Real Estate Valuation and CRE Market Trends

Georgia Banking SchoolUniversity of GeorgiaMay 8th, 2017

Cal Evans

CRE Market Intelligence Director

Synovus Financial Corp.

calevans@synovus.com

#1 Rule: ASK QUESTIONS!

1) If you are thinking it, someone else is too; help yourself and your classmate2) As my wife will attest I am definitely not psychic, so ask the question

3) Question Quid Pro Quo

There Are Many More Dumb Answers than Questions!

This Could Be More Brilliant than Dumb…

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

• Commercial Real Estate Trends

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

Sources and Types of CRE Financing

• 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

• 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 Feepaid 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

• 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

• 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

• 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-Chi Phi House at UGA example

• Inherent Factors in HBU:

– Time

– Location

– Utility Factors

– Government Regulations

Source: Farren, Highest and Best Use

Highest and Best Use

CRE Valuation Roller Coaster 2000-2016

• 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:

• 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

• 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

𝑪𝒂𝒑𝒊𝒕𝒂𝒍𝒊𝒛𝒂𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒆 =

𝑳𝒐𝒂𝒏 𝒕𝒐 𝑽𝒂𝒍𝒖𝒆 % ∗ 𝒀𝒊𝒆𝒍𝒅 𝒕𝒐 𝑩𝒂𝒏𝒌+

𝑬𝒒𝒖𝒊𝒕𝒚 % ∗ 𝒀𝒊𝒆𝒍𝒅 𝒕𝒐 𝑩𝒐𝒓𝒓𝒐𝒘𝒆𝒓

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

Capitalization Rate Formula for Leveraged Transaction

• 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

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

Average Cap Rate History Chart: All CRE, 4Q08-1Q17

Cap Rate Movements: Multi, CBD Off, Ind/WH, Retail

Value to Investor = Net Operating Income/Capitalization Rate

Peak Loss from Cap Rate Increases in Recession

Source: PWC

Value Index Movements: Multi, CBD Off, Ind/WH, Retail

• 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

• EVEN LOWER VALUES FOR COMMERCIAL REAL ESTATE

Back to the Income Approach: Recession 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

2017 2018 2019

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

• Development Approach

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

– Used for residential/commercial subdivisions, condoprojects

– Sometimes called subdivision analysis

Other Income Approach Subtypes

• Based on the premise that an informed purchaser wouldpay no more for a property than the cost of acquiring aproperty 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 largenumber of relatively homogenous sales

Sales Comparison (Market Data) Approach

The Cost Approach

• Based on the proposition that the informed purchaser wouldpay no more than the cost of producing a substitute propertywith 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 intoaccount the different approaches used in the appraisal

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

• As-Is Value

• As-Completed Value

• As Stabilized Value

The Final Value in an Appraisal

• 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 (Optional)

CRE Underwriting Example: Typical Class A Multifamily

• 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 thesame 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

Commercial Real Estate Market Review and Forecast

Georgia Banking SchoolUniversity of GeorgiaMay 8th, 2017

Where Are We Now?: Report Headlines Tell the Story

RERC 2016 Report Titles

RERC 1Q16: Spotlight on Values

RERC 2Q16: The Beat Goes On-Instability Creates Stability

RERC 3Q16: Adjusting Expectations

RERC 4Q16: Aligning to New Realities

PWC 2016-2017 Report Titles

PWC 1Q16: Time to Wave the Caution Flag?

PWC 2Q16: Stabilizing Values May Signal End of Expansion

PWC 3Q16: Playing for Advantage, Guarding the Flank

PWC 4Q16: Staying Disciplined in a Competitive Market

PWC 1Q17: Unknowns Create Hesitancy in the MarketplaceA good bit of the change has to do with the guy on the right, or it will; the question is when and how much!

• Tax Reform, aka the Brady/Ryan Plan

Tax Reform:Individual tax rates would be lowered in most instances, allowable itemized deductions would be greatly reduced (deductions for mortgage interest and charitable donations would remain), and the tax code would be simplified.

Corporate tax rates would be lowered, investments could be immediately expensed, interest expense would not be deductible, and a Border Adjustment Tax would be implemented. The BAT would tax imported inputs and goods but would not tax exported goods or components; this rewards companies who produce domestically and export goods and services. Conversely, it is punitive to companies that import goods for sale or import components that are produced abroad and then assembled domestically to be sold as a finished product. In theory, ForEx dynamics would strengthen the dollar as more US dollars are demanded to buy the initially cheaper US produced and denominated good; once the dollar has adjusted, most trade advantage goes away.

