work longer or are choosing to do so

1 year lag Permits 1 year lag Permits

Current Hurdle Ratio 5:1 Forecast Hurdle Ratio 5:1

MSA ST A B

4Q18 YOY Ann

Non-Farm Job

Growth

4Q18

YOY %Δ

Job

Growth

3Q17 T12

Multifamily

Permits**

4Q18 YOY Ann

Jobs: 3Q17 T12

Permits

Axio 2019 FC

Job growth

3Q18 T12

Multifamily

Permits**

2019 FC Jobs:

3Q18 Permits

Birmingham-Hoover AL 95.8% 95.4% 7,742 1.5% 256 30.24 6,146 428 14.36

Huntsville AL 97.1% 96.6% 7,233 3.1% 452 16.00 4,324 35 123.54

Tuscaloosa* AL 97.0% 1,475 1.4% 612 2.41 452

Jacksonville FL 95.2% 95.3% 19,208 2.8% 3,939 4.88 18,850 3,230 5.84

Miami-Ft. Lauderdale-West Palm Beach FL 45,042 1.7% 13,462 3.35 61,160 12,582 4.86

Miami-Miami Beach-Kendall FL 94.1% 95.6% 21,158 1.8% 26,266

Ft. Lauderdale-Pompano Beach-Deerfield BeachFL 94.0% 94.8% 14,975 1.8% 18,717

West Palm Beach-Boca Raton-Delray Beach FL 94.7% 94.0% 8,908 1.4% 16,177

Cape Coral-Ft Myers FL 94.4% 94.8% 4,808 1.8% 1,864 2.58 8,400 2,576 3.26

Orlando-Kissimmee-Sanford FL 95.1% 95.4% 50,775 4.1% 6,353 7.99 41,832 9,395 4.45

Tampa-St Petersburg-Clearwater FL 94.6% 95.2% 30,633 2.3% 5,639 5.43 30,439 3,831 7.95

Naples-Immolakee-Marco Island FL 94.5% 95.2% 150 0.1% 891 0.17 4,457 990 4.50

North Port-Sarasota-Bradenton FL 95.8% 94.4% 7,700 2.6% 1,194 6.45 7,958 3,562 2.23

Athens-Clarke County* GA 98.4% 3,142 3.2% 176 17.85 141

Atlanta-Sandy Springs-Roswell GA 94.3% 94.8% 55,083 2.0% 10,032 5.49 45,949 9,673 4.75

Augusta-Richmond County GA 93.9% 95.4% 6,150 2.6% 500 12.30 2,929 239 12.26

Columbus GA 97.7% 95.9% 1,667 1.4% 259 6.44 995 205 4.85

Savannah GA 94.6% 94.7% 817 0.5% 70 11.67 2,571 906 2.84

Charlotte-Concord-Gastonia NC 93.8% 94.9% 31,125 2.6% 6,316 4.93 21,756 9,391 2.32

Durham-Chapel Hill NC 94.7% 94.7% 5,533 1.8% 1,554 3.56 2,069

Raleigh NC 94.7% 94.7% 18,975 3.1% 3,337 5.69 20,881 5,704 3.66

Charleston-North Charleston SC 92.7% 93.5% 5,958 1.7% 3,003 1.98 6,178 1,556 3.97

Columbia SC 94.9% 93.5% 2,925 0.7% 890 3.29 6,230 409 15.23

Greenville-Anderson-Mauldin SC 93.9% 94.7% 7,058 1.7% 1,040 6.79 8,240 1,420 5.80

Spartanburg SC 93.9% 94.7% 2,792 1.8% 0 0

Chattanooga TN 96.6% 95.7% 6,542 2.5% 899 7.28 4,369 (36) -121.36

Nashville-Davidson-Murfreesboro TN 92.6% 94.9% 20,875 2.1% 5,690 3.67 18,279 5,182 3.53

Austin-Round Rock TX 94.7% 94.6% 36,458 3.5% 9,787 3.73 25,059 12,851 1.95

Dallas-Plano-Irving TX 93.7% 94.6% 84,133 3.3% 26,485 3.18 62,049 27,203 2.28

Houston-Woodlands-Sugar Land TX 93.1% 92.7% 95,583 3.2% 5,474 17.46 89,527 11,728 7.63

San Antonio-New Braunfels TX 93.7% 93.4% 16,000 1.5% 3,012 5.31 20,809 4,424 4.70

*Heavy Student Housing in permit numbers >6 >6

**4Q18 permit numbers have been delayed by 1Q19 government shutdown >=4 but <=6 >=4 but <=6

<4 <4

Axiometrics Multifamily Demand: Supply Ratio

• Axiometrics Multifamily Data/Bureau of Labor Statistics

Percentage of Inventory: ATL MSA (Regulator Favorite)

• Axiometrics Multifamily Data

Percentage of Inventory: Atlanta Midtown Submarket

• Axiometrics Multifamily Data

Market Intel can produce this for all Axiometrics Submarkets

• Rent growth has peaked

• Occupancies have peaked for Class A– Not for B/C (Workforce Housing Need)

• Pace of Expense Growth will or does exceed rent growth

• Cap rates have bottomed out or will bottom out

• Construction costs elevated (hurricanes/tariffs)

• So, just by the math, we are not going upwards in value!– Two Caveats:

• Markets are on different timetables

• Wage growth greatly affects performance of sector and classes

What Can We Say About Multifamily in 2019?

