commercial real estate: has the tide turned?

7/29/2019 Commercial Real Estate: Has the Tide Turned?

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Asset Managemen

Executive Summary

The 20082009 global nancial crisis brought the real estate markets to a virtual standstill inmost developed regions of the world. The causes of the collapse have been widely covered,including excessive borrowing, inated property prices, heightened unemployment, reducedeconomic growth and overall contractions within many global economies. One of the mostsignicant outcomes of the market dislocations was the negative impact on the mortgage-backedsecurities market, which suffered dramatically in the aftermath of the crisis.

While there is no question that the sector suffered, signs of a sustained revival in commercialreal estate have emerged. As the market regains strength, we believe investors would benetfrom opportunities in select commercial property, a sector that historically has led recoveries fromprevious downturns.

In this paper, we discuss the opportunity and the factors which, in our view, are pointing to arecovery. This recovery, however, is unlikely to be even throughout the world. In fact, we believethat the US commercial real estate market will likely provide the most compelling opportunities inthe rst phase of the recovery as a result of:

Stabilizing debt markets and the re-emergence of commercial mortgage-backed securities(CMBS) issuance;

Property demand improvements, as shown in vacancy and absorption trends; Favorable commercial property valuations;

Macro-economic tailwinds; and

Signicant level of capital ready to be deployed for US real estate.

Many of the worlds largest investment rms, institutional investors and pension plans have beenincreasing allocations to this asset class. Starting in 2009 and throughout 2010, institutionalcapital poured into core and stabilized real estate in primary US market regions in search ofreliable, long-term yield. Public pension plans, such as California Public Employees RetirementSystem (CalPERS), have been restructuring their real estate initiatives to include a greaterallocation to core commercial property.1

This investment activity has led to a meaningful recovery for these properties as yields re-approached pre-nancial crisis levels. The growing liquidity has also made possible the re-openingof the initial public offering (IPO) market for real estate ventures. For example, Archstone, oneof the largest real estate rms focused on the development and management of multi-family(apartment) properties, has been exploring the possibility of a US$5 billion IPO, which would bethe largest real estate IPO in history.2 Low interest rates in the US have also been instrumentalin containing the cost of capital for real estate investors and making property returns attractive incomparison to other asset classes, such as xed-income instruments.

Continued on next page

Commercial Real Estate: Has the Tide Turned?June 2011 WHITE PAPER

For more information onthe views expressed here,please write to us [email protected]

Kelly Williams

Head, Customized FundInvestment Group

Nadim BarakatChief Investment Ofcer,

Customized FundInvestment Group

Peter BraffmanPartner, Customized

Fund Investment GroupReal Estate

Market Research byDavid Weissman, CFA,Customized FundInvestment Group

1 Bloomberg, February 14, 2011.2 Archstone Looks Likely to Go Public Again, Dow Jones, February 23, 2011.


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Commercial Real Estate: Has the Tide Turned?

2|Credit Suisse Asset Management

Meanwhile, our analysis shows that certain regions arestill facing some headwinds. In Europe, sovereign debtconcerns are likely to linger, which could delay the sectors

recovery. In the Asia-Pacic and Latin-America propertymarkets, economic growth has accelerated propertydemand, but rising ination may be a limiting factor as itleads to potentially higher interest rates. China and Brazil,for instance, have each raised interest rates several times in2010 and 2011.

In this light, we believe that investors may be able to take

advantage of the changing real estate conditions in the US

by considering the following strategies:

Acquire over-leveraged opportunistic US commercialproperty (e.g., distressed) that is favorably priced forfuture income growth and capital appreciation, based onexpectations that economic conditions may continue toimprove over time;

Invest in income-generating valued-added commercialreal estatesuch as multi-family and ofcepropertiesas well as select retail and industrial assetslocated in regions of the US with favorable demographicgrowth trends. Other non-traditional (niche market)

income-generating real estate may also be attractive,including senior housing, student housing, medicalofces and self-storage; and

Emphasize private real estate investments for tworeasons: a) public REITs recovered from the globalnancial crisis rst, with signicant performance overthe past year, and appreciating over 130% since theirlows in February 2009 to the end of March 2011.3This was based on both investors desire for currentyield and expectations for improving net asset valuesof the underlying properties; b) private real estate istypically less correlated to equity market conditionswhen compared to public REITs, which are usuallytraded on open nancial markets. Incorporating private

commercial real estate, we believe, can improve therisk/return prole of a diversied portfolio.

This paper also addresses the risks associated with thecommercial real estate market, and how investors shouldconsider developing real estate investments in the context oftheir aggregate portfolio. We believe that success in takingadvantage of nascent commercial real estate opportunitieswill predicate on careful valuations and deep due diligence.With these caveats in mind, we believe the US commercialreal estate opportunity set is compelling.

Continued from cover page

3 US All REITs Real Estate Index Series, FTSE NAREIT, April 2011.


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Display 1: Commercial borrowing and CMBS issuance increasing

4 Credit Suisse Economics Research, Global Economy Review, May 6, 2011.5 The Linneman Letter, Linneman Associates, Winter 2010-2011.6 Glimmer of Better Days for Manhattan Ofces, New York Times, March 30, 2011.7 Lenders Entering 2011 with Rising Optimism, Commercial Mortgage Alert, January 7, 2011.8 CMBS Market Watch Weekly, Credit Suisse Fixed Income Research, March 11, 2011.9 US CMBS Issuance Data, John Lang LaSalle and JP Morgan, March 2011.

Credit Suisse Asset Management | 3

CS

Projection

0

50

100

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200

250

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

US$

Billions

US CMBS Issuance

US real estate prices and investment returns for most properties

have been in decline since the beginning of the credit market

collapse in 2007. There are signs, however, that the US real

estate market may benet from a gradually improving economy(GDP growth is expected to reach 4% in 2011 measured

on a Q4/Q4 basis).4 Major urban regions, such as New York

and Washington, are already experiencing heightened leasing

activity for ofce space, and vacancy rates have been trending

lower.5 In New York, for example, some prime ofce markets are

experiencing vacancy rates of only 4%, with average vacancy

rates across New York ofce properties of approximately 12.8%

in the rst quarter of 2011, compared to 13.9% for the same

period last year.6 The prospects for a commercial real estate

revival have emerged consistent with the economic recovery,

and are related to improving trends in commercial lending,

stabilization of vacancy rates and property pricing that appearson the verge of increasing in value.

Debt Conditions Stabilizing and CMBS Issuance Rising

The availability of credit will be essential to a real estate revival.

With interest rates at historically low levels and banks lending

more, the favorable reversal for debt conditions, which started

in 2010, is likely to continue. However, we see the road to a full

recovery as somewhat volatile.

Support for lending has come from insurance companies andother nancial institutions, who are once again increasing their

mortgage allocations. Another stabilizer for debt markets is the

revival of commercial mortgage-back securities (CMBS), with

new issuance expected to triple in the US in 2011 versus last

years levels.7 Key recent developments in CMBS include:

In 2010, total new CMBS issuance in the US rose to

US$5.3 billion, up vefold from the US$3 billion overall

issuance in 2009,8

Total US issuance in 2011 is expected to top US$40billion, which would provide added liquidity to purchasers o

owners with maturing loans to renance; and

The rst quarter of 2011 was off to a strong start with

approximately US$10 billion of additional issuance in the

pipeline (Display 1).9

Signs of a US Revival

Data through March 11, 2011Source: Credit Suisse Fixed Income Research


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Display 2: Commercial mortgage ows may be reversing

As debt has re-entered the market (largely for core properties in

late 2009 and early 2010), cap ratesthe income yield or rate

of return of a propertys income based on its purchase price or

valuehave begun to normalize as valuations started to recover(Display 2). We believe the re-emergence of debt for real estate

transactions marks the beginning of a sustained recovery in

the sector.

Positive trends in loan charge-offs (also known as write-offs),

which have fallen since reaching a peak in November 2010, also

indicate improved commercial-lending conditions. Loan charge-

offs are recorded by the lender when future mortgage payments

or full payoff are no longer likely. Similar to the recent decline in

charge-offs, the trailing six-month-average loss-severity trend

has reversed from the 2009 peak of 70%. Lower charge-off and

loss-severity rates support the case for banks to cautiously openthe window to further lending (Display 3).

A nal considerat ion regarding the improving lending condit ion

in the US is the ongoing inuence of the Federal Reserve and

other government bodies. First, governmental organizations

have continued to pressure banks to increase the volume oflending, although the exact breakout for activity levels between

residential and commercial lending remains clouded. Second,

the Federal Reserve remains committed to the stability of

nancial markets, setting interest rate targets at historically low

levels. As a result, demand for commercial mortgages, and the

renancing of these mortgages, continues to build momentum.

Based on these indicators, there is guarded optimism

percolating at major nancial institutions, especially as debt

liquidity has emerged, and the mortgage securitization market

appears to be reviving.

300

200

100

0

-100

-200

-300

01 02 03 04 05 06 07 08 09 10

Commercial MortgageNet Capital Flow

Cap Rate

10.0

9.0

8.0

7.0

6.0

%

US$Millions

400

US Commercial Mortgage Flows and Cap Rate

0

10

20

30

40

50

60

70

80

0

100

200

300

400

500

600

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900

Feb

03

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Feb

09

Feb

10

Feb

11

US$Millions

Trailing six-month numberof liquidated loans

Trailing six-month averageloss severity (RHS)

US Liquidated Loans and Loss Severity

Display 3: Lower CMBS liquidated loans and loan

charge-offs may support further bank lending

Data through December 31, 2010Source: Federal Reserve and Real Capital Analytics

Data through March 31, 2011Source: Trepp and Credit Suisse


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Commercial Real Estate Demand Outweighing New

Supply Growth

The stabilization of real estate fundamentals is both a function

of economic trends, as well as a favorable supply picture forcommercial real estate. Unlike prior real estate cycles, the

collapse of valuations in 2008 was primarily credit driven, rather

than stemming from oversupply.

Indicating more robust demand, vacancies appear to have

stopped rising at the end of 2010, after increasing nearly

35% since 2008.10 Demand for warehouse/distribution space

within this sector drove the majority of occupancy gains, as the

vacancy rate in this segment fell to 10.9% at the start of 2011.

Overall absorption has been positive for the third consecutive

quarter with annual net gains reaching 13.1 million square feet

(msf) at the end of 2010.

The US ofce market is showing particular strength. In the

fourth quarter of 2010, and for the rst time in more than

three years, the US ofce vacancy rate decreased and net

absorptions increased. Nationwide, the vacancy rate dropped

20 basis points to 16.4%, and appears to be trending back

towards the global average of approximately 14.1% across 104markets globally and 14.6% in the US.11,12

This vacancy trend is supported by corporate cash balances

and earnings, which are robust and expected to promote

corporate spending on expansions. According to the Business

Roundtables CEO Economic Outlook survey, 52% of CEOs

plan to add staff over the next six months (as of April 2011),

the highest reading since the group started its survey in 2002. 1

As a result , we expect shortages of quality space (Class-A

properties) in 2011. Class-B and Class-C properties, however,

may lag in terms of meaningful improvements, especially

outside major urban areas, where employment hiring generallyremains weaker. Nonetheless, the overall trend of increasing

demand is positive (Display 4).

Display 4: Vacancy rates and absorptions point to increasing demand

Source for all charts: CBRE Econometric Advisors Outlook, Winter 2011

10 Bridgewater Daily Observations, Bridgewater Associates, February 28, 2011.11 CBRE Investors, CB Richard Ellis, January 2011.12 Global Market Perspectives 1Q 2011, Jones Lang Lasalle, March, 2011.13 CEO Economic Outlook Survey, Business Roundtable, 1Q 2011.

120

100

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-60

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-100

SquareFeet(Millions)

20

18

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64

2

0

%

90 92 94 96 98 00 02 04 06 08 10

Absorption Vacancy Rate(right hand side)

450

350

250

150

50

-50

-150

8

7

6

5

494 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10


S

quareFeet(Millions)

55

45

35

25

15

5

-5

-15

-25

14

12

10

8

6

%

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

%


Vacancy Rate(right hand side)

Absorption

90 92 94 96 98 00 02 04 06 08 10

400

300

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100

0

-100

-200

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15

14

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6

SquareFeet(Millions)

%

Un

its(Thousands)

Office (1990-2010) Multi-Family (1994-2010)

Retail (1996-2010) Industrial (1990-2010)


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14 Moodys/REAL Commercial Property Price Indices, February 201115 Moodys/REAL Commercial Property Price Indices, February 2011

In contrast, new supply has been limited since 2007,

constrained by lower levels of construction activity. In 2010,

for example, only 15.9 msf of commercial real estate was

completed, the lowest level in over a decade. New constructionrepresents only 1.2% of the total stock of available US ofce

properties, as of the rst quarter of 2011. Based on the

consequent reduction in supply and improving demand, we

expect continued declines in vacancy rates to facilitate higher

leasing income and property appreciation in regions most

sensitive to economic expansion. Even if construction should

happen to increase signicantly, the completion of those future

projects would take some time. Therefore, any additional supply

would not be inuential for several years (Display 5).

Favorable Pricing Trends

As a result of these supply and demand conditions, the realestate valuation trends point upward, in our view. In 2010, the

Moodys/REAL All Property Type Aggregate Index declined

2.1%, approaching the lows of 200102.14 However, price

levels have started to recover, with an initial increase of 5.5%

at the beginning of 2011. Despite the improvement, property

valuations remain attractive, in our view. As represented by the

Moodys/REAL Commercial Property Price Index (CPPI), prices

remain 42.1% below the peak of real-estate asset pricing

in October 2007.15 This is a result of: a) the overall decline

in real-estate operating income (which is a primary driver of

valuation); and, b) the failure of non-stabilized and non-core

real estate to participate in the appreciation that was recentlyexperienced by core and stabilized assets. The latest direction

of price improvement and increased transaction activity provide

encouraging signs that the upside potential will likely outweigh

the possibility of further pricing declines (Displays 6a and 6b).

90

110

130

150

170

190

210

Index,

December2000=100

NationalAggregate

NationalApartments

NationalIndustrial

National

Office

NationalRetail

4Q0

0

2Q0

1

4Q0

1

2Q0

2

4Q0

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4Q1

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Commerical Property Price Index

9

87

6

5

4

3

2

1

080 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

%

Office Warehouse Recessionary PeriodsRetail Apartments

Construction as percent of stock

0

1,000

2,000

3,000

4,000

5,000

Thousand

s

ApartmentsProperties Sold

RetailProperties Sold

IndustrialProperties Sold

Office

Properties S

2005 2006 2007 2008 2009 2010

US Properties Sold

Display 5: Low level of new construction hasconstrained supply

Display 6a: Real estate prices are coming off the lows...

Data through June 30, 2010Source: Torto Wheaton Research, REIS (US Top 50 Metros), Jones LangLaSalle and LaSalle Investment Management Research

Data through February 2011Source: Moodys/Real Commercial Property Price Indices

Data through December 2010Source: NCREIF

Display 6b: ...While increased transaction activityis encouraging


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16 Institutional Real Estate Investment Values Release for 4Q, NCREIF, January, 2011.17 Institutional Real Estate Investment Values Release for 4Q, NCREIF, January, 2011.18 US Bureau of Labor Statistics, May 2011.19 Commercial Real Estate Resurgence, Global Market Perspective, Jones Lang LaSalle.20 Managing Fixed Income in a Rising Ination and Interest-Rate Environment, Credit Suisse Asset Management, March 2011.


Recent real estate return performance has also been reected

in the National Council of Real Estate Investment Fiduciaries

(NCREIF) property index (which includes apartment buildings).

The NCREIF index reported a total return of 4.6% for the fourthquarter of 2010, compared to 3.9% in the third quarter, and a

loss of 2.1% in the fourth quarter of 2009. 16 Specic segments

of the US commercial property market recorded positive results.

For the fourth quarter of 2010, apartment investments returned

6.3%, ofce holdings returned 3.9%, and industrial properties

yielded 3.4% (Display 7).17

US Macro-Economic Tailwinds

Economic indicators appear more positive in early 2011,

supporting more favorable property conditions, as utilization

and vacancy of commercial space is historically correlated to

economic growth and business planning. At the same time,private sector jobs are being added, albeit at a slow pace.

The US Bureau of Statistics non-farm payroll survey reported

private sector job growth of 244,000 for April 2011, following

an increase of 230,000 for March 2011, marking the seventh

consecutive month of non-farm payroll increases.18 Business

condence levels are also trending higher as the US recordedseven consecutive quarters of real GDP growth as of the rst

quarter of 2011. This positive sentiment is often considered a

leading indicator for future business expansion.19

Even with the recent economic improvements, ination growth

as measured by the Consumer Price Index (CPI)in the US has

been near historical lows, indicating pricing pressures of less

than 1% to 2% annualized. Accordingly, we believe US interest

rates are likely to remain low in 2011, facilitating investors

access to advantageous nancing for property purchases.

However, the combination of geopolitical pressures, expansionary

scal and monetary policies and economic growth is likely toignite inationary pressures over time.20

-1

0

1

2

3

4

5

6

7

Hotel Industrial Office Retail Apartment

%

1Q 2010 2Q 2010 3Q 2010 4Q 2010

NCREIF Property Index(Total Returns by US Property Segment Sub-Indices)

Display 7: Real estate returns improved in 2010

Data through December 31, 2010Source: National Council of Real Estate Investment Fiduciaries (NCREIF)


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Capturing Commercial Property Opportunities


Deleveraging. Most real estate assets acquired in 2005

07 are currently over-leveraged, or their owners are

personally over-leveraged. During this three-year period,

while property income remained relatively stable, propertyvalues skyrocketed as debt and equity poured into real

estate. This was because the availability of leverage

was based on property market values, and not on cash

ows. When credit markets collapsed in 2007, valuations

began to fall in tandem, and equity values were largely

wiped out. While valuations have recovered to some

degree for core assets, the same cannot be said for

non-core assets. The debt on these assets is maturing

at a time when it cannot be renanced for the same level

of proceeds. Credit Suisse estimates that over US$400

billion of new equity will be needed to recapitalize theseassets, which may create a signicant opportunity to

acquire assets at discounts to replacement cost. This

could present a substantial base from which attractive

opportunities may arise to acquire high-quality assets at

discount prices through distressed sales (Display 8).

However, the US markets have not seen a signicant

volume of these distressed opportunities until recently.

This is because many lenders extended loans on

distressed assets while they grew their way out of the

problem through earnings to cover losses. Lenders

We turn our focus now to a selected set of opportunities that,

we believe, may benet institutional investors. These are based

on criteria such as identifying underpriced assets, demographic

trends, and other changes in conditions following the nancialcrisis. Specically, we believe that investment strategies in private

real estate value-added and niche investments may best capture

opportunities in the commercial space in the current environment,

depending on investors risk tolerances and objectives.

Value-Added Strategy

The primary objective within the value-added strategy would be

to acquire well-located assets within markets that feature solid

demographics, rising employment and exhibit a strong recovery

in underlying real-estate fundamentals. The implementation

of a value-added strategy in this manner should provide the

portfolio with strong appreciation potential, as well as someinitial current income that should grow meaningfully over the life

of the investment. Value-added assets would typically be those

that are well leased, but not completely stabilized (i.e., 70%

to 80% occupied). In our assessment, the best value-added

opportunities exist within the smaller end of the market. Returns

may be generated within this strategy by: a) acquiring assets at

a meaningful discount to core properties; b) investing capital;

and, c) leasing them up to stabilization, thereby creating core

properties that can be sold into a core market.

We believe that the investment opportunity within value-added

investments is driven by the following trends:

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2007 2008 2009 2010

%

US

$Billions

Distressed Sales % of Total Sales (right hand side)

Distressed Sales

Display 8: Distressed property sales increased sharply in late 2010

Data through December 31, 2010Source: US Capital Trends and Real Capital Analytics


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have also generally maintained a tempered approach

to foreclosures and restructurings of troubled assets.

However, this dynamic is changing now as real estate

prices have begun appreciating from their marked-downvaluations. Lenders have begun to sell assets, while many

owners have nally capitulated and are looking to divest

their properties.

Capital Flight into Core. As discussed earlier, most of

the real estate capital invested over the past 18 months

has ooded into core and stabilized assets in a chase for

yields. This direction of capital ow has moderated prices

in the value-added segment, creating what we believe to

be a compelling purchase environment, and an opportunity

to achieve superior risk-adjusted returns. Furthermore,there is excessive capital currently allocated to the core

space that may take years to deploy. This should create

a deep market of core buyers to whom todays value-

added investors can sell their then stabilized assets at

attractive pricing. The fact that value-added investments,

in general, and smaller assets, in particular, have largely

been overlooked until now, should present an opportunity

to purchase such assets at an attractive cost basis.

Lack of New Supply. We also discussed earlier that new

construction has been minimal. Accordingly, the limitedsupply picture bodes well for a sustained recovery in

valuations, in our view. We have begun to witness this

dynamicinitially among multi-family assets, where

vacancies have disappeared and rent growth has begun

and now with ofce, retail and industrial. This supply-

constraint picture is important in all real estate, but even

more critical for the value-added strategy, which relies on

lease-up and rent growth. We believe the present supply

environment should meaningfully reduce the risk of such

a strategy.

Value-Added Asset Selection

Multi-family properties exhibit the best fundamentals among

the major asset classes by a wide margin. Since debt markets

have been most favorable in multi-family, this asset class hasbeen the most liquid. Consequently, the multi-family asset class

has attracted signicant amounts of capital. This has resulted in

gateway marketssuch as New York, Boston and Washington,

DCbecoming more expensive, although positive leverage

is still available, potentially increasing returns. This trend of

increased capital ow into multi-family warrants a cautious view

on pricing.

While the ofce, industrial and retail sectors have different

drivers, they share a common feature of generally having

long-term lease structures with their tenants. As suchand

as opposed to multi-family assetstheir net operating income(NOI) streams are all continuing to trend downward as leases

roll and rents reset to new levels. Since additional capital is

needed for leasing costs and capital expenditures, even if

owners can pay debt service, they may not be able to infuse

the capital that would be necessary to keep tenants. Therefore,

there should be signicant acquisition opportunities arising from

these asset types over the next few years, as these dynamics

and debt maturities play out.

Ofce. In this sector, Credit Suisse would favor well-

located urban ofce assets in secondary cities, and would

generally avoid suburban ofces. The US ofce market is

showing increased signs of recovery, as demonstrated in

the fourth quarter of 2010 when, for the rst time in more

than three years, the vacancy rate decreased and net

absorptions increased. Credit Suisses focus for value-

added investments would be on small, urban ofces that

require capital expenditure and tenant-improvement capital

to attract and keep tenants in knowledge-driven secondary

markets, such as Atlanta, Miami, Houston, Seattle, Austin

and Portland.


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Retail. The specic location of an asset is of greater

importance within retail than in any other asset class

because location relative to customers is an important

variable that all retailers must account for in their businessstrategy. As a result, well-positioned retail real estate is

irreplaceable and highly sought after by retailers seeking

to gain a competitive advantage, or targeting select

demographics that should support higher-than-average

sales. In this vein, location should be one of the most

important criteria in investors selection of assets within

the retail strategy. Within the US, the tech regions of

Austin, San Francisco, Boston, San Jose and Seattle

are showing favorable fundamentals, such as strong

employment growth projections, robust migration trends

and expectations for strong retail sales.

Industrial. This is a strong asset class for a value-added

strategy when compared to ofce and retail properties,

as it is not expensive to hold due to its low capital

requirements for leasing. On the other hand, maximizing

investment outcomes does require signicant knowledge

of the tenant base. When investing in industrial assets, we

believe investors should take advantage of consolidation

in the industry, and target properties in port cities and

major distribution corridors.

Multi-Family. Given the fact that positive multi-family

fundamentals have attracted increased amounts

of investment capital to the asset class, prices are

appreciating as a result. Therefore, any investment

program would approach multi-family acquisitions on

a selective basis in the value-added strategy, primarily

targeting properties that present a compelling purchase

opportunity due to nancial distress on the part of the

owner. Within the US, weighting should be given to

the Smile States (Washington, DC, down through the

Carolinas and Florida, over to Texas and up the West

Coast). Target markets within these states include Denver,Raleigh, Austin, San Antonio, Houston, Portland, Seattle,

Los Angeles and San Francisco.

Niche Investment Opportunities

Niche assets are those that have generally been overlooked

by the institutional market but which are characterized by

strong demographics and outsized yields. These assets can be

accumulated, stabilized and sold as portfolios to an institutional

market that is currently starved for yield. Since these asset

types are relatively under-represented in the institutional

market, exit opportunities would need to be carefully

understood and mapped out as part of an assets underwriting.

Student Housing. A highly fragmented market with few

established players, student housing should present an

opportunity for well-priced purchases, given the relatively

limited competition in this sector. The off-campus student

housing market has seen a signicant increase in demand

from enrollment growth at public universities. A second

driver of demand is a lack of university capital and

expertise to build or manage new on-campus facilities.

As such, attrac tive student housing opportunities are

likely to be found among cities in the US that have large

student populations like Austin, Charlotte, Chapel Hill

and Philadelphia.


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Senior Housing. This sector consists of multiple forms of

multi-family housing involving residences and/or support

services for individuals age 55 and older. The senior

housing opportunity is driven by an aging population,coupled with limited construction starts, as constrained

capital markets have curtailed development of these

properties. Target locations would be characterized by a

large and growing senior population, such as south Florida,

South Carolina and Arizona, with additional focus on

proximity to hospitals, shopping, public transportation and

senior centers.

Medical Ofce Buildings. These are primarily located

on or near a hospital facility. Tenants typically consist

of physicians, diagnostics providers, imaging and otherhealthcare delivery businesses. An attractive feature of

medical ofce buildings is that tenants make a signicant

investment in their location and rarely move, which has

resulted in this asset class producing long-term stable

occupancy and rent growth over time, compared to the

traditional ofce sector.

Self-Storage Facilities. These serve the needs for storage

space created by family or senior downsizing, or the

accumulation of goods during stronger economic periods.

Self-storage is a defensive sector with a low breakeven

rate (approximately 40% occupancy), low operating

expenses and capital expenditures, and an ability to re-

price month-to-month leases in an inationary environment.

Attractive markets include major employment centers withrelative space constraints like New York City, Washington,

DC and Seattle.

Emphasis on Private Equity Real Estate

The recommended approaches described above involve

private-transaction strategies. Private markets have a much

broader domain of property investments than do public real

estate offerings, such as REITs. An important consideration

of private real estate investments is directed to the return

potential. Reviewing the recent pricing levels between public

REITs and PE real estate investments, we note that public

REITs have appreciated signicantlymore so than the price

of private real estateaccording to most indices. Public REITs

are often valued on market prices that investors are willing to

pay for exchange-listed shares, and usually are accompanied

with a liquidity premium. Therefore, it is important to pay close

attention to the underlying net asset value (NAV) of the REIT

holdings. We see a widening disparity between the underlying

worth of a property (as valued by REITs NAVs or private real

estate products), and the prices given to REITs in the public

markets.22 As of the end of 2010, public REITs were generally

trading at a 20% premium to their underlying NAVs. 23



22 REITs prices can trade at a premium or discount to their NAVs similar to a closed-end fund.23 Risk Return and Correlation Data, Capital IQ and NCREIF, December 2010


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We use the NCREIF Open End Diversied Core Equity Index returns (ODCE) as a proxy for private real estate.Data through December 31, 2010Source: Capital IQ and NCREIF

Another factor favoring PE real estate is related to market

correlation. Since REITs are traded on open markets, similar

to equities, they are often more correlated with overall equity

market conditions than private real estate. Display 9 showslower correlations to equities for private real estate investments

(as proxied by the Open End Diversied Core Equity Index or

ODCE), and, accordingly, a better mean return per unit of risk

of 0.6 versus 0.1 for US REITs, and 0.2 for US equities.

Risks

There appear to be many compelling incentives for commercial

real estate in the US. However, these opportunities have a

variety of risks that need to be considered in determining

their suitability for an investment portfolio. First and foremost,

the economic environment must continue to improve (this

risk applies to both the national and local markets). Withoutfavorable economic conditions, the identied commercial real

estate trends will most likely become less attractive, and a

further slowdown may impede valuations. Should ination and/

or interest rates move higher, the revival of loans and nancing

for real estate may be negatively impacted. Also, higher real

estate operating costs, such as those for energy and repairs,

will tend to limit returns from income-generating properties.

Global markets are more integrated today than ever before.

Natural disasters, political conict and nancial market

volatility around the world may affect performance of US-

based real estate investments. Since real estate is typically

an illiquid asset, rapid turnover and sales may not constitute

readily available options. This may be one important risk

consideration for insurance companies and other institutions

that need to manage liabilities on a continual basis (sovereign

wealth funds, however, may have more exibility to committing

signicant proportions of their portfolios to longer-term

alternative investments). These are just some of the risks toconsider along with other factors associated with return and

diversication objectives.

NASDAQCompositeIndex

S&P 500Index

MSCI USREIT Index

PrivateRE(ODCE)

Correlation with MSCI REIT Index 0.7 0.8 1.0 0.3

Correlation with Private RE (OCDE) 0.1 0.2 0.3 1.0

Mean Quarterly Return 2.8% 1.8% 1.1% 2.0%

Median Quarterly Return 3.5% 2.4% 2.5% 2.7%

Standard Deviation/Risk 14.0% 8.6% 16.5% 3.5%

Mean Return per Unit of Risk 0.2 0.2 0.1 0.6

Display 9: Private real estate has low correlations to public real estate and US equities




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It appears from a number of trends that we outlined in this

paper that real-estate values have stabilized or are increasing

in many commercial property markets in the US. From the

perspective that commercial property lending is improving,valuation levels may trend higher as demand picks up with

limited new supply available.

The prospects for the commercial real-estate sector remain

positive. Furthermore, the US market may be less risky in

comparison to other global regions, since the US economic

recovery is expected to be more pronounced and more likely to

occur before most other developed economy turnarounds. As

primary markets for commercial real estate have already shown

signs of recovery, it is important to consider select opportunities

carefully, focusing on those that have not yet been fully

adjusted on a valuation basis to the improving conditions.

Conclusion

As a result , we believe that select commercial real estate funds

with ofce, industrial, retail and multi-family property offer

attractive opportunities as favorable economic trends continue,

particularly in the US. In a low interest-rate environment thatmay soon contend with rising inationary pressures, income-

generating commercial properties may offer compelling

investments and help mitigate rising prices.

For many investors, we believe the size, correlation and

income-generating benets of private real estate investment

opportunities may outweigh the liquidity benet associated with

publicly traded REITs.

In our view, several niche commercial real estate markets

offer compelling value, but these areas of opportunity must

be aligned with the investors overall portfolio policy andobjectives. This usually requires a dened investment plan

and a comprehensive understanding of real estate markets to

make sure the diversication benets and return potential are

accessed appropriately.




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The views and opinions expressed within these publications are those of the authors, are based on matters as they exist as of the date ofpreparation and not as of any future date, and will not be updated or otherwise revised to reect information that subsequently becomes available orcircumstances existing, or changes occurring, after the date hereof.

For a copy of any of these papers, please contact your relationship manager or visit our website at www.credit-suisse.com.

Credit Suisse Asset Management Alternatives Quarterly

Q2 2011Our CIO and portfolio managers weigh in on theimpact on nancial markets of recent events (e.g., earthquake

in Japan, political tensions in the Middle East), and provide anoutlook for investors.

Robert Parker, Credit Suisse Senior Advisor

May 2011 Market Update

May 2011Given the moderation in economic growth andthe lack of a further acceleration in corporate earnings, equitymarkets may consolidate in the near term.

Managing Fixed Income Investments in a Rising Ination

and Interest-Rate Environment

March 2011This paper addresses key challenges facingxed income investors today: How to achieve higher returns ina still low-yield environment while mitigating the rising threats

of ination and interest-rate risks? The ISS teams analysissuggests that diversifying xed income exposure into specicinstruments as well as adding ination hedges may present anefcient way to manage these challenges. A full case study helpsto illustrate the teams ndings.

How Commodities Can Help Investors Face the

Uncertainty of the Ination/Deation Debate

December 2010In this paper, our Commodities Team arguesthat uncertainty about the consumer-price outlook in developedeconomies creates challenges for capital markets to properlyprice in ination expectations. The Commodities Teams researchsuggests that exposure to real assets can help investors cushion

the impact on the portfolio of unexpected changes in theinationary environment in the long run.

The Anatomy of a Modern Emerging Markets Portfolio

November 2010This paper examines the quickly evolvingemerging markets investment landscape and argues that theproliferation of sophisticated investment vehicles in thesemarkets presents an opportunity for investors to augment theefciency of their emerging markets portfolios.

Liquid Alternative Beta:

Enhancing Liquidity in Alternative Portfolios

June 2010How to increase a portfol ios liquidity without

sacricing returns, especially in a post-crisis, low-yieldenvironment? The paper illustrates how institutional investors canuse Liquid Alternative Beta to seek to enhance portfolio liquidity,increase portfolio transparency, short hedge fund sectors andgain hedge-fund-like exposure when investment policies restrictdirect hedge fund investments.

Can Infrastructure Investing Enhance

Portfolio Efciency?May 2010The paper provides an in-depth look atinfrastructure as an investment tool, and analyzes what role theasset class might play in institutional portfolios. Specically, thepaper examines whether infrastructure can be an effective toolto mitigate ination and duration risks, reduce funding gaps and

enhance portfolio efciency.

Credit Portfolio Management in 2010:

A Nimble Approach Needed

January 2010Tracking and timing credit cycles can bechallenging, particularly since todays credit environment appearsto be going through increasingly rapid cycle changes. We believethat xed income investors need to be increasingly nimble andtactical in 2010, while at the same time considering strategicpreparations for medium-to-longer-term regime changes ininterest rates and ination.

Risk Management: A Changing Paradigm

November 2009Renewed interest in risk management andthe creation of a culture of risk awareness are driving currentinvestment committee meeting agendas. This should come as nosurprise in light of market events in 2008 and early 2009. Whileexperience and judgment that have been battle-tested undervarious market conditions prepares CIOs for uncertainty in thefuture, how do they implement risk-based solutions while facingreal-world events?

Risk ParityA Risk-Based Approach

to Portfolio Structuring

November 2009This paper discusses a different approachto portfolio risk management, called risk parity, which aims toequate the contribution of risk across asset classes and, as aresult, create a portfolio which performs better in a variety ofmarket conditions.

Credit Suisse Asset Management Publications



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commercial real estate: has the tide turned?

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