there is a difference. wading through deep water: turmoil in the economy and capital markets western...
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There is a Difference.
Wading Through Deep Water: Turmoil in the Economy and Capital Markets Western States Commercial Real Estate FinanceMary K. Ludgin, PhDSeptember, 2008
2
Real Estate Values Being Pulled Multiple Ways
Sources of Downward Pressure
Economy in recession, job losses mounting, consumer and business sentiment plunging and outlook is weak
Decline in tenant space demand in primary sectors
Capital markets repricing risk
Credit crunch restricting debt capital availability
Mitigating Factors
Low vacancy rates for onset of recession
Low construction for onset of recession
Enormous fiscal and monetary stimulus
Market Conditions
3
Equity Real Estate Prospects:2008 vs Early 1990s
Market Conditions
1990 2008
Investor Double-digit returns, inflation Single-digit core returns, Expectationshedge, low volatility inflation hedge if markets in
balance, moderate volatility
Liquidity Deteriorating and no capital Deteriorating but capital availablefor some strategies
Institutional Undisciplined Debt side undisciplinedUnderwriting Equity side disciplined
Pricing Spread between NCREIF current valueSpread between NCREIF current valuecap rate of 6.97% and 10-Year cap rate of 5.61% and 10-Year Treasury Yield of 8.68% = -171 bps Treasury Yield of 4.26% = +135 bps
Property No link between supply and demand Demand and supply linkedMarket Office vacancy downtown: 14.0% Office vacancy downtown: 9.6%Conditions Office vacancy suburban: 21.2% Office vacancy suburban: 14.2%
OutcomeOutcome Value decline: 32%Value decline: 32% Value Decline: 15%-20%Value Decline: 15%-20%
Source: NCREIF; Moody’s Economy.com; Heitman ResearchSource: NCREIF; Moody’s Economy.com; Heitman Research
4
U.S. Economy in RecessionMarket Conditions
0.9%0.9%
3.3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
7%
8%Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Economy.com; Heitman Research
Gross Domestic Product, Inflation-Adjusted
U.S. 2001-2010
forecast
annualized % change
5
Sparked by Declining Home Values
5
Mountain
Pacific
Southwest Southeast
Mideast
Northeast
West North Central East North Central
Seattle, WA-7.1%
Portland, OR-5.8%
San Francisco, CA-23.7%
Los Angeles, CA-25.3%
San Diego, CA-24.2%
Denver, CO-4.7%
Dallas, TX-3.2%
Minneapolis, MN-13.9%
Chicago, IL-9.5%
Detroit, MI-16.3%
Cleveland, OH-7.3%
Miami, FL-28.3%
Tampa, FL-20.1%
Atlanta, GA-8.1%
Charlotte, NC-1.0%
Washington, DC-15.7%
New York, NY-7.3%
Monthly 20-City Composite -15.9%Monthly 10-City Composite -17.0%
Las Vegas, NV-28.6%
Phoenix, AZ-27.9%
As of June 30, 2008
Source: S&P/Case-Shiller
Boston, MA-5.2%
Market Conditions
Market Conditions
6
Job Losses Expected into 4th Quarter
Market Conditions
-200,000
-100,000
0
100,000
200,000
300,000
400,000J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D
2005 2006 2007 2008 2009 2010
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Source: Bureau of Labor Statistics; Economy.com; Heitman Research
Historical and Forecast Employment GrowthU.S. 2005-2010
forecastjobs created job growth
Pessimistic Case
Optimistic Case
7
Giving No Near-Term Lift for Housing Market
46,000
107,000
57,000
74,00081,000
140,000
60,000
41,000
-76,000-83,000-88,000
-67,000
-47,000-51,000-51,000
162,000
-150,000
-100,000
-50,000
0
50,000
100,000
150,000
200,000
Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul
2007 2008
4,000
4,500
5,000
5,500
6,000
6,500
7,000Employment Growth (L)
Total Home Sales (R)
x1,000monthly change
Employment Growth vs. Total Home SalesU.S. April 2007-July 2008
Source: Bureau of Labor Statistics; National Association of Realtors; U.S. Census Bureau; Heitman Research
Market Conditions
8
Conditions Vary Widely by MarketMarket Conditions
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
Job Growth July 2007-July 200850 Largest U.S. Metropolitan Areas
Source: Economy.com; Heitman Research
Austin
Houston
Dallas
Seattle
Washington, D.C.
Atlanta
Philadelphia
U.S. Average
Chicago
San Francisco
Phoenix
Detroit
New York City
Los Angeles
Miami
Boston
Riverside
Baltimore
Tampa
Denver
Orange Co.
Charlotte
9
And Could Improve Over Next Four Quarters
Market Conditions
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
Job Growth Forecast Q3 2008-Q3 200950 Largest U.S. Metropolitan Areas
Source: Economy.com; Heitman Research
Houston
Austin
Dallas
Seattle Washington, D.C.
AtlantaPhiladelphia
U.S. Average
Chicago
San Francisco
Phoenix
Detroit
New York City
Los Angeles
Miami
Boston
Riverside
Baltimore
Tampa
Denver
Orange Co.Charlotte
10
Consumers Encumbered by Mountain of Debt
Market Conditions
10.0
10.5
11.0
11.5
12.0
12.5
13.0
13.5
14.0
14.5
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
2011
2012
%
Debt Service Burden as a Percentage of Disposable Personal IncomeU.S. 1980-2012
Source: Economy.com; Heitman Research
forecast
11
Inflation has Added to Consumer Woes:But Picture May Be Brightening Some
Market Conditions
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Headline Inflation
Core Inflation
y-o-y change
Headline vs. Core InflationU.S. 2001-2010
Source: Economy.com; Heitman Research
forecast
12
Inflation Helped Restrain Development
Market Overview
12
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Industrial
Office
Retail
Apartment
Source: Torto Wheaton; CoStar; REIS; Heitman Research
New Supply as a Percentage of Existing StockU.S. 1988-2009
forecast
13
Loss of Debt Capital Causing Ripple Effect
Capital Markets
14
Showing Up in Huge Pull Back in Transactions
Capital Markets
77102
120
187
275
357
520
76.6
$0
$100
$200
$300
$400
$500
$600
2001 2002 2003 2004 2005 2006 2007 2008
Primary Property Type Transaction VolumeU.S. 2001-2008 Q2
Source: Real Capital Analytics; Heitman Research
Billions
Volume for f irst half of 2008 down 68% f rom
same period in 2007
15
Putting Pressure on Cap Rates
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
2001 2002 2003 2004 2005 2006 2007 2008
Apartment
Industrial
Office - CBD
Office - Suburban
Strip Retail
Capitalization RatesU.S. 2001-2008 (June)
Source: Real Capital Analytics; Heitman Research
Capital Markets
16
National Apartment Market Weakening
Apartment Overview
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 08
Effective Rent Growth vs. Apartment VacancyU.S. 1996-2008 Q2
Rent Growth
Vacancy
Source: Axiometrics; Heitman Research
6.6%
1.8%
17
Fewer Markets Seeing Above-Inflation Rent Growth
Market Overview
17
Effective Apartment Rent Growth
Q2 2007-Q2 2008
Columbus 1.9%Durham 1.9%Indianapolis 1.9%Baltimore 1.8%Kansas City 1.8%Raleigh 1.6% Denver 3.9%Santa Ana-Anaheim 1.5% Bethesda 3.5%Boulder 1.4% Dallas 3.4%Camden 1.3% Chicago 3.1%
New York -0.3% Detroit 1.3% San Diego 3.0%Providence, RI -0.4% Philadelphia 1.3% Washington, DC 2.9%Riverside-SB -1.2% Cincinnati 1.2% Albuquerque 2.8%Miami -1.3% Hartford 1.1% Austin 2.8%Fort Lauderdale -1.7% Nassau-Suffolk 1.1% Boston 2.8%Phoenix -1.9% Atlanta 0.8% Houston 2.8% Salt Lake City 8.9%Tampa -2.4% Los Angeles 0.8% Colorado Springs 2.7% Tacoma 8.0%Orlando -2.8% Memphis 0.7% Cambridge 2.6% San Jose 6.2%West Palm Beach -3.7% Tucson 0.6% San Antonio 2.6% San Francisco 5.9%Jacksonville -3.8% Charlotte 0.5% Edison 2.5% Seattle 4.9%Palm Bay -4.9% St. Louis 0.5% Warren 2.3% Nashville 4.8%Sarasota -7.0% Las Vegas 0.3% Savannah 2.2% Oklahoma City 4.8%Fort Myers -9.3% Minneapolis 0.3% Sacramento 2.1% Oakland 4.5%Naples -10.0% Lake County, IL 0.0% Cleveland 2.0% Portland 4.1% NONE!
10%+ growth
Source: Axiometrics Research; Heitman Research
Declining rents < 2.0% growth 2.0% to 3.9% growth 4.0% to 9.9% growth
18
211,271
187,818
164,070
141,782
126,914
101,474
89,333 88,038 86,220
98,452 98,911
0
50,000
100,000
150,000
200,000
250,000
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Units
Source: REIS; Heitman Research
Apartment CompletionsU.S. 1999-2009
forecast
Apartments Helped by Lack of Construction
Market Overview
18
19
Industrial Overview Pullback in Imports Affecting
Industrial
7.3
10.39.8
9.49.5
6.7
11.7
10.0
7.67.77.8
11.211.1
7.6
9.9
9.4 9.3 9.3
-200,000
-150,000
-100,000
-50,000
0
50,000
100,000
150,000
200,000
250,000
300,000
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007 Q2 Q3 Q4 Q1 Q2
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
Completions
Net Absorption
Availability Rate
Industrial Completions, Net Absorption, and AvailabilityU.S. 1995-2008 Q2
Source: Torto Wheaton Research; Heitman Research
sf x 1,000 Vacancy Rate (%)
2007 2008
20
Multiple Healthy MarketsMarket Overview
20
Industrial Market Vacancy Rates U.S. 2008 Q2
Washington, D.C. 12.4
Sacramento 12.0 KEY:Dallas 11.8 Sum of MarketsAustin 11.6 Diversified Industrial CtrsChicago 11.5 Locally Driven MarketsRaleigh 11.5 Major Logistics Hubs
Kansas City 7.5 Hartford 11.3
Orange County 7.5 Oakland 9.9 Edison 11.2
Houston 7.3 Nashville 9.8 St. Louis 11.1
Portland 7.3 Cleveland 9.7 Indianapolis 10.9 Boston 14.8
San Francisco 6.9 Fort Worth 9.6 San Jose 10.7 Baltimore 14.4
Albuquerque 6.7 Charlotte 9.2 Denver 10.5 Columbus 14.1
Las Vegas 6.7 Cincinnati 9.1 Market Avg. 10.3 Phoenix 13.7Seattle 6.6 Miami 9.0 Philadelphia 10.3 Pittsburgh 13.7
Tucson 6.2 Minneapolis 8.7 Orlando 10.2 Atlanta 13.3 Memphis 18.2
Salt Lake City 5.8 Newark 8.5 Jacksonville 10.1 Wilmington 12.7 Detroit 17.4
Los Angeles 5.4 Tampa 7.7 San Diego 10.1 Riverside 12.6 Stamford 15.4
Source: Torto Wheaton Research; Heitman Research
7.5% or less 15.1%+7.6%-10% 10.1%-12.5% 12.6%-15%
21
But Western Markets Under Greater Pressure
Market Overview
21
-70
60
90 100
150
440
530
-100
0
100
200
300
400
500
600
Seattle Oakland National Average Los Angeles Las Vegas Phoenix Riverside
Y-O-Y Vacancy Change
bps
Industrial Market Vacancy Rate ChangeSelected Markets Q2 2007 vs. Q2 2008
Source: Torto Wheaton; Heitman Research
22
Market Overview And Real Rent Growth Disappearing
22
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
6%
7%
8%
9%
10%
11%
12%
13%
Inflation-adjusted year-over-yearwarehouse rent growth (L)
Warehouse availability rate (R)
Forecast warehouse availability
Warehouse Real Rent Growth and AvailabilityU.S. 1990-2013
Source: Torto Wheaton Research; Heitman Research
forecast(Torto Wheaton)
23
Market Overview Drivers of East Coast Container
Growth
Suez Canal all-water routePort facility expansion
High transcon intermodal rail fees Panama Canal expansion23
24
13.212.9
12.512.512.5
15.4
16.5
13.9
12.2
9.9
14.1
16.8
8.6
12.613.6
8.9
9.5
12.5
-100,000
-75,000
-50,000
-25,000
0
25,000
50,000
75,000
100,000
125,000
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007 Q2 Q3 Q4 Q1 Q2
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
Completions
Net Absorption
Vacancy Rate
Office Completions, Net Absorption, and VacancyU.S. 1995-2008 Q2
Source: Torto Wheaton Research; Heitman Research
sf x 1,000Vacancy Rate (%)
2007 2008
Initial Signs of Softer Office MarketOffice Overview
25
Downtowns Much Healthier than Suburbs
25
Market Overview
0.0
5.0
10.0
15.0
20.0
25.0
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
YTD
2008
Source: Torto Wheaton; Heitman Research
%
Office Vacancy RatesU.S. 1988-2008 Q2
15.1%
9.8%
Suburban
CBD
26
Great Variability at Metro Level Market Overview
26
Office Market Vacancy Rates U.S. 2008 Q2
KEY:Boston 14.6 Primary Downtown Portland 14.6 Primary Suburban San Jose 14.4 Secondary MetroCleveland 14.2 National AveragesSan Diego 14.2
Orlando 14.1
Baltimore 12.5 Phoenix 14.1 Orange County 17.1
Los Angeles 12.5 Kansas City 14.0 Atlanta 16.7
Fort Worth 12.4 Sub. Maryland 14.0 Columbus 16.6
St. Louis 12.2 Cincinnati 13.9 Denver 16.6
Long Island 9.9 Houston 12.0 Philadelphia 13.8 Hartford 16.6
Downtown Avg. 9.8 Denver 11.9 Fort Lauderdale 13.6 Las Vegas 16.1
Philadelphia 9.5 Miami 11.9 Salt Lake City 13.6 San Diego 16.1
Portland 9.1 Nashville 11.3 Oakland 13.5 Sacramento 16.1 Phoenix 19.9
Seattle 8.6 San Francisco 11.3 North. Virginia 13.3 Charlotte 16.0 Cincinnati 19.7
San Francisco 8.2 Chicago 11.0 Overall Avg. 13.2 Indianapolis 15.8 Atlanta 19.0
Washington DC 7.6 Houston 11.0 Baltimore 13.1 Minneapolis 15.8 St. Louis 18.8 Detroit 26.3
Boston 6.3 Westchester 10.8 Miami 13.0 Tampa 15.7 N. New Jersey 18.7 Dallas 22.1Downtown-NYC 6.1 Los Angeles 10.7 Minneapolis 13.0 Austin 15.4 W. Palm Beach 18.6 Dallas 20.9
Midtown-NYC 4.3 Seattle 10.7 Riverside 13.0 Oakland 15.1 Jacksonville 18.1 Detroit 20.8
Charlotte 2.8 Stamford 10.1 Raleigh 12.9 Suburban Avg. 15.1 Cleveland 17.6 Chicago 20.5
Source: Torto Wheaton Research; Heitman Research
17.6%-20.0% 20.0% or more10.0% or less 10.1%-12.5% 12.6%-15.0% 15.1%-17.5%
27
Great Variability Within Suburban Markets
Market Overview
27
10.0%
8.7%
10.4%
14.3%
12.2%
13.9%
13.0%
15.9%
10.8%
14.2%
10.6% 10.6%
13.5% 13.7%
14.6%15.1%
16.1%16.6%
17.8%
19.9%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
20.0%
Seattle Los Angeles San Jose SanFrancisco
Salt LakeCity
NationalAverage
San Diego Denver OrangeCounty
Phoenix
Q2 2007
Q2 2008
Suburban Office Vacancy RatesSelected Markets Q2 2007 vs. Q2 2008
Source: Torto Wheaton; Heitman Research
28
And Within Downtown Markets Market Overview
28
8.7%
7.3%
10.0%
11.6%
9.3%
14.0%13.6%
13.2%
15.3%
7.9%
8.7%
9.8%
11.0%
11.9%12.5%
14.1% 14.2%14.8%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
SanFrancisco
Seattle NationalAverage
Sacramento Denver Los Angeles Phoenix San Diego Oakland
Q2 2007
Q2 2008
Downtown Office Vacancy RatesSelected Markets Q2 2007 vs. Q2 2008
Source: Torto Wheaton; Heitman Research
29
Market at Position Where Rent Growth Stopped in 2001
Market Overview
29
12.9
14.0
12.8
14.1
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
0.0
2.5
5.0
7.5
10.0
12.5
15.0
17.5
20.0Rent Growth (L) Vacancy (R)
National Office Vacancy Rate vs. Rent GrowthU.S. 1988-2010
Assuming No Net Absorption
%
Source: Torto Wheaton Research; Heitman Research
30
Retail Helped by Strong Starting Position
Market Overview
30
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 08
NCREIF Retail Vacancy Rate U.S. 1995-2008 Q1
% Vacant
Source: NCREIF; Heitman Research
31
But Retail Sales Trending DownMarket Overview
31
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
2000 2001 2002 2003 2004 2005 2006 2007 2008
Chain Store Sales
Three-Month Moving Average
Historical Average
Chain Store Sales TrendsU.S. 2000-2008 (July)
y-o-y change
Source: ICSC; Heitman Research
Historical Average = 4.1%
YTD Average = 2.2%
32
That Trend will Continue as Savings Grow
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
Retail Sales
Personal Income
Savings Rate
Mortgage Equity Withdrawal Peak
Retail Sales Growth vs. Personal Income GrowthU.S. 1993-2014
savings rategrowth rate
Source: Economy.com; Heitman Research
forecast
Market Overview
Market Overview
33
Retail Vacancy Will Rise Off Historical Lows
Market Overview
5.9% 6.0%6.2% 6.2% 6.2% 6.3% 6.2% 6.3% 6.4%
6.6%
7.1% 7.2%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
1 2 3 4 1 2 3 4 1 2 3 4
2006 2007 2008 2008 2008
Retail Vacancy RateU.S. Q1 2006-Q4 2008
Source: CoStar; Heitman Research
34
Vacancy Concentrated in Newest Centers
4%5%
6% 6%
9%
13%
22%
28%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
2001 2002 2003 2004 2005 2006 2007 2008
Shopping Center Vacancy by Year CompletedU.S. 2001-2008
Source: CoStar; Heitman Research
Market Overview
Market Overview
35
There is a Difference.
Wading Through Deep Water: Turmoil in the Economy and Capital Markets Western States Commercial Real Estate FinanceMary K. Ludgin, PhDSeptember, 2008