How Has the Economy Changed Multifamily?

• Continued demand from mobile millennials

• Demand from downsizing boomers who like CBD

• Demand from renters priced out of home buying

• Smaller, in-town units preferred

• Oversupply of upper-end units, not enough affordable housing on market

OfficeSlimming Down and Getting Healthy!

Subscribe to Marcus and Millichap Office (and other sector) Market Reports Here:

http://www.marcusmillichap.com/research/researchreports

• High Rise

• Mid Rise

• Low Rise

• Medical Office

• Single Tenant Office

• Owner Occupied Office

• Class A, B, C

• Differential between CBD and Suburban

Office Types and Class Differences

Price Per Square Foot for CBD, Suburban, Med Office

Demand Slimming Down in Office Sector

Regular Office: Tech, Efficiency, Preferences

Med Office: Tech, Government, Volume

Technology Effect: iPhone vs. Radio Shack ca. 2000

The iPhone is only 11 years old!

Technology Effect: Automation/AI

Secular Downtrend in Office Demand: Nashville

Source: REIS

Affordable Care Act’s Effect on Office

• Costs to Hospitals/Doctors Are Significant

o Treat 40mm More People with

o Reduced Reimbursement Rates

o Less Doctors

o Increased Government Presence and Compliance Burden

• Savings Strategies that Affects CRE:1. Scale:

o Hospital Consolidationso Centralize Example

o Practice Acquisitions2000: 57% of Physicians Operate

Independently2016: 37% (Nearing Retirement?)

2. Technology: o Reduce Drains on Doctor Timeo Reduce Physical Space Needso All Files Are Digitalo Patient Portalso Much Smaller Admin Demando Utilizing Compatible Technology

Office Building from Die Hard

– $88mm Loan

– Approximately 275k SF

– 4 year term/30 year am

– 3.5% Rate, stress at +250 bps

– 75% LTV

– 1.20x DSC

• IS Die Hard a Christmas Movie?

Office Underwriting Example

PROFORMA REVENUES DISCOUNTED 10% REVENUES DISCOUNTED 15% REVENUES DISCOUNTED 20%

$/SF $/SF $/SF

INCOME:

GROSS POTENTIAL BASE RENT: $13,697,833 $49.90 $12,328,050 $44.91 $11,643,158 $42.41

PERCENTAGE RENT $0 $0.00 $0 $0.00 $0 $0.00

CAM REIMBURSEMENTS $876,932 $3.19 $789,239 $2.87 $745,392 $2.72

REAL ESTATE TAX REIMBURSEMENTS $0 $0.00 $0 $0.00 $0 $0.00

INSURANCE REIMBURSEMENTS $0 $0.00 $0 $0.00 $0 $0.00

Total Reimbursement Income $876,932 $3.19 $789,239 $2.87 $745,392 $2.72

PARKING INCOME $867,435 $3.16 $780,692 $2.84 $737,320 $2.69

Total Gross Potential Income $15,442,200 $56.25 $13,897,980 $50.63 $13,125,870 $47.81

Less: Physical Vacancy $1,024,978 6.64% $1,389,798 10.00% $1,312,587 10.00%

Less: Collection Loss / Abatements $445,557 2.89% $401,652 2.89% $379,338 2.89%

Total Economic Vacancy ($1,470,535) -9.52% ($1,791,450) -12.89% ($1,691,925) -12.89%

EFFECTIVE GROSS INCOME $13,971,665 $50.89 $12,106,530 $44.10 $11,433,945 $41.65

EXPENSES:

Management Fees $0 0.00% $0 0.00% $0 0.00%

Administrative $0 $0.00 $0 $0.00 $0 $0.00

Advertising $0 $0.00 $0 $0.00 $0 $0.00

Payroll $0 $0.00 $0 $0.00 $0 $0.00

Common Area Maintenance $0 $0.00 $0 $0.00 $0 $0.00

Contract Services $0 $0.00 $0 $0.00 $0 $0.00

Utilities $0 $0.00 $0 $0.00 $0 $0.00

Insurance $0 $0.00 $0 $0.00 $0 $0.00

Repairs & Maintenance $0 $0.00 $0 $0.00 $0 $0.00

Ground Rent $0 $0.00 $0 $0.00 $0 $0.00

Real Estate Taxes $0 $0.00 $0 $0.00 $0 $0.00

Other Expenses $0 $0.00 $0 $0.00 $0 $0.00

TOTAL OPERATING EXPENSES $4,512,228 $16.44 $4,512,228 $16.44 $4,512,228 $16.44

Replacement Reserve $0 $0.00 $0 $0.00 $0 $0.00

TOTAL EXPENSES & REP. RESERVE $4,512,228 $16.44 $4,512,228 $16.44 $4,512,228 $16.44

NOI AFTER REP. RESERVE $9,459,437 $34.46 $7,594,302 $27.66 $6,921,717 $25.21

TENANT IMPROVEMENTS $0 $0.00 $0 $0.00 $0 $0.00

LEASING COMMISSIONS $0 $0.00 $0 $0.00 $0 $0.00

Total TI & LC $0 $0.00 $0 $0.00 $0 $0.00

CASH FLOW BEFORE DEBT SERVICE $9,459,437 $34.46 $7,594,302 $27.66 $6,921,717 $25.21

STRESSED DEBT SERVICE $4,741,912 $17.27 $4,741,912 $17.27 $4,741,912 $17.27

Net Cash Flow $4,717,525 $17.18 $2,852,390 $10.39 $2,179,805 $7.94

STRESSED DSCR 1.99 1.60 1.46

EXPENSE RATIO (net of R/Rsrvs) 32.3% 37.3% 39.5%

DSCR @ 3.5% rate hedge 1.99 1.60 1.46

10.7% Debt Yield 8.6% Debt Yield 7.9% Debt Yield

Underwriting for Office: No Rate Stress

PROFORMA REVENUES DISCOUNTED 10% REVENUES DISCOUNTED 15% REVENUES DISCOUNTED 20%

$/SF $/SF $/SF

INCOME:

GROSS POTENTIAL BASE RENT: $13,697,833 $49.90 $12,328,050 $44.91 $11,643,158 $42.41

PERCENTAGE RENT $0 $0.00 $0 $0.00 $0 $0.00

CAM REIMBURSEMENTS $876,932 $3.19 $789,239 $2.87 $745,392 $2.72

REAL ESTATE TAX REIMBURSEMENTS $0 $0.00 $0 $0.00 $0 $0.00

INSURANCE REIMBURSEMENTS $0 $0.00 $0 $0.00 $0 $0.00

Total Reimbursement Income $876,932 $3.19 $789,239 $2.87 $745,392 $2.72

PARKING INCOME $867,435 $3.16 $780,692 $2.84 $737,320 $2.69

Total Gross Potential Income $15,442,200 $56.25 $13,897,980 $50.63 $13,125,870 $47.81

Less: Physical Vacancy $1,024,978 6.64% $1,389,798 10.00% $1,312,587 10.00%

Less: Collection Loss / Abatements $445,557 2.89% $401,652 2.89% $379,338 2.89%

Total Economic Vacancy ($1,470,535) -9.52% ($1,791,450) -12.89% ($1,691,925) -12.89%

EFFECTIVE GROSS INCOME $13,971,665 $50.89 $12,106,530 $44.10 $11,433,945 $41.65

EXPENSES:

Management Fees $0 0.00% $0 0.00% $0 0.00%

Administrative $0 $0.00 $0 $0.00 $0 $0.00

Advertising $0 $0.00 $0 $0.00 $0 $0.00

Payroll $0 $0.00 $0 $0.00 $0 $0.00

Common Area Maintenance $0 $0.00 $0 $0.00 $0 $0.00

Contract Services $0 $0.00 $0 $0.00 $0 $0.00

Utilities $0 $0.00 $0 $0.00 $0 $0.00

Insurance $0 $0.00 $0 $0.00 $0 $0.00

Repairs & Maintenance $0 $0.00 $0 $0.00 $0 $0.00

Ground Rent $0 $0.00 $0 $0.00 $0 $0.00

Real Estate Taxes $0 $0.00 $0 $0.00 $0 $0.00

Other Expenses $0 $0.00 $0 $0.00 $0 $0.00

TOTAL OPERATING EXPENSES $4,512,228 $16.44 $4,512,228 $16.44 $4,512,228 $16.44

Replacement Reserve $0 $0.00 $0 $0.00 $0 $0.00

TOTAL EXPENSES & REP. RESERVE $4,512,228 $16.44 $4,512,228 $16.44 $4,512,228 $16.44

NOI AFTER REP. RESERVE $9,459,437 $34.46 $7,594,302 $27.66 $6,921,717 $25.21

TENANT IMPROVEMENTS $0 $0.00 $0 $0.00 $0 $0.00

LEASING COMMISSIONS $0 $0.00 $0 $0.00 $0 $0.00

Total TI & LC $0 $0.00 $0 $0.00 $0 $0.00

CASH FLOW BEFORE DEBT SERVICE $9,459,437 $34.46 $7,594,302 $27.66 $6,921,717 $25.21

STRESSED DEBT SERVICE $6,331,254 $23.06 $6,331,254 $23.06 $6,331,254 $23.06

Net Cash Flow $3,128,183 $11.39 $1,263,048 $4.60 $590,464 $2.15

STRESSED DSCR 1.49 1.20 1.09

EXPENSE RATIO (net of R/Rsrvs) 32.3% 37.3% 39.5%

DSCR @ 3.5% rate hedge 1.99 1.60 1.46

10.7% Debt Yield 8.6% Debt Yield 7.9% Debt Yield

Underwriting for Office: Rate Stress

How Has the Economy Changed the Office Sector?

