Expectations Market Realities In

8/6/2019 Expectations Market Realities In

1/47D E L O I T T E | R E a L E s T aT E R E s E a R c h c O R p O R a T I O n | R E a L c a p I T a L a n a L y T I c s

E x p E c T a T I O n s & M a R k E T R E a L I T I E s I n R E a L E s T a T E 2 0 1 1

BALANCING RISK AND RETURN IN AN ERA OF UNCERTAINTY


2/47

2011 | Real Estate Research Corporation, Deloitte Development LLC, Real Capital Analytics.

All Rights Reserved.

No part of this publication may be reproduced in any form electronically, by xerography, microlm, or otherwise, or incorporated into any database or infor-mation retrieval system, without the written permission of the copyright owners.

Expectations & Market Realities in Real Estate 2011 is published by:

Real Estate Researc Crrat

980 North Michigan Avenue, Suite 1400

Chicago, IL 60611

Deltte

111 S. Wacker DriveChicago, IL 60606

Real Catal Aalytcs

139 Fif th AvenueNew York, NY 10010

Disclaimer: This report is designed to provide general information in regard to the subject matter covered. It is sold with the understanding that the authorsof this report are not engaged in rendering legal or accounting services. This report does not constitute an oer to sell or a solicitation of an oer to buy any

securities, and the authors of this report advise that no statement in this report is to be construed as a recommendation to make any real estate investment

or to buy or sell any security or as investment advice. The examples contained in the report are intended for use as background on the real estate industry asa whole, not as support for any particular real estate investment or security. Neither Real Estate Research Corporation (RERC), Deloitte, nor Real Capital Ana-

lytics (RCA), nor any of their respective directors, ocers, and employees warrant as to the accuracy of or assume any liability for the information contained

herein. Unless otherwise noted herein, the data presented in this report is sourced from RERC and RCA.

As used in this document, Deloitte means Deloitte & Touche LLP, Deloitte Financial Advisory Services LLP, Deloitte Consulting LLP, Deloitte Tax LLP, and

Deloitte Corporate Finance LLC. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.


3/47

E x p E c T a T I O n s & M a R k E T R E a L I T I E s I n R E a L E s T a T E 2 0 1 1

BALANCING RISK AND RETURN IN AN ERA OF UNCERTAINTYD E L O I T T E | R E a L E s T aT E R E s E a R c h c O R p O R a T I O n | R E a L c a p I T a L a n a L y T I c s


4/47 2 0 1 1 D E L O I T T E D E v E L O p M E n T L L c , R E a L E s T aT E R E s E a R c h c O R p O R aT I O n , R E a L c a p I T a L a n a L y T I c s . a L L R I g h T s R E s E R v E D . | 4

E x p E c T aT I O n s & M a R k E T R E a L I T I E s I n R E a L E s T aT E 2 0 1 1 | b a L a n c I n g R I s k a n D R E T u R n I n a n E R a O f u n c E R T a I n T y

SPONSORING FIRMS

Real Estate Researc Crrat

Founded in 1931, Real Estate Research Corporation was one o the frst national frms dedi-cated to commercial real estate research, valuation, and consulting services. Today, RERCis also known or its independent fduciary services, management inormation systems,valuation management, and litigation support serv ices. With its practical know-how anddiscipline, RERC serves as the independent fduciary and oversees all real estate invest-ment- and valuation-related activity o the multi-billion dollar real estate accounts orseveral major pension unds. In addition, RERC provides web-based portolio technologysolutions and valuation management or several other major unds. Further, RERC hasprovided airness opinions on dozens o major acquisitions totaling over $1 billion. RERCsvaluation services also have proven rewarding to real estate owners and investors or tax

appeals and expert witness testimony in partnership disputes.

Deltte

Deloitte is a recognized leader in providing audit, tax, consulting, and fnancial advi-sory services to the real estate industry. Our clients include top REITs, real estate buyers,property owners and managers, lenders, brokerage frms, investment managers, pensionund managers, and leading homebuilding and engineering & construction companies.Our Real Estate Services team provides an integrated approach to assisting clients mini-mize real estate costs and enhancing frm value. We customize our services in ways toft the specifc needs o each player in a real estate transaction, rom owners to invest-ment advisors, rom property management and leasing operators to insurance compa-nies. Our multi-disciplinary approach allows us to provide regional, national and globalservices to our clients. Our real estate practice is recognized or bringing together teamswith diverse experience and knowledge to provide customized solutions or all clients.Deloittes national Real Estate Services industry sector comprises over 1,200 proession-als supporting real estate clients out o oces in 50 cities; key locations include Atlanta,Boston, Chicago, Dallas, Denver, Houston, Los Angeles, Miami, New York, San Francisco,and Washington, D.C.

Real Catal Aalytcs

Real Capital Analytics, Inc. (RCA) is a global research and consulting frm with oces in

New York City, San Jose, London, Singapore and e Hague. Started in 2000, the frmsproprietary research is ocused exclusively on the investment market or commercial realestate. In addition to collecting transactional inormation or current property sales andfnancings, RCA analyzes and interprets the data, providing valuable insight on commer-cial real estate investment. Covering all markets globally, RCAs investment market dataand analysis is relied upon by all segments o the real estate community: buyers, develop-ers, brokers, lenders and regulatory agencies. Among other reports, RCA publishes GlobalCapital Trends, US Capital Trends and Troubled Assets Radar. Timely, complete and accu-rate reporting o investment activity is the hallmark o Real Capital Analytics.




FOREWORD

April 2011

Dear Readers,

As we put the fnishing touches on our annual orecast report,Expectations & Market Realities in Real Estate 2011, we arestruck by the challenges acing the commercial real estate industry in this uncertain world. Despite our experience and senseo having been t hrough this a ll beore, we remain cautious with our expectations and about the investment environment overall. e recovery that took hold in the second hal o 2010 continues, but we are well aware o the headwinds that could quicklyderail both the growth o our economy and the markets.

As such, Real Estate Research Corporation (RERC), Deloitte, and Real Capital Analytics (RCA) are pleased to present this un-

damental guide or Balancing Risk and Return in an Era of Uncertainty. Our collective viewpoints, commentary, and analy-ses oer you an unbiased look at what you can expect regarding the expanding economy, capital markets, and individualproperty markets throughout 2011 and beyond.

ank you to everyone who has contributed to this report, including research analysts and data providers, economists, business associates, research survey respondents, and the many others who have shared your inormation and ideas. We alsothank youour readers, clients, and consultantsor your interest in our report, and we hope you fnd Expectations & MarketRealities in Real Estate 2011Balancing Risk and Return in an Era of Uncertaintyhelpul as we navigate through a still-ragile recovery.

Sincerely,

Robert M. White, Jr., CRE, FRICS

Founder & PresidentReal Capital Analytics, Inc.

Matthew G. Kimmel, CRE, FRICS, MAI

Principal & US Real Estate Services LeaderDeloitte Financial Advisory Services LLP

Kenneth P. Riggs, Jr., CFA, CRE, FRICS

President & CEOReal Estate Research Corporation




ACKNOWLEDGEMENTS

SponSoRing FiRmS & ChAiRS

mattew g. Kel, CRE , FRiCS, mAi Deloitte Financial Advisory Services LLPKeet p. Rs, Jr., CFA, CRE, FRiCS Real Estate Research Corporation

Rert m. Wte, Jr., CRE, FRiCS Real Capital Analytics, Inc.

ConRibuing AuhoRS

bar bs Real Estate Research Corporation

Sa Cada, pD. Real Capital Analytics, Inc.

dd J. Dla, mAi, mRiCS, Ser maaer

Deloitte Financial Advisory Services LLPDavd garca Deloitte Financial Advisory Services LLP

Keet W. Kaeck, mAi, CRE, FRiCS, Ser maaer

Deloitte Financial Advisory Services LLPLdsey Kla Real Estate Research Corporation

Ady mller, maaer Deloitte Financial Advisory Services LLP

D mry Real Capital Analytics, Inc.peter Slat Real Capital Analytics, Inc.

patrck erralt Real Capital Analytics, Inc.

na rer Real Capital Analytics, Inc.bra Velky, CFA Real Estate Research Corporation

mra Westfal Real Estate Research Corporation

EDioRiAL oVERSighpeter Slat Real Capital Analytics, Inc.

DESign & LAou

Lke baldw 21Fingers

Je Carr Real Estate Research Corporation

ohER DiSinguiShED ConRibuoRS

Rert bac Grubb & EllisRald Jsey Axiometrics, Inc.

Rert madela PKF Hospitality Research

R. mark Wdwrt PKF Hospitality Research

RERC EDioRiAL boARD

Stee blak Urban Land Institute

Davd blakes AEGON USA Realty Advisors, Inc.

nclas g. bss INVESCO Real Estate

Ssae Ca DePaul University - The Real Estate Centergerey Dra Institutional Real Estate, Inc.

