RE Capital Markets Update & Outlook

presented to:

Center for Real Estate and Urban Economic Studies

October 11, 2013Jim Clayton, Ph.D.Vice President – Research

Cornerstone Real Estate Advisers LLCjclayton@cornerstoneadvisers.com | (860) 509-2237

From My Presentation Here 2 Years Ago …

1

4

Trends in housing, employment, manufacturing, and leading indicators

2

Sources: Moody’s Analytics, Cornerstone Research, 10/10/2013

High Frequency Indicators Supporting Slow Expansion

500

700

900

1,100

New Private Housing Starts, 000s

300,000

350,000

400,000

450,000

Initial Unemployment Claims, 4wa

115

120

125

130

135

ECRI Weekly Leading Index (monthly av)

7

9

11

13

15

17

New Vehicle Sales: Total (Mil, SAAR)

Stock Prices Show Strong Gains as Labor Market “Improves”

3Sources: Cornerstone Research, Bureau of Labor Statistics, Federal Reserve Board.

Weekly data through September 21, 2013 for initial claims and September 28, 2013 for S&P 500.

400

600

800

1000

1200

1400

1600

1800

200

250

300

350

400

450

500

550

600

650

700

S&

P P

rice

In

de

x (1

94

1-4

3=

10

)

Job

less

Cla

ims

(4 w

ee

k M

A,

00

0s)

Initial Jobless Claims S&P 500

4

Not a “Typical” Recovery … but starting to become more like one

4

Housing cycle structurally different this time; Housing sector not able to lead the recovery as in previous cycles

but now beginning to transition from a drag to a driver of economic growth

Total Housing Starts

(Single + Multifamily)

Quarterly data through 2Q13. The “Real” House Prices series is an inflation adjusted index created by dividing a nominal house price index by the level of the Consumer Price Index (CPI).

Source: Cornerstone Research, Federal Reserve Board, Robert Shiller.

“Real” House Prices

(Single-Family)

4

0

50

100

150

200

250

0

500

1,000

1,500

2,000

2,500

3,000

1960 1970 1980 1990 2000 2010

Re

al H

ou

se P

rice

In

de

x (1

89

0=

10

0)

Ho

usi

ng

Un

its

Sta

rte

d (

00

0s,

SA

AR

)

But … Déjà vu all over again??

5

But … Déjà vu all over again??

6

Macroeconomic and Policy Uncertainty Spikes

7

Does heightened volatility increase the (real option) value of waiting to invest??

0

50

100

150

200

250

300

2000 2002 2004 2006 2008 2010 2012

Economic Policy Uncertainty Index

Monthly data

through 9/13

Source: Scott Baker, Nicholas Bloom and Steven J. Davis at www.PolicyUncertainty.com.

Financial Market “Stress” Measures Up But Remain Low

8

Fed Stress Index = common component extracted from 18 financial market variables

But is this a good

ex ante measure

of risk??

Fed Set to Pare Back it’s “QE” Asset Purchase Program “Soon”

Why Start Scaling Back Long-Term Asset Purchases (i.e. “QE”)?

Labor Market Good News/Bad News

11

Sources: Cornerstone Research, Bureau of Labor Statistics.

Monthly data through August 2013. Monthly data through August 2013.

Projected Trend

63

64

65

66

67

68%

Labor Force Participation Rate

Trend

The falling labor force participation rate, and lack of wage growth have led to concerns regarding the quality of the new jobs

6

7

8

9

10

11

Unemployment Rate

At the current pace of job growth, the U.S. unemployment rate will reach the Fed’s 6.5% target in 2015Q1

12

Slow process of labor market improvement and significant “slack” to keep

Short-Term Interest Rates to Stay Near Zero into 2015

0

1

2

3

4

5

6

7

8

54

56

58

60

62

64

66

Fed

Fu

nd

& L

IBO

R (

%)

Em

plo

ym

en

t/P

op

ula

tio

n Employment to

Population Ratio

3-month LIBOR

Fed Funds Rate

Monthly data through August 2013.

Sources: Cornerstone Research, Federal Reserve, BLS.

13

But Longer-Term Rates Have Risen Sharply …

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

90

95

100

105

110

115

120

Jan. Feb. Mar. Apr. May June July Aug. Sept.

Tre

asu

ry Y

ield

(%

)

S&

P 5

00

Sto

ck P

rice

In

de

x

2013

10 Year Treasury

S&P 500

Treasury yields up sharply on talk of scaling back Treasury and MBS purchases; broader stock market shows

heightened volatility but maintains upward trend …

Weekly data through September 20, 2013.

Sources: Cornerstone Research, Federal Reserve.

Fed Governor Candidates … “Hawkish” or “Dovish”

15

“Taper Talk” Adds to Financial Market Volatility … Hits REITs

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

90

95

100

105

110

115

120

Jan. Feb. Mar. Apr. May June July Aug. Sept.