• Secular downtrend in demand has lowered the upside on office recovery

• Technology advances have limited the need for equipment space

• Financial considerations have led to consolidations in space needs

• Preferences may lead to non-office workspaces; shared “office hotels”

• Government policies have resulted in lower reimbursements for medical providers, which has caused a reboot of the way physicians operate (bad pun, sorry!)

Retail and WarehouseEvolution of Supply and Demand

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• The property segment with the most variation

– Big Box/Value: Best Buy

– Community Center: over 150k sf, multiple anchors

– Neighborhood: under 250k sf, generally one anchor

– Regional: clusters of big box

– Mall

– Specialty

– Single Tenant, Credit Rated NNN: CVS, Verizon

• Treated like a corporate bond

– Going Concern Operations:

• Franchise restaurants, C-stores, owner-occupied retail

Retail Property Types

• Warehouse– Logistics/Distribution (what makes a good one?)

• Post-Panamax Compliant, Last Mile Logistics, etc.

– Traditional vintage warehouse

• Flex– Contains larger office component

• Industrial

• Light Industrial

• Data Center– Some call this office, depends on the configuration

• Self-Storage

Warehouse/Industrial Property Types

Retail, Warehouse, and E-Commerce: Sector Evolution

E-Commerce Growth Since 20152018: 15.6% Annualized

2017: 16.9% YOY2016: 14.4% YOY2015: 14.5% YOY

E-Commerce 9.6% of all Retail Sales

5,200 Store Closures in ’174,900 Store Closures in ’1812,000 estimated for ’19

Multiple New Openings (from ecommerce roots)

E-commerce and brick and mortar are notmutually exclusive

Mobile Is the Conduit!

Omnichannel Distribution Model

Three Risks to Retail: Labor, Leverage, and Logistics

Logistics Can Involve Omni Dev Costs, Marketing, Data Analytics, Experiential

What Do You Do With a $15.00 Minimum Wage?Are We There Yet?

Putting the Screws to Regular Retail Competition

• Basically cost Amazon nothing

• Did away with– Bonuses

– Restricted Stock Units

• Great rationale too:– “We’ve heard from our hourly fulfillment and

customer service employees that they prefer the predictability and immediacy of cash”

• Bernie Sanders Liked It!

• We will see a lot of this in 2019Graph/Data: CBRE Econometric Advisors

Humor Break: Think Back Ten Years Ago (or 30…)

• Did You Ever Think Preferred Retail Tenants Would Include:

– Gyms

– Restaurants

– Dry Cleaners

– Nail Salons

– Non-Credit Tenants

– Local In-Line Services?

How Has the Economy Changed the Retail Sector?

• E-Commerce driving an ever-larger share of sales

• Indecision in establishing store template in Big Box retail

• Emphasis on Service Providers and Single Tenant Retail

• Demographics drive drug stores

• Dual income families with no time drive fast casual restaurants

• Equity Stakes in Mall Chains

Warehouse and Industrial

Manufacturing and Logistics Drive Sector Growth

Why America?

Patent Protection

Energy Advantages

Why Southeast/Southwest?

Right to Work States

Relatively Inexpensive/Trainable Labor

Transportation Infrastructure: Ports/Interstate System

Population Migration: GA, FL, SC, NC, TN, TX all Top 10

How Far Fake Can Go in China: Root of Sec 301 Tariffs

How Has the Economy Changed the Warehouse Sector?

• E-Commerce makes warehouse much more active in the delivery chain

• Modern warehouses are required to manage and move products in current logistics environment

• Will be more distribution centers that are smaller near population centers (“last mile”)

Amazon Drone WILL NOT WORK in the SOUTH!…or TEXAS!

• Shipping indices (ARA intermodal and Truck Tonnage Index) are at high points, port volumes are very healthy

• Consumer spending, consumer sentiment, industrial production, and business inventories were strong all through 2018, and all four are drivers of supply chain demand. All are highly dependent on trade situation as well.

• Growth of e-commerce (to the tune of approximately 15% per QUARTER) has stoked demand; values up significantly

• Investors have swarmed the southeast as economic drivers for manufacturing/logistics improve

• CBRE cites “levels of speculative demand that are historically unprecedented”.

– Planning Levels ATL and DAL in excess of 20mm SF

• 2019?

Warehouse/Logistics 2018 Highlights

Warehouse Cap Rates Lead to Sector Value Increases

Recall Warehouse Rent Growth Still Exceeds Expense Growth!

How Has the Economy Changed the Warehouse Sector?

