sunnier days ahead? - federal reserve bank of …...july 2010 four markets $50 $75 200 300 al annual...

Sunnier Days Ahead?

AEW Real Estate Market Outlook1

This material has been prepared for the intended recipient and is for informational purposes only. This material may not be distributed, published or reproduced, in whole or in parts for parties other than the intended recipient without prior approval of AEW. Nothing contained herein shall constitute an offer to sell or solicitation of an offer. Any such offer will be made only to qualified investors pursuant to an offering document.

The U.S. Commercial Property Market Today

Transaction market coming back to life

Yield compression continues for “flight to quality” core properties

Deterioration in property market fundamentals slowing rapidly but NOI will not bottom for 12‐18 months

$1.5 trillion of loan maturities (or defaults) still expected over the next few years

“Extend and pretend” coming to an end?p g

“Weak hand” owners unable to hang on much longer


Transaction Market Improving From Low Levels

Transaction volume rising from depths of early 2009 but still at lowest

TOTAL TRANSACTION VOLUME

$150 600

still at lowest levels of past decade

$45.7 billion $100

$125

400

500

e, $Billion

s (Bar)

e, $Billion

s (Line)

$YTD through July 2010

Four markets $50

$75

200

300

al Ann

ual V

olum

e

ling 3‐Mo Volum

e

account for 30% of all trades: NYC, DC, LA and Chicago

$25 100

Tot

Rol

and Chicago$‐0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Retail Office Industrial Apartment Rolling 3‐Mo Total


Source: Real Capital Analytics

Core Pricing Responds to a World Without Yield

Investor demand for high quality yield growing as rates stay 8 50%

9.00%

AVERAGE CAP RATE (%)

as rates stay low and spreads narrow

7.50%

8.00%

8.50%

6.50%

7.00%

5.50%

6.00%

5.00%

2005 2006 2007 2008 2009 2010

Primary Secondary & Tertiary



Primary Secondary & Tertiary

Lower Cap Rates But Low Price Per Pound Too

Price per pound continues to trend down

PRICE PER FOOT/UNIT FOR PROPERTIES THAT TRADED

$120$300

Recent small increase in apartments reflecting

$80

$100

$200

$250

000s)

Foot

e ect gfavorable GSE financing and core buyer demand

$40

$60

$100

$150

Price Pe

r Unit (0

rice Per Squ

are F

$20

$40

$50

$100 P

Pr

$0$0



Industrial Office Retail Apartment (Right Scale)

Vacancy Rates Peaking

Hotel occupancy rates also bottoming now at all time low

VACANCY RATE BY PROPERTY TYPE

16.00

18.00

at all time low

Operating fundamentals stabilizing but

12.00

14.00

stabilizing but NOI decline continues for some time 8.00

10.00

2.00

4.00

6.00

0.00

Mar‐94

Sep‐94

Mar‐95

Sep‐95

Mar‐96

Sep‐96

Mar‐97

Sep‐97

Mar‐98

Sep‐98

Mar‐99

Sep‐99

Mar‐00

Sep‐00

Mar‐01

Sep‐01

Mar‐02

Sep‐02

Mar‐03

Sep‐03

Mar‐04

Sep‐04

Mar‐05

Sep‐05

Mar‐06

Sep‐06

Mar‐07

Sep‐07

Mar‐08

Sep‐08

Mar‐09

Sep‐09

Mar‐10

Sep‐10

Mar‐11

Sep‐11


Source: CBRE‐EA (Torto Wheaton Research)

Apartment Industrial Office Retail

Aggregate NOI Bottoms in 2011/2012

PEAK‐TO‐TROUGH DECLINE IN PROPERTY NOIINDEX 2007 Q4 = 100

105.0

Real estate is a lagging sector

NOI bottoms 12 36 h

100.0

12‐36 months after GDP and jobs

Jobs trail GDP

90.0

95.0 Jobs trail GDP

Occupancy trails jobs

85.0 Rents trail Occupancy

NOI t il R t80.0

Apartment Office Retail Warehouse

NOI trails Rent


Source: P&PR

Apartment Office Retail Warehouse

Deferred & Maturing Loans Hitting Right Now

Very few loans scheduled to mature in 2009 were resolved

NON‐BANK LOANS, $ BILLIONS

$180

$200

Becoming more difficult to extend

$120

$140

$160

$60

$80

$100

$0

$20

$40

$60

$0

Scheduled to Mature 2009S

Matured 2009

2010 2011 2012 2013 2014 2015 2016 2017

CMBS Agency Insurance Company Credit Company


Source: Mortgage Bankers Association

Very Little Resolved So Far

Resolution of troubled assets accelerating but long way to go

TROUBLED ASSETS ($ BILLIONS)

$300

go

$200

$250

$150

$50

$100

$0

Jan‐08 Jan‐09 Jan‐10

Troubled REO Restructured Resolved



Troubled REO Restructured Resolved

The End of “Extend and Pretend”?

