global real estate investment and performance 2006 and 2007

RREEF Research

Chart 1: Global Cross-Regional Real Estate Investing in 2006

Source: RREEF Research, DTZ, RCA, JLL Note: The table summarises the major sources of cross-border real estate investment in 2006, and the arrows indicate the source and destination of these flows

1Cross-border activity refers only to purchases coming from non-domestic capital 2 The focus of the paper is on the “direct” market with a detailed review of the “listed” real estate securities market being provided in: RREEF Research (2007, January) “Global Real Estate Securities”

Table of Contents 1. Introduction………………...1 2. Global Real Estate Investment Activity............. 2 3. Global Real Estate Returns 2006………..………..……...8 4. Prospects for Returns 2007………………………..11

1. Introduction The recent and sustained strong investment performance of real estate has led to increased interest in the asset class from a wide range of institutional, retail and high net worth investors. In turn, this has led to a surge of investment activity across most global real estate markets, with turnover more than doubling over the past three years to reach close to US$ 600 billion during 2006. Beyond this increased level of investment activity there has been a surge of cross-border investing, as global markets have matured and as investors have sought to diversify their exposure to real estate1. The amount of cross-border investment has tripled since 2001 to reach US$ 116 billion in 2006, 20% of the global total. It is within the context of these trends that this paper explores three key dimensions of investing across global “direct”2 real estate markets. First, a summary of global real estate investment during 2006, both at a global level and within Europe, Asia and North America. Second, a review of the performance of direct real estate markets during 2006 and, third, the outlook for returns in 2007 based on the three key drivers of investor appetite, rent growth prospects and spreads with bond yields. In terms of the outlook for 2007, it is likely that at a global level real estate will continue to perform well, albeit with lower returns than over the past two years. Beyond 2007 it seems that returns will revert to average long run levels, with increasing uncertainty over whether this will be through a “soft” or “hard” landing.

Authors: Henry Chin +44 (0)20 7545 6611 [email protected] Ermina Topintzi +44 207 545 6674 [email protected] Peter Hobbs +44 (0)20 7547 4855 [email protected]

March 2007

Authors: Henry Chin +44 (0)20 7545 6611 [email protected] Ermina Topintzi +44 207 545 6674 [email protected] Peter Hobbs +44 (0)20 7547 4855 [email protected]

MPORTANT: PLEASE SEE MPORTANT DISCLOSURES AND NALYST CERTIFICATION

MMEDIATELY AT THE END OF THE EXT OF THIS REPORT

Global Real Estate Investment and Performance 2006 and 2007

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... real estate investment volumes have increased threefold, reaching another record of $580 bn..

... cross border investing now represents 20% of total activity

2. Global Real Estate Investment Activity in 2006 Global real estate investment volume has increased threefold since 2001, reaching another record during 2006, with US$ 580 billion of transactions, up 20% on the previous year3. Investment activity remains concentrated on a small number of countries, with the US accounting for 53% of turnover, and the UK a further 16%. Although the US continues to dominate investment activity, the greatest percentage increases have been in Asia and Europe reflecting the increasing maturity and liquidity of these markets. Chart 2 : Global Real Estate Investment by

Geography Chart 3: Global Real Estate Investment Activities Domestic vs Cross Border

Source: RREEF Research, CBRE, JLL Source: RREEF Research, CBRE, JLL

The amount of cross border investment activity has tripled over the past five years to reach US$ 116 billion in 2006. Office and retail sectors remain favourites for foreign transactions accounting for 80% of the total cross border activity. In terms of “cross-regional” investing, American and Asia Pacific investors were the most active in 2006, spending US$ 28 billion and US$ 16 billion respectively outside their domestic regions. European investors only spent US$ 5 billion outside Europe with greater focus on cross-border investing within Europe which represented US$ 84 billion or 40% of total European activity.

Table 1 : Cross-Continental Investment Activity 2006, US$ Billion

Source of Capital America Europe Asia PacificAmerica 23.4 4.4Europe 4.7 0.7

Asia Pacific 7.1 8.7

Total Cross Regional 11.8 32.1 5.1Total Cross Border 20.0 84.4 11.9

Total Transaction 311.0 212.5 63.1

Destination of Activity

Source: RREEF Research, CBRE, JLL

In 2006, total direct real estate investment in the US rose by another 20% to nearly US$ 310 billion. Since 2001, investment activity has grown steadily, largely driven by institutional investors and private national buyers4. The continued increase in activity during 2006 was due primarily to the wave of pubic companies that were taken private during the year.