Stee Frary ING Clarion Partners

mcael gately Cornerstone AdvisersDavd gelter MIT Center for Real Estate

Jacqes grd LaSalle Investment Management, Inc.

J Levy John B. Levy & Companymary Ld Heitman Capital Management, LLC

Des mart RREEF/DB Real Estate

gle meller University of DenverSctt mldav The Muldavin Company, Inc.

Jse palar University of Chicago

Rcard Sklv Simon Property Group

Alla Sweet AMLI Residential Properties, LLCR. bra We UBS AgriVest, LLC

Carles Wrtzeac DePaul University-The Real Estate Center

Sa Zell Equity Group Investments, LLC




CONTENTS

1 | inRoDuCion

Balancing Risk and Return in an Era o Uncertainty .............................................................................................................................8

2 | hE CApiAL mARKES

Capital Begins to Flow .............................................................................................................................................................................11

3 | hE pRopER mARKES

Perspective and Analysis ........................................................................................................................................................................21

4 | ouLooK FoR 2011 AnD bEonD

Uncertainty and the Need or Balance ..................................................................................................................................................39

SponSoRing FiRmS

................................................................................................................................................................................................................... 44




1 | INTRODUCTION

balac Rsk ad Retr a Era f ucertaty

When Real Estate ResearchCorporation (RERC), Deloitte, andReal Capital Analytics (RCA) frst dis-cussed partnering together to publishthis orecast report, a distinct sense ouncertainty about the economy, aboutthe capital markets, and about com-mercial real estate dominated ourconversation. Our unease was under-standablewe were barely out o thelongest and most severe recessionsince the Great Depression, the level

o U.S. debt was reaching epic propor-tions, and the number o new bankailures attributed to their exposure tobad commercial real estate loans wasincreasing weekly.

It seemed that the invest-ment environment was fnally start-ing to turn around when a new Con-gress came to town and tax cuts wereextended or businesses and individu-als. We were thrilled when the stockmarket fnally began to grow by leapsand bounds, and even more thrilled when institutional real estate returnsincreased to approximately 13 percentin ourth quarter 2010, according to theNational Council o Real Estate Invest-ment Fiduciaries (NCREIF).

As 2011 got underway, welooked or additional signs o recovery,but major world crises during the frstew months o this yearthe earth-quake, tsunami, and nuclear power

disaster in Japan, the unrest spread-ing throughout the Middle East, thesovereign debt crisis in Europe andthe downgrading o those nationscredit ratings, continued threats oterrorism, to name a ewremindedus how quickly real events can temperoptimism. Now, as the year unolds,the economy still aces a series ospeed bumps, and the investment

environment, although improv-ing, remains uncertain. Risk is ever-present and returns seem to be eet-ing or all asset classes, as investorstry to balance these opposing orces.

As such, investors are ocusingon why they invested in real estate inthe frst place. Real estate is a tangiblealternative to the more volatile stockmarket, and is more transparent thanstocks. It oers reasonable income

returns, which investors are seekingtoday, instead o the glitz and glamouro Wall Street. No one wants, or canaord, to make mistakes, and by ocus-ing on the undamentals o their prop-erty investments, investors are keepingthings simple and direct.

at is what we have tried to doin Expectations & Market Realities

in Real Estate 2011Balancing Risk

and Return in an Era of Uncertainty

In this frst introductory chapter tothe report, we have ocused on theeconomy and the various risk actorsassociated with our ragile recovery asthe backdrop or investing in commer-cial real estate. Chapter 2 examinesthe debt and equity markets, as welas the banking practices/new regula-tions aecting the availability o capi-tal. In Chapter 3, we take a close look

at the oce, industrial, retail, apart-ment, and hotel markets, and analyze volume, pricing, capitalization rates vacancy/occupancy rates, and rentarates/revenue or the specifc propertysectors. In our fnal chapter, we oerour collective assessment and invest-ment outlook or the risk and returnassociated with the major propertymarkets or 2011 and beyond.




hE EConomA Qualifed Recovery Presents NewChallenges

In the atermath o this genera-tions deepest and most destabilizingrecession, many o our oundationalassumptions about the Americaneconomy and investment environ-ment have been upended. While theeconomy has resumed its expansion,questions about the speed and dura-

bility o the recovery have coincided with proound uncertainties relatingto the direction o monetary and fscalpolicy and the changing relationshipbetween government, business, andthe American people. For policymak-ers and businesses alike, new threatsto geopolitical and global macroeco-nomic stability have added to the pre-vailing headwinds; the broader context

o the recovery has precluded a singu-lar ocus on the issues that are withinour control. In the ace o this remark-able opacity, commercial propertyinvestors and lenders have nonethe-less powered orward, albeit unevenly,anticipating stronger undamentals asthe recovery progresses. In 2010, com-mercial property sales doubled romthe previous years nadir. e marketsmomentum has carried over into 2011, with broad metrics relating to liquid-ity and credit availability reecting

investors optimism in the sectorstrajectory.

A Fragile Economic Recovery

Even as investor activity haspicked up, the economy and labor mar-kets have measured qualifed gains.e recession has been over or longerthan it lasted, and businesses and

consumers have recaptured a measureo confdence. Banks and other lend-ers, emerging rom unprecedentedupheaval, have loosened the strictureson credit, supporting a modest renewao investment and spending. And

whereas the initial return to growthwas powered by a dramatic and costlysurge in public activity, the private sec-tor has now taken the place o the gov-ernment in sustaining the expansion.

However, employers have a longway to go in replacing the 8.7 million jobs lost in 2008 and 2009. rougearly 2011, we have measured theslowest progress in the labor marketsrecovery ollowing any post-World WarII recession. For most o the past year,

the absence o robust payroll growthhas ollowed rom slack in the utilization o currently employed workers andstrong gains in productivity. In recenteconomic history, these are typical eatures o a recovery in the labor marketthat lags the broader economys emergence rom recession.

But exacerbating the expectedlag in payroll gains, businesses havebeen navigating a more complicatedroute in the current recovery, managing the aorementioned uncertainties around the regulatory and policyenvironment and, more recently, anincreasing incidence o mismatchin required skill sets and the skillspresent in the unemployed labor poolJob openings remain extremely lowby any historic norm, but have beenincreasing in recent months. Howeverin many o the sectors that are moscrucial or a recovery in spending anddirect space demand, hiring has no

kept pace.

e most recent data suggesthat hiring may accelerate modestlyover the course o 2011. Barring anydisruptive shocks, the consensus esti-mates suggest that payrolls at midyearmay be expanding at a ast enoughpace to oset new entrants to thelabor orce, thereby reining in broader

For policymakers and businesses alike, new threats to geopolitical and

global macroeconomic stability have added to the prevailing headwinds

commercial property investors and lenders have nonetheless powered

forward, albeit unevenly, anticipating stronger fundamentals.


10/47 2 0 1 1 D E L O I T T E D E v E L O pM E n T L L c , R E a L E s T aT E R E s E a R c h cO R p O R a TI O n , R E a L c a p I T a L a n a L y T I c s . a L L R I g h T s R E s E R v E D . | 1 0


measures o unemployment. Still,property investors with heady expecta-tions or job growth and space absorp-tion must contend with the possibilitythat stresses on cash ow may persist.

Rebalancing Investment

e qualifed economic tra- jectory has prompted investors toassign unusually large premiums tothe liquidity o assets. As a result, theindustrys headline statistics belie astriking and persistent unevenness othe recovery in investment and credittrends. In a ight to quality, investorsover the past year have ocused theireorts on acquiring properties in thenations most visible and most liquid

markets. is ocus has resulted ina concentration o capital in a smallsubset o marketsNew York City, Washington, D.C., and San Franciscooremost amongst them. It is in thesemarkets that competition or assetshas been most intense, supported bya diversity o domestic and oreigninvestors, with domestic investorsrustrated by the absence o opportu-nities in distress and oreign investorsless dependent on mortgage fnanc-ing. In some cases, pricing threatens todecouple rom the undamental basisor value.

Underpinning gains in majormarkets and or the highest qualityproperties, the availability o creditin support o signifcant propertysales, as well as or the refnancing omaturing debt, has improved sharplyin recent quarters. Buoyed by theaorementioned pricing trends andnascent recovery in property unda-

mentals in major markets and someproperty sectors, a broader range olendersincluding commercial mort-gage-backed securities (CMBS) con-duit originators, oreign banks, andlie companieshas re-engaged withcommercial real estate investors inthe latter hal o 2010, albeit on termsthat remain conservative by historicstandards and even as smaller banks

have curtailed their lending. isimprovement in mortgage availabil-ity has been necessary or a broadermove towards normalization in thesectors capital markets.