Falling NOI forcing more properties into inadequate coverage

Debt service coverage reserves burningDebt service coverage reserves burning off at accelerating rate

Capital events (TI’s, leasing commissions) t b i f d d b “ k h d”not being funded by “weak hand” owners

Higher recovery rates giving lenders more courage to act

What will the banks do? How long will the government let them defer the problem?problem?


Great Variation by Lender

Across all lenders, 64% recovery rate on 2009 defaulted loans

RECOVERY RATES ON 2009 DEFAULTS

Development Loans

Acquisition and Re‐Fi Loansdefaulted loans

Recovery rates improving during 2010 –

CMBS 62%

Insurance Companies 79%

Regional/Local Banks 55% 73%during 2010 particularly on development loans

National Banks 53% 70%

Private Investors 32% 68%

Foreign Banks 60% 65%

Non‐Bank Financial 58% 68%



Weak Hands #1: The Banks

More than 800 banks on the FDIC “watch list”

NUMBER OF FAILED BANKS

800

900

FDIC reports nearly 3,000 banks with commercial real estate exposure

600

700

estate exposure > 300% of capital

Largest banks 300

400

500

gare now willing to work with fresh equity investors, smaller banks

100

200

300

smaller banks still in denial 0


Source: FDIC, As of July 2010

Weak Hands #2: The Servicers

More than 10% of CMBS loans now in special servicing

CONDUIT LOANS IN SPECIAL SERVICING

11.0%

12.0%

$90

$100

Small loans are less profitable to service

Servicers need 7 0%

8.0%

9.0%

10.0%

$60

$70

$80

Servicers need to clear “shelf space” for future defaults

4.0%

5.0%

6.0%

7.0%

$30

$40

$50

$

1.0%

2.0%

3.0%

$10

$20

$30

0.0%$0

Jan‐07

Mar‐07

May‐07

Jul‐0

7

Sep‐07

Nov

‐07

Jan‐08

Mar‐08

May‐08

Jul‐0

8

Sep‐08

Nov

‐08

Jan‐09

Mar‐09

May‐09

Jul‐0

9

Sep‐09

Nov

‐09

Jan‐10

Mar‐10

May‐10

Jul‐1

0

Unpaid Balance ($B) % of CMBS Total Delinquent (%)


Source: Realpoint LLC

Unpaid Balance ($B) % of CMBS Total Delinquent (%)

Institutional De-Leveraging Ahead?

60% of all NCREIF properties are leveraged with 65% LTV

AVERAGE LEVERAGE RATIO FOR PROPERTIES WITH LEVERAGE

70%

For apartments, 75% are leveraged and average leverage

50%

60%

g gratio is 75%

30%

40%

10%

20%

0%

Average Leverage Ratio Percentage of Properties With Leverage


Source: NCREIF

Average Leverage Ratio Percentage of Properties With Leverage

Will They Give the Properties Back?

>10% of leveraged NCREIF properties currently valued below the debt

AVERAGE LEVERAGE RATIO FOR PROPERTIES WITH LEVERAGE

35%

40%

below the debt

One‐third of leveraged properties have 25%

30%

35%

p pdebt above 80% of value

Two‐thirds of 15%

20%

leveraged properties have debt above 60% of value 5%

10%

0%

60% 80% 80% 100% 100%+


Source: NCREIF

60% ‐ 80% 80% ‐ 100% 100%+

Will Yield Compression Save the Day?

Cap rate spreads to Treasuries near all‐time highs

CAP RATES AND YIELDS (%)

10.00

11.00

7.00

8.00

9.00

4.00

5.00

6.00

??

1.00

2.00

3.00

0.00

1990

Q2

1990

Q4

1991

Q2

1991

Q4

1992

Q2

1992

Q4

1993

Q2

1993

Q4

1994

Q2

1994

Q4

1995

Q2

1995

Q4

1996

Q2

1996

Q4

1997

Q2

1997

Q4

1998

Q2

1998

Q4

1999

Q2

1999

Q4

2000

Q2

2000

Q4

2001

Q2

2001

Q4

2002

Q2

2002

Q4

2003

Q2

2003

Q4

2004

Q2

2004

Q4

2005

Q2

2005

Q4

2006

Q2

2006

Q4

2007

Q2

2007

Q4

2008

Q2

2008

Q4

2009

Q2

2009

Q4

2010

Q2


Source: BLS, Moody’s Economy.com, NCREIF

Ten‐Year Treasury Yield NCREIF Carrying Value Cap Rate NCREIF Transaction Cap Rate

Will Yield Compression Save the Day?CAP RATES (%) AND THE NET FLOW OF CAPITAL IN COMMERCIAL & MULTIFAMILY MORTGAGES

Real estate prices driven by availability of financing

(4 QUARTER MOVING AVERAGES)

$400

9%

10%

$200

$300

6%

7%

8%

$

$100

4%

5%

6%

$(100)

$‐

1%

2%

3%

$(200)0%

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Cap Rate Mortgage Flow


Source: NCREIF, Federal Reserve (Flow of Funds)

p g g

What are Institutional Investors Doing?