3 Investment activity is based on actual transaction deals 4 Real Capital Analytics

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... significant changes in the composition of foreign investors in US real estate…

... first from Germany, then Australia and now Middle East and Pacific Rim…

Within the US, cross-border investment has only represented around 7% to 8% of total investment activity over recent years (Chart 4) but, given the scale of the US market, this amounted to US$ 20 billion in 2006. Office remains a favourite sector for foreign investors, which accounted for two thirds of cross-border activity. There was a sharp fall-off in foreign investment in retail real estate, in line with the increasing concerns over the prospects for the sector, but investment in apartments nearly doubled to US$ 4 billion.

Chart 4 : The US Real Estate Investment (2001 to 2006), US$ Billion


Although foreign investment as a share of the total has remained relatively constant in recent years, there have been significant changes in its composition. German investors accounted for 40-50% of foreign activity at the start of decade but, given the outflows from the Open-Ended funds, fell to 10% in 2006. As Germany activity decreased in 2004 and 2005, the Australian investors came to play a more important role, rising to 39% of all cross-border activity in 2005. Over the past year, the most significant investors were from the Middle East and Pacific Rim, representing more than 40% of cross border activity in 2006 compared with less than 20% in 2001.

Table 2: Share of US Cross-Border Real Estate Investment by Investor’s Nationality

Source: RREEF Research, RCA

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2001 2002 2003 2004 2005 2006Australia 1% 5% 25% 24% 39% 19%Pacific Rim 6% 1% 2% 3% 2% 16%German 49% 40% 41% 29% 18% 10%Middle East 13% 15% 12% 13% 17% 26%

Cross-Border Investment by Investors Nationality

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... the UK continues to dominate European investment, at 43%of the total..

... but there has been a surge of activity in Germany.

Chart 5: Share of US Cross-Border Real Estate Investment by Investor’s

Nationality

Source: RREEF Research, RCA

Although investment activity in the US is expected to remain strong in 2007, they are unlikely to exceed the record levels of last year for two main reasons. First, the recent wave of public-to-private transactions, which has exceeded US$ 110 billion over the past 18 months, is likely to decline given the increasingly aggressive pricing of REIT stocks and the limited scope for arbitrage opportunities. Second, the relative attractiveness of real estate is reducing given the decline in real estate returns and the relatively strong recovery in equity markets. European direct real estate investment activity reached another record in 2006, at US$ 212 billion, a 20% growth from the previous year5. Although representing less than 20% of Europe’s GDP, the UK accounted for 43% of investment activity, reflecting the maturity and liquidity of the market. Beyond the UK, Germany accounted for 17% (up sharply on the sub-5% in 2005) and France for a further 14% of total activity. The level of cross-border investment also increased from US$ 36 billion in 2001 to US$ 84 billion in 2006. Over the past 5 years, cross-border investment has been concentrated on the UK and France which, together, represented over 50% of activity. Over the past 18 months, there has been a surge of cross-border activity in Germany, especially driven by US and UK investors. In 2006, Germany was the third largest investment destination for cross border investment, representing 12% of the regional cross-border total, far higher than in previous years. This upward trend is likely to continue in 2007. Across Europe as a whole, the office sector remained the favourite for cross-border investment, representing around 55% of activity in 2006. But there was a further increase in retail activity, by 60% over the year and 25% of the total, due to retail chain expansion, tight supply and strong demand across the region.

5 This is based on commercial investment activity. Residential investment activity is excluded although this is becoming an increasingly important part of the market. For instance, it is estimated that residential in Germany stood at over US$16 billion in 2006 (AtisReal Investment Market Report, Germany 2007)

Pacific Rim16%

Others11%

German10%

Canada13%

Australia19%

Mid East26%

UK5%

Total Transactions: US$ 20 Billion

Pacific Rim16%

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US investors continue to dominate cross-border activity in Europe.

Chart 6 : European Real Estate Investment (2001 to 2006), US$ Billion

Source: RREEF Research, DTZ

The majority of cross border investments in Europe are intra-regional, with European investors from one country acquiring assets in another. UK and German investors are the most active intra-regional players. Beyond the UK and German investors, a host of other European investors are becoming more active in cross-border investing. For example, Spanish investors have focused on acquiring French assets and Austrian investors have concentrated on Central and Easter Europe. In terms of non-European investors in Europe, US investors have dominated, accounting for 40% of activity in 2006. This amounted to US $ 23 billion, twice the level of 2005, and even this figure is likely to be an underestimate as US investors have dominated the purchases of residential portfolios in Germany which, as explained earlier, are not included in the figures Middle Eastern investors also increased their investment significantly, with most of their activity focusing on the UK, France and Sweden.

Chart 7 : European Cross Border Real Estate Investment

Source: RREEF Research, DTZ

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2001 2002 2003 2004 2005 2006United States 38% 30% 22% 35% 24% 28%Germany 20% 29% 37% 28% 19% 8%Middle East 4% 7% 8% 3% 6% 4%United Kingdom 5% 8% 9% 5% 8% 10%Ireland 4% 4% 5% 8% 10% 5%



















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Capital continues to flow in Asia-Pacific with domestic activity dominating…

Capital continues to flow strongly in the Asia Pacific region. Investment activity has increased five times since the start of the decade, reaching US$ 63 billion in 2006. Domestic activity continues to dominate, with over 80% of turnover being generated by domestic investors. The scale of the market means that Japan represents close to 50% of all investment activity in the region, with other countries such as Australia, China, Hong Kong and Singapore making up the bulk of the rest of the activity. The strong activity in Japan has been driven by the growth of both the J-REIT and the unlisted markets which grew in market cap by 40% and 60% respectively during the year6. Although domestic activity dominates, the level of cross border activity has increased from US$ 2.5 billion in 2003 to US$ 12 billion in 2006. Office remains the favourite sector but the share of industrial investments has grown to represent 20% of total activity. This increase is due to the strong market fundamentals (industrial is high-yielding and the fastest growing sector in the region), third-party logistics activity picking up, and the desire from investors for income producing assets.

Chart 8 : Asia Pacific Real Estate Investment (2001 to 2006), US$ Billion

Source: RREEF Research, JLL

In dollar terms, cross-border activity has been greatest in Japan, with increasingly significant levels in China, Hong Kong and Australia. Cross-border activity has increased in most markets, with the main exceptions being Australia and Korea where strong domestic competition has made it harder for foreign investors to be successful7. In terms of the drivers of cross-border investing, the US and Australian investors were the most active in 2006, with Australian capital moving to the region, having concentrated on the US during 2005.

6 STB Research Institute (2007) “2006 Market Survey Results”, January 7 REIS (2007) “Asia’s Real Estate Market Forecast Update”

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Chart 9: Asia Pacific Cross Border Real Estate Investment

Source: RREEF Research, JLL

Asia Pacific Foreign Investment by Investor’s Nationality


2004 2005 2006USA 53% 59% 37%Australia 24% 6% 41%Germany 4% 1% 0%Singapore 14% 31% 6%Hong Kong 1% 1% 9%Netherlands 2% 2% 2%
















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Sustained cap rate compression of recent years

3. Global Real Estate Returns in 2006 The strong weight of capital to real estate has led to sustained yield compression in recent years and this continued into 2006 across most global markets (Charts 10 and 11). In certain markets, such as those in the US, the compression slowed during the latter half of the year such that cap rates now seem to have stabilised. In others, such as many in Europe, cap rates continued to compress throughout the year with the final quarter seeing a further compression of 25bp in markets including Paris, Dublin, Amsterdam, Brussels and London West End.

Chart 10: Global Office Cap Rate Trends, 2000-2006

Note: Aggregate performance based on twenty four global markets – 10 in US, 10 in Europe and 4 in Asia-Pacific

Source: RREEF Research, NREI, CBRE, JLL

Chart 11: Cap Rate Movements Across Major Global Office Markets 2005 and 2006

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… has driven strong returns, achieving around 17% for 2006

Value growth has contributed to over 60% of total returns in many markets over recent years

This strong cap rate compression and the recovery in rental markets means that total unlevered returns are likely to have been very strong across global markets. As at the start of March, the 2006 total return figures have been released for six real estate markets (Australia, Canada, Ireland, Sweden, UK and US), with the remainder due to be released over the coming months8. Based on these results and estimates for the remaining markets, it seems that global total returns will have been around 17% for 2006, similar to the level in 2005 and far higher than the average over the previous ten years (Chart 12).

Chart 12: All-Property Total Returns History,(2000-2006)

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Source: RREEF, IPD, NCREIF, PCA, Property Council of New Zealand

Note: Regional aggregates are calculated by RREEF Research. For more information, please refer to theAppendix

Much of this strong performance over the past two years has been due to capital value growth. Over the longer term, income return has accounted for a large proportion of total returns in most real estate markets. The strong cap rate compression of the past two years means that value growth has contributed to over 60% of total returns across a number of major markets, including Australia, Ireland, UK and the US (Table 3).

Table 3: % Contribution of Capital Value Growth to All-Property Returns

France Ireland NetherlandsUnited

Kingdom USA Canada Australia Japan

2003 20% 52% 15% 36% 11% -1% 33% -63%2004 36% 48% 21% 62% 46% 34% 40% 0%2005 57% 75% 41% 67% 63% 54% 39% 46%2006 65% 81% 60% 70% 60% 58% 55% 66%

Source: RREEF Research, IPD, NCREIF, PCA

Note: Figures for France, Netherlands, Australia, and Japan are RREEF estimates

The increased convergence in performance across global markets is clearly shown in the summary of recent trends in Table 4. Returns in the US remained strong, at close to 17%, but this is slightly lower than the previous year. Given the slowing of cap rate compression, the quarterly NPI numbers fell-off towards the end of the year, with total returns of 4.5% in the final quarter, down by 92 bps on Q4 2005.

8 Source: IPD and NCREIF. 2006 Total Return figures will be released for other countries over the coming months such as: Denmark and Norway in March; Germany, Switzerland and France in April; Belgium, Spain and Italy in May.

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Table 4: All-Property Total Returns by Region (2001 – 2006)

France Germany Ireland Italy Netherlands Sweden United Kingdom USA Canada Australia Japan

2001 9.7% 5.4% 8.1% 12.4% 11.4% 4.6% 6.8% 7.3% 9.2% 10.3%2002 8.6% 3.9% 2.3% 9.3% 8.8% 2.4% 9.6% 6.7% 8.8% 9.5%2003 8.0% 2.9% 12.7% 11.0% 7.1% 0.9% 10.9% 9.0% 8.4% 12.0% 4.0%2004 10.1% 1.1% 11.5% 8.9% 7.8% 5.8% 18.3% 14.5% 13.0% 13.1% 6.3%2005 15.2% 0.5% 24.3% 9.0% 10.2% 12.7% 19.1% 20.1% 18.7% 12.7% 11.7%2006 17.7% 14.1% 27.2% 11.6% 14.4% 16.2% 18.1% 16.6% 18.6% 17.3% 17.6%

Europe North America Asia

Source: RREEF Research, IPD, NCREIF, PCA, Property Council of New Zealand

Note 1: 2006 figures are RREEF estimates with the exception of recently published numbers for Ireland, UK,Sweden, Canada, Australia and the US.

Note 2: Regional aggregates are calculated by RREEF Research. For more information, please refer to theAppendix

Within Europe, one of the most striking features of performance in 2006 has been the degree of convergence across both countries and property types. After very weak performance in 2005, the surge of investment activity in Germany over the past twelve months is likely to have driven strong real estate returns. Cap rate compression in Germany and in other European markets has fuelled strong performance, with returns ranging between 12% for Italy to 27% for Ireland, with an overall average of around 16.4%. Within Asia, the rental recovery and weight of capital led to strong cap rate compression and overall performance during 2006, with Australia, Japan and Singapore all performing particularly well. Although rents continued to grow strongly in Hong Kong, the upward pressure on cap rates, due to rising interest rates, is likely to have reduced overall performance in the market. This brief review of performance in 2006 reveals the very strong performance that was paralleled in the listed real estate markets. The strong recent performance raises questions over its sustainability, and this issue is addressed in the following section.

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Prospects for returns are driven by three interrelated factors….

First, investor appetite … which continues to remain strong…

4. Prospects for Returns 2007 In estimating the prospects for real estate returns, three, interrelated, but at time contradictory, pressures need to be considered:

The weight of capital to real estate. This is essentially investor sentiment formed by investors’ perceptions of real estate and its relative performance against other asset classes.

Rental growth expectations as a good proxy for expectations of changes in net incomes. The latter depend on increasing leasing activity, declining vacancies and rising rent levels.

Spreads between cap rates and the risk free rate or finance rates, often indicated by the 10-year bond rates. In general terms, the wider the spread the stronger the potential for cap rate compression.

4.1 Investor Appetite As explained in recent RREEF Research 9 , both institutional and retail investors have sought to increase the real estate allocation of their investment portfolios. Across the world, there continues to be strong demand for real estate exposure as shown by the current and target allocations to real estate (Chart 13). In most markets, investors are seeking to increase their real estate weightings.

Chart 13: Pension Real Estate Allocations

Source: RREEF Research; UBS, IREI/Kingsley, Mercer, JP Morgan, PGGM, ABP

A number of structural factors suggest that there will be continuing pressure to make significant allocations to real estate. Foremost amongst these is the continued growth in ageing populations, with more than 20% of the overall population being over 65 years old in Japan, Italy and Germany by 2020, and dependency ratios increasing across the world. Other factors include the more general trend towards increasing exposure to “alternatives”, and the maturing of the real estate asset class that increases the options for investors seeking to invest in real estate10.

9 RREEF Research (2007), Global Real Estate Securities, January 10 McKinsey (2006), The Asset Management Industry in 2010.

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Increasing demand for foreign real estate in both US and Europe…,

Over the short term, there continues to be strong appetite for real estate investing across each of the major regions. Within the US, the gap between target and actual allocations has narrowed such that the amount of new capital to be invested in 2007 is likely to be lower than in 2006 (Chart 14). Despite this there continues to be strong pressure to invest in real estate and the appetite for foreign real estate continues to increase. The recent survey by IREI/Kingsley Associated demonstrated that “foreign real estate” is the top new real estate strategy, with over a third of respondents claiming this to be the top strategy, well ahead of other strategies such as Securities and Infrastructure11. This pressure of US capital will continue to support values both in the US and in other markets around the world.

Chart 14: Expected US Capital Flows to Real Estate

Source: IREI; Kingsley Associates

Within Europe, the weight of capital to real estate is, if anything, stronger than in the US. Allocations continue to increase and a new range of investors is starting to enter the market. The strong overall weight of capital to the European market is demonstrated by the responses to a recent Cushman and Wakefield Survey that suggest there will be an additional $70bn allocated to the asset class during 2007, up on the levels in 200612. Demand from retail investors also remains strong. A further indicator of continuing strong demand is INREV’s survey of investor intentions in which over 80% of respondents planned to increase allocations to unlisted real estate compared with only 5% planning to reduce the allocations13. Although the bulk of European capital allocations is expected to be invested within Europe, an increasing proportion is headed further afield, with particularly strong demand for real estate in the US and Japan, as shown in Chart 15.

11 IREI/Kingsley Associates (2007), 2007 Plan Sponsor Survey January 12 Cushman & Wakefield (2007) “Attitudes towards 2007/8: A Survey of European Investors”, February

13 INREV (2007) “Investment Intentions Survey”

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Greater appetite for real estate in a diverse range of countries

Chart 15: European Real Estate Investor Allocations and Intentions

Source: INREV (2007)

Outside of Europe and the US the weight of capital to real estate continues to remain strong although there are significant variations in the way in which this capital is going to be invested:

• The huge wealth in the Middle East and the quest for suitable investment opportunities will continue to lead to strong demand for real estate assets around the world. As explained earlier, Middle Eastern investors represented the largest share of overseas investment in the US during 2006, and this is set to continue in 2007. Middle Eastern investors are also active throughout Europe and Asia, supporting real estate pricing in both regions.

• Australian investors continue to make strong allocations to real estate with increasing demand from both institutional and retail (wholesale) investors. Over recent months there seems to have been a shift in demand for unlisted funds given the desire for domestic real estate that is not exposed to the volatility of the listed market. The recent JLL survey of investors found that 87% of investors are seeking to increase their exposure to direct real estate (with only 4% seeking to sell), compared with 50% seeking to increase exposure to LPTs (with 15% seeking to sell)14.

• The weight of capital to Asian real estate continues to grow with an increasing number of domestic, regional and international investors seeking to access the market. Within many Asian countries there remain restrictions on the ability for institutions to invest in real estate. As these restrictions are relaxed, a further wave of capital will be added to the market. There is increasing interaction between the more mature and the more emergent markets with, for instance, REOCs and REITs based in Hong Kong, Singapore and Australia increasingly investing in the emerging markets of China, India and elsewhere in Asia.

• Allocations to real estate in Japan remain relatively low, at 1.4%. Although low, these allocations have increased from less than 1% in 200315, and there are signs

14 JLL (2006), Survey of Investor Sentiment, Q4 15 UBS (2005), Global Real Estate Investment – vol. II: The World is becoming Flatter, UBS

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The second driver is rent growth, and prospects remain good … but only over the short term

that they will increase further during 2007. This increase is coming through both private funds, and through J-REITs and other forms of listed real estate.