Short version-if you export, great; if you import, you are screwed!

The Trump Effect: Four Elements that Could Affect CRE

• Repeal of Obamacare/ACA with American Health Care Act

• AHCA:

The AHCA eliminates penalties stemming from the individual mandate that citizens purchase health insurance and the employer mandate that large employers offer their employees health insurance coverage. It greatly reduces pricing and offering restrictions on insurance companies and, through a wide range of measures, shifts more of the economic impact of these changes to older non-group plan members from younger non-group plan members. It also caps certain areas of Medicaid and allows the states more latitude and control over their role in Medicaid allocations.

24 mm less insured by 2026, reduces Federal Deficit approximately $350B

https://www.washingtonpost.com/news/to-your-health/wp/2017/05/04/what-is-in-the-republican-health-care-bill-questions-and-answers-on-medicaid-preexisting-conditions-and-more/?utm_term=.441c64fc3cbb

The Trump Effect: Four Elements that Could Affect CRE

• 2018 Proposed Federal Budget

• 2018 Budget:

The 2018 budget, of the three items discussed here, is the most likely to change and the least well-defined. General measures regarding discretionary elements of the budget are as follows:

Environmental Protection Agency (-31%), State (-29%), Agriculture (21%), Labor (-21%), Health and Human Services (-18%), Commerce (-16%), Education (-14%), HUD (-13%), Transportation (-13%), Interior (-12%), Energy (-6%), SBA (-5%), Treasury (-4%), Justice (-4%), NASA (-1%), Veterans Affairs (+6%), Homeland Security (+7%), Defense (+9%)

This is the “Skinny Budget”-we don’t know what infrastructure would be expanded beyond the border wall

The Trump Effect: Four Elements that Could Affect CRE

The Trump Effect: Four Elements that Could Affect CRE

• Regulatory Rollbacks

• Commercial Bank– Construction Lending

– Mini-Perm Lending

– Concentration Issues

• Life Company

• Gov. Sponsored Enterprise– FNMA/FRMC or SBA

• CMBS/”Conduit” Lenders– Risk Retention Rules

– Basically switched w/banks

Data: Real Capital Analytics

Regulatory Rollbacks: Bank Share of Total CRE Debt

Data: FRB Board of Governors/ATL FRB Risk Analytics 3.2017

Capitalization Rates

CBRE Semiannual Cap Rate Survey:

http://www.cbre.us/research/2016-U-S-Reports/Pages/H2-2016-North-America-Cap-Rate-Survey.aspx

𝑪𝒂𝒑𝒊𝒕𝒂𝒍𝒊𝒛𝒂𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒆 =

𝑳𝒐𝒂𝒏 𝒕𝒐 𝑽𝒂𝒍𝒖𝒆 % ∗ 𝒀𝒊𝒆𝒍𝒅 𝒕𝒐 𝑩𝒂𝒏𝒌+

𝑬𝒒𝒖𝒊𝒕𝒚 % ∗ 𝒀𝒊𝒆𝒍𝒅 𝒕𝒐 𝑩𝒐𝒓𝒓𝒐𝒘𝒆𝒓

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

Capitalization Rate Formula for Leveraged Transaction

Average Investment Grade Cap Rates: All CRE 4Q08-1Q17

Data: PWC 3.2017

Cap Rate vs. Ten Year Yield Spread

0

100

200

300

400

500

600

700

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

'10 '11 '12 '13 '14 '15 '16

10yr UST* Cap Rate** Spread (bps)

Data: Real Capital Analytics 3.2017

RERC SE Cap Rates vs. TNX: 2006, Before, and After Election

Data: RERC 3.2017

1.5X

2.0X

Multifamily Example: 106 bps “less risky” than 2006

Data: RERC 3.2017

259 bps

365 bps

• A Few Different Opinions I Have Seen:

– Positive correlation that shows up 18 months after yield movements (too late!)

– No correlation at all

– Relatively quick impact but only accounts for 30% of cap rate movement √

– Is correlated but influenced by Fed Monetary Policy of late and becomes more correlated as we normalize rates √

• Look to Bank Rates/Cost of Borrowing to Find Effects

Effect of Ten Year Yield on Cap Rates?

Why Do Caps Continue to Drag?

From CBRE Survey Link at Section Start Page

Acquisitions increase in secondary and tertiary markets, yield gap narrows

Decreased Deal Volume: Across Property Spectrum

• January 2017: -54% YOY

• February 2017: -22% YOY

• March (1Q17): -18% YOY

• Bid/Ask Gap between sellers and buyers is very wide

• Sales that are occurring are generally happening at low caps; repricing at year end added about 25 bps to multi

Data: Real Capital Analytics 3.2017

All*

0

20

40

60

80

100

120

140

160

180

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17

$b Individual Portfolio Entity

-100%

-50%

0%

50%

100%

150%

200%

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17

YoY Change

The Influence of International Capital on Cap Rates

International Acquisitions Approximately 40% Industrial/35% Office

Currency Issues: Asset Preservation/Dollar Denominated Returns

FIRPTA 1980: Extension of exceptions for foreign retirement/pension

Composition of Buyers

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

Cross-Border Inst'l/Eq Fund Listed/REITs Private User/other

Data: Real Capital Analytics 3.2017

So What Gives? Cap Rates Are a Mixed Bag…

• Cap rates are at or below historical pre-recession lows. In gateway, primary, and better secondary markets, international capital inflows have caused pricing distortions; in most markets, value increases are driven by demand more than operational gains.

• Relative to comparable pre-recession lows, spreads between cap rates and the ten year Treasury yield are roughly 1.5x prior levels, showing higher built-in risk premiums. Increases in bank rates are moving in step with Treasury yields now; the market is adjusting to increased risk through pricing and stricter underwriting standards.

• CRE sales volume is down from 2015 and 2016 but the quality of the assets being traded has not decreased; this shows some restraint and a general cognizance of market fundamentals and conditions

• Yellen: “There are areas…where price to rent are very high and cap rates very low. That’s something that has caught our attention….while values are high, we are seeing some tightening of lending standards and less debt growth” -FRB CRE Commentary, October 2016

2017 2018 2019

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

Core Property Sectors and Subtypes

Characteristics, Market Trends, and Analysis

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

Subscribe to the Axiometrics Multifamily Blog Here:

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

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

Baby Boomer Demand for Multifamily

Source: PWC

Completions as % of Existing Inventory (FRB)

Largest Office Component is Renovation!

Southeastern Markets with High % of Multi Inventory

Multifamily Supply and Pricing: National Level

2015 Deliveries: 267k 2016 Deliveries: 331k 2017FC Deliveries: 272k

National Vacancy Projected in 5% to 6% Range Through 2021

National Rent Change 4% to 5% 2014-2016, 2-3% in 2017

2015-2016: Class Performance Bifurcation in MSAs

Source: REIS

2017: Do We See Adjustments to Class Bifurcation?

Data: Axiometrics 2.2017

1: A/B Twist

2: A Troughs,Concessions

3: A/B Normalize

How Do We Check for Oversupply?

We can look at multifamily permits as an indicator of future supply and non-farm job growth as an indicator of future demand.

1 year lag Permits 1 year lag Permits

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

MSA

4Q16 YOY Non-

Farm Job

Growth

4Q15 YTD

Multifamily

Permits

YE16 YOY Jobs:

YE15 Permits

Axio 2017 FC

Job Growth

4Q16 YTD

Multifamily

Permits

2017 FC Jobs:

2016 Permits

Athens* 2,625 591 4.44 1,900 31 61.29 ↑

Atlanta 85,675 9,929 8.63 73,000 13,040 5.60 ↓

Augusta 4,725 364 12.98 3,100 340 9.12 ↓

Austin 36,883 10,047 3.67 25,400 8,385 3.03 ↓

Birmingham 4,600 1,174 3.92 3,900 762 5.12 ↑

Charleston 11,975 1,647 7.27 7,300 2,150 3.40 ↓

Charlotte 40,650 6,861 5.92 23,800 6,293 3.78 ↓

Chattanooga 6,233 298 20.92 4,200 665 6.32 ↓

Columbia 7,392 898 8.23 4,400 711 6.19 ↓

Columbus (392) 551 -0.71 1,000 262 3.82 ↑

Dallas 93,192 27,618 3.37 83,600 25,187 3.32 ↓

Greenville 7,792 2,043 3.81 4,900 1,200 4.08 ↑

Houston 4,700 19,884 0.24 28,900 9,070 3.19 ↑

Huntsville 5,300 466 11.37 2,900 672 4.32 ↓

Jacksonville 21,267 2,320 9.17 17,800 3,044 5.85 ↓

Miami 74,317 15,745 4.72 34,600 11,699 2.96 ↓

Nashville 35,033 6,881 5.09 22,000 6,395 3.44 ↓

Orlando 48,508 7,621 6.37 43,100 8,627 5.00 ↓

Raleigh 21,075 3,267 6.45 14,900 4,037 3.69 ↓

Durham 7,192 1,762 4.08 4,700 1,403 3.35 ↓

Savannah 4,000 109 36.70 4,300 196 21.94 ↓

Tampa 45,867 6,044 7.59 27,900 6,332 4.41 ↓

Tuscaloosa* 417 255 1.63 N/A 871 N/A

*Heavy Student Housing in permit numbers >=6 >=6

>=4 but <=6 >=4 but <=6

<4 <4

Data: BLS, Census Bureau 3.2017 Update

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

• Rent growth has peaked or will peak

• Occupancies have peaked or will peak

• Pace of Expense Growth will or does exceed rent growth

• Cap rates have bottomed out or will bottom out

• 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 2017-2018?

OfficeSlimming Down and Getting Healthy!

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

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

Demand Slimming Down in Office Sector

Regular Office: Tech, Efficiency, Preferences

Med Office: Tech, Government, Volume

Secular Downtrend in Office Demand: Nashville

Source: REIS

The Old “Dallas” Office…

Large enough to have a drink, watch a non-flat screen TV, or even fight your brother

The New Dallas Office: Use as a Check on Oversupply

Data: REIS 12.2016

Office Sector Investment Outlook

Value Index Growth for CBD and Suburban Office

Demographics, Insureds, & Spending Support Medical Office

• Demand for new medical office space has increased as hospitals and medical groups consolidate assets on central campuses; additionally, satellite care centers that feed central locations are more common

• Office vintage has become increasingly important, particularly in medical facilities, as older offices do not have the technological infrastructure or size to accommodate current demand patterns

• 40% of all 2014 ACA New Insureds Came from Southeastern US and Texas

Not Just Med Office: ‘05 vs. ‘14 Real Dollars

Hospitals

Med Office

Retail Drug

Senior Housing

How Has the Economy Changed the Office Sector?

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

• Technology has limited the need for equipment space

• Expense control has necessitated consolidations in area

• Preferences may lead to non-office workspaces; shared “office hotels”, work-at-home

• Government policies have resulted in lower reimbursements for medical providers, which has caused a reboot of the way physicians operate

Retail and WarehouseEvolution of Supply and Demand

Subscribe to the Retail Dive Here:

http://www.retaildive.com/

Blurred Lines in Distribution and Retail: Omnichannel

E-Commerce Growth Past 8Q:

4Q16: 1.9%

3Q16: 4.0%

2Q16: 4.5%

1Q16: 4.0%

2015: 14.5% YOY

Redefining Retail and Warehouse: E-Commerce

• Traditional big box retailers, mall department stores, and large national discount stores are wrestling with implementing omnichannel distribution strategies and reconfiguring store templates in order to compete with Amazon and other e-tailers

• There is a movement towards restructuring tenant composition to include more service providers such as restaurants, health, and cellular tenants; historically these have been riskier tenants that are more prone to shock from a downturn

• 2016 represented a high water mark in retail innovation (new store templates, development of experiential concepts in selling, overhaul of traditional distribution strategies) which will continue throughout the coming years

Source: US Census 2Q16 E-Commerce Report

Columbus Macon Rd K-Mart: T Minus Five Days to Close

Why I Won’t Miss that K-Mart: 1979 Kidnapping

Very Limited Retail Construction Growth

2017 Announced Retail Closings

Tenant: 2017 Announced Closings Future Possible

JC Penney 135

Macys 68 30

Sears 200

K-Mart 108

HH Gregg 220

HH Gregg Distribution Centers 3

Office Depot 300 over next three years

Abercrombie and Fitch 60

Kenneth Cole 63

Crocs 160

The Limited* 250

Wet Seal* 171

American Apparel* 110

BCBG Max Azaria 210

CVS 70

Family Christian Bookstores* 240

Radio Shack* 185

Gander Mountain* 32 more coming

Gordmans* 106

Staples 70

Payless* 400 600

Bebe** 173

Game Stop 150

Finish Line 24 20

Ralph Lauren** 1 50

Bob's/Eastern Outfitters* 48

Gymboree* 1300

Claire's ?

Pier One 25

Rue 21* 400

*filed/filing/looking to file bankruptcy

** exploring alternatives, plan to close retail locations

Since October:

89,000 Retail Jobs Lost

45,000 from Department Stores!

Most of the job losses from the closures in the

chart have not materialized

Biggest Money Maker in Retail Makes These Signs

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 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!

Amazon Delivers Beer and Wine: My Town is Set!

General Observations: Warehouse Overlap with Retail• Given the torrid pace of logistics and distribution channel development driven by customer demand for

faster delivery times, warehouse demand has surged in larger port and inland port markets; this has spurred speculative development in some markets. However, overall global and national shipping volume has declined in 2016 in line with generally tepid global economic growth

• Warehouse and distribution facilities represent the bulk of total CRE product in the planning stage; larger inland ports such as Atlanta and Dallas have over 25mm square feet of warehouse space in planning

• The push for faster delivery times will result in the demand for new, smaller distribution facilities located in or near population centers. These are sometimes called “Last Mile” distribution

• Opportunities – Credit tenants, warehouses/distribution centers serving ports or logistic hubs, and self-storage facilities in areas of high baby boomer and millennial demand

• Caution - Older warehouse/industrial facilities that cannot accommodate the demands of current logistics networks or modern manufacturing requirements

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

Subscribe to Hotel News Now Here:

http://www.hotelnewsnow.com/

Hotel Cycle: Record Run of Six Year Gains Ends in 2017?

Revenue per Available Room (RevPAR) = Occupancy * ADR

Hotel Supply and Demand: About 3 Year Lag

February 2017:Supply + 1.9%

Demand + 1.4%

Top 25 T12 Occupancy/ADR Growth Jan 16 vs. Mar 17

Military Markets performed well in ‘16

Georgia T12 Occupancy/ADR Growth Jan 16 vs. Mar 17

Military Markets performed well in ‘16

Augusta

Columbus

Negative Trending in Occupancy Growth

Revenue per Available Room (RevPAR) = Occupancy * ADR

Average Daily Rate Still Relatively Healthy

Revenue per Available Room (RevPAR) = Occupancy * ADR

Occupancy x Average Daily Rate = RevPAR

Hotel Cap Rates by Segment

• 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 2017-2018, but should see the cycle inflection point

Observations on the Hotel Industry

Multiple factors will determine how quickly this cycle ends, most importantly how much can get done in DC and when!

• Multifamily:– In general, no component of the value equation favors appreciation

• Office:– Secular downtrend portends lower demand, banks wary of construction timing

with cycle length, tech leading to renovations of best locations

• Retail:– The best omnichannel retailers will hang in with Amazon, weaker retailers will

be culled out, B-/C malls in trouble

• Warehouse/Logistics:– Overall probably best sector but limited to port/infrastructure resources; could

benefit most from progress in Washington

• Hotel:– Cresting cycle points downward; would benefit greatly from corporate

tax relief and a weaker dollar

Thoughts on 2017-2018

Unemployment Rate (Seasonally Smoothed) Bureau of Labor Statistics https://www.bls.gov/lau/metrossa.htm

MSA Average Weekly Earnings (NSA) BLS http://www.bls.gov/sae/tables.htm Table D-6

Employment (Seasonally Smoothed) Bureau of Labor Statistics https://www.bls.gov/lau/metrossa.htm

Labor Force (Seasonally Smoothed) Bureau of Labor Statistics https://www.bls.gov/lau/metrossa.htm

Previous Year Emp Change Actual CES http://www.deptofnumbers.com/employment/georgia/atlanta/

Employment Change United States Conference of Mayors http://www.usmayors.org/metroeconomies/

GMP Change United States Conference of Mayors http://www.usmayors.org/metroeconomies/

Population Change SNL https://www.snl.com/interactivex/DemographicsData.aspx?National=ON&ViewBy=0&Refreshed=1&State=0

Mining and Logging Bureau of Labor Statistics http://www.bls.gov/eag/

Construction Bureau of Labor Statistics http://www.bls.gov/eag/

Manufacturing Bureau of Labor Statistics http://www.bls.gov/eag/

Trade, Trans, & Utilities Bureau of Labor Statistics http://www.bls.gov/eag/

Information Bureau of Labor Statistics http://www.bls.gov/eag/

Financial Activities Bureau of Labor Statistics http://www.bls.gov/eag/

Professional & Business Svs Bureau of Labor Statistics http://www.bls.gov/eag/

Education/Health Bureau of Labor Statistics http://www.bls.gov/eag/

Leisure/Hospitality Bureau of Labor Statistics http://www.bls.gov/eag/

Government Bureau of Labor Statistics http://www.bls.gov/eag/

Median Home Price National Association of Realtors http://www.realtor.org/topics/metropolitan-median-area-prices-and-affordability/data

Single Family Permits YTD US Census Bureau https://www.census.gov/construction/bps/msamonthly.html

Multifamily Permits YTD US Census Bureau https://www.census.gov/construction/bps/msamonthly.html

Home Ownership Rate US Census Bureau Homeownership Rates for Top 75 MSA http://www.census.gov/housing/hvs/data/rates.html

FHFA ∆ MSA House Price Index FHFA House Price Index http://www.fhfa.gov/DataTools/Tools/Pages/House-Price-Index-(HPI).aspx

Free MSA Data Metrics: click on links to access

Synovus CRE Market Intelligence1111 Bay Avenue Suite 501

Columbus, GA 31902

Cal Evans

calevans@synovus.com

706-644-8084

REQUIRED RATES OF RETURN

1Q 2017

®

Sneak Peek

1Q 2017

SitusRERC.com Situs.com © 2017 RERC LLC. All rights reserved.2

REAL ESTATE REPORT

Required Rates of Return — 1Q 2017

Situs RERC’s required pre-tax yield rates increased or remained the same for the majority of property sectors during first quarter 2017, with the exception of the neighborhood/community retail sector (see table on the next page). In particular, the rates for the industrial warehouse and R&D sectors rose 20 basis points, while the suburban office, regional retail mall and hotel sector rates increased 10 basis points. Rates were stable for the CBD office, industrial flex, retail power center, apartment and student housing sectors during first quarter 2017. According to Situs RERC’s his-torical records, first-quarter 2017 rates for the majority of the property sectors (except the regional retail mall and hotel sectors) remained lower than pre-crisis rates.

Situs RERC’s required going-in cap rates increased for both office sectors and the industrial flex sector during first quarter 2017, while the rates for the industrial warehouse and apartment sectors were unchanged. In com-parison, the cap rates for the industrial R&D sector, all three retail sectors, the hotel sector and the student housing sector decreased, according to respondents. Notably, the retail power center and student housing sec-tor cap rates fell 30 basis points quarter-to-quarter. Situs RERC’s historical records going back to third quarter 1992 show that the industrial R&D sector cap rate has never been this low.

In comparison, Situs RERC’s required terminal cap rates decreased for the majority of property sectors during first quarter 2017. The exceptions were the CBD office sector cap rate, which increased 10 basis points, and the industrial R&D and flex sector cap rates, which were unchanged from the previous quarter.

During first quarter 2017, Situs RERC’s expected rental growth rates were unchanged for the suburban office sector, all three industrial sectors, neighborhood/community retail sector and student housing sector. Nota-bly, the retail power center rate jumped 30 basis points from the previous quarter. However, rates declined for the CBD office, regional retail mall, apartment and hotel sectors.

Situs RERC’s expected expense growth rates for all of the property sectors during first quarter 2017 increased between 10 basis points and 20 basis points. While rates for both office sectors and all three industrial sectors were at 2.8 percent, rates for all three retail sectors, the apartment sec-tor, the student housing sector and the hotel sector were at 2.9 percent.

Conclusion: Required going-in cap rate compression has been a popular topic in the CRE world in recent quarters as economists and market par-ticipants alike have been placing bets on when required cap rates will find a floor. In the case of the CBD and suburban office sectors and the indus-trial flex sector, required cap rates may have already found their floor, as rates increased in first quarter 2017. While the required going-in cap rates for several property sectors did compress for another consecutive quar-ter, there is little to no doubt that rates are decreasing at a slower rate. The question remains, how much runway is left for rates?

1Q 2017

SitusRERC.com Situs.com © 2017 RERC LLC. All rights reserved.3

REAL ESTATE REPORT

Situs RERC Required Return Expectations1 by Property Type – 1Q 2017

Office Industrial RetailApartment Student

Housing Hotel Average All Types

Situs RERC

Portfolio Index5CBD Suburban Ware-

house R&D Flex Regional Mall

Power Center

Neigh/Comm

Pre-tax Yield Rate (IRR) (%)

Range2 5.3 - 10.0 7.0 - 10.0 5.8 - 10.0 7.0 - 10.0 7.0 - 9.8 6.0 - 9.0 6.5 - 10.0 5.8 - 8.5 5.8 - 9.0 7.3 - 8.8 9.0 - 11.0 5.3 - 11.0 5.3 - 11.0

Average2 7.4 8.3 7.4 8.2 8.3 7.7 8.0 7.27.2 7.8 9.9 7.9 7.6Weighted

Average3 7.8 7.5 7.6

BPS Change40 10 20 20 0 10 0 -10

0 0 10 0 1010 20 0

Going-In Cap Rate (%)

Range2 4.5 - 7.0 5.5 - 8.0 4.5 - 7.5 5.5 - 7.3 5.5 - 9.0 4.0 - 8.0 6.0 - 7.0 5.0 - 7.0 4.0 - 6.5 5.3 - 6.3 6.5 - 8.5 4.0 - 9.0 4.0 - 9.0

Average2 5.4 6.6 5.8 6.4 7.0 6.1 6.4 5.85.2 5.7 7.6 6.2 5.8Weighted

Average3 5.9 5.9 6.1

BPS Change410 10 0 -10 20 -10 -30 -20

0 -30 -10 0 010 0 -10

Terminal Cap Rate (%)

Range2 5.0 - 7.5 6.3 - 8.5 5.0 - 7.5 6.0 - 8.0 6.0 - 9.5 4.5 - 8.5 6.5 - 7.5 5.5 - 7.8 4.3 - 6.3 5.8 - 7.3 7.5 - 9.3 4.3 - 9.5 4.3 - 9.5

Average2 6.1 7.2 6.2 7.2 7.5 6.6 6.9 6.45.6 6.4 8.2 6.8 6.3Weighted

Average3 6.6 6.3 6.6

BPS Change410 -10 -10 0 0 -20 -30 -20

-10 -30 -20 -10 -1010 -10 -20

Rental Growth Rate (%)

Range2 2.0 - 4.0 2.0 - 3.5 2.5 - 4.0 2.0 - 4.0 1.5 - 4.0 1.5 - 4.0 2.0 - 3.5 2.0 - 3.0 1.5 - 4.0 2.4 - 3.0 1.0 - 3.0 1.0 - 4.0 1.0 - 4.0

Average2 2.8 2.6 3.0 2.8 2.7 2.8 2.8 2.8 2.9 2.8 2.3 2.8 2.8

BPS Change4 -10 0 0 0 0 -10 30 0 -10 0 -40 0 -10

Expense Growth Rate (%)

Range2 2.0 - 3.0 2.0 - 3.0 2.0 - 3.0 2.0 - 3.0 2.0 - 3.0 2.5 - 3.0 2.5 - 3.0 2.5 - 3.0 2.0 - 4.0 2.0 - 4.0 2.5 - 3.5 2.0 - 4.0 2.0 - 4.0

Average2 2.8 2.8 2.8 2.8 2.8 2.9 2.9 2.9 2.9 2.9 2.9 2.9 2.8

BPS Change4 10 20 10 20 20 20 20 10 10 20 10 20 101 This survey was conducted in January, February and March 2017 and reflects expected returns for first quarter 2017 investments. 2 Ranges and other data reflect the central tendencies of respondents; unusually high and low responses have been eliminated. 3 Weighting based upon 1Q17 NCREIF Portfolio market values, excluding student housing. 4 Change (+/-) in basis points (BPS) from quarter immediately preceding current rate.5 Excludes student housing. Source: Situs RERC Investment Survey, 1Q 2017.