• Labor and transportation costs are highest components of the delivery chain for e-commerce retailers

– Well-placed, modern logistics facilities can offset those expenses significantly

– This explains, in part, the record high prices paid for modern facilities in the current market

• Due to the variation in the types of retail properties, an underwriting example will not be done here

– It is fundamentally the same as the office

– There are two major exceptions, one quantitative, one qualitative

• Percentage (Overage) Rent

– Additional rent paid over base when a sales threshold has been surpassed by a tenant

– Considered in the quantitative analysis

• Co-Tenancy Clause

– The ability of one tenant to exit a lease based on the status of another tenant (can be death sentence to strips and malls)

Underwriting for Retail

• See Underwriting for Office

– Probably the simplest underwriting you would do

• With the exception of Self Storage, which is actually similar to multifamily underwriting on the revenue side.

Underwriting for Warehouse

HotelUnique Among Its Peers!The Market Crests: Sector Tide Turns on a Wave of New Supply

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• Luxury

• Upper Upscale

• Upscale

• Upper Midscale

• Midscale

• Economy

• Independent

• Flag vs. Non-Flag

• Resort vs. Non-Resort

Hotel Subtypes

• There are several idiosyncrasies in hotel operation, starting with operational metrics– RevPAR: Revenue per Available Room

– ADR: Average Daily Rate

– Occupancy: Yes, just Occupancy

– RevPAR = ADR x Occupancy

• Going Concern Component: Operator, Franchisor, Landlord

• Additional Revenue Generators– Food and Beverage

– Entertainment

– Communications

Operational Characteristics of a Hotel

• The Value of a Hotel is the sum of its:

– Real Property Value

– Personal Property/FF&E

– Business Enterprise Value

• A hotel that is under construction does NOT have any business enterprise value!

Hotel Valuation

Year YE 2015 YE 2016 Acquisition PRO FORMA

Period 12 months 12 months 2017

Rooms Available 43,800 43,800 43,800

Rooms Sold 31,676 30,800 32,802

Occupancy 72.32% 70.32% 74.89%

ADR $94.74 $90.23 $97.13

RevPar $68.52 $63.45 $72.74

Revenue

Room Revenue $3,001,176 86.73% $2,779,110 86.71% $3,186,012 86.46%

Food & Beverage $322,000 9.31% $299,000 9.33% $353,000 9.58%

Telephone $50,000 1.45% $45,000 1.40% $54,000 1.47%

Other $87,000 2.51% $82,000 2.56% $92,000 2.50%

Gross Revenue $3,460,176 100.00% $3,205,110 100.00% $3,685,012 100.00%

Departmental Expenses

Rooms $642,000 21.39% $589,000 21.19% $623,000 19.55%

Food & Beverage $282,000 87.58% $279,000 93.31% $278,000 78.75%

Telephone $42,000 84.00% $39,000 86.67% $40,000 74.07%

Other $14,500 16.67% $14,000 17.07% $13,000 14.13%

Total Departmental Expenses $980,500 28.34% $921,000 28.74% $954,000 25.89%

GROSS OPERATING INCOME $2,479,676 71.66% $2,284,110 71.26% $2,731,012 74.11%

Undistributed Operating Expenses

Admin & General $237,000 6.85% $222,000 6.93% $235,000 6.38%

Marketing $169,000 4.88% $159,000 4.96% $170,000 4.61%

Franchise Fee $238,000 6.88% $202,000 6.30% $258,000 7.00%

Management Fee $136,000 3.93% $115,300 3.60% $147,500 4.00%

Repairs and Maintenance $118,000 3.41% $112,000 3.49% $120,000 3.26%

Utilities $122,000 3.53% $116,000 3.62% $125,000 3.39%

Total Undist. Oper. Expenses $1,020,000 29.48% $926,300 28.90% $1,055,500 28.64%

Gross Operating Profit $1,459,676 42.19% $1,357,810 42.36% $1,675,512 45.47%

Fixed Expenses

Real Estate Taxes $86,000 2.49% $101,000 3.15% $95,000 2.58%

Insurance $28,000 0.81% $33,000 1.03% $30,000 0.81%

Lease $0 0.00% $0 0.00% $0 0.00%

Other Expenses $0 0.00% $0 0.00% $0 0.00%

FF&E Reserves $116,000 3.35% $136,000 4.24% $147,500 4.00%

Total Fixed Expenses $230,000 6.65% $270,000 8.42% $272,500 7.39%

Net Operating Income $1,229,676 35.54% $1,087,810 33.94% $1,403,012 38.07%

STRESSED DEBT SERVICE $981,320 $981,320 $981,320

STRESSED DSCR 1.25 1.11 1.43

ACTUAL DSCR 1.49 1.32 1.70

Hotel Operating Statement Example

Top 5 Hospitality Markets

• Smith Travel Research January 2019

“12 Pack” Hospitality Markets

• Smith Travel Research January 2019

Atlanta Hospitality: Metric Trends

1/2019 STR Reports; 3/2019 CBRE-EA SupplyTrak

2019 Supply Shock Risks

133

1/2019 STR Reports; 3/2019 CBRE-EA SupplyTrak

• Upper Tier Secondary Market Hotel

– $45,000,000 Loan Amount

– 288 Rooms

– 5 Year Term

– 25 year Amortization

– 3.25% Rate; 6.0% Stressed Rate

– 65% Max LTV

– Minimum DSCR = 1.40x

Hotel Underwriting Example

Year COMP SET AVG REVPAR PROFORMA APPRAISAL STRESSED BREAKEVEN

YEAR ONE YEAR ONE REVENUES DISCOUNTED 10%

Rooms Available 105,120 105,120 105,120 105,120 105,120

Rooms Sold 82,204 70,346 73,584 70,346 70,346

Occupancy 78.20% 66.92% 70.00% 66.92% 66.92%

ADR $157.54 $161.73 $171.90 $145.56 $129.00

RevPar $123.20 $108.23 $120.33 $97.41 $86.33

Revenue

Room Revenue $12,950,393 87.56% $11,377,780 86.08% $12,649,000 82.46% $10,240,002 86.08% $9,074,673 84.56%

Food & Beverage $961,903 6.50% $961,903 7.28% $2,065,000 13.46% $865,713 7.28% $865,713 8.07%

Telephone $281,400 1.90% $281,400 2.13% $0 0.00% $253,260 2.13% $253,260 2.36%

Other $597,075 4.04% $597,075 4.52% $625,000 4.07% $537,368 4.52% $537,368 5.01%

Gross Revenue $14,790,771 100.00% $13,218,158 100.00% $15,339,000 100.00% $11,896,342 100.00% $10,731,014 100.00%

Departmental Expenses

Rooms $2,557,432 19.75% $2,246,874 19.75% $2,781,000 21.99% $2,022,400 19.75% $1,792,248 19.75%

Food & Beverage $746,185 77.57% $746,185 77.57% $1,716,000 83.10% $671,533 77.57% $671,534 77.57%

Telephone $140,700 50.00% $140,700 50.00% $0 #DIV/0! $126,630 50.00% $126,630 50.00%

Other $447,807 75.00% $447,807 75.00% $328,000 52.48% $403,026 75.00% $403,026 75.00%

Total Departmental Expenses $3,892,124 26.31% $3,581,566 27.10% $4,825,000 31.46% $3,223,589 27.10% $2,993,438 27.90%

GROSS OPERATING INCOME $10,898,647 73.69% $9,636,592 72.90% $10,514,000 68.54% $8,672,753 72.90% $7,737,577 72.10%

Undistributed Operating Expenses

Admin & General $1,136,351 7.68% $1,015,530 7.68% $1,319,000 8.60% $913,639 7.68% $824,142 7.68%

Marketing $532,565 3.60% $475,941 3.60% $659,000 4.30% $594,817 5.00% $536,551 5.00%

Franchise Fee $700,229 4.73% $625,778 4.73% $1,012,000 6.60% $594,817 5.00% $536,551 5.00%

Management Fee $423,679 2.86% $378,632 2.86% $460,000 3.00% $594,817 5.00% $536,551 5.00%

Repairs and Maintenance $367,189 2.48% $328,148 2.48% $554,000 3.61% $295,029 2.48% $266,129 2.48%

Utilities $566,784 3.83% $506,521 3.83% $573,000 3.74% $455,630 3.83% $410,998 3.83%

Total Undist. Oper. Expenses $3,726,797 25.20% $3,330,550 25.20% $4,577,000 29.84% $3,448,750 28.99% $3,110,921 28.99%

Gross Operating Profit $7,171,850 48.49% $6,306,042 47.71% $5,937,000 38.71% $5,224,003 43.91% $4,626,656 43.11%

Fixed Expenses

Real Estate Taxes $475,200 3.21% $475,200 3.60% $1,058,000 6.90% $475,200 3.99% $475,200 4.43%

Insurance $100,800 0.68% $100,800 0.76% $121,000 0.79% $121,000 1.02% $121,000 1.13%

Lease $0 0.00% $0 0.00% $0 0.00% $0 0.00% $0 0.00%

Other Expenses $0 0.00% $0 0.00% $0 0.00% $0 0.00% $0 0.00%

FF&E Reserves $126,211 0.85% $126,211 0.95% $307,000 2.00% $594,817 5.00% $536,551 5.00%

Total Fixed Expenses $702,211 4.75% $702,211 5.31% $1,486,000 9.69% $1,191,017 10.01% $1,132,751 10.56%

Net Operating Income $6,469,639 43.74% $5,603,831 42.39% $4,451,000 29.02% $4,032,986 33.90% $3,493,905 32.56%

STRESSED DEBT SERVICE $3,507,835 $3,507,835 $3,507,835 $3,507,835 $3,507,835

STRESSED DSCR 1.84 1.60 1.27 1.15 1.00

DSCR BASED ON PRIME @ 3.50% 2.37 2.06 1.63 1.48 1.28

14.3% Debt Yield 12.4% Debt Yield 9.8% Debt Yield 8.9% Debt Yield 7.7%Debt Yield

Hotel Underwriting: A Different Beast

• Much more competition in the market

– Specialty brands

– AirBNB, VRBO, apartment blocks, condos

• Very subject to change, tech innovations

• Business climate and dollar strength will affect performance in 2019, but should see the cycle inflection point

Observations on the Hotel Industry

Economic Hot Topics Affecting CRE: Taxes, Trade, and Labor

The Wild Cards: Shoot First, Ask Questions Later!