The continuing strong demand for real estate across all global regions will continue to support pricing during the course of 2007. The significant allocations to real estate suggest that this pressure will be maintained into 2008 and beyond, although this will be critically dependent on how real estate performs in absolute terms and relative to other classes. 4.2 Rent Growth Prospects The short term prospects for rent growth remain strong, certainly for the remainder of 2007. This is well-demonstrated by the movement of the office markets through their cycle (Chart 15). The Asia-Pacific markets are tending to lead the global markets followed by those in the US which, in turn, are further ahead than the European markets. There are significant variations within these broad regional trends with, for instance, the more cyclical “bounceback” markets of Hong Kong, Shanghai, London, Madrid and New York, each experiencing very strong growth during 2006. In most of these “bounceback” markets, excepting New York, the surge of new construction means that rent growth is likely to fall off sharply towards the end of the decade. More sustained rent growth is expected in cities with a better supply-demand balance, including Tokyo, Singapore, Paris, Stockholm and Los Angeles.

Chart 16: Rental Growth Prospects by Region

Note: Unweighted aggregate performance based on twenty four global markets – 10 in US, 10 in Europe and 4 in Asia-Pacific.Forecasts as at December 2006

Source: RREEF Research

The US office sector continued to perform strongly during 2006, with vacancy rates falling from 13.6% to 12.6% during the year, with the resultant improvements in rent and NOI. Although the slowing economy will reduce net absorption, new construction remains contained such that prospects for rent growth remain favourable, certainly over the next 24 months. Beyond the economic uncertainties, the major risk facing the US markets remains the levels of new construction, with new supply starting to build in a number of markets including such as Washington DC, Orange County, Phoenix, San Diego, and Seattle.

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In terms of the third driver, spreads with finance costs or the risk free rate, prospects are not so good…

The Asia-Pacific markets continue to exhibit marked variations in their movement through the rent cycle. Hong Kong and Shanghai experienced particularly strong rent growth, of around 25%, during 2006, and these markets are nearing the peak of their cycles. Although supply continues to remain constrained in the Central area of Hong Kong, rents are becoming expensive and there is a surge of supply in other parts of the city such as Kowloon such that rent growth will likely turn negative by the end of the decade. Other markets are at a more attractive stage of their rent cycle, with both Singapore and Tokyo, both of which experienced strong growth in 2006, set to see continued rent hikes through 2007 and 2008.

Although rent growth across Europe as a whole will be more modest than the US and many markets in Asia, certain cities are bouncing back sharply from the recent downturn. London and Madrid each experienced 20%+ headline rent growth in 2006, and rents will continue to rise strongly during the coming year. Although the short term prospects for these cities remain good, the surge of new supply means that rent growth will fall off rapidly between 2008 and 2010. A series of other cities such as Brussels, Frankfurt and Milan continue to experience flat or marginally negative rent growth, with the better medium term prospects being in some of the more provincial markets or those with good supply-demand balances such as Paris and Stockholm.

4.3 Bond Yield Prospects The third key driver of real estate market performance is movement in yields (cap rates) which, in turn, are heavily influenced by trends in finance costs or in the risk free rate. Although the strong cap rate compression of recent years was partially based on the weight of capital to real estate and the prospects for a rental recovery, a fundamental driver was the sharp reduction in finance costs at the start of the decade. As cap rates have compressed and bond yields risen, the spreads have narrowed and the attractiveness of real estate has reduced, as shown in Chart 17.

Chart 17: Cap Rate/Bond Rate Spreads for Key Global Markets (%)

Source: RREEF Research; CB Richard Ellis; NREI, JLL; Deutsche Bank Global Markets

The Global long-maturity government bond yields have increased since the end of 2005, standing at 4.5% in the end of 2006. At the start of 2007, most forecasters were expecting long-term interest rates to rise only marginally in all regions, and to remain around 4.6% in the US, 3.6% in the Eurozone and 4.0% in Asia by the end of the year. Over recent weeks,

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Prospects for 2007 remain good across most global markets

with the release of Q4 GDP data for the US, Japan and Germany surprising on the upside, it seems the global economy is growing faster than had earlier been expected. This stronger growth suggests that short term interest rates will stay higher for longer, with the increased risk that long term rates will rise further than shown in Chart 18.

