Kuwait Financial Centre “Markaz” U S R E A L E S T A T E U P D A T E

Real Estate Outlook, on the United States

The U.S. commercial real estate market is still perceived as a favorable investment despite uncertainty about energy prices, interest rates and the possibility of higher capitalization rates down the road. In fact, over the past few months, the combination of lower energy prices and slowing inflation has eased some of these pressures. Even though increases in interest rates throughout 2005 and much of 2006 are putting the brakes on the purchasing ability of some leveraged buyers, many all-cash buyers such as pension funds, are picking up the slack and continue pursuing investment opportunities in many individual markets where limited supply is helping to lower vacancy and increase the rental rates. Below we discuss some of the key trends influencing the US commercial real estate market. Interest Rates The Federal Open Market Committee in August voted to leave the overnight lending rate at 5.25% and ended a run of 17 consecutive quarter point increases. In the four subsequent meetings (the last held on January 31, 2007), the Fed has maintained the rate at 5.25%. However, the Fed still maintains a tightening bias in light of inflationary pressures. Average hourly earnings in December increased 4.2% year-on-year, despite only moderate gains in productivity, and consumer prices increased 2.0%. There are concerns that higher wages combined with low productivity increases may translate into higher prices for consumers. However, the downturn in the auto industry and the slowing US housing market are likely to place a larger drag on the US economy than economists expected a few months ago. Thus, the Fed is unlikely to change interest rates significantly, at least through the first half of 2007.

Figure 1 - Rising Interest Rates

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Source: Economy.com

Jan 31 2007 Research Highlights: Outlook on the Real Estate Market in the US Authors Kumar Srinivasan +965 224 8000 ext. 1104 ksrinivasan@markaz.com Sohail Ladha +965 224 8000 ext. 1117 sladha@markaz.com

Kuwait Financial Centre “Markaz” Corporate Finance Address: P.O.Box 23444, Safat 13095, Kuwait Tel: +965 224 8000 Ext: 1101 Fax: +965 246 3049 corporatefinance@markaz.com www.markaz.com

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Cap Rates The outlook for cap rates remains stable over the next twelve months. The continued growth in purchasing activity by leveraged and all-cash investors has resulted in downward pressures on cap rates over the past four years. However, lack of available products has resulted in decelerating sales volumes as investors prefer to hold on to their investments. This implies that further downward impetus is likely to be absent. Also, interest rates are likely to remain stable, at least until the middle of 2007, thereby failing to provide significant upward stimulus to cap rates. As a result, we expect cap rates to exhibit only minor movements over the next 12 months. Over the longer-term, we expect cap rates to rise slowly as the growth in net operating income outpaces the growth in prices.

Figure 2 - National Cap Rates

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Apartments Industrial Office Retail Source: Real Capital Analytics

The Office Market The office market has performed well despite a slowing economy. Vacancy rates have declined over a 140 basis points over the past year and effective rents have increased by 9.0%. The office market is expected to continue to strengthen due to the fact that muted construction activity is limiting supply, medium term outlook for the economy remains positive, and there is continued job growth. In fact, the December Employment Report showed that payroll employment increased by 167,000 in December and the unemployment rate remained stable at 4.5%. REIS, Inc, estimates that vacancy rates will decline by 260 basis points and that effective rents will increase at a CAGR of 4.4% over the next four years.

Figure 3 - Office Market Outlook

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Cap rates are expected to remain stable over the next twelve months Robust employment growth coupled with muted construction activity is leading to higher rents and lower vacancy rates in the office market

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Industrial Market The industrial market has strengthened year-on-year since the end of 2003, when vacancy rates were high and rental growth was negative. The strong performance witnessed in 2005 and 2006, is expected to continue over the next four years backed by improving fundamentals. Inventory levels as a percentage of retail sales and wholesale sales have declined to their lowest levels this decade, indicating growing demand for storage space. In addition, orders for durable goods are at their highest levels since 2000 and industrial production is at its highest level ever. REIS estimates that vacancy rates will decline by over 80 basis points over the next four years and effective rents will increase at a CAGR of 3.5%.

Figure 4 - Industrial Market Outlook

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Retail Market The strong growth in personal incomes and retail sales has been exerting downward pressure on vacancy rates and upward pressure on effective rents since 2003. However, a significant amount of completions in 2006 resulted in vacancy rates rising by approximately 20 basis points. The rising level of scheduled completions of neighborhood and community shopping centers until 2008 is likely to continue pushing vacancy rates slightly higher before declining again in 2009 and 2010. Stable demand from retailers as well as the introduction of modern retail stock is expected to yield an average effective rental growth rate of 3.2% over the next four years.

Figure 5 - Retail Market Outlook

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The outlook for the retail sector, therefore, remains largely stable with rents continuing at trend levels and vacancy rates

Record levels of industrial production and strong growth in orders for durable goods are driving demand for industrial real estate Significant completions of neighborhood and community shopping centers are expected to lead to slightly higher vacancy rates

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fluctuating only marginally. However, a possible slowdown in consumer spending presents risks. Potential rises in interest rates in an environment characterized by high household debt, adverse wealth effects from declining house prices, and continued volatility in energy prices present the potential to erode consumer spending power. Apartment / Multifamily Market The apartment market has performed well over the past three years as evidenced by growth in rents and declining vacancy rates. The general rise in both interest rates and home prices over the past few years are strengthening the demand for rental units as homes have become less affordable. The apartment intense 20 to 29 age cohort is expected to expand by 500,000 people annually over the next four years; increasing the potential renter population. In addition, the large number conversion of apartments to condominiums since the year 2002, have starved the market of supply. As a result, the outlook for apartments remains positive; rents are expected to rise at a CAGR of 3.6% and vacancy rates are expected to decline by 60 basis points over the next four years.

Figure 6 - Apartment Market Outlook

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Housing Market After four and a half years of substantial growth, with single family home prices and condominium prices increasing by 50% and 84% respectively between 2001 and their peaks in mid 2006, house prices declined in the latter half of 2006. Single family home prices and condominium prices are lower by 5.2% and 2.0%, respectively, relative to their peaks. These trends are exacerbated by declining sales activity and rising inventory levels. Sales volumes have dropped by 8.1% and 10.6% year-on-year for single family homes and condominiums, respectively. The ratio of inventories to sales has increased from 4.5 months in 2005 to 6.6 months in December 2006 for single family homes and from 4.8 months to 8.3 months for condominiums, indicating excess supply in the market. However, the housing market is showing signs of bottoming out. The rate of decline in prices appears to be slowing and inventory levels appear to be reverting from their peaks. The reduction in housing starts and support from the job market is expected to lower the inventory further throughout 2007, providing insulation from significant declines in prices.

Positive demographic fundamentals in conjunction with limited supply are driving demand for apartment properties The housing market is showing signs of bottoming out

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Figure 7 - Prices of Condominiums and Single Family Homes

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Source: National Association of Realtors

Conclusion Going forward, we believe that the Office, Apartment and Industrial segments of the US real estate market offer potential for generating attractive returns. However, capital appreciation is expected to be driven by growth in rents and occupancy rates rather than cap rate compression. The Retail segment is expected to offer stability through relatively constant vacancy rates and normal rent growth. Despite the decline in prices witnessed in the latter half of 2006, the Housing sector is showing signs of bottoming out and we expect house prices to stabilize.

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