Coinciding with the improvingposition o many lenders, the dominantrole o agency fnancing in the apart-ment sector has moderated as otherinstitutions have begun to competemore aggressively or lending opportu-nities. In major markets, in particular,institutional and securitized lendersreadiness to provide new acquisitionfnancing on perorming assets hassupported the shit in investor activityaway rom the agency and private buy-ers that dominated activity in 2009 andearly 2010.

As an important acilitator othis healthier new acquisition fnanc-ing environment, additions to distressnationally ell to their lowest levels in2 years in third quarter 2010, reect-ing a slower pace o deterioration inlegacy mortgage pools and the positiveimpact o more stable economic and

credit market conditions. O course,slower inows to distress and theabsence o distress investment oppor-tunities do not mean that deterioratingmortgage perormance is not a eatureo the market landscape. Rather, dis-tress has been heavily intermediated,let unresolved, or is residing on bankbalance sheets. e question o how wemanage to draw down these balances,

when some o the most aggressivelunderwritten loans have yet to matureremains an issue or the market. Whilea sudden outpouring o distress wouldinevitably provide opportunities or

distress investors, it would do so byundermining the price stability thathas been crucial in driving improvements in sales and credit.

e Year Ahead

Whether in primary markeor urther afeld, the positive trendsin headline transaction volume maycontinue into 2011, barring a seriousreversal in the underlying economicand labor market recovery. But inmeasuring this recovery, investors wilhave to remain vigi lant, particularly asconcerns the magnitude o job growththe regulatory and policy environ-ment, and the complex, nonlinear rela-tionship between broad interest ratesand cap rates.

In the realms o public and pri vate markets, and at their juncture

signifcant risks may continue to exerdrags on consumer and business con-fdence in a way that is material or thecommercial property outlook. Giventhis unique environment o uncer-tainty, and in planning or the utureinvestment strategies that anticipatethe need or exibility (as opposed torelying on a rigid and deterministicoutlook) remain crit ically important.




2 | THE CAPITAL MARKETS

Catal bes t Flw

Despite a residential market thatis still in decline, anemic employmentgrowth, and a record-high ederal debt,the U.S. economy saw positive growththroughout 2010 and is expected tocontinue to grow, i slowly, over thenext ew years. is is no small eat,given the recent near-collapse o ournations fnancial system and a reces-sion more severe than any since theGreat Depression. It is a tribute to thenations economic resilience to havesurvived this crisis, and although agreat deal o uncertainty continues inthe economy, the geopolitical land-scape, and the markets, we are hopeulthat the broader recovery holds posi-

tive prospects or orward momentumin commercial real estate investment.

Capital has become increasinglyaccessible, as companies, unds, andindividuals continue to regain someo the wealth lost in the crash; accord-ing to some estimates, corporationsare holding as much as $2 trillion inreserve. Although only a percentage

o this will likely be directed towardcommercial real estate, investors

responding to RERCs institutionainvestment survey have seen theavailability o capital or commerciareal estate investment increase sig-nifcantly rom its low in third quarter2008 (see Exhibit 2-1). In ourth quarter2010, the availability o capital beganto overtake discipline or the frst timesince the fnancial crisis began. Capital ows increased rom virtually everysector, including private investorspension unds, real estate investmen

trusts (REITs), institutions, oreigninvestors, and others. Many respond-ents to RERCs investment survey alsostated that they intend to direct morecapital toward commercial real estateduring 2011 than they invested in 2010

is changing sentiment isalso reected in the Buy-Sell-Holdrecommendations noted by RERCs

1

2

3

4

5

6

7

8

9

10

Discipline

Availability

4Q201

0

4Q200

9

4Q200

8

4Q200

7

4Q200

6

4Q200

5

4Q200

4

4Q20

03

4Q200

2

4Q200

1

Rating

Exhibit 2-1. RERC Historical Availability and Discipline of Capital

Rti re ed o ore o 1 to 10, wit 10 ei i.sore: RERc, 4q 2010.




institutional investment surveyrespondents (Exhibit 2-2). e Holdreerence retains the highest-ratedrecommendation, reecting quiteclearly the dominant strategy withinthe market. But more interesting, and

perhaps more relevant, is the narrow-ing gap between the Buy and Sell rec-ommendations, indicating increasingagreement on pricing and valuation.While we have seen transactions in thetop-tier markets or high-quality prop-erties at record high prices during thepast ew quarters, demand is startingto extend to core properties in some othe secondary and tertiary markets aswell, as investors move out on the riskspectrum.

LEnDing SAbiLiZES AnDiSSuAnCE piCKS up

As commercial real estate own-ers continue to deleverage, many keylending sources have become moreexible in the treatment o existingdebt, but have been less accommo-dating concerning new loan origina-tion. Commercial mortgage origi-nations, though increasing, remainsignifcantly below peak-market levels.While new issuances rom alternativesources remain minimal, new lendingis expected to continue at subdued lev-els in the near term. However, stabili-zation is apparent and signs o revitali-zation are evident.

Bank Lending

Banks initially responded tothe fnancial crisis by rapidly tight-ening underwriting on commer-

cial loans, but in general, approvalstandards began to ease in 2010. eJanuary 2011 Federal Reserves Sen-ior Loan Ocer Opinion Survey onBank Lending Practices noted that inourth quarter 2010, approximately69 percent o banks let their lendingstandards or commercial real estatebasically unchanged, approximately 8percent o banks eased standards, and

approximately 23 percent o bankstightened their lending standards(this was down signifcantly rom ahigh o 87 percent in ourth quarter2008, immediately ollowing the col-lapse o Lehman Brothers).

Buttressing the warming trend,about 10 percent o domestic bankson net reported increased demandor commercial real estate loans inourth quarter 2010, the strongestreading since early 2006. Foreignbanks also reported that net demandhad strengthened, according to theFederal Reserve.

Still, certain commercial reaestate loan terms tightened in 2010. eFederal Reserves January 2011 SeniorLoan Ocer Opinion Survey on BankLending Practices urther stated thaabout 40 percent o domestic banks onnet reported having tightened loan-tovalue ratios, and a moderately smalleraction tightened debt service cover-age ratios and maximum loan sizesduring ourt h quarter 2010.

Despite examples o tighten-ing, according to preliminary esti-mates rom the Mortgage Bankers Associations (MBA) Quarterly Survey

1

2

3

4

5

6

7

8

9

10

Hold

Sell

Buy

4Q201

0

4Q200

9

4Q200

8

4Q200

7

4Q200

6

4Q200

5

4Q200

4

4Q200

3

4Q200

2

4Q200

1

Rating

Exhibit 2-2. RERC Historical Buy-Sell-Hold Recommendations

Rti re ed o le o 1 to 10, wit 10 ei i.sore: RERc, 4q 2010.




of Commercial/Multifamily MortgageBankers Originations, mortgage bank-ers originated $110 billion o commer-cial and multiamily mortgages during2010, up a healthy 36 percent rom 2009originations.

e threat to banks associ-ated with bad loans remains great,but according to the Federal DepositInsurance Corporation (FDIC), thenumber o bank ailures shoulddecline in 2011. Although 157 banksailed in 2010 (the most since 1992during the savings and loan crisis) and884 banks remained on the FDICs listo problem banks at the end o ourthquarter 2010, the FDIC expects to seeewer bank ailures in 2011. (For com-

parison, there were no bank ailuresin 2006 and only three in 2007.)

Other Sources o MortgageOriginations

Lie insurance companies werea leading source o lending in 2010, with originations volume 155 percenthigher than 2009 levels, although thedollar volume was low in absoluteterms. Signifcantly, the MBA reportedthat originations or CMBS conduitsincreased more than 10-old in 2010,and that government-sponsored enti-ties (GSEs) also saw strong volumes,with increases in production or FHA/Ginnie Mae osetting a decline inproduction or Fannie Mae/FreddieMac. Although the low absolute levelsdramatically inated the growth per-centage, there were clearly positivechanges in borrowing and lending orcommercial real estate.

Going orward, the expectationis that more avorable market condi-tions or both lenders and borrowerswill l ikely help boost CMBS issuance inthe near term, although the level willremain below the 2007 peak over thelonger term. In 2008, CMBS accountedor 25.6 percent o commercial mort-gage loans; however, due to the cen-tral role these and similar securities

played in the fnancial crisis, issuancedropped to nearly zero in 2009 (just$720 million was issued in 2009). Butlast year, lenders issued a total o $11.6billion o CMBS, and improved condi-

tions have led most analysts to expect$35 billion to $45 bill ion o CMBS issu-ances in 2011 according to Standard &Poors (S&Ps) estimations. However,that is still ar o the markets peak o$230.5 billion in 2007.