Tre

asu

ry Y

ield

(%

)

S&

P 5

00

an

d N

AR

EIT

Eq

uit

y P

rice

In

dic

es

(Ja

n 2

01

3=

11

0)

2013

10 Year Treasury Equity REIT S&P 500

Treasury yields up sharply on talk of scaling back Treasury and MBS purchases; broader stock market shows

heightened volatility but maintains upward trend while equity REIT prices hit hard …

Weekly data through September 20, 2013.

Sources: Cornerstone Research, Federal Reserve, NAREIT.

Property Prices versus Equity REIT Prices

16

50

100

150

200

250

300

2001 2003 2005 2007 2009 2011 2013

Moody's/RCA Commercial Property Price Index (CPPI)

FTSE/NAREIT Equity REIT Price Index

Monthly data through July 2013 for the CPPI and August 2013 for the Equity REIT Index.

Sources: Cornerstone Research, Moody’s, Real Capital Analytics, NAREIT.

Public REIT prices often viewed as a leading indicator of private property values

Bad news ahead for

property values or

false signal?

?

17

“Taper Talk” Adds to Financial Market Volatility … Hits CMBS

Source: Commercial Mortgage Alert (10/3/13)

Aggregate indices mask divergent pricing dynamics (Moody’s/RCA national all properties index and sub-indices)

Commercial Property Price Recovery

18

CPPI

Gateway CBD Office

Top chart shows monthly data through August 2013. Bottom chart shows quarterly data through Q2 2013.

Sources: Moody’s Investor Services, Real Capital Analytics (RCA), Cornerstone Research (October 10, 2013).

0.8

1

1.2

1.4

1.6

1.8

2

2.2

2.4

2002 2004 2006 2008 2010 2012

Gateway Apt.

Other Apt.

Gateway Retail

Other Retail

Gateway Industrial

Other Industrial

Gateway CBD Office

Other CBD Office

Gateway Sub. Office

Other Sub. Office

All Properties CPPI

Gateway Apartment

Gateway Retail

NCREIF Property Index (NPI) Returns by Property Sector

Quarterly total holding period (income plus capital) returns, 2010:1 – 2013:2

Spread over the aggregate NCREIF Property Index (NPI) each quarter – sector convergence to the index

Source: Cornerstone Research, NCREIF (August 2013)

.

0%

2%

4%

6%

8%

2010 2011 2012 2013

Office - CBD Industrial

Retail Apartment

Office - Suburban NPI

-2%

-1%

0%

1%

2%

3%

2010 2011 2012 2013

19

20Sources: Cornerstone Research, NCREIF, Federal Reserve.

Core Real Estate Priced Favorably on a Relative Basis

Average NCREIF Property Index (NPI) cap rate spread to 10 year Treasury yield well above historical average

Cap rate is value weighted average of cap rates inferred from appraisals of properties held in the NPI. Treasury yield is average of end of week

values during each quarter. Quarterly data with cap rates through 2Q13 and Treasury yields through 3Q13 as of September 19. Dashed lines

are base case forecasts as of September 2013.

And expected to remain relatively high over the next couple of years

0%

1%

2%

3%

4%

5%

0%

2%

4%

6%

8%

10%

2000 2002 2004 2006 2008 2010 2012 2014

Ca

p R

ate

an

d T

rea

su

ry Y

ield

Ca

p R

ate

to

Tre

asu

ry S

pre

ad

Ca

p R

ate

an

d T

rea

su

ry Y

ield

Ca

p R

ate

to

Tre

as

ury

Sp

rea

d

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

1%

3%

5%

7%

9%

11%

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Spread 10 Year Treasury Yield Cap Rate

21

Sources: Cornerstone Research, NCREIF, Federal Reserve.

Cap rate is value weighted average of cap rates inferred from appraisals of properties held in the NPI. Treasury yield is average of end of week values during each

quarter. Quarterly data with cap rates through 2Q13 and Treasury yields through 2Q13 as of September 19.

Ca

p R

ate

an

d T

rea

su

ry Y

ield

Ca

p R

ate

to

Tre

as

ury

Sp

rea

d

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Spread 10 Year Treasury Yield Cap Rate

�Historically, relatively large upward moves in the 10 year Treasury yield have not caused similar magnitude changes in NCREIF cap rates.

� In fact, these periods have seen little subsequent change in cap rates, but rather adjustment via decline in the “Cap Rate Spread to Treasury Yield”, reflecting reduced economic and financial risk and improved rent growth prospects.