83% of North America institutional investors report that they are currently below their target allocation

51% report that they are likely to commit new capital to real estate over the next 12 months

63% targeting core/core plus strategies

Why core? 49% cite low risk, 40% cite stable incomeWhy core? 49% cite low risk, 40% cite stable income

Average time to reach final close on a private equity real estate fund:

– 9.8 months in 2006

– 19.7 months in 2009


Source: Prequin Investors Spotlight August 2010

Investment Environment Today

COREBuy expensive durable income and hope inflation and yields stay very low

VALUE‐ADDEDBuy cheap vacancy in anticipation of strong recovery in demand—if you buy vacancy, how cheap is cheap enough?

OPPORTUNISTICOPPORTUNISTICWork with owners or lenders to re‐cap existing high quality assets (broken capital structures, not broken assets)


h C lBrigham CircleREPRESENTATIVE CORE TRANSACTION

PROPERTY TYPE OffiPROPERTY TYPE Office

LOCATION Boston, Massachusetts

PROPERTY SIZE 199,488 square feet

YEAR BUILT 2003

ACQUISITION DATE March 2010

CURRENT VALUE $96.8 million ($485/sf)

INVESTMENT ATTRIBUTES

• Four‐story office/retail mixed‐use development

• Office component consisting of 124,774 sf is 100% occupied by Partners HealthCare through 2018

l l f f h k• Retail component totals 74,714 sf consisting of Stop&Shop supermarket, Walgreens and other neighborhood related stores

• Centrally located in Longwood Medical area, a dense urban section of Boston surrounded by medical institutes, colleges/universities and a large residential neighborhood

INVESTMENT STRATEGY

• Hold for the long‐term and benefit from strong economic drivers (education and healthcare) and above average NOI growth


As of June 30, 2010. Although this transactions represent the types that we may pursue in the future, no representation is made that similar opportunities will be available. There are no assurances that the investment will meet its objectives.

b d lLiberty Industrial CenterREPRESENTATIVE VALUE‐ADDED TRANSACTION

PROPERTY TYPE I d t i lPROPERTY TYPE Industrial

LOCATION Atlanta, Georgia

PROPERTY SIZE 851,349 square feet

YEAR BUILT/RENOVATED 2006U / O 006

ACQUISITION DATE February 2010

CURRENT VALUE $15.6 million

INVESTMENT ATTRIBUTESINVESTMENT ATTRIBUTES

• Well‐ located, state‐of‐the‐art, Class A industrial building located in an improving industrial market.

• Investment basis is approximately 60% of cost and substantially lower than competitive existing buildings.p g g

• Low investment basis provides flexibility in leasing space as well as downside protection.

INVESTMENT STRATEGY

• Acquire new Class A industrial building at a significant (40%) discount to replacement cost.

• Lease up vacant space over 30 month period at current market rents.


As of June 30, 2010. Although this transactions represent the types that we may pursue in the future, no representation is made that similar opportunities will be available. There are no assurances that the investment will meet its objectives.

lCypress HotelREPRESENTATIVE OPPORTUNISTIC TRANSACTION

PROPERTY TYPE H t lPROPERTY TYPE Hotel

LOCATION Cupertino, California/Silicon Valley

PROPERTY SIZE 224 rooms

YEAR BUILT 2002U 00

ACQUISITION DATE April 2010

CURRENT VALUE

INVESTMENT ATTRIBUTESINVESTMENT ATTRIBUTES

• Acquire high‐quality, well located hotel at substantial discount to replacement cost through the discounted acquisition of a mortgage loan and simultaneous transfer through friendly deed‐in‐lieu

• First‐class hotel located in in Cupertino in close proximity to numerous p p ycorporate demand generators including Apple Computer, HP, Cap Gemini and Trend Micro.

• Hotel should generate 10+% current unlevered return if hotel rates return to 2006/2007 levels

INVESTMENT STRATEGY

• Take advantage of distressed market conditions and capitalize on the asset’s strong position in the submarket in order to benefit from the market recovery


y

Biographical Information

MICHAEL J. ACTON, CFA

Managing Director

Michael J. Acton, CFA, is Director of Research for AEW Capital Management, L.P. with ibilit f di ti th ti iti f AEW R h th fi ’ hi hl d d i hresponsibility for directing the activities of AEW Research, the firm’s highly regarded in-house

research group. Mike joined the firm in 1990 and has over 24 years of experience as an economic analyst and forecaster. He chairs AEW’s Investment Policy Group and is a standing member of the firm’s Investment Committee and Management Committee. The resources of AEW Research are an integral part of AEW’s investment process and Mike works closely with senior professionals in all areas of the firm to develop investment strategies that match clients’ risk/reward objectives with market opportunities. Mike is also a member of the firm’s Compliance Committee and Risk Management Committee. Prior to joining AEW, he was with

Please feel free to contact Mike regarding any of the information

DRI/McGraw-Hill where he managed the Metropolitan Area Forecasting Service. He is a graduate of Bates College (B.A.) and a Chartered Financial Analyst.

the information contained herein

[email protected] or 617-261-9577


sunnier days ahead? - federal reserve bank of …...july 2010 four markets $50 $75 200 300 al annual...

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