Securitized loans issued in 2009and 2010 have been dubbed CMBS 2.0,and are characterized by simpler struc-tures that involve greater subordina-tion levels, ewer classes and loans,and thicker tranches, all designedto reduce the level o due diligence

required to execute. Additional und-ing sources are also emerging, includ-ing covered bonds, which consist osecurities issued by banks and backedby a cover pool o mortgage or public-

sector loans. is vehicle is one o theoldest orms o capital in the Europeanbond market, and could provide a newunding mechanism as the industryattempts to rebound. Another simpleand direct throwback that is being utilized is seller fnancing, in which theseller provides a secured loan to thebuyer to fnance a portion o a prop-ertys purchase price.

A breakdown o 2010 investmentin commercial real estate by investortype is shown in Exhibit 2-3.

Institutional

13%Non-ListedREIT 9%

Equity Fund14%

Private30%

User/Other

9%Cross-Border

7%

Listed/REIT18%

Exhibit 2-3. Commercial Real Estate Investor Groups (2010)

sore: Rca, ferr 2011.




Commercial Mortgage Debt

According to the Federal ReserveFlow o Funds, the level o commercial/multiamily mortgage debt outstand-ing decreased to $3.15 trill ion in ourth

quarter 2010 rom third quarter totals. As demonstrated in Exhibit 2-4, thelargest holder o commercial debt con-tinues to be commercial banks.

high DEb mAuRiiESREmAin A ChALLEngE

While lenience by banks hashelped cushion commercial real estaterom a more severe downturn, the highlevel o maturing debt remains a signi-

icant barrier to ull recovery. e coreo the dilemma is that debt incurred at

the top o the market is now coming dueat a time when economic uncertaintyand barely recovering commercialreal estate undamentals are making itharder or borrowers to generate cashow needed to make debt payments. Inact, Trepp, LLC noted that as much as60 percent o current commercial realestate loans maturing between 2011and 2015 are considered underwater,indicating the amount o debt exceedsthe market value o the property itsel.

How Big Is the Dilemma?

Trepp, LLC predicts that anestimated $1.7 trillion in commer-cial real estate debt is set to come duebetween 2011 and 2015, a fgure thatcould turn out to be even higher oncethe impact o amend and extend isconsidered (see Exhibit 2-5). Morgan

Stanley estimates that modifca-tions have pushed CMBS maturitiesrom the 2009-2011 range out to the2013-2017 time period. As the major-ity o commercial real estate loans areor a period o 5 years, a majority othe debt incurred during the peak o

the market in 2007 and 2008 is set tomature in 2012 and 2013. e peak yearor maturities is expected to be 2013 when $367.7 billion will come duebeore the amount decreases modestlyto $333.0 billion in 2015, and then subsides to less than $100 billion by 2020.

Commercial Banks44%

Life InsuranceCompanies

20%

CMBS, CDO andother ABS

9%

Savings Institutions6%

Govt. Sponsored Entities

16% Other5%

Fixed Income Markets - $3.15 Trillion

Lender Composition

Exhibit 2-4. Fixed-Income Lender Composition

sore: federl Reere, 4Q 2010.

$0

$50

$100

$150

$200

$250

$300

$350

$400

Other

Life Cos

CMBS

Banks

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

Billions

Exhibit 2-5. Commercial Real Estate Maturities Set to Peak in 2013

sore: Tre, LLc, 4Q 2010 udte.

e peak year for maturities is

expected to be 2013, when $367.7

billion will come due, before the

amount decreases modestly to

$333.0 billion in 2015, and then

subsides to less than $100 billion

by 2020.




Oe o te mi reo or te iqe tre o tidowtr i te w e roed troled

det. I teir eort to tem write-dow, ete loer-term ro to otetil loe, worito modi d eted ored ommeril rel ette loi tiitio o imroi le. I reio le, teomitio o rl delii roert le d teomrtiel ort drtio o ommeril rel ettelo (eerll 5 er) relted i ttil write-o or leder d ireed orelore or ower.howeer, ti dowtr ee rterized ewwillie to modi d eted te term olo liel to retr ll le o riil d iteretred. Ti med d eted trte ommol i-ole ermitti elow-mret iteret rte d tret-

i ot mtritie or orrower wit troled lo.

Ti eled ower to reti roertie rter tloe et d ietmet, d it lo reeted teietmet mret rom ei ooded wit deel di-oted roertieto te rtrtio o ome oort-iti ietor. b, i tr, e ee le to del dee rede write-o o ommeril rel ette lotil orle oditio retr, wi el to liome troled lo erormi, tere miimizite mot o reere mt et ide.

Te mi didte or ti rtie i tt rotrt-ed eriod o retrtri limit retr o ommerilrel ette. I dditio, eteio t oor derte mret, mi it dilt to ow we te ottom

ee reed, d rter deli te ieitle me more eere dowtr i te tre.

gide reltor ertil ed re-oe to teir troled lo ortolio. I Otoer 2009,te federl fiil Itittio Emitio coil(ffIEc), wi ilde te federl Reere, fDIc, dte comtroller o te crre, reoded to oerot ommeril roert loe d det omi de ii oli ttemet eti tt erormilo wold ot e delred troled olel ee o delie i te le o derli ollterl.

Wile te ffIEc ide w iteded ie to imroeoite d eiilit i te tretmet o ommeril

rel ette lo, te iitil relt w reter oioi te mret, wit ome leder miiterreti teide orm o orere d ietie toretrtre mtri lo. I reoe, i M 2010, teffIEc eld oeree ll wit 1,400 eetie,eliitl tti tt it did ot ited or ietor der to iterret te ide ll to med deted eiti lo.

sie te ffIEc oriil ide, leder e oredworot oer orelore. Ti i eori itt widered ommeril rel ette orelore me deled til te eoom imroe; oweer, it loidite tt iit mer o mtri lo eet to e ilded i te roe.

iact f Aed ad Exted




Underlying Factors: ModeratingDelinquencies and Deaults

Although a high level o com-mercial real estate debt remains in dis-tress, the recent uptick in restructuring

and resolution o commercial loans isa positive sign and the pace o deaultsand delinquencies has begun to sub-side, as shown in Exhibit 2-6.

While the majority o outstand-ing commercial real estate maturi-ties are rom loans issued by banks,loan delinquencies rom other lendingsources indicate a similar trend o lev-eling o but not subsiding. For exam-ple, Trepp, LLC reported that 30+ daydelinquencies on CMBS loans climbed

rapidly rom 4.36 percent in Septem-ber 2009 to 7.61 percent in March 2010,beore leveling o between 8.5 per-cent and 9.3 percent rom June 2010through January 2011. Analysts expectCMBS delinquencies to continue risingat a modest pace, ultimately peakingbetween 10.0 percent and 12.0 percent.(Moodys orecasts that this rate willreach 9.5 percent to 11.0 percent by theend o 2011.)

Aided by loan extensions, com-mercial real estate mortgage deaultshave ollowed a similar trend as delin-quencies, climbing rapidly between

2008 and 2010 but at a slower pace inrecent quarters.

Although commercial realestate deaults may be moderatingoverall, there also have been morereports o strategic deaults, a trendthat has migrated rom the residen-tial to the commercial property sector.Some o the nations largest propertyowners have recently chosen to return

the keys or buildings valued below theamount o debt, and since commercialoans are non-recourse, it is actuallyeasier or commercial owners to walkaway rom their loans than or home-owners. While this may seem like anextreme step, it is oten the result oa pragmatic business decision to exitproft-draining investments in order todivert unds to perorming projects orto shareholders.

ere has been a shit in direc-tion, however. As demonstrated inChapter 3 o this report, althoughproperties continue to go into deaultthere was an inection point with thepace o resolutions beginning, how-ever slowly, to eat away at the moun-tain o distressed assets during ourth

quarter 2010.

REi REbounD ConinuES

Commercial real estate undamentals may be in the early stages o aslow recovery, but REITs have alreadyexperienced a strong rebound. isdisparity has occurred because while

-1

0

1

2

3

4

5

6

7

8

9

10

11

Delinquency Rate

Charge-O Rate

4Q201

0

4Q200

9

4Q200

8

4Q200

7

4Q200

6

4Q200

5

4Q200

4

4Q200

3

4Q200

2

4Q200

1

Percent

Exhibit 2-6. Delinquencies Remain Elevated, but Starting to Decline

sore: federl Reere, noemer 2010.


17/47




once REIT shares began their reboundin the spring o 2009, they were ableto acquire properties rom highly-leveraged investors at deeply dis-counted prices; their greater access tolower-cost capital at a time o severely

constrained credit was also a majoradvantage.