• Mortgage interest deduction has been lowered from $1mm to $750k– This could lower home values in higher priced metros as well as those held

by the affluent

• HELOC interest deductibility has been limited to interest related specifically to purchase money or home improvement transactions– This could be difficult to enforce, however the perception is that HELOC

interest is not deductible at all and this should impact demand of the product from consumers

• SALT (State and Local Tax) deductibility has been limited to $10k, which includes property tax– This is another potential deflator to prices in higher end homes and markets

• The moving expense deduction has been eliminated (with the exception of military personnel)

• In general, the tax reform is more favorable to multifamily rental properties and less so to single family home owners

Tax Changes: Potential Residential Impacts

• Commercial mortgage interest is fully deductible for landlords

• 1031 Tax Free Exchange program has been preserved

• Section 42 LIHTC program has been preserved in full– This is a necessity given the rising rent percentage of income for workforce (B&C

class) multifamily housing

• Corporate tax rate lowered to 21%– Repatriation of capital could also spur demand for new facilities to house repatriated

human assets and domestic operations

• REIT dividends are still fully deductible– Should push REIT share prices upwards, potential disparity between assets held by

REITs and portfolio value of REIT holdings

• Capital investments in plant assets, equipment, and buildings are able to be fully depreciated in the first year– This could overstimulate building that is not needed in the office and retail sectors– New plant and equipment investment would most likely have some effect on

workforce as automation trends replace human capital

Tax Changes: Potential Commercial Impacts

Trade/Tariff Situation and Effects on CRE

Section 232 Tariffs: National Security Concerns

3.23.2018

6.22.2018 7.1.2018

US places tariffs on steel ($10.2B

imported) and aluminum

($7.7B imported)

EU retaliates with tariffs based on 3.7.2018

declaration, $3.4B of US

exports

Canada retaliates on $12.8B of US

exports, primarily steel and

aluminum

6.5.2018

Mexico retaliates

with Phase 1 of $3B of

tariffs

9.30.2018

US, Canada, and Mexico reach a

new agreement, titled “USMCA”,

pending approval by each nation’s

legislature

May 2019

May 2019

US, CAN, MX drop

232 tariffs and

retaliations

US pushes 232 Auto

Tariff Discussion to 11.2019

Section 301 Tariffs: Unfair Trade/Technology Theft

7.6.2018

8.23.2018

Chinese Phase 1 tariffs of

$32B go into effect

US Phase 2 tariffs of $16B go

into effect

7.6.2018

US Phase I tariffs of $32B go

into effect

8.23.2018

Chinese Phase 2 tariffs of

$16B go into effect

9.24.2018

US tariffs on consumer goods of

$200B at 10% go into effect

9.24.2018

China’s retaliatory tariffs of

$60B go into effect

12.2.2018

US and China

extend tariff

cease-fire to March

2019

March 2019

Tariff cease-fire extended

indefinitely

May 2019

US Implements Phase 2 25%

Tariffs on $200B; China retaliates on

$60B

China/US Trade War on in May Despite Positive Outlook 25% tariffs on $200B; $300B threatened Earliest possible meeting late June at G20

USMCA not signed but has regained momentum No EU Deal on 232 tariffs (including Automobiles); discussion pushed out

Economic Impacts: U.S.: Stock market volatility, inventory pulled forward

US imports from China up 6%, exports to China down 5% Chinese investment in US at $4B, down from $29.4B in ’17 Consumer hasn’t felt it yet as tariffs target intermediate goods

They will on the next $300B!

China: Economy, stock markets, political direction Chinese GDP dropped from 6.9% in 2017 to 6.6% in ’18 (probably more), will go

to the 5% range Yuan has moved from 6.2$/¥ to 6.9$/¥, roughly offsetting 13% tariffs

Current Trade/Tariff Situation

• Cost of construction materials

• Negative impact on investment climate (sentiment or legislated)

• General drop in aggregate demand for goods and services

• Tenant Risk related to specific industry challenges

• Main Sectors at Risk

– Warehouse/Distribution

– Industrial

– Retail

• Dollar Stores are especially susceptible to tariff challenges

CRE Risks Related to Trade (in order of appearance!)

Dollar Store Historical Pricing Structure?

.25

Regional Migration/Labor Trends

Laying the Foundation for CRE Performance in the South

Factors of a Slowing Economy

• Congressional Budget Office: “The Budget and Economic Outlook: 2019-2029

“From 2024 to 2029, economic growth and potential growth are projected to average 1.8 percent per year—less than theirlong-term historical averages, primarily because the labor force is expected to grow more slowly than it has in the past.”

