urban land institute real estate capital markets real estate finance in 2014: return to normalcy 1

Urban Land Institute Real Estate Capital Markets

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Real Estate Finance in 2014:Return to Normalcy


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2007: The “Beginning of the End”

“…the end of an economic illusion, facilitated by a

bubble, built on a delusion, perpetuated by greed,

living on both borrowed time, and borrowed money”

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We Told Ourselves: “This Time It’s Different”

U.S. housing bust pushed global economy into recession

Rental demand for commercial real estate “evaporated”

Federal Reserve flooded capital markets with liquidity, driving interest rates to near zero

U.S. government brokered mergers of shaky financial institutions (J.P. Morgan/Bear Sterns; B of A/ML)

U.S. government bailed out AIG, let Lehman fail, and allowed Goldman Sachs, Morgan Stanley, America Express, MetLife, et al to convert to bank structures and thereby qualify for bailout money

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We Told Ourselves: “This Time It’s Different” (continued)

Overall, largest government intervention into the financial system and capital markets…ever

To date, solutions have been short-term in nature with no evidence of a long-term, systemic plan

What was initially a liquidity crises became a crises in confidence as “civil discourse” between political parties seemed impossible

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Real Estate Finance 2012: New Realities


“Two Speeches for Audience to Chose From”

For Speech A, text “A” to: 4-5-6-6-6 *

For Speech B, text “B” to: 3-6-6-6 **

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* 4-5-6-6-6 spells “gloom”; ** 3-6-6-6 spells “doom”


tenuous

ten∙u∙ous

[ten-yoo-uhs]-adjective

1. thin or slender in form, as a thread.

2. lacking in sound basis, as reasoning; unsubstantiated; weak: a tenuous argument.

3. thin in consistency; rare or rarefied.

4. of slight importance or significance; unsubstantial: He holds a rather tenuous position in history.

5. lacking in clarity; vague: He gave a rather tenuous account of his past life.

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2012: Between Uncertainty

and Extreme Uncertainty

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Becoming Resigned to Uncertainty

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Emerging Trends in

Real Estate 2013:

“Recovery Anchored in Uncertainty”

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“Signposts for 2013…First Thoughts”

The 21 century became a teenager in 2013, and as with any young adolescent, it kept odd hours; tough issues seemed to get pushed off; and there were likely to be wild highs and lows

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“If you laid all the economists end-to-end, they would never reach a conclusion”

George Bernard Shaw

“It has been said that the only purpose of economic forecasts is to make astrology look respectable”

Anonymous


Federal Open Market Monetary Policy

In December 2013, the FOMC began winding down its QE program by reducing asset purchases from $85 billion to $75 billion per month

The Fed also strengthened its forward interest rate guidance, making this a “Dovish Taper”

Policymakers noted that the fed funds rate would remain “at rock bottom levels well past the time the unemployment rate fell below 6.5%”

All-in, interest rates should remain at historical low levels through yearend 2014

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Federal Reserve Board Beige Book

Showed economic activity expanded at a modest to moderate pace across Federal Reserve districts from mid-November through early January

In the real estate sector, home sales ended the year higher than a year earlier in most districts as momentum slowed in several districts

Residential construction was generally stronger, led by multifamily construction

Conditions were mixed for commercial real estate markets

Commercial real estate construction is on the increase broadly, and the outlook for 2014 is generally positive

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U.S. economy: what to watch for

Risk spreads – narrower and steady

Inventories – building up in line with increased output

New factory orders – increasing, especially for capital goods

Unemployment claims – increased post-Sandy; now declining

Building permits – increasing moderately for single family residential and reluctantly for commercial real estate

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2011

Defensive strategies; focus on core markets; multifamily favored property class

2012

Continued focus on core markets/property; slowing cap rate compression; commercial real estate yields remain attractive

2013

Core markets and property becoming “too pricey”; focus turns to secondary/tertiary markets and overlooked sectors as values in many markets have returned to 2006-2007 “high-water” mark

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Say “Goodbye to 2013”

Continued improvement in fundamentals in all food groups

Property sales volume increasing

Vacancy rates down or declining

Equity and debt capital available from array of sources

Development activity is cautiously increasing

Federal Reserve began to “taper” bond purchases

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Say “Hello to 2014”

The Real Estate Roundtable Sentiment Index

Views of CEO, President, and other top officers regarding current conditions and future outlook on real estate conditions, capital markets, and asset pricing

Participants note continued improvement in fundamentals, but remain cautious due to slow pace of economic recovery

New construction and an increased tolerance for risk suggest optimism beyond the core “gateway” markets and multifamily sectors

Rising interest rates could undermine improvements in NOI, potentially putting renewed downward pressure on asset values

For now, the strong availability of capital (increasingly flowing to riskier transactions) is helping to offset the recent run-up in long-term interest rates

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Say “Hello to 2014” (continued)

Numerous “players” in the equity, debt, and property markets

Some think “Too many people, too many dollars, too few deals”

Some argue “we’re in a precarious position with the wind at our backs and capitalization and interest rates down…” for the moment and NOIs growing…slowly

Others caution “we’re in a precarious position with the wind in our faces, NOI growth “slack”, interest rates and cap rates ready to increase, and new supply on its way

Properties are “priced to perfection” or “priced to disappoint”

Too many people are focused on “buying yield, not creating yield”

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“Logistics”,i.e., Fundraising

Remains challenging for the majority of private real estate fund managers

Results indicate you need to be “big and global” or a “nimble and a local sharpshooter”

Key factor investors consider include: track record (32%); experience (30%); returns (27%); strategy (18%); risk profile (18%); and fees (14%)

Largest domestic and foreign institutional investors, wanting greater control over investments, are focusing on direct investments, joint ventures, and other forms of structured transactions

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Real Estate Equity Capital Markets

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Property Transaction Trends

As of 3Q2013, transaction volume equaled $293+/- billion, 27% ahead of 2012

Multifamily remains in the “wonder” zone with investor’s wondering if too much is under construction and if pricing is sustainable

Investors appear to be rotating to higher yielding, higher risk plays such as hospitality, retail, and niche property types

Geography continues to expand to include formerly overlooked secondary and tertiary markets

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 $-

$100.00

$200.00

$300.00

$400.00

$500.00

$600.00

$88.30 $104.70

$129.50

$209.90

$359.00

$415.50

$570.70

$171.70

$66.20

$142.60

$229.20

$283.20

$315.00(e)

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Transaction Volume

Urban Land Institute Real Estate Capital MarketsRanking of Investment Categories and Strategies

Value-added Investments

Development

Opportunistic Investments

Core-Plus Investments

Core Investments

Distressed Properties

Distressed Debt

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Real Estate Investment TrustsContinue to enjoy broad access to capital from many public and private sources including common/preferred equity, unsecured debt, and balance sheet lendersContinuing to recycle lower tier assets, supported by increasingly active CMBS marketREIT conversions for non-traditional assets such as infrastructure, billboards, correctional facilities in processDividend yields and valuations remain attractiveNon-Traded REITs having another record year

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Real Estate Debt Capital Markets

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Debt Sources

“New and improved CMBS”, a.k.a. CMBS 2.0 is taking market share from competitors

CMBS’s ability to process B and C quality property in secondary and tertiary markets is a competitive advantage not lost on borrowers

CMBS 2.0 has also learned to compete with commercial banks and insurance companies for mandates on core property in primary markets

No new credible source has entered the market since the end of the current crises as spreads are only marginally attractive compared to alternative investments

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Urban Land Institute Real Estate Capital MarketsCumulative Distress for All Property Types

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Sector 1/4/2013(in Basis Points)

12/13/2013(in Basis Points)

Change (in Basis Points)

Office 210 162 -48

Retail 192 160 -32

Multifamily 182 157 -25

Industrial 191 159 -32

Average 194 160 -34

10-Year Treasury Bonds 1.86% 3.04% +1.18%

10-Year, 50%to 59% Loan-to-Value

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CMBS Issuance: 1995 – 2014 (Projected)

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20132013

2014$0

$50,000

$100,000

$150,000

$200,000

$250,000

U.S. ($Mil.)Source: Commercial Mortgage Alert.


Commercial Banks

Against a backdrop of deleveraging and reduced exposure to acquisition, development, and construction lending

2011: commercial banks started to test the water

2012: commercial banks began to put their toes in the water

2013: switch from loan resolution to loan origination

2014: anticipated profitability will allow increase in originations and growth of loan book

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Life Insurance Companies

Will face stiffer competition in 2014 from both commercial banks as well as securitized lenders

Insurers “fighting back” with tighter loan spreads, higher leverage, and less recourse

Industry worries about a “race to the bottom” in the application of credit standards

Originations expected to equal $50 billion, long-term run rate for insurers

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Debt Funds

Developed to fill lender gap

Provides higher yields than equity with (hopefully) less risk

Not the savior everyone expected…as yet

Over time, may grow from niche player to important part of the capital stack

Will need to develop its own infrastructure

Focused on institutional size property and “Best of Breed” borrowers

Global geographic focus: U.S.; Japan; UK, Europe

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“Prediction is very difficult, especially if it’s about the future”

Economy continues to “grind it out”

Interest rates “flat” through 2014

Real estate fundamentals continue to improve, benefitting from improving economy and little new construction

Transaction volume increases from $325 billion in 2014

Fundraising remains challenging

Competition for investments increases; buyers resort to “hand-to-hand” combat

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REITs remain ferocious competitors

Pension will increase allocations

Foreign investors focus on core assets in gateway markets (and political and physical safety)

Mortgage capital “abundant and cheap”

Mortgage delinquencies continue to decline

Refinancing dealt with promptly

Commercial banks: originations equal to $150 billion

CMBS: originations total $90 billion to $100 billion

Insurance: originations reach $50 billion

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“Best Bets”

Infill locations in 24-hour markets

Develop industrial property in hubs near ports and airports

Develop multifamily property…carefully

Scour the secondary and tertiary markets

Single family housing funds…maybe

Buy and hold REITs

Non-performing mortgage loans (if you can get any)

Anything with an “R” in it: refinance; renovate; re-position; rehabilitate; re-lease; restructure; recapitalize; etc.

The “Age Game”: seniors, students, and medical office

Distressed: think Europe

Food trucks: combine social media and prime locations

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“If it looks like a bubble, and floats like a bubble…

Summer 2013: inflection point or the pause that refreshes?

“Priced to perfection” or “Priced to disappoint”

Let’s role play for a minute; I’ll be the buyer and seller and the lender and the borrower

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urban land institute real estate capital markets real estate finance in 2014: return to normalcy 1

Documents

commercial real estate

capital marketsever

spells doom slide

tenuous argument

tenuous account

tenuous position

extreme uncertainty

borrowed time