A key advantage or the segmentis its ability to tap the stock market,and REITs have been responding toinvestor interest by raising capital viaequity oerings and unsecured debt.In 2009, REITs raised $34.7 billion viaequity and unsecured debt, nearlydouble the $17.9 billion total raised in2008. As demonstrated in Exhibit 2-9,REITs then surpassed the 2009 total

with $47.5 billion raised in 2010, rep-resenting year-over-year growth o37.2 percent. In 2009, REITs used thiscapital to strengthen balance sheets bypaying down debt ahead o scheduleand to cover dividends. More recently,however, a greater share has been usedto und acquisitions, and in 2010, REITproperty purchases totalled approxi-mately $20 billion, compared with $4billion in 2009.

Outlook

Even though low interest ratespresent a very attractive borrowingenvironment, the specter o loom-ing loan maturities and the sluggishundamentals tied to persistentlyhigh unemployment rates have eda relatively slow transaction market,although the demand equation has

begun to shit. With increasing reportso lenders starting to loosen their reinson capital, reports o all-cash investorscoming to the table, and record-highprices being paid or trophy proper-ties in select markets, it is clear that themarket is fnally beginning to moveand this should lead to additional or-ward momentum in 2011.

Prevailing trends suggest thatlending by commercial banks, lieinsurance companies, and Fannie Maeand Freddie Mac may remain stablebut below peak levels or the next ew

years, as underwriting standards easeand maturities are gradually resolvedSubdued levels o new loan originations will likely be somewhat oset byalternative sources, and S&P estimatesthat lower risk-ree interest rates andtighter spreads will result in CMBSissuance o between $35 billion and$45 billion in 2011.

While nobody expected thdeleveraging process ollowing the2001-2007 credit boom to be quick andpainless, there is hope that matur-ing commercial real estate debt canstill be reduced to a manageable level without a substantial increase in thelevel o properties that have been ore-

closed upon, or returned to the lender(also considered real estate-owned, orREO). ere are basically two avenuesor unwinding high levels o commercial real estate debt, and neither ismutually exclusive. e frst is classicloan reduction via deault or repay-ment, and the second is robust eco-nomic growth, which would stimu-late demand. Forecasters expect only

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

Secondary DebtSecondary EquityIPO

20102009

Billions

$34.7

$47.5

$21.2$26.2

$19.2

$10.4

$2.0$3.0

Exhibit 2-9. REIT Fundraising On the Rise

sore: naREIT, Deemer 2010.




modest economic perormance in thecoming quarters, but GDP growth hasbeen positive since second quarter2009, leading to an improvement in theratio o commercial real estate debt toGDP, which peaked at 26.3 percent in

frst quarter 2009, and declined to 24.1percent by third quarter 2010. While$3.15 tri llion in total commercial mort-gage debt remains, an improvement inthe ratio o commercial real estate debtto GDP can be interpreted as a move inthe right direction.

e willingness o banks toamend and extend loans that areunlikely to return ull value on prin-cipal and interest accrued in order topreserve capital, delay write-os, and

avoid taking over properties that can-not be sold or a avorable price, havehelped to stave o some delinquen-cies and oreclosures, thus providingmixed loan perormance.

Further declines may also beprevented by additional increasesin private equity investment, whichincreased in 2010. e continuedaccommodative monetary policyactions by the Federal Reserve in keep-ing interest rates low or an extended

period, along with the purchase oadditional Treasurys have also helpedbolster the commercial real estateinvestment marketplace in a challeng-ing environment.

As or REITs, there is no way topredict whether returns will continueto outpace the stock market, but thesecompanies retain key qualities thatsuggest they will continue to remainattractive to investors; as the economyrecovers, analysts expect another yearo double-digit returns in 2011. edividends REITs provide to investorsare supported by hard assets, whichtraditionally have been perceived assae havens during economic down-turns, as well as potential hedges

against ination. As recent resultshave indicated, REITs also have a lowcorrelation to conventional assets suchas stocks and bonds. Over the longerterm, demand will also be driven byincreased popularity o the REIT struc-ture on a global scale.

However, one critical barrierto the recovery o the commercialreal estate industry is the biurcationbetween the haves and the havenots. Increased restructuring and

moderating delinquency and deaulrates suggest progress, but maturitiesremain at a high level, and not all prop-erty owners holding troubled loansqualiy or extensions.

According to RCA, restructurings totaled $114.9 billion as o Decem-ber 2010, compared to a total o $187.1billion o troubled commercial reaestate loans. Lenders exible atti-tudes have so ar been limited to ClassA quality assets, and or the most partthey have turned away rom owners oproperties at the Class B and C levelsand in secondary and tertiary mar-kets, especially those with rolloverand lease-up exposure, above-markerents, and vacancy challenges.

e bottom line is that ownerso trophy and high-quality propertieshave been able to obtain new fnancingrom sovereign wealth unds, insurers, private equity frms, and evensome CMBS, while owners o lower-tierproperties have had ewer options. Fora timely and robust recovery to takeplace, it will be necessary or owners oproperties below Class A to be includedin the refnancing, restructuring, andresolution process.

Relats Drectly ad idrectly iact CRE

I 2008 d 2009, oermet iteretio i te orm otiml rorm ildi te Troled aet Relie pro-rm (TaRp) d te Term aet-bed Lo filit (TaLf)imted ommeril rel ette ijeti liqidit itote il tem d eli to reet te il riirom iteii rter. stiml rorm lo d diret

imt, we TaLf w eteded i at 2009 to ildecMbs, eli drie modet reod i cMbs ie.

newl-itroded il d elt re reltio willlo imt ommeril rel ette ot diretl d idiretli 2011, liel ledi to ireed demd or ommerile, d otetill dereed e to itl.

healtcare Refr iact

Te ewl eted ptiet protetio d aordle cre at(ommol ow heltre Reorm) i eeted to e mied imt o ommeril rel ette. O te oitie ide,te ireed ire iere i eeted to led to de-

md o 60 millio qre eet o medil e etwee 2010d 2019, ordi to National Real Estate Investormzie.I rtilr, retil lii re eeted to iree 10 to 15eret etwee 2010 d 2012, d 30 eret etwee2013 d 2014. howeer, ti eltre reorm reltioold lo idiretl limit ommeril rel ette rowt, ee-ill i ireed oerti ot e omie wit 50 ormore emloee to t o eio l.

Continued on next page




Facal Refrs iact

Te ollowi reetl-eted d rooed il reormreltio re eeted to otie to limit e to leer-e or ommeril rel ette:

Te Dodd-fr Wll street Reorm d comer prote-tio at, wi w ied ito lw i Jl 2010, ilderoiio wi tite itl d omlie reqire-met or , d old led to redtio i relette ledi d ietmet. More diretl, te rel-tio reqire cMbs ier to roide reter dilored to reti t let 5.0-eret te i te eritizedet, wi old rete more retritie eirometor ier d redit rti eie.

Te gsE rool oed i ferr 2011 im torede ttill te role o fie Me d freddieM i te u.s. oi e mret. Ti liel will

led to lower redit ililit or te mltimil e-met, wi trditioll ee derered riteredit mret. I dditio, it will led to iree i teire d iteret ot o morte lo mi itmore llei or m orrower to oti lo.

prsed Acct Stadards

Te fiil aoti stdrd bord (fasb) d te I-tertiol aoti stdrd bord (Iasb) e rooedew lee oti tdrd tt wold reqire rm toreoize ll lee liilitie d et o teir ororte l-e eet. Te joit rool ilde:

Te rooed idelie re eeted to e lized deetie trti i 2013, d wold rete reter or-orte trre d oite i lee otiroedre. Te rooed e old e tetto loo or orter-term lee, t ti m e eeilto ower ee mri re ote ier or orter

lee.

fasb d Iasb e lo reetl rooed ew tdrdor leder to ot or lo loe. Te ew tdrdrooe to it rom te irred lo ro, wireqire eidee o lo, to te eeted lo -ro, wi i more reditie o tre loe. Tote ew rle will roide timel d relet iormtioo tre redit loe, te llee wi remi iow to et imlemet it temtill, i olttiowit ll te teolder.

oter prsed Relats

Te oermet rooed oter ew reltio wiold e iee o idtr erorme. for e-mle, rooed reorm to te forei Ietmet i Relproert T at (fIRpTa) wold rie te leel o orei ow-eri llowed i li REIT rom 5.0 eret to 10.0 eret,otetill ledi to ireed orei ietmet. I ddi-tio, te commeril Rel Ette fie coil (cREfc) rooed te itrodtio o oered od, wi oldroide ltertie ore o itl or ietor.

Impact of Regulation on Commercial Real Estate

sore: bloomer, Deemer 2010.