Rising Construction Costs

State 2017 In-Migration 2017 US Rank

Florida 566,476 1

Texas 524,511 2

California 523,131 3

North Carolina 313,834 4

New York 285,252 5

Georgia 278,889 6

Arizona 261,727 7

Washington 260,787 8

Virginia 250,490 9

Tennessee 191,909 14

South Carolina 166,573 15

Alabama 111,803 26

Economic Concerns: Labor Pool

• US Census Bureau: 2017 Numbers (November 2018 Report)

In-Migration population numbers are very high in SE/SW

2017 MSA Net Migration

• US Census Bureau: 2017 Numbers (November 2018 Report)

Worst MSAs for Net Migration: NYC, LA, Chicago, San Juan PR, Detroit

Current Forecast

MSA ST

3Q18 YOY Ann

Non-Farm Job

Growth

3Q18

YOY %Δ

Job

Growth

Axio 2019 FC

Job growth

Orlando-Kissimmee-Sanford FL 45,817 3.7% 41,800

Austin-Round Rock TX 34,600 3.4% 25,100

Dallas-Plano-Irving TX 81,133 3.2% 62,000

Jacksonville FL 21,708 3.2% 18,800

Raleigh NC 18,042 2.9% 20,900

Augusta-Richmond County GA 6,783 2.9% 2,900

Charlotte-Concord-Gastonia NC 33,300 2.8% 21,800

Chattanooga TN 7,008 2.7% 4,400

Athens-Clarke County* GA 2,592 2.7% 1,000

Houston-Woodlands-Sugar Land TX 80,467 2.7% 89,500

Huntsville AL 5,925 2.6% 4,300

Spartanburg SC 3,617 2.4% 2,200

North Port-Sarasota-Bradenton FL 7,050 2.4% 8,000

Nashville-Davidson-Murfreesboro TN 22,225 2.3% 18,300

Tampa-St Petersburg-Clearwater FL 30,008 2.3% 30,400

Atlanta-Sandy Springs-Roswell GA 51,675 1.9% 45,900

San Antonio-New Braunfels TX 18,925 1.8% 20,800

Greenville-Anderson-Mauldin SC 7,442 1.8% 8,200

Charleston-North Charleston SC 5,875 1.7% 6,200

Ft. Lauderdale-Pompano Beach-Deerfield Beach FL 13,600 1.6% 18,400

Durham-Chapel Hill NC 5,050 1.6% 4,800

Miami-Miami Beach-Kendall FL 17,967 1.5% 26,200

Tuscaloosa* AL 1,608 1.5% N/A

Miami-Ft. Lauderdale-West Palm Beach FL 37,233 1.4% 15,500

Birmingham-Hoover AL 6,292 1.2% 6,100

Cape Coral-Ft Myers FL 2,900 1.1% 8,400

Columbus GA 1,225 1.0% 1,000

West Palm Beach-Boca Raton-Delray Beach FL 5,667 0.9% 15,800

Savannah GA 1,217 0.7% 2,600

Columbia SC 200 0.1% 6,200

Naples-Immolakee-Marco Island FL (1,958) -1.4% 4,500

3018 YOY Job Growth/2019 Projected Job Growth

• US Bureau of Labor Statistics; Axiometrics

United States employment growth rate 12.17-12.18 = 1.02%; we like over 2%

Of 31 markets tracked, only 5 are below national growth rate*

MSA

Most Recent

Wage

Growth/NSA

Job Growth

YE18 Industry Drivers

Birmingham 7.4% 1.9% Logisitics, Manufacturing, Health

Huntsville 3.9% 4.1% Tech/Defense

Orlando 9.5% 4.0% Tech/Defense, Logisitics, Health, Tourism

Atlanta 5.0% 2.5% Tech, Logistics, HQ

Charleston 3.7% 2.6% Tech/Defense, Manufacturing, Logistics

Greenville 7.7% 2.6% Manufacturing, Logistics

Chattanooga 8.0% 1.3% Tech (start-ups), Logistics, Manufacturing

Nashville 10.5% 2.0% Health, Manufacturing, Tourism

Austin 6.4% 3.8% Tech (start-ups), Education, Government

Dallas 6.1% 3.2% Logistics, HQ

Houston 6.0% 3.5% Logisitics, Health, Defense/Tech

The RIGHT Jobs: MSA Wage and Job Growth

• BLS

Common Theme: Logistics, Tech/Defense, Health, Manufacturing

Building a Market Intelligence ProgramBecause Regulators Like to See One!

Tailoring to Your Bank’s Needs and Resources

Get Your Economic Data Calendar Here:

http://mam.econoday.com/

• Because you want to make more informed decisions on loans

• Because you want to manage your portfolio more effectively and mitigate concentration risks

• Because CRE industry is changing at a rapid pace and you need to be cognizant of the lending environment and risks

• Because you have seen there are several concerns in each property sector and the cyclical winds has shifted

• Because regulators are going to want to see some evidence of a Market Intelligence effort

Why Do You Need a Market Intel Program?

• If you bookmarked or signed up for free access to the links posted underneath each section header, you are well on your way to having the data that you need to stay informed.

– Best part is those resources were free!

• E-mail me at calevans@Synovus.com for examples of reporting you can use

Section Header Links

Test Preparation:10 T/F15 M.C.