Outlook for Commercial Real Estate in the

Near and Long Term

UC Real Estate RoundtableNovember 2, 2012

Calvin SchnureVP, Research & Industry Information

NAREIT

Fundamentals still support the commercial real estate recovery, despite the weak macro news• Economic growth is disappointing—extremely—but

weakness is cyclical, not structural;

• Drags on GDP growth are set to fade, while sources of strength build;

• Momentum to pick up slowly through 2013, 2014;

• Commercial real estate markets are facing low new supply, considerable pent-up demand.

2

The “Tug of War” on economic growth:

Drags

• Housing crisis/ mortgage mess/ deleveraging

• Fiscal drag, incl. state & local

• Uncertainty, lack of confidence… and Europe, US fiscal cliff

Sources of strength

• Productivity growth

• Monetary policy

• Growing pent-up demand

3

• Wealth effect

Longer-term Outlook

When did the “New Normal” begin?

4Source: Bureau of Labor Statistics, Haver Analytics.

Months since trough

Longer-term Outlook

-1

0

1

2

3

4

1960 - 2008:Q2 2008:Q3 - 2009:Q4 2010:Q1 - 2010:Q3 2010:Q4 - 2012:Q2

“New Normal”? Private sector GDP growth is in line with history

5Source: U.S. Bureau of Economic Analysis, Haver Analytics.

Longer-term Outlook

Contribution to GDP growth, in percentage points

Federal GovernmentPrivate sector

State and Local Governments

Productivity growth hasn’t flagged

6Source: U.S. Census Bureau, Haver Analytics.

“Stagflation” was the original “New Normal”

Longer-term Outlook

-6

-4

-2

0

2

4

6

8

1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011

Percent change

1-year change

3-year change

The "Lost Decade" is into re-runs

7

Productivity growth stagnated during Japan’s “Lost Decade”

Source: Haver Analytics

Wealth effects: shifting from negative to positive

8Source: Federal Reserve Board Flow of Funds Accounts, Bureau of Economic Analysis.

Longer-term Outlook

Monetary policy is supportive

9Source: Federal Reserve Board.

Longer-term Outlook

State of Commercial Real Estate

• Q3 saw modest improvements nationwide;– Multifamily: vacancy rates slide lower still, rent

growth slows;– Office: vacancies edging down, rent growth weak.

CBD vs suburban;– Retail: regional malls seeing improvements in

vacancies, rents, while neighborhood and community centers lag.

• A puzzle: the macro economy is at a crawl; why did CRE show any improvement?– New supply is negligible, so even a tiny bit of

absorption yields improvements.– But robust gains will need a robust macroeconomy.

• Rates are low but access to financing still tight.10

Construction at decades-low levels generates more pent-up demand

11Source: U.S. Census Bureau, Haver Analytics.

Longer-term Outlook

12

Borrowing demand for commercial mortgages is gaining momentum

Source: Federal Reserve Board Senior Loan Officer Survey, October 2012.

13

But standards are still tight

Source: Federal Reserve Board Senior Loan Officer Survey, October 2012.

14

Forecasters have been expecting long term interest rates to rise… for a decade, now.

Percent

0

1

2

3

4

5

6

0

1

2

3

4

5

6

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Actual 10-year Treasury yield (solid black line)

Predictions out to five quarters ahead of professional forecasters (hatched lines)

Percent

Source: Philadelphia Federal Reserve Survey of Professional Forecasters, Bloomberg

Pent-up demand continues to drive multifamily sector, while new supply still falls short

• Market conditions in multifamily rental housing have tightened since the housing crisis began;

• Sustained low household formation has caused unprecedented pent-up demand;

• New supply falls far short of potential demand;

• Key factor limiting rent growth: wages.

15

Focus onMultifamily

0

1

2

3

1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

16

Household formation plunged during the Great Recession, remains less than half its trend pace

Percent change over year ago

Fitted Trend

Source: U.S. Census Bureau, Haver Analytics.

Focus onMultifamily

20

21

22

23

24

25

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

17

Millions have moved in with parents, other family, or nonfamily housemates

Shared households, percent of total

The number of shared households, defined as

those with an extra adult, rose 2.9 million in 2008-

2010.

Source: U.S. Census Bureau, Haver Analytics.

Focus onMultifamily

0

100

200

300

400

500

600

2000 2002 2004 2006 2008 2010 2012

Average, 2000-2007

18

Multifamily housing construction since 2008 has totaled 700,000 below the prior trend paceThousands of units, seasonally-adjusted annual rate

Source: U.S. Census Bureau, Haver Analytics.

Focus onMultifamily

REIT acquisitions benefit from access to capital, market discipline

• The REIT business model influences property acquisitions in two ways:– Access to capital allows REITs to buy properties

when they are available at attractive prices—rather than being rationed by credit standards or driven by investment fund flows;

– Market discipline discourages REITs from over-paying at the market peak—in fact, REITs sold at the top of the 2000s boom.

• REIT acquisitions early in a price cycle add value over the long haul… and REITs are the main buyers today.

19

Focus onAcquisitions

20

Commercial Property Prices

Source: NARIET Pure Property Index®

Percent change over year ago

Focus onAcquisitions

Gross Acquisitions and Dispositions

21Source: RCA

Focus onAcquisitions

Net Acquisitions Adjusted*

22Source: RCA

* Adjusted to remove the Equity Office and Archstone transactions

Focus onAcquisitions

0

10

20

30

40

50

60

2004 2005 2006 2007 2008 2009 2010 2011 2012*

Debt

Preferred shares

IPO

Secondary equity offerings

Billions of dollars

23

REITs are raising record amounts of capital

*2012 offerings through July. Source: SNL Financial, NAREIT.

Focus onAcquisitions

24

Pre-boom

2001-2003$ Millions

Boom and market peak2004-2007

$ Millions

Bust

2008-2009$ Millions

Recovery

2010-Current

$ MillionsTotal

$ Millions

REITs

15,400

(20,898)

(7,425)

27,313

14,390

Private

11,760 (81,483)

9,120

(22,957)

(22,360)

Inst'l/Eq

(13,101)

141,731

5,579

(2,439)

131,771 Cross-Border

736

38,140

2,533

1,054

42,464

Other

(14,795)

(77,490)

(9,808)

(2,971) (166,264)

Net Acquisitions… buy low, sell high

Source: RCA

Focus onAcquisitions

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