Regulation ImplicationsDirect

Impact

Indirect

Impact

The Healthcare Act

Negative Impact Limited business expansion X

Positive ImpactHigher demand for overall medical space, especially retail clinics X

Increased role for retail clinics X

Financial

Regulations

Negative ImpactDodd-Frank Act: Restricted investments and credit lending in real estate X

GSE Reform Proposal: Lower credit availability for Multifamily segment X

Positive Impact

Foreign Investment in Real Property Tax Act (FIRPTA): Improved foreign capital ows and stabilized assetvalues

X

Proposed Introduction of Covered Bonds: Improved real estate lending and investment X

Proposed New

Lease Accounting

Standards

FASB and IASB proposed new guidelines in accounting to push lease liabilities onto corporate balance sheets.

XNegative Impact Tenants may prefer short-term leases in order to show lower lease liabilities in their balance sheets.

Positive Impact Shorter leases commonly include higher rent, which could offset the impact. X




3 | THE PROPERTY MARKETS

persectve ad Aalyss

We expected that commercialreal estate transaction volume in 2010 would be well above 2009s depressedlevels, but it was more than encourag-ing when sales doubled the 2009 tallyeven beore the end o the ourth quar-ter. Just as important as reaching thatbenchmark, however, were the sup-porting actors that guided investmentactivity and grew stronger as the yearwore on. While it is dicult to assignrank to any one o these actors (as

they are all important contributors tothe growth in commercial real estateinvestment), it is sae to say that lowinterest rates and easing access to cap-ital were the chie enablers o acquisi-tions. Although REITs and other listedcompanies were the prime benefci-aries o a capital market that avoredthese more liquid, transparent vehi-cles, other capital sectors, especiallyequity unds, began returning to themarket late in 2010, and promise to bequite active going orward.

On the supply side, the seem-ingly careul apportioning out othe most sought-ater propertiescash-owing, stabilized high-qualityassets in a small handul o top mar-ketskept prices or such propertieson the rise, along with yields, even asundamentals struggled to gain trac-tion. And although or most o the yeardemand was slight or either value-add properties or or assets beyond the

leading primary markets, the crusho competition in ourth quarter 2010began to turn some buyers towardsecondary markets and less well-sta-bilized properties. Meanwhile, creep-ing gains in new issues o CMBSatrend that has reely blossomed in frstquarter 2011have helped smallerprivate investors get back into theacquisitions marketplace.

One key signal o health in themarket was the growing presence oportolio sales. Large portolios tradedin every property sector, includingboth distressed and non-distressedassets, and that momentum clearlycarried into 2011 as major merger andconsolidation activity picked up.

e strength o the reboundin investment activity in 2010 wascemented in November, as signifcantsales or properties and development

sites trading or at least $2.5 millionpassed the $100 billion threshold.Property sales ended the year at morethan $135 billion, the strongest fnishsince 2007, but still not quite a third othe volume in that peak year, as dem-onstrated in Exhibit 3-1. Nonetheless,the vigor o the turnaround rom arough 2009especially with a blowoutourth quarter 2010signaled that t he

markets momentum may be durableand sustainable in 2011.

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

Jan20

11

Jan20

10

Jan20

09

Jan20

08

Jan20

07

Billions

Exhibit 3-1. Commercial Property Volume On the Rise

sore: Rca, Jr 2011.




Quarterly acquisition momen-tum grew throughout the year, as play-ers on both sides o the sales equationmoved toward greater exibility. eadvantages that public companiesavailed themselves o in the equity and

debt markets began to be matched tosome extent by well-capitalized equityunds and institutions, as those inves-tors conronted more realistic pric-ing than they had once anticipatedrom the vast pool o distressed assets.Improving undamentals in the apart-ment and hotel sectors appear to haveboosted investment in these propertytypes, while the oce market waspumped up by investor groups battlinghard or the highest-quality propertiesin the best markets.

Yields and pricing reectedthis competitive pressure to vary-ing degrees across all property types,although the positive changes weremost pronounced in the oce sector, where capitalization rates slid stead-ily through 2010, alling by some 200basis points. Average apartment yields,the lowest o any property type, com-pressed as well, though not as sharply. Yields ell modestly or retail andindustrial assets.

Although cap rates are cer-tainly trending lower, especially ortop assets, the prevailing low risk-reerate has oered investors a comorta-ble yield cushion that is advantageousin contrast to yields rom other assetclasses. is has also been a boon tothe commercial real estate market.

As noted above, listed and non-listed REITs used their capital to good

eect in 2010. Listed REITs were netinvestors or the frst time since 2005,and have continued as aggressive buy-ers into 2011. In ourth quarter 2010,as other investor groupsespeciallyinstitutions and equity undspickedup activity, REITs aced sti competi-tion. Last years other net acquirerslendersare bringing more REO to t hemarketplace, shiting to net sellers as

they begin to unwind exposures builtup since the markets downturn.

Even as investors began toaccept the notion that the opportuni-ties they had hoped or were not likely to

emerge, lenders began to increase salesout o distress as the year wore on, asshown in Exhibit 3-2. At the same time,they also began to pull back somewhaton extend-and-pretend restructuringsand modifcations o troubled loans.Still, an important inection point wasreached in ourth quarter 2010 as the volume o sales out o distress beganto exceed the level o newly distressedassets in every property type. By year-end, some $186 billion in troubledassets remained outstanding, accord-

ing to RCA; the volume o resolutions,split evenly between sale or restructur-ing, reached past $70 billion.

e gains in pricing metricsthat are enabling lenders to achievehigher recovery rates have encouragedlenders to bring more assets to mar-ket rather than hold them on balancesheets or try to restructure or modiy

loan terms. In ourth quarter 2010alone, $11 billion in distressed-assesales accounted or 30 percent o tota volume. e recovery rates on thessales, including a large number o ulrecoveries, have been signifcantly

higher than during previous cycles.

us, investors had much tobe pleased about by the close o 2010 with improved transaction volumand easing credit conditions chieamong them. With the weight o pentup investment capital rom multiplesources, including cross-border inves-tors, institutional capital recalibratedtoward commercial real estate, publicequity and debt, and slowly improv-ing economic conditions, 2011 should

mark another year o increased salesvolume.

Several actors could cre-ate headwinds or investors in themonths ahead, however. A discus-sion o those possible headwinds andthe conditions surrounding the 2011marketplace is provided in Chapter 4o this report.

Billions

$0

$50

$100

$150

$200

$250

$300

$350

Resolved

Restructured

REO

Troubled

Jan20

11

Oct

201

0

Jul2

010

Apr201

0

Jan20

10

Oct

200

9

Jul2

009

Apr200

9

Jan20

09

Oct

200

8

Jul2

008

Apr200

8

Jan20

08

Exhibit 3-2. Sales of Resolved Distressed Properties Increase

sore: Rca, Jr 2011.




hE oFFiCE mARKE

Market Overview

e oce sector was the clearstandout or investment in 2010.

Transaction volume more than dou-bled rom 2009, and cap rates ell bynearly 200 basis points. From a 2009low o $17.3 billion, sales volume rose138 percent to $41.2 billion in 2010.Sales volume grew with each quarter,with the year ending in a ourth-quar-ter blowout o $18.3 billion in sales, asdemonstrated in Exhibit 3-A1, greaterthan the entire prior year or ocesales and the strongest quarter sinceourth quarter 2007.

Oce investors clearly pre-erred well-tenanted properties in justa handul o major markets: New York,Washington, D.C., San Francisco, Bos-ton, and Chicago. Nonetheless, volumeincreased or stabilized assets across abroad geography, with volume climb-ing year-over-year in the vast majorityo the top 40 markets nationwide.

e slow jobs recovery andunenthusiastic lending o value-addsituations or much o the year damp-ened such investment. Meanwhile,lenders also held tightly onto their dis-

tressed assets, although that practicebegan to change in ourth quarter 2010;oce sales associated with distressexceeded $3 billion in ourth quarter2010, more than the three prior quar-ters combined.

An important component inthe recovery o the oce investmentmarket was the return o large deals

and portolios. Portolio sales volumequadrupled, rising to $6.2 billion. Average oce deal size spiked to $27million in 2010 rom $17 million in2009. is also reects a smaller risein transaction counts, which grew just49 percent year-over-year, ar less thanthe 138-percent jump in sales volume.

e gains in deal size reectstrong gains in central business dis-trict (CBD) oce sales volume, whichleaped 237 percent in 2010, comparedto an 86-percent increase or subur-ban oce sales volume. Capitalizationrates also ell signifcantly (see Exhibit3-A2), more or CBD properties than or

VolumeinBillions

Average$/Sq.Ft.

$0

$10

$20

$30

$40

$50

$60

$70

Volume Oered

Volume Closed

4Q201

0

3Q201

0

2Q201

0

1Q201

0

4Q200

9

3Q200

9

2Q200

9

1Q200

9

4Q200

8

3Q200

8

2Q200

8

1Q200

8

4Q200

7

3Q200

7

2Q200

7

1Q200

7

4Q200

6

3Q200

6

2Q200

6

1Q200

6

4Q200

5

3Q200

5

2Q200

5

1Q200

5$100

$150

$200

$250

$300

$350

Price $/SF Oered

Price $/SF Closed

Exhibit 3-A1. Oce Property Volume and Pricing

sore: Rca, 4Q 2010.

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

Oered

Closed

4Q201

0

3Q201

0

2Q201

0

1Q201

0

4Q200

9

3Q200

9

2Q200

9

1Q200

9

4Q200

8

3Q200

8

2Q200

8

1Q200

8

4Q200

7

3Q200

7

2Q200

7

1Q200

7

4Q200

6

3Q200

6

2Q200

6

1Q200

6

4Q200

5

3Q200

5

2Q200

5

1Q200

5

Percent

Exhibit 3-A2. Average Oce Property Cap Rates

sore: Rca, 4Q 2010.

Sales volume grew with each

quarter, with the year ending in

a fourth-quarter blowout of $18.3

billion in salesgreater than the

entire prior year for oce sales,

and the strongest quarter since

fourth quarter 2007.




suburban oce properties, but bothexperienced sharp contractions. CBDcap rates reached 6.1 percent, just 100basis points above 2007 levels. Reect-ing more stable undamentals and aconcentration o transactions in Man-

hattan and Washington, D.C., averageper-square-oot pricing strengthened,rising 47 percent in 2010 to $231.

Investor Composition

REITs, both listed and non-listed, were by ar the most active capi-tal sector in oce acquisitions. Eachadded over $4 billion o oce prop-erty to their portolios in 2010. Evenso, the marketplace grew increasinglycompetitive throughout the year, as

institutional and private buyers grewmore active in the hunt or top-qual-ity assets. As credit conditions so-tened and average deal size expanded,national banks reclaimed a leadingrole rom the regional and local banksthat were more active lenders on thesmaller deals more common in 2009.Insurance companies and interna-tional banks also increased their origi-nations. CMBS, which revived in 2010,are widely expected to positively inu-ence the market in 2011.

Only two markets in 2009exceeded $1 billion in oce transac-tion volume, while 13 markets crossedthat threshold in 2010. e majorurban markets all posted solid growthin 2010 while some secondary mar-kets posted extreme percentage gainsover very small 2009 totals. Manhat-tan and Washington, D.C. remainedin frst and second place, respectively, while Chicago, up nearly 400 percent,

muscled into third place rom No. 9. Another market that moved rapidlyup the rankings was the Washington,D.C./Virginia suburbs, where ocesales exceeded those in Boston and Los Angeles. Generally, the Southern Cali-ornia markets underperormed andthe Texas markets all outperormed.e Atlanta, Sacramento, and the Washington, D.C./Maryland suburbs

were the only major markets whereewer oce property sales occurred in2010 than in 2009.

Oce Market Fundamentals(courtesy of Grubb & Ellis)

In September 2010, the U.S.Bureau o Economic Analysis (BEA)announced that the Great Recessionhad actually ended in June 2009, mak-ing it the longest and deepest down-turn since the Great Depression. How-ever, job losses continued or another6 months, eventually reaching 4 mil-lion rom December 2007 to December2009, with 2.5 million o those losses

in the oce-using sectors o inorma-tion, fnance, and proessional andbusiness services. As a result, the U.S

oce vacancy rate soared to 17.9 percent by second quarter 2010, as shownin Exhibit 3-A3, just 10 basis pointsshy o the all-time high in the 24-yearhistory o the Grubb & Ellis database Yet the actual net absorption o negative 71 million square eet was onlyone-third o the potential decline indi-cated by the job losses, suggesting thepresence o a substantial amount oshadow spaceempty cubes, oorsor wings vacated due to layos butstill counted as occupied. Had the joblosses registered right away as negative

Vacan

cyRate(%)

RentalRate

($

/Sq.Ft.)

0

5

10

15

20

25

Combined Vacancy Rates

Suburban Vacancy Rates

CBD Vacancy Rates

2011

F

2009

2007

2005

2003

2001

$18

$20

$22

$24

$26

$28

$30

$32

$34

Class A Rental Rates

Class B Rental Rates

Exhibit 3-A3. Oce Property Vacancy and Asking Rental Rates

sore: gr & Elli, ferr 2011.




absorption, the vacancy rate wouldhave sailed above 22 percent. Never-theless, 2010 ended on a positive note.Employers added 1.1 million net new jobs during the year, and the ocemarket recorded three consecutive

quarters o positive absorption total-ing 14.6 million square eetenough tonudge the vacancy rates slightly lower,to 17.7 percent at year-end. e increasein occupied space was driven in part bytenants moving up rom Class B spaceto take advantage o the low rents onoer in higher-quality buildings. us,average asking rents or Class A spaceended the year at $30.90 per squareoot per year gross, roughly at or thethird consecutive quarter.

Outlook

All o this data suggests a hal-speed recovery in the oce marketduring 2011 and 2012. Job creation islikely to remain subpar at about 1.5million in 2011just the level neededto accommodate the expanding labororceand 2 million in 2012. About20 percent o these jobs will likely belocated in oce buildings, and a large

share o those will likely be accom-modated in shadow spaceaboutone-third in 2011 and one-ourth in2012. is should generate 35 millionsquare eet o net absorption in thecoming year (see Exhibit 3-A4) and 47million square eet in 2012, a moder-ate perormance compared with the

2005-2007 expansion when annuaabsorption ranged rom 62 million to89 million square eet. On the otherhand, new space completions willikely be at a minimum during the next2 years, meaning that even the modest absorption orecast will drive the vacancy rate down rom 17.7 percenat year-end 2010 to 17.0 percent in 2011and 15.9 percent in 2012still abovethe equilibrium vacancy level o 12percent to 14 percent. is rate o tight-ening (+/- 1 percentage point in each othe next 2 years) will be about hal thepace o a normal recovery cycle.

Asking rental rates may havound their oor, but should riseonly slowly during this period at anexpected rate o 0.4 percent in 2011 and1.4 percent in 2012 or Class A spaceClass B rates will likely trail until the

market tightens enough to create ameaningul cost dierential with Class A rates, which remains several yearo. Landlords will continue to competeor tenants in 2011, particularly solidtenants with good credit. Tenants, ortheir part, may be more willing to signlong-term leases to lock in a good dealis should mark a turnaround romthe past couple o years when tenants

Millions(Sq.

Ft.)

-100

-75

-50

-25

0

25

50

75

100

125Completions

Absorption

2011

F

2009

2007

2005

2003

2001

Exhibit 3-A4. Oce Property Absorption vs. Completions


Class B rates will likely trail until the market tightens enough to create a

meaningful cost dierential with Class A rates




preerred to sign 1-year extensions astheir leases expired in order to keeptheir options open.

ere is some upside risk tothis outlook, meaning that condi-

tions may improve more quickly thanexpected. Economists revised theirgrowth orecasts upward as a resulto the tax agreement reached by Con-gress in the lame-duck session at theend o 2010. is agreement includeda 2-year extension o the Bush-era taxcuts, a 13-month extension o ederaljobless benefts, a temporary cut in theshare o the Social Security payroll taxpaid by employees, and several otherprovisions. While the bond marketswooned on this news, driving inter-

est rates higher, the Federal Reservesquantitative easing program may helpkeep interest rates low through 2011,providing more uel or the economy.Companies are sitting on a record $1.8trillion o cash reserves, and they maybegin deploying some o this cash in2011 as the economy strengthens, andthe hal-speed recovery in the ocemarket could turn out to be more like athree-quarters-speed recovery.

hE inDuSRiAL mARKE

Market Overview

Industrial property sales vol-ume improved steadily throughout2010. is improvement was driven

by several key portolio transactions,including ProLogis ourth-quarter2010 sale o its North American assetsto aliates o Blackstone. Volumejumped to $19.0 billion or the year, up78 percent rom a cyclical low in 2009. As shown in Exhibit 3-B1, the ourthquarter 2010 was especially active, sug-gesting that strong sales growth willcontinue or the sector. Volume or the3 months ending Dec. 31, 2010 totaled$7.6 billion, up 63 percent rom thirdquarter 2010 and up 132 percent romthe same quarter a year ago. And eventhough the oce sector, which hascaptured so much attention because

o rapidly declining cap rates and anumber o high-profle trophy salesonly saw sales volume in the ourthquarter 2010 reach one-third o quar-terly volume at the peak, industriaproperty sales in ourth quarter 2010 were almost 50 percent o the sectorstrongest peak period in second quar-ter 2007.

Sales o industrial warehousesincreased to $12.6 billion in 2010, ris-ing 81 percent rom 2009s low o $7.0billion. Following a slow start in 2010sales activity picked up in the thirdand ourth quarters, even as oering volumes declined. While initial gainwere modest, activity spiked in ourthquarter, rising 91 percent higher thanthe previous quarter and 168 percentahead o sales in ourth quarter 2009

At $5.6 billion, sales volume in ourthquarter 2010 closed the year at its high-est level since frst quarter 2008.

Sales o ex properties increasedto $6.3 billion in 2010, rising 69 per-cent rom 2009s low o $3.7 billion While activity has picked up or eproperties, absolute volume remainslow, reecting a market where price

VolumeinBillions

Average$/Sq.Ft.

$0

$5

$10

$15

$20

Volume Oered

Volume Closed

4Q201

0

3Q201

0

2Q201

0

1Q201

0

4Q200

9

3Q200

9

2Q200

9

1Q200

9

4Q200

8

3Q200

8

2Q200

8

1Q200

8

4Q200

7

3Q200

7

2Q200

7

1Q200

7

4Q200

6

3Q200

6

2Q200

6

1Q200

6

4Q200

5

3Q200

5

2Q200

5

1Q200

5$40

$60

$80

$100Price $/SF Oered

Price $/SF Closed

Exhibit 3-B1. Industrial Property Volume and Pricing

sore: Rca, 4Q 2010.




discovery is still maturing. Unlike mostother property types and subtypes,which improved consistently over thecourse o the year and which gener-ally measured their strongest resultso the recovery in ourth quarter 2010,sales o ex properties were essentiallyunchanged rom second and thirdquarter at $1.7 billion.

Still, industrial property pric-ing benchmarks have been somewhatmurkier than or other property types.Capitalization rates, as demonstratedin Exhibit 3-B2, were essentially atbetween the third quarter 2010 andourth quarter 2010, barely allingto 8.3 percent, although they weredown by almost 50 basis points year-over-year to near-2004 levels. As in

other property types, higher-qualityindustrial assets brought lower yields.Meanwhile, cap rates diverged acrossindustrial warehouse and ex assets,even though sales volume increasedat roughly the same rate or both. Butwhile cap rates or ex assets dropped100 basis points over the year, ware-house yields edged up, and are nowalmost at par with those or ex.

Investor Composition

Regional and local banks werethe stand-out lenders or industrialassets, active on one-third o the dealslargely because the smaller deal sizeand private-heavy buyer mix ft theirborrower profles better than other

property sectors. On the other handinsurance unds were attracted toinstitutional deal sponsors or higher-quality assets and portolios.

Chinas relative importance in

U.S. commerce was reected in the West Coasts pre-eminence as a targeor industrial property acquisitions. Ledby Los Angeles, fve West Coast marketswere among the top 10 industrial prop-erty transaction locations. Also rankingwell was Atlanta, although Chicago lostground. Dallas moved ahead o Chicagoas the Southwest gained importance asa trading center.

Industrial Property Fundamentals(courtesy of Grubb & Ellis)

Fundamentals or the U.Sindustrial market bottomed out in frstquarter 2010 when the vacancy ratepeaked at 10.9 percent (see Exhibi3-B3), one quarter ahead o the ocemarket (industrial property developers were able to shut down the construction pipeline more quickly as demandevaporated). As the year wore on, theindustrial market benefted rom anearly bounce in two key economic indicatorsglobal trade, and the restocking

Vaca

ncyRate(%)

RentalRate

($/S

q.Ft.)

0

2

4

6

8

10

12

14

Industrial Vacancy

2011

F

2009

2007

2005

2003

2001

$0

$2

$4

$6

$8

$10

$12

Warehouse/ Distribution Rent

R&D/Flex Rent

General Industrial Rent

Exhibit 3-B3. Industrial Property Vacancy and Asking Rental Rates


6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

Oered

Closed

4Q201

0

3Q201

0

2Q201

0

1Q201

0

4Q200

9

3Q200

9

2Q200

9

1Q200

9

4Q200

8

3Q200

8

2Q200

8

1Q200

8

4Q200

7

3Q200

7

2Q200

7

1Q200

7

4Q200

6

3Q200

6

2Q200

6

1Q200

6

4Q200

5

3Q200

5

2Q200

5

1Q200

5

Percent

Exhibit 3-B2. Average Industrial Property Cap Rates

sore: Rca, 4Q 2010




o depleted inventories by retailers, wholesalers, and manuacturers. eweak dollar spurred a bounce in exports while a spotty but gradual recovery inconsumer spending boosted imports.at ueled demand in Southern Cali-ornias Inland Empire and other mar-kets that serve as transer stations orcontainer shipments headed to thecountrys interior. Another support orindustrial property demandcompa-nies continued to squeeze costs out otheir supply chains during the down-turn, striving or ever greater ecien-cies, which helped put a oor underleasing and user sales activity throughthe lean times.

Ater hitting its peak, industrial vacancy dropped sharply to 10.6 per-

cent in the second quartera rapidshit or the billion-square-oot U.S.marketsuggesting that a vigorousrecovery was underway. But the pacecooled with vacancy dropping by 20basis points through the rest o 2010 to10.4 percent. In hindsight, the second-quarter drop was likely ueled by pent-up demand rom an early improvementin manuacturing and the inventory

correction cycle. Indeed, asking rentalrates, typically the last market indicatorto turn the corner, weakened throughmost o the year until the ourth quar-ter, when a surprising increase o 1.7percent pushed the asking rate or alltypes o industrial space to $5.35 persquare oot per year. Rates or avail-able space ended the year at $5.18 persquare oot or general industrial usage(primarily manuacturing), $4.27 persquare oot or warehouse-distributionspace, and $9.31 per square oot orR&D-ex space.

Outlook

All o this data suggests a grad-ual recovery in leasing market un-damentals or the industrial sector in

2011, with net absorption rising to 60million square eet, as shown in Exhibit3-B4, ollowed by a robust doubling othat rate to 120 million square eet in2012. With construction starts mostlyconfned to build-to-suit projects, eventhese middle-o-the-road absorptiontotals should push down the vacancyrate, expected to end 2011 below 10percent and in the low 9-percent range

in 2012. e average asking rental rateacross all U.S. markets, which slippedby 16 percent rom frst quarter 2007to third quarter 2010 (peak-to-trough)is expected to increase very gradu-ally by 0.6 percent in 2011 and 1.0 per-

cent in 2012. Net eective lease ratesshould rise more quickly, as landlordspull back on concessions. Propertiesin built-out submarkets near majortransportation hubs such as ChicagosOHare submarket, the South Bay inLos Angeles, and a number o otherareas should see aster rent gains asuser demand picks up.

e wild card in the comingexpansion cycle may be uel prices When prices spiked in 2008, logistic

companies and shippers were mov-ing down the path toward more andsmaller distribution centers in order tomaximize the use o uel-ecient raiand to minimize trucking costs. isprovided a boost to emerging distr ibution hubs, such as Phoenix and KansasCity, but the recession and the declinein energy prices put a hold on this strat-egy. With energy prices rising again inthe wake o Mideast turmoil, in addition to the weak dollar and the bur-geoning demand in China and othergrowing economies, expect to seedemand return or smaller distributionacilities across secondary markets.

Demand patterns are alreadyshiting as a result o the Panama Canaexpansion that will open in 2014. Portsalong the Gul and East coasts haveattracted more container volume romshippers intent on diversiying theirsupply chains and lowering depend-ence on the Southern Caliornia ports

New York/New Jersey, Norolk, andCharleston will be the only ports toeciently handle the majority o post-Panama ships due to port depth issuesHowever, New York and New Jerseymay have air drat issues related to theBayonne Bridge.

e trend toward greater reli-ance on the Gul and East Coast ports

-150

-100

-50

0

50

100

150

200

Completions

Absorption

2011

F

2009

2007

2005

2003

2001

Millions(Sq.

Ft.)

Exhibit 3-B4. Industrial Property Absorption vs. Completions





which goes back over 5 years, waned tosome extent in 2010 as shippers movedslightly more volume through WestCoast ports to speed the restocking o warehouses in the West and Midwest.We have yet to see i this was an anom-

aly or a more permanent trend.

hE REAiL mARKE

Market Overview

Ater a sluggish start to the year reecting continuing consumerconcerns, retail property investmentincreased consider

Expectations Market Realities In

Documents

Transcript of Expectations Market Realities In