Core Property Cap Rates vs. Long Term Interest Rates

NCREIF Property Index (NPI) cap rates do not move one-to-one with Treasury yields; other influences matter

The relatively large cap rate to Treasury spread today provides measure of cushion to allow long-term interest rates to rise without impacting NPI average cap rates

Core Property Cap Rates vs. Long Term Interest Rates

22

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

0% 2% 4% 6% 8% 10%

NP

I C

ap

Ra

te

10 Year Treasury Yield

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

-3% -2% -1% 0% 1% 2% 3%

Ch

an

ge

in

NP

I C

ap

Ra

te

Change in 10 Year Treasury

NCREIF Property Index (NPI) cap rates do not move one-to-one with Treasury yields; other influences matter

Levels Annual Change

Few observations in this quadrant

Sources: Cornerstone Research, NCREIF, Federal Reserve.

NPI Cap Rate vs. 10 Year Treasury Yield(Quarterly, 1990:1 – 2013:2)

Core Property Cap Rates vs. Long Term Interest Rates

23

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

0% 2% 4% 6% 8% 10%

NP

I C

ap

Ra

te

10 Year Treasury Yield

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

-3% -2% -1% 0% 1% 2% 3%

Ch

an

ge

in

NP

I C

ap

Ra

te

Change in 10 Year Treasury

� While positively related over the long-term, historical data reveal no

statistically significantly relationship between short-term (1 year)

changes in Treasury yields and cap rate changes.

� The impact of changes in Treasury yields on cap rates depends on what

drove the change in Treasury yields and what this implies for property

income growth expectations and the real estate risk premium; cap rate

to Treasury spread and the stage of the economic cycle are crucial to

understanding the Treasury yield – cap rate linkage dynamic.

NCREIF Property Index (NPI) cap rates do not move one-to-one with Treasury yields; other influences matter

Average NPI Cap Rate and 10 Year Treasury Yield Levels(Quarterly, 1990:1 – 2013:2)

Changes in NPI Cap Rates and 10 Year Treasury Yields(Annual change in quarterly data, 1991:1 – 2013:2)

� Historical data indicate that over the long-term, there is a positive

relationship between 10 year Treasury yields and average NPI

appraisal cap rates, although the relationship is not a simple

linear one.

� The correlation is well below one (about 0.37) indicating that, on

average, a small change in Treasury yield tends to produce a

change in cap rates in the same direction, but much smaller in

magnitude. Moreover, changes in Treasury yields do not

necessarily produce changes in cap rates in all periods

Few observations of cap rates rising when Treasury yields increase

Sources: Cornerstone Research, NCREIF, Federal Reserve.

24

Sources: Cornerstone Research, NCREIF, Federal Reserve, (October 10, 2013)

Core Real Estate Priced Favorably on a Relative Basis ?

NCREIF Cap Rates versus to Moody’s Baa Corporate Bond Yield

Quarterly data with 10 year treasury and Baa Corporate through Q3 2013 and NCREIF Cap Rate trough Q2 2013.

0%

2%

4%

6%

8%

10%

2000 2002 2004 2006 2008 2010 2012

10 Year Treasury NCREIF Cap Rate Baa Corporate

Total Non-Farm Employment in RCA “Secondary” Metros

25

0.8

0.85

0.9

0.95

1

1.05

1.1

1.15

1.2

2007 2008 2009 2010 2011 2012 2013

AtlantaAustinBaltimoreCharlotteCincinnatiClevelandColumbusDallasDenverDetroitHoustonIndianapolisJacksonvilleKansas CityLas VegasMemphisMilwaukeeMinneapolisNashvilleOrlandoPhiladelphiaPhoenixPittsburghPortlandRaleighSacramentoSalt Lake CitySan AntonioSan DiegoSeattleMiamiSt. LouisTampa

Source: BLS, Cornerstone Research July 2013.

Quarterly Employment, 2007:1 to 2013:2 (Index 2007:1 =1)

Looking Forward - PREA Consensus Forecast of the NPI 3Q13

26

-25

-15

-5

5

15

25

2000 2003 2006 2009 2012 2015 (f)

%

Income Return Appreciation Return

Forecast

Solid returns but reversion to the mean in 2014 and 2015 at the overall NCREIF portfolio level

Sources: Cornerstone Research, NCREIF, PREA (September 2013)

27

Thanks

Questions?

Jim Clayton, Ph.D.

Vice-President of Research

(860) 509-2237

jclayton@cornerstoneadvisers.com

Disclosure Statement

• This information provided herein is believed to be obtained from sources deemed to be

accurate, timely and reliable. However, no assurance is given in that respect. The reader

should not rely on this information in making economic or other decisions.

• This analysis does not make any recommendation about your investments, and should not be

considered investment advice. Any opinions expressed herein reflect our judgment at this date

and are subject to change. Certain of the statements contained herein are statements of

future expectations and other forward-looking statements that are based on management's

current views and assumptions and involve known and unknown risks and uncertainties that

could cause actual results, performance or events to differ materially from those expressed or

implied in such statements.

• Opinions and estimates offered herein are subject to change without notice, as are statements

of market trends, which are based upon current market conditions.