VOLUME AND PRICING TRENDS SPRING 2019

TEN-X STRATEGIC INSIGHTS

Ten-X Strategic Insights, led by Chief Economist and industry veteran, Peter Muoio, Ph.D. is based in New York. The group focuses primarily on custom analysis and business development support services, as well as industry-leading data science and predictive modeling initiatives.

CAPITAL MARKETS ACTIVITY OVERVIEW

After seeing some of their strongest performance this cycle in the latter half of 2018, commercial real estate capital markets slowed in the first quarter of 2019. Real estate deal volume fell considerably in the first quarter of 2019, as entity/M&A activity came to a crashing halt, falling to less than 2% of what is was in the prior quarter. The primary cause of this jarring decline is likely seasonal, as parties sought to finalize M&A deals prior to the end of 2018. Heightened investor caution toward the end of 2018 amid higher interest rates, followed by the 32-day government shutdown, may have also played a role.

In the first quarter, total deal volume saw a double-digit decline year-on-year, and slowed nearly 40% from the prior quarter, per Real Capital Analytics. The slowdown is not yet a cause for concern, as first quarter deal volume is usually lower than end-of-year transaction volume.

The US economic expansion is now almost the longest in history, as employment and wages rise higher and

DEAL FLOW

Deal Volume Softens in First Quarter With the exception of the apartment sector, deal volume across all segments declined year on year in the first quarter of 2019, resulting in an 11.7% decline in the total. At just over $98.3 billion, per RCA, total US deal volume is at its lowest level since mid-2014. The decline is due in part to a cooling in M&A activity, which formed a large part of transaction volume in the latter half of 2018. In the first quarter of 2019, entity-level transaction volume measured less than $500 million, less than 2% of the prior quarter’s level. Overall declines notwithstanding, the apartment and office sectors continue to lead the pack in terms of deal volume. At a combined $62 billion, the two segments make up nearly two thirds of total five-sector deal volume this quarter. Hotel deal volume saw the largest annualized decline of 35.6%, leaving it at the lowest level of all the segments at $6.7 million. This pales in comparison to last quarter amid the merger of LaSalle Hotel Properties and Pebblebrook Hotel Trust. Not even the industrial segment was immune to the cooling, as deal volume nearly halved from the prior quarter to $17.6 million, as fundamentals are beginning to wane. Retail deal volume fell 15.9% annually to $11.9 billion, as redevelopment activity that characterized 2018 appears to be diminishing.

Apartment Staying Ahead Cooling redevelopment and M&A activity has caused the share of retail and hotel volume to revert to a fraction of the total at a respective 12.1% and 6.9%. Despite a significant decline year-on-year, multifamily activity continues to make up the largest share at 37%. Office deal volume used to occupy more than a third of total deal volume less than two years ago, but declining transactions have left it at just 26.1% in the first quarter. At 18%, industrial deal volume is high relative to its history at 18%, though it is down 180 bps from the prior quarter, which may portend further weakening.

unemployment remains at historic lows. The growth of the US economy continues to be at odds with the commercial real estate market, where fundamentals saw a considerable slowing in the first quarter across all segments, even industrial.

Per Situs/RERC, cap rates have seen little deviation from the prior quarter, though the 40 bps drop in treasury rates has resulted in a rise in spreads across all sectors. Their slackening has allowed spreads to become a sufficient buffer to increased pricing, should it occur, preventing any sizable disruption in cap rates and inspiring investor confidence.

While strong economic growth persists, the slowdown in first quarter deal volume coupled with lower interest rