Bay Area Economic and Apartment Market Outlook Prepared for South Bay Apartment Brokers Forum...

Bay Area Economic and Apartment Market Outlook

Prepared for

South Bay Apartment Brokers Forum

Prepared by

Lawrence Souza, CREChief Economic CouncilCalifornia-Tri-County Apartment Association

- Principal - Real Estate and Financial Economist Johnson/Souza Group, Inc.

- Commercial Real Estate Broker - Professor – Real Estate Finance RE/MAX Commercial Santa Clara University

Golden Gate UniversityWed. 2/9/05

IntroductionIntroduction

• Introduction • U.S. & California Budget Issues • National Economic Fundamentals• Technology/Venture Capital Trends• Local Business Cycles• California• Demographics• Employment/Inflation• Housing Market• Apartment Market• Commercial Market• Conclusions: Comparative Advantages and Risks

IntroductionIntroduction

• Over 15 years of real estate economic and financial research, and institutional due diligence underwriting.

• Specializes in residential and commercial market research, valuation and brokerage services.

• Tracking and forecasting of economic, real estate and financial cycles and efficient portfolio construction, optimization and risk management.

Johnson/Souza Group, IncJohnson/Souza Group, Inc

Contact Information: Contact Information: [email protected]

Direct: (415) 713-0213 Message: (415) 826-2216Direct: (415) 713-0213 Message: (415) 826-2216

mailto:[email protected]

Economic Environment and ForecastEconomic Environment and Forecast

• National Economy Economic growth accelerated in 2003 - 2004 to average 4.2% per

year, compared to 2.4% in 2003, expected to slow to 3.5% in 2005, barring any major shocks such as stock-bond market declines from rising short/long-term interest rates caused by massive government funding (crowding out) of federal-state-local budget deficits

Apartment construction peaked in 2002; bottomed in 2003 at higher levels compared to historical cycles; and projected to rise through 2008 as high capital flows persist

Tech sector reached first cyclical peak in 2004, moving from recovery-to-growth phase, reflecting rising demand (prices) and business investment in semiconductors and IT services and equipment; however, industry slowed in second half of 2004, revenues expected fall slightly in first half of 2005

Economic Environment 2005Economic Environment 2005

Global • Terrorist attacks, military buildups

• Aggression for natural resources (Oil Shocks $35-$45)

• Mass migrations (Immigration)

• Rising gap between rich and poor nations (Poverty)

• Currency devaluations (deflation), trade wars

• Mounting sovereign debt

• Environmental catastrophe-degradation

United States • Massive federal (war/entitlements), state and local debt

• Currency devaluation (disinflation), rising interest rates

• Healthcare crisis (underinsured-none), rising costs

• Affordable housing crisis, rising urban homelessness

• Slow job growth (manufacturing sector), trade deficits

California • Continued budget deficits, low credit ratings

• Continued cutbacks in social welfare, education, infrastructure spending and state bureaucracy

• Higher fees and taxes at local level

• Affordable housing crisis, rising urban homelessness

Economic Risks 2005-2006Economic Risks 2005-2006

Bay Area • Job losses since 2000 exceeds 350,000 -- driven by tech sector, 32% of wages -- job growth strong upward trend

• High home prices, extremely low affordability

• Rental rate declines bottoming at structural occupancy rates, reduced use of concessions, normal turnover

Sacramento • Weakness in economy from state budget deficits, expenditure reductions-layoffs in gov-tech sectors

• Rapidly rising, but more affordable home prices

• Benefiting from continued firm-population in-migration

• New supply being absorbed, more competitive

Southern California • Diversified economic base, exposure to declining dollar, competition from cheap China imports

• Housing demand in excess of supply, price exposure to rising mortgage interest rates

• Orange County improving; Inland Empire regional job leader

Economic Environment 2005Economic Environment 2005

• The local economy continues to recover, low levels of employment growth (Jobless Recovery), on upward trend.

• Economic growth to accelerate second half 2005 into 2006.

• Apartment construction cycle peak 2002, trough in 2003-2004, growth phase from 2005 through 2008.

• Next business cycle peak 2004 - 2005, next technology-employment cycle peak 2006 - 2008.

• Target submarkets for apartment investment:

• Mountain View, Milpitas, and Sunnyvale• Santa Clara, Campbell and San Jose

Silicon Valley Silicon Valley Business-Market Cycle Overview

U.S. Policy IssuesU.S. Policy Issues

• $2.568 trillion budget, 55.4% mandatory ($1.4 trill.), 36% discretionary ($922 bill.), 8% interest ($211 bill.), $427-to-$390 billion deficit (3.5% GDP)

• Borrows $170 billion from social security trust fund.• $20 billion cut in domestic programs, $137 billion in entitlement

programs, $1.4 billion for Amtrak, $56 bill. education.• Does not include $81 billion for Iraq War, tax cuts ($1.5 trill.2011-

2015), social security ($1.0 trill. 10 years).• Increased spending on defense ($419 bill.), up 41% since 2001.• $69 billion cut in Medicaid, California to see $550 mill. cut in

Medicaid, $4.6 bill. over decade. • Elimination of State Criminal Alien Assistance Program, $120 million

Cal.• Research-and-Development Programs, $132 bill, up 45% since 2000.• Basic technology research, up 2.4%, Nanotechnology to get $344 bill

• Under current system, deficits debt-to-GDP to +50% by 2014

2005-2006 Budget2005-2006 Budget

• $7.6 trillion public debt outstanding, $33 billion in interest.

• $427 billion annual budget deficit, not including $192 billion for Iraq War 2004 - 2005

• Administration to cut deficit in half by 2009, under optimistic assumptions for rising tax revenue, excluding cost of Iraq/Afghanistan wars ($100 billion in 2005)

• After 2005, will have to pay $500 billion for permanent tax cuts and $400 billion for Medicare prescription drug program

• Budget deficits to total $5 trillion over next 10 years

• Foreigners currently own 47% of U.S. government debt (China/Japan)

Budget DeficitsBudget Deficits

• 70 year-old retirement system (New Deal FDR) will be taking in less than it pays by 2018 (Pay-as-you-go) as boomers retire

• System once had 16 taxpaying workers per retiree in 1950, will have two workers per senior by 2030, has 3.3 workers today

• No longer “trust fund” accumulating assets to pay beneficiaries: surpluses have been spent on war, pork-barrel projects, tax relief, etc. Government is now issuing IOUs.

• Percentage of income tax revenues needed to meet payroll tax shortfall on Social Security and Medicare to rise from 3.6% in 2004, to 28.6% in 2020, and 52.7% in 2030

• $3.7 trillion shortfall over 75 years, dwarfed by Medicare shortfalls, less than projected value of tax cuts

Social SecuritySocial Security

• Adding private accounts similar to 401K programs, to earn higher returns; however, since 1990, defined benefit median annual returns (7.42%), compared to defined contribution median returns of (6.86%) (Watson Wyatt Worldwide)

• Includes cuts in future benefits, would cost $2 trillion to over 10 years to move system to private accounts, plus borrow money to balance accounts

• Index benefits to price-index from wage-index

• Business to pay from $19 today to $30 per participant to fund the Pension Benefit Guaranty Corp., up 58%, may cause small funds to stop providing retirement benefits, deficit doubled to $23.3 billion in 2004, to introduce more complicated formula to calculate premium

• System will have to be financed through higher payroll taxes on future generations, increased borrowing, lower benefits, lower expenditures, etc.

Social SecuritySocial Security

California BudgetCalifornia Budget

• 2005-2006: Gov. Arnold Schwarzenegger (R)• $85.7 billion budget, 4.2% increase (revenues 6.8%)

• $4 billion in new borrowing, to close $9.1 billion deficit, +$30 billion in Outstanding Debt; will face $6 billion deficit next year

• No new taxes, $3 billion in spending cuts: local governments, social service programs/schools, eliminate cost-of-living increases

• Take $1.3 billion from transportation funds, redirect Prop. 42 funds

• Schools would get $2 billion less than promised, will need to pick up $1.1 billion in pension costs, looking to weaken Prop.98 guaranteed funding; did come through on UC/CSU compacts, increased spending on prisons

• Gov. wants constitutional amendment, spending cap (budget control), across-the-board cuts if lawmakers do not me deadline, special election to cost $15-to-$20 million

• Privatize pension system, from defined benefit to defined contribution by 2007 (CalPERS/CalSTRS)

California BudgetCalifornia Budget

National Economic FundamentalsNational Economic Fundamentals

Consumer ConfidenceConsumer Confidence

Fell dramatically in Feb, lowest in 16-months, due to policy announcements

Gross National Product (GDP)Gross National Product (GDP)

2005f

3.5%

World GDP Growth Rates

2004 2005

Wld 3.6% 2.9%

U.S. 4.4% 3.5%

Eur 1.8% 1.9%

Jap 4.0% 2.1%

China 9.2% 8.0%

Non-Farm Productivity Non-Farm Productivity (Output Per Hour)(Output Per Hour)

2002-2004

4.3% Ann.

Avg.

1996 - 2001

2.5% Ann. Avg.1993 - 1995

0.7% Ann. Avg.

1990 - 1992

2.5% Ann. Avg.

6.6% 4Q01

0.8%

4Q05

Source: Bureau of Labor Statistics.

Payroll EmploymentPayroll Employment

U.S. added 157,000 jobs in Dec.’04, added 2.23 million in 2004, best since 1999, below labor force growth rates

Note: U.S. lost 2.0 million mfg jobs since 2000, added 96,000 in 2004, weakest rebound in factory employment of any economic recovery on record.

150,000-to-175,000 needed per month to compensate for labor force growth

U.S. lost 1.7 million jobs to China imports from 1989-to-2003

Domestic Revenue Aircraft DeparturesDomestic Revenue Aircraft Departures

U.S. Unemployment RateU.S. Unemployment Rate

5.0% Natural Rate

People are finding jobs, but working more hours, at less income and less benefits (low-wage service jobs).

Median length of time to find job, dropped from 10.5-to-9.5 weeks

Dec.’04 5.4%

442,000 people not looking for work

Inflation ExpectationsInflation Expectations

Up 114%

Down 27%

Oil Prices up from $15 in 1998 to $45 in 2005, up 200%

Inflation ExpectationsInflation ExpectationsU.S. Producer Price Index

Note: Commodity prices up 75% since 2001, 15% in 2004, 50% from three years ago; spot gold up 57% since 2002 to $414 troy ounce; in 2004: materials up 16.2%, copper up 34%; healthcare costs up 8% per year since 2000.

Inflation ExpectationsInflation ExpectationsU.S. Consumer Price Index

Increased Volatility8% Ann. Avg.

3% Ann. Avg.

4% Ann. Avg.

Source: U.S. Department of Labor Consumer Price Index – All Urban Consumers, Johnson/Souza Group, Inc.

2003 2004

United States 1.8% 3.8%

Western Region 2.1% 2.3%

SF Bay Area 1.8% 1.5%

Los Angeles 2.6% 3.7%

Regional Economics - Inflation Rates

Pt.Ch.

2.0

0.2

- 0.3

1.1

3.4%

2.9%

2.5%

3.5%

2005f

Yield 10-Year TreasuryYield 10-Year Treasury10-Year Treasury Yield up over 50 basis points since March 04’ due to rising 10-Year Treasury Yield up over 50 basis points since March 04’ due to rising

inflation expectations, geo-political risk, and government deficit financinginflation expectations, geo-political risk, and government deficit financing

4.24%

Imputed Mtg. Int. Rt. 4.24% + 2% = 6.24%

Yield CurveYield CurveYield Curve rose in 2004 - 2005 due to rising economic activity, consumer-producer Yield Curve rose in 2004 - 2005 due to rising economic activity, consumer-producer

inflation expectations (Oil Prices), and government deficits (Crowding out)inflation expectations (Oil Prices), and government deficits (Crowding out)

http://www.bloomberg.com/markets/rates/

http://stockcharts.com/charts/YieldCurve.html

Yield Cure Analysis:

1 mth T-bill up 100 bpts 1%-to-2.0%



2 yr T-bond up 150 bpts 1.75%-to-3.25%



30 yr T-bond down -25 bpts 5.0%-to-4.75%

Prime 5.25%

Fed Funds 2.25%, from 6.5% ‘00

Discount 3.25%

http://www.bloomberg.com/markets/rates/

Balance of TradeBalance of Trade

Current Account BalanceCurrent Account Balance

China foreign-exchange reserves to $610 billion in 2004, biggest single year, largest behind Japan, exports up 35% & foreign direct investment up 17%, will continue, due to pegging of Yuan below PPP

China trade surplus, $100 bn per year, to increase due to removal of quotas: textiles, apparel, and capital-intensive high-tech goods.

5.6% of GDP

Foreign CurrencyForeign Currency

U.S. dollar to be in long-term bear mkt, similar to 1970s/1985-95 period: external financing exceeds private savings, current account/budget deficits, currency policy Japan/China, slowing economic growth in Europe/Asia, etc. Euro up 13.3% since

Aug 2004, 40% since introduction

TechnologyTechnology

N ot Im portant

Average Im portance

H ighly Im portant

Note: IT accounts for 10.5% of U.S. Em ploym ent

The Importance of IT Industries

Silicon Valley GeographySilicon Valley Geography

Technology

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

92 93 94 95 96 97 98 99 00 01 02f 03f 04f 05f 06f 07f 08f 09f 10f

Source: Milken Institute and BRE Properties Research Department.

HIGH-TECH GROSS DOMESTIC PRODUCT GROWTH(From 1992 to 2010)

Non-Residential Fixed InvestementNon-Residential Fixed Investement

R&D ExpendituresR&D Expenditures

Technology

1985-2000

2010%

2000-2003

-80%

2003-2005

100%Global merger activity up

59% in 2004, highest since 2000

• Global chip sales up 48% Y-O-Y Nov. 2003, up 40% in 2004, due to capital spending by chip makers, end of 5-Year (1998-2000) GAAP depreciation cycle (2002 – 2005).

• In 2004, global chip revenues up 33%, 12.5% per year through 2008.

• In 4Q03, global PC shipments grew 11.4% Y-O-Y, -4% in 2001.

• In 2004, chip-making tools and equipment revenue growth: equipment up 39.3% and Chips up 27%.

• In 3Q03, IT spending up 8.7% Y-O-Y, 3% in 3Q02, 12.5% in 2004.

Technology

Silicon Valley - Information/Manufacturing Employment

Venture Capital TrendsVenture Capital Trends

Silicon Valley Venture Capital Flows hit bottom 2003, rising stock prices-IPOs drive flows

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004f 2005f

Total VC Investment

Sources: Venture Economics, Pricewaterhousecoopers, Johnson/Souza Group. Inc.

SILICON VALLEYVENTURE CAPITAL INVESTMENT

In Millions

AnnualPercent Change

Bay Area still captures over 32% of all VC invested in the U.S.

Source: Venture Economics and Johnson/Souza Group, Inc.

3Q03 3Q04

California $1.83 bil. $1.97 bil.

San Jose $1.06 bil. $1.17 bil.

San Francisco $0.24 bil. $0.28 bil.

Sacramento $0.02 bil. $0.00 bil.

No. Cal. Venture Capital Flows% Ch.

7.7%

10.4%

16.7%

- 100%

Silicon Valley* $1.35 bil. $1.44 bil. 6.7%

*Accounts for 33% of all VC raised in U.S.

3Q03 3Q04

Los Angeles $0.17 bil. $0.13 bil.

Orange Co. $0.06 bil. $0.07 bil.

San Diego $0.22 bil. $0.31 bil.

So. Cal. $0.45 bil. $0.51 bil.

So. Cal. Venture Capital Flows% Ch.

- 24%

17%

41%

13%

United States $4.32 bil. $4.33 bil. 0.2%

Source: Venture Economics and Johnson/Souza Group, Inc.

Business CyclesBusiness Cycles

-7.0%

-5.0%

-3.0%

-1.0%

1.0%

3.0%

5.0%

7.0%

9.0%

1948

q1

1949

q4

1951

q3

1953

q2

1955

q1

1956

q4

1958

q3

1960

q2

1962

q1

1963

q4

1965

q3

1967

q2

1969

q1

1970

q4

1972

q3

1974

q2

1976

q1

1977

q4

1979

q3

1981

q2

1983

q1

1984

q4

1986

q3

1988

q2

1990

q1

1991

q4

1993

q3

1995

q2

1997

q1

1998

q4

2000

q3

2002

q2

2004

q1

Source: Bureau of Economic Analysis and Johnson/Souza Group, Inc.

R R R RR R R R

G

G

G G G

G

UNITED STATES BUSINESS CYCLES (1948 - 2004)

http://www.bea.doc.gov/bea/dn/home/gdp.htm

United States Business CyclesUnited States Business Cycles

California California Employment Growth (YOY)Employment Growth (YOY)

2004200019951990198519801975197019651960195519501945-10.0%

-7.5%

-5.0%

-2.5%

0.0%

2.5%

5.0%

7.5%

10.0%

12.5%

15.0%

17.5%

20.0%

CALIFORNIA YEAR-OVER-YEAR EMPLOYMENT GROWTH (1941 - 2004)

G

G

G

G GG

G G

G

R

R R

R

R

R

R

RRR

G

G

Source: Department of Labor Statistics.

San Jose PMSA Non-Farm San Jose PMSA Non-Farm Employment Growth (YOY)Employment Growth (YOY)

R R R RR

GG

G

G G

R

CaliforniaCalifornia

California: World’s 5th LargestEconomic Power

Employment (14.6 Million)

11% of total U.S. employment today

13% of U.S. employment growth through 2008

Adds 262,000 new jobs per year

Gross State Product

Exceeds $1.3 trillion

Population (35.8 Million)

12.3% of total U.S. population today

19% of U.S. population growth through 2007

Adds 479,000 people per year

Source: Economy.com, U.S. Census, Venture Economics

Venture Capital ($9.2 bill. 04’)

Up 13.6%, 45% of all U.S. Venture Capital depends on 580,000 of students enrolled at University of California & State Colleges for “brain power/human capital investment”

The Western Region is projected to outperform the nation overall, driven largely by employment and population growth in California.

Non-Farm Employment Growth Trends

California Non-Farm Employment Growth Absolute Change Year-Over-Year

-400

-300

-200

-100

0

100

200

300

400

500

600In Thousands (000's)

Sources: Economy.com and Johnson/Souza Group, Inc.

Change in HH Formation vs. Change in Total Residential Permits

-50,000

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

Household Formations Y-O-Y Total Permits Annual (4QMA)


California Household Formations vs. Total Residential Permits Issued

From 2000 through 2005, the accumulated gap between housing production and housing demand is projected to total 370,000

units, averaging 50,000-to-60,000 housing units per year

California Housing DeficitAn Average of 230,000 - 250,000 Homes Needed Annually

25

20

00

25

40

00

23

80

00

16

4,0

00

10

6,0

00

98

,00

0

85

,00

0

97

,00

0

84

,00

0

92

,00

0

110

,00

0

12

4,0

00

14

0,0

00

14

9,0

00

15

0,0

00

15

1,0

00

14

9,0

00

17

2,0

00

19

7,0

00

16

0,0

00

14

7,0

00

14

5,0

00

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

220,000

240,000

260,000

Ho

usin

g P

rod

ucti

on

Source: California Department of Finance, Construction Industry Research Board, U.C. Berkeley Department of City and Regional Planning, Economy.com, and Johnson/Souza Group, Inc.

Average Annual Housing Need

Production Gap

http://www.bankrate.com/brm/rate/mtg_home.asp

Residential Mortgage Rates Fixed

5.13%

- 70 bpts

Existing Median Home PriceAppreciation - California

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

'73 '75 '77 '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03

* 04 appreciation shown as Nov ’03 vs. Nov ’04

Source: California Association of Realtors

0

20

40

60

80

100

120

140

160

United States California

Sources: Economy.com, National Association of Realtors, and Johnson/Souza Group, Inc.

United States vs. California Affordability GapHousing Affordability Index (1984 - 2006)

…creating an ever increasing affordability gap…

Silicon Valley FactsSilicon Valley Facts


Silicon Valley (Epicenter of Information Technology)

• Greatest concentration of high-tech industries• Leading development next generation technologies• 40% workforce in tech related industries• Home to 61 fastest-growing high-tech firms• +60% manufacturing in high-tech, 9% for U.S.• 90% exports high-tech• 34% of all California exports• 53% of exports to Asia

• Silicon Valley is poised for the next tech boom, driven by combined bio-science and information technologies, continued Internet innovation and investment, and molecular electronic circuitry.

• Tech sector accounts for 32% of all wages and 11% of all jobs in the Bay Area.

• Since 1993, federal R&D funding into the Bay Area totaled $20 billion.

• Bay Area labor productivity is projected to average 4.2% per year through 2007.


DemographicsDemographics

Population Change by Bay Area Counties

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

SantaClara

San Mateo SanFrancisco

Alameda ContraCosta

Marin

1990-2000 2000-2010

Source: Association of Bay Area Governments, 2001 data.

Bay Area Demographics

Components of Population Change Santa Clara Co., 1991-2003F

-60,000-50,000-40,000-30,000-20,000-10,000

010,00020,00030,00040,00050,000

Net

Pop

ulat

ion

Cha

nge

Natural Increase Net Immigration Net Domestic Mig

Source: California Dept. of Finance and Johnson/Souza Group, Inc.

South Bay Demographics

Santa Clara County Age Distribution

0 100,000 200,000 300,000 400,000 500,000

<15

15-24

25-34

35-44

45-54

55-64

65-74

75+

Age

Ran

ge

2010 2000

Source: California Dept. of Finance.

South Bay Demographics

ECHO BOOMERS

GEN X

BABY BOOMERS

SWING GENERATION

WWII GENERATION

Population Densities Population Densities Santa Clara County Target MarketsSanta Clara County Target Markets

Household Income Distributions Household Income Distributions Santa Clara County Target MarketsSanta Clara County Target Markets

Prime Renter Cohort Densities Prime Renter Cohort Densities Santa Clara County Target MarketsSanta Clara County Target Markets

UnemploymentUnemployment

Unemployment is projected to reach Natural-Frictional rates by 2004 – 2005

EmploymentEmployment

Bay Area Non-Farm Employment growth turned positive in 4Q04

San Francisco Bay Area Non-Farm Employment Growth Absolute Change Year-Over-Year

-300

-250

-200

-150

-100

-50

0

50

100

150

200In Thousands (000's)


Nov ’02-’03 Nov ’03-‘04

San Jose - 3.8% - 1.2%

San Francisco - 3.8% 0.9%

Oakland - 2.3% 1.1%

Sacramento 1.0% 0.1%

MSA Year-Over-Year Employment Growth Rates Pt.Diff.

2.60

4.7

3.4

- 0.9

Western Region 0.9% 2.9% 2.0

Ann.Ch.

Gain/Loss

- 9,800

8,800

10,900

700

915,618

Northern California Economics

*1990 – 2000: 2.6%, 23,850

*1990 – 2000: 1.4%, 14,400

*1990 – 2000: 1.7%, 16.600

*1990 – 2000: 2.5%, 15,760

*Average annual compound growth rate, and average annual absolute change in non-farm employment.

Source: U.S. Department of Labor, Johnson/Souza. Note: Non-farm employment growth rates are not seasonally adjusted.

*1990 – 2000: 2.0%, 548,095

Absolute Change in Job Growth

0

50,000

100,000

150,000

200,000

1990s Projected '00-'10

Source: Association of Bay Area Governments, Projections 2001.

South Bay Economics

South Bay Economics Job Growth Trends 1984-2008F

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

California West SFBA San Jose MSA

Source: California Employment Development Dept., Johnson/Souza Group, Inc., and Economy.com.

-74,000

-31600

72,000

- 112,000

-9,800

10,100Average

1995-2000

201,000 jobs created

2005-2008

60,700 new jobs

18,70027,000 16,250

2000-2004

216,000 jobs lost

15,650

52,00027,000

Major Employment Clusters Major Employment Clusters Santa Clara County (+850 Employees)Santa Clara County (+850 Employees)

Home PricesHome Prices

Home Prices Nov’03 Nov’04 Y-O-Y % Ch.

United States $175,000 $188,500 7.7%

West $235,800 $271,000 14.9%

California $386,760 $473,260 23.1%

Bay Area $574,340 $661,660 15.2%

Los Angeles $382,190 $474,570 24.2%

Santa Clara $560,000 $649,000 15.9%

Sacramento $261,310 $346,170 33.1%

Riv.-San. Co. $235,150 $321,950 36.9%

Orange Co $526,270 $633,340 20.3%

San Diego $454,620 $564,830 24.2%Source: California and National Associations of Realtors and Johnson/Souza Group, Inc.

Median Home Prices

Housing Market

Median Home Prices 1982 – 2005

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

1982 1985 1988 1991 1994 1997 2000 2003

Bay Area Santa Clara Los Angeles California

Source: California Association of Realtors, Johnson/Souza Group, Inc., and Economy.com.

Housing Market

Bay Area home prices increased 11.4% per year since 1997, and are almost three times the

national average

Housing AffordabilityHousing Affordability

…high home prices, low affordability…

60

65

70

75

80

85

90

95

100

105

Sources: Economy.com, National Association of Realtors, and Johnson/Souza Group, Inc.

San Francisco Bay Area Housing Affordability Index (1984 - 2006)

Bay Area Housing Market

WESTERN REGION HOUSING AFFORDABILITY INDEX 2003(Sorted from Lowest to Highest Affordability)

0.50

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

SF Bay

Are

a

San D

iego

Ora

nge Co

Los Angele

s

Seattle

Portlan

d

Tucson

West

ern R

egion

Albuquerq

ue

Las V

egas

Salt L

ake C

ity

Phoenix

Sacra

mento

Rivers

ide

Denver

United S

tate

s

Aff

orda

bili

ty In

dex

Note: The Housing Affordability Index is a measure of a median household's ability to afford a median-priced home in a given metro area. Metros with indices over 100% indicate a greater ability for the median household to afford a median-priced home than those metros who's indices are below 100%.

Source: U.S. Census, Regional Financial Associates, Johnson/Souza Group, Inc.

Affordability Nov ‘03 Nov ‘04 Y-O-Y % Ch.

United States 57% 55% -3.5%

California 25% 19% -24.0%

SF Bay Area 19% 14% -26.3%

Los Angeles 24% 17% -29.1%

Santa Clara 26% 23% -11.5%

Sacramento 38% 25% -34.2%

Riv.-San Co. 33% 20% -39.4%

Orange Co 18% 13% -27.8%

San Diego 16% 12% -25.0%Source: California Association of Realtors and Johnson/Souza Group, Inc.

Housing Affordability Index

Housing Market

Apartment MarketApartment Market

Applications - Real Estate Cycle Theory

Employment Driven Apartment DemandBay Area total 5+ multifamily permits issued are

projected to fall below employment driven demand by 2005

-50,000

-40,000

-30,000

-20,000

-10,000

0

10,000

20,000

-50,000

-40,000

-30,000

-20,000

-10,000

0

10,000

20,000

30,000

40,000

96 97 98 99 00 01 02 03 04 05 06

1 Apt-to-5 New Jobs

1 Apt-to-7 New Jobs

1 Apt-to-10 New JobsTotal 5+ MF Permits Issued

Sources: Economy.com, Bureau of Labor Statistics, U.S. Census, and Johnson/Souza Group, Inc.

Bay Area household formations turned positive in 3Q/2003 as net outmigration slowed

San Francisco Bay Area Total HouseholdsAbsolute Change Year-Over-Year vs. Total Residential Permits

Issued

-20,000-15,000-10,000

-5,0000

5,00010,00015,00020,00025,00030,00035,00040,00045,00050,000

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

Household Formations Total Residential Permits

Sources: Economy.com, U.S. Census, and Johnson/Souza Group, Inc.

Bay Area apartment market at structural vacancy,

job growth recovery to drive rent growth

Bay Area Apartment Market

-22,000

-18,000

-14,000

-10,000

-6,000

-2,000

2,000

6,000

10,000

14,000

18,000

22,000

1993 1995 1997 1999 2001 2003 2005 2007

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

New Construction Net Absorption Vacancy Rate Eff ective Rent Growth

SAN FRANCISCO BAY AREA NEW CONSTRUCTION, NET ABSORPTION, VACANCY RATES AND RENT GROWTH 1993 - 2007

Vacancy Rate/ Rent GrowthUnits

Source: RealData, RealFacts, REIS Reports, MP/F Research, and J ohnson/Souza Group, Inc.

Commodity (Mountain/Desert/Pacific North West) markets have been much more volatile than supply constrained

(California) marketsAVERAGE EFFECTIVE RENT GROWTH, VOLATILITY (RISK) AND RISK-ADJUSTED

Annual Effective Rent Growth 1986 - 2003 Risk-Adjusted Effective RentsGeography Mean Median Standard Deviation Mean/Std. Median/Std.

Denver 2.5% 5.2% 5.4% 0.5 1.0Seattle 3.5% 3.9% 4.5% 0.8 0.9Phoenix 1.5% 1.3% 4.1% 0.4 0.3Sacramento 3.8% 4.1% 3.5% 1.1 1.2SF Bay Area 2.8% 4.2% 10.3% 0.3 0.4Los Angeles 2.8% 2.6% 3.2% 0.9 0.8Orange Co. 3.4% 3.5% 3.0% 1.1 1.2Inland Empire 2.0% 1.5% 2.3% 0.9 0.7San Diego 3.7% 3.1% 3.3% 1.1 0.9Sources: REIS Reports Inc. and Johnson/Souza Group, Inc.

Update: 05/06/2004

Vacancy and Rent Trends

Market Vacancy Rate Trends

Asking Rents 2003 2004


Orange Co. 4.9% 4.5%

San Diego 5.2% 4.1%

Riverside 4.3% 4.1%

Sacramento 6.9% 7.2%

Seattle 7.8% 7.0%

Source: MP/F Research, Inc., REIS Reports, Inc., RealFacts, Inc., and *Johnson/Souza Group, Inc.

2005f

4.6% 4.7% 3.8%

3.9%

6.6%

5.5%

Vacancy Rate

Phoenix 10.0% 8.7% 7.4% 6.4%

4.2%

2006f

Denver 10.5% 9.9% 8.6% 7.2%

4.2%

3.2%

3.8%

5.6%

4.0%

*Vacancy Rate

SF Bay Area 7.4% 6.6% 5.6% 4.7%

Market Rent Trends

Asking Rents 2003 2004


Orange Co. 2.1% 3.3%

San Diego 1.7% 3.5%

Riverside 4.1% 5.6%

Sacramento - 2.9% - 2.3%

Seattle - 5.8% - 2.2%

Source: MP/F Research, Inc., REIS Reports, Inc., RealFacts, Inc., and *Johnson/Souza Group, Inc.

2005f

4.2% 3.0% 4.4%

5.2%

0.9%

3.4%

Effective Rent Growth

Phoenix - 4.6% - 2.0% 2.7% 5.4%

5.4%

2006f

Denver - 8.8% - 4.4% - 1.0% 2.9%

4.2%

5.7%

5.4%

3.5%

5.1%

*Effective Rent Growth

SF Bay Area - 9.0% - 3.1% 2.5% 5.7%

Metro Area Relative Rankings

California’s Limited supply leads to sustained revenue growth...

LAX 7.27%SFO 3.92%PHX 0.34%DEN ( 0.82%)

CAGR

Same-Store Revenues

$80

$90

$100

$110

$120

$130

$140

$150

$160

$170

1997 1998 1999 2000 2001 2002 2003

SFO 100 PHX 100 LAX 100 Den

Supply-Constrained Markets

Commodity Markets

…and even stronger NOI growth

LAX 10.45%SFO 4.88%PHX (1.40%)DEN (2.74%)

CAGR

Same-Store Net Operating Income

$50

$70

$90

$110

$130

$150

$170

$190

$210

1997 1998 1999 2000 2001 2002 2003

SFO 100 PHX 100 LAX 100 Den

Supply-Constrained Markets

Commodity Markets

Silicon Valley Cap Rate Trends

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

$85

$105

$125

$145

$165

$185

$205

$225

Apt Cap Rate Apt Price PSF

Source: National Real Estate Index and Johnson/Souza Group, Inc.

SAN JOSE PMSACAPITALIZATION RATE V.S. PRICE PER SQUARE FOOT

(From 1989 to 2004)Cap Rate Sale Price PSF

Commercial MarketCommercial Market

Office Industrial YOY Ch.Rnts

San Jose 24%/19% 10%/12% - 12%

San Francisco 20%/17% 13%/9% 5.8%

Oakland 19%/18% 15%/13% 0%

Sacramento 12%/14% 12%/11% - 4%

MSA Office-Industrial Vacancy Rates (4Q03/4Q04)

Silicon Valley Commercial MarketSilicon Valley Commercial Market

Source: CB Richard Ellis, Inc.; and Johnson/Souza Group, Inc.

Bay Area: 9,000,000 sf Net Absorption 2004 (Silicon Valley 16%)

114,570,000 sf Available as of 4Q04 (Silicon Valley 49%)

Office-Industrial-Apartment Markets Office-Industrial-Apartment Markets

Santa Clara CountySanta Clara County

0.0%

2.5%

5.0%

7.5%

10.0%

12.5%

15.0%

17.5%

20.0%

22.5%

25.0%

-50,000

-40,000

-30,000

-20,000

-10,000

0

10,000

20,000

30,000

Off. Vac. Rate* Struct.Vac.Rt Apt Vac. Rt. Struct.Vac.Rt Empl. Ch.

Quarterly Employment Growth

Quarterly Office Vacancy Rate

Quarterly Apartment Vacancy Rate

Employment GrowthVacancy Rates

12.25 Million Square Feet Vacant

7.2 Million Sq.Ft. Office Net Absorption

2004 - 2006: +40,000 Jobs Created

7,000 units of Apartment Absorption

Structural Office Vacancy Rate

Structural Apartment Vacancy Rate

Sources: CB RichardEllis, Inc.; Economy.com; REIS Reports, Inc.; MP/F Research; and Johnson/Souza Group, Inc.

SILICON VALLEY OFFICE-APARTMENT MARKET

Non-Residential Permits Valuations

SOURCE:U.S. Real Estate Research Councilof Northern California

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

5500

6000

6500

7000

7500

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Industrial BldgsRetail BldgsOffice BldgsOther(Gap to Non Res Total)

Millions of Dollars

• 9 Bay-Area Counties (1989-2003)

SOURCE: Torto Wheaton

90

95

100

105

110

115

120

125

San Francisco Oakland Sacramento San Jose

1999 2000 2001 2002 2003 2004 2005

Office Bldg Total Rentable Space (1999 = 100)

•


0

5

10

15

20

25

1999 2000 2001 2002 2003 2004 2005

Va

ca

nc

y R

ate

in P

erc

en

t

Oakland San Francisco San Jose Sacramento

Office Vacancy Rates

•


0

5

10

15

20

25

30

35

40

45

50

55

60

1999 2000 2001 2002 2003 2004 2005


Office Rent Index, $/SF

•


94

96

98

100

102

104

106

108

110

Oakland San Jose Sacramento San Francisco

1999 2000 2001 2002 2003 2004 2005

Industrial Total Rentable Space (1999 = 100)

•


0

5

10

15

20

25

1999 2000 2001 2002 2003 2004 2005

Va

ca

nc

y R

ate

in P

erc

en

t


Industrial Vacancy Rates

•


0

2

4

6

8

10

12

14

16

1999 2000 2001 2002 2003 2004 2005


Industrial Rent Index, $/SF

•

Construction Lending

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

Millions of Dollars

SOURCE:U.S. Real Estate Research Council of Northern California

9 Bay Area Counties

ConclusionsConclusions

Comparative AdvantagesComparative Advantages

Long run apartment market fundamentals:

Extremely low housing affordability

Scarcity of developable land

High concentrations of wealth

High quality of life

Strong Demographic Trends:

Growing population of Empty-Nesters and Echo-Boomers

Future job growth-housing demand:

• High-tech and Bio-tech Manufacturing• Healthcare-Information Systems Services• Financial Services and Venture Capital• Telecommunications/Networking• Multimedia and Entertainment• Internet and Software Programming• International trade and Tourism• Construction and Engineering Services• Education and Government Services• Defense

Comparative AdvantagesComparative Advantages

Economic RisksEconomic Risks

Market-Economic Risks:

High costs of living and doing business

State-Local Regulations, taxes, workers comp, deficits

Lack of affordable/developable land

Traffic Congestion and Infrastructure Constraints

Out sourcing and migration

Severe cut-backs in education and social services

Mergers-consolidation industrial, technology,

telecommunications and financial institutions

Macro-Economic Risks

• Middle East Wars (Oil Price Spikes)

• Current Account and Budget Deficits (Interest Rates)

• Rising Inflation Expectations (Health Care Costs)

• High Credit-Equity Risk Premiums (Spreads)

• Consumer-Business Confidence Investment

• European Recessions and Trade Wars

• Rising loan defaults, foreclosures, bankruptcies

• Labor strikes, falling wage growth, underemployment

• Accounting Announcements, Investor Confidence

Lawrence Souza (lsouza@Johnson/SouzaGroup.com) brings to Johnson/Souza Group, Inc. (Direct: (415-713-0213) over 15 years of experience in real estate economic and financial research. As Director of Research for BRE Properties, Inc. (REIT) in San Francisco and holding Senior Market/Research Analyst positions at Metric Institutional Realty Advisors and Mellon-McMahan/MacFarlane Realty Advisors, and market research positions at Norris, Beggs and Simpson and Grubb & Ellis commercial brokerage. Mr. Souza combines traditional fundamental real estate economic and market research with fundamental and technical financial and capital market research. This combined approach allows for the tracking and forecasting of economic, real estate and financial cycles and efficient portfolio construction, optimization and risk management.

Mr. Souza is also a licensed California Real Estate Broker (Realtor), affiliated with RE/MAX Commercial, specializing in urban-infill residential, commercial property transactions, and 1031 Exchanges in the San Francisco Bay Area and Western Region. Mr. Souza has undergraduate degrees in Economics (BA) and Business Administration (BS) with concentrations in Accounting, Finance, Banking and Real Estate; and holds master’s degrees in Applied Economics (MA), Finance/Investments (MS), Public Administration (MPA), and Information Systems (MSIS). Mr. Souza has been teaching Modern Real Estate Principles and Finance since 1996 with an emphasis on real estate in a modern portfolio and capital markets context; and the institutionalization, securitization, internationalization and technologization of real estate markets and products.

mailto:lsouza@Johnson/SouzaGroup.com

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