Chart 18: Government 10-year Bond Yields by Region

Source: OECD; Global Insight; Deutsche Bank Global Markets

With cap rates now close to historically low levels and bond yields set to rise during 2007, there is little prospect for further cap rate compression during the rest of the year, certainly in the US. Within the US, the ULI Emerging Trends survey and recent evidence from RCA suggest that cap rates could even rise marginally for non-core assets during 2007 16 . Elsewhere, there is likely to be continuing downward pressure on cap rates, although this will be less significant than in recent years. The greatest prospect for further cap rate compression is in a number of Eurozone countries and in Japan, although both of these markets face the risk of rising interest rates that could curtail this compression. Beyond these established markets, there remains the prospect for reductions in less mature markets such as Russia and China where the markets are gaining in scale, liquidity and transparency. 4.4 Prospects for 2007 Based on the drivers outlined above it seems that the prospects for total returns to real estate in 2007 remain favourable in most markets around the world. The weight of capital remains strong and rental growth is feeding through to an increase in incomes and values. Although the recent cycle of cap rate compression in the US now seems to be over, it is likely that they will remain broadly stable for the remainder of the year. Elsewhere, cap rates could compress yet further, although less significantly than over recent years. Based on the combination of these factors, total returns are set to remain relatively strong across global markets (Chart 19).

16 ULI (2007) “Emerging Trends in US Real Estate”

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Chart 19: All-Property Total Returns (2004 – 2007)

Source: RREEF Research, IPD, NCREIF, PCA, Property Council of New Zealand

There are important variations in return expectations across the global markets (Chart 20). On the one hand, the US and UK are expected to have returns closer to 10-12% during 2007 which, although robust, are down sharply from the average of 17-19% over the previous three years. On the other hand, the recovery of two other major markets, those of Japan and Germany, suggest that total returns in these markets will exceed those of recent years. A further series of markets, such as Sweden, Ireland and Spain are also expected to generate strong, double-digit, returns. Chart 20: Estimated All Property Total Returns for Major Global Direct Real Estate

Markets, 2001- 06 and 2007

Source: RREEF Research; IPD; NCREIF

Note 1: Average annual unleveraged market returns for Direct Real Estate Note 2: Size of bubble represents the size of the market

Beyond 2007, the prospects for returns are less favourable for a range of factors. First, cap rate levels have already become low in both absolute terms and relative to history.

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… but return prospects weaken towards the end of the decade.

Second, the rise in short and long term interest rates will narrow spreads with cap rates. The latter becomes more imminent particularly if stronger than expected economic growth or further oil price shock accelerates inflation, and, hence, interest rates. Third, the rent recovery will be relatively weak given the increase in supply and as markets move into an ex-growth phase. Fourth, the recent strong performance of the stock market will increase investor confidence in the broader equity market compared with real estate. The combination of these factors suggests that total returns will revert to average long run levels, certainly by the end of the decade. The key issue facing markets around the world is how this reversion takes place. At present, the signs of some stabilisation in cap rates coupled with continuing strong weight of capital and growth in incomes suggest there could be “soft landing” during 2008 and 2009. Although this remains the most likely scenario, there is an increasing risk that the four factors identified above could lead to a sharp reduction in returns, with potential value losses in a number of markets, before the end of the decade. These are obviously key issues for real estate markets, and investors, around the world. Future editions of this “Global Real Estate Investment and Performance” publication will provide further analysis of how these scenarios are likely to unfold.

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Appendix: Construction of Aggregate Total Return Series for Direct Real Estate and Real Estate Securities

Direct Real Estate All-Property Total Return Aggregates

Due to differences in the length of the time series for the individual countries’ total returns, RREEF Research has back-cast some of them to 1990. The countries for which their series have been back-cast are: Germany, France, the Netherlands, Spain, Italy, Sweden and Japan. More detailed information on back-casting methodology for total returns can be found in RREEF’s forthcoming Global Total Returns research paper.

Table 5: Total Returns Back-cast Period by Country

Key to back-castingCountry PeriodGermany 90 - 95Spain 90 - 00France 90- 97Italy 90 - 02Netherlands 90 - 94Sweden 90 - 96Japan 90 - 02

Source: RREEF Research

Regional aggregates of total returns have been weighted by using RREEF’s invested stock estimates for 2006. The latter show the size of the investable stock that has been used for investment purposes. In other words, this excludes owner-occupied properties. According to our estimates, Europe forms roughly 30% of the global market, North America 55%, and Asia 15%.

RREEF North America Direct Total Returns is constructed as the aggregate market performance weighted by market size for Canada and the United States.

Western Europe has been used as a proxy for Europe direct RE returns. This has been constructed as an aggregate market performance weighted by market size for Germany, Spain, the Netherlands, Sweden, France, Ireland, Italy, and the UK. Analysis has shown that Western Europe’s performance moves similarly to IPD’s Pan-European performance index. The latter comprises the same countries as well as Finland, Norway, Denmark, Portugal, and Switzerland.

RREEF Asia Direct Total Returns is constructed as the aggregate market performance weighted by market size for Australia, New Zealand, and Japan.

RREEF Global Direct Total Returns is constructed as the aggregate market performance weighted by market size for North America, Western Europe, and Asia.

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ANALYST CERTIFICATION The views expressed in this report accurately reflect the personal views of the undersigned lead analyst. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. (Signed) Peter Hobbs

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Important disclosure

© 2007. All rights reserved. RREEF is the brand name of the real estate and infrastructure division for the asset management activities of Deutsche Bank AG. In the US this relates to the asset management activities of RREEF America L.L.C.; in Australia: Deutsche Asset Management (Australia) Limited (ABN 11 076 098 596) Australian Financial Services licence holder; in Hong Kong: Deutsche Asset Management (Hong Kong) Limited (“DeAMHK”); in Japan: Deutsche Securities Inc.; and in the United Kingdom: RREEF Limited, Deutsche Asset Management (UK) Limited and DWS Investment Trust Managers Limited; in addition to other regional entities in the Deutsche Bank Group. RREEF offers a diverse menu of investment options, including: separate accounts, core and value-added private investment vehicles and investments in publicly-traded real estate securities. We also have an extensive track record in the property re-assignment business. An investment in real estate involves a high degree of risk and is suitable only for sophisticated investors who can bear substantial investment losses. This material is for wholesale investors only and is intended for information purposes only and does not constitute investment advice or a recommendation or an offer or solicitation and is not the basis for any contract to purchase or sell any security or other instrument, or for Deutsche Bank to enter into or arrange any type of transaction as a consequence of any information contained herein. Reference to specific companies are being shown to relate regional employment to real estate prospects in the area and should not be considered a recommendation for such a company. RREEF Research is a department within RREEF. To the extent permitted by applicable law, no member of the Deutsche Bank group, or the Issuer of this document or any officer, employee or associate of them accepts any liability whatsoever for any direct or consequential loss arising from any use of this presentation or its contents, including for negligence. Although the information contained in the material has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. Opinions expressed are our present opinions only, reflecting prevailing market conditions and are subject to change. Opinions and estimates involve a number of assumptions which may not prove valid and may be changed without notice. In preparing this material, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. Neither this material, nor any of its contents, may be used for any purpose without the consent and knowledge of RREEF. Past performance is not indicative of future results. For Investors in the United Kingdom: Issued in the United Kingdom by RREEF Limited. Authorised and regulated by the Financial Services Authority. This document is directed only at persons falling within the following exemptions from s.21 of the United Kingdom Financial Services and Markets Act 2000 (“FSMA”): (i) authorised firms under FSMA and certain other investment professionals falling within article 19 of the FSMA (Financial Promotion) Order, (the “FPO”); (ii) high net worth entities (not individuals) falling within article 49 FPO; and (iii) persons who receive this document outside the United Kingdom. The distribution of this document in the United Kingdom to anyone not falling within the foregoing categories is not permitted by the Issuer and may contravene FSMA. No one in the United Kingdom who is not either a high net worth entity or person with professional experience in matters relating to investments as referred to in the foregoing should treat this document as constituting a promotion to him, or act on it for any purpose whatsoever. For Investors in Australia and Hong Kong: An investment with RREEF is not a deposit with or any other type of liability of Deutsche Bank AG ARBN 064 165 162, Deutsche Asset Management (Australia) Limited or Deutsche Asset Management (Hong Kong) Limited or any other member of the Deutsche Bank AG Group and the capital value of and performance of an investment with RREEF is not in any way guaranteed by Deutsche Bank AG, Deutsche Asset Management (Australia) Limited or Deutsche Asset Management (Hong Kong) Limited or any other member of the Deutsche Bank AG Group. Investments are subject to investment risk, including possible delays in repayment and loss of income and principal invested. For Investors in Dubai: This information has been provided to you by Deutsche Bank AG Dubai branch, an Authorised Firm regulated by the Dubai Financial Services Authority. It is solely directed at wholesale clients of Deutsche Bank AG Dubai branch, who Deutsche Bank AG Dubai branch is satisfied meet the regulatory criteria as established by the Dubai Financial Services Authority.

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global real estate investment and performance 2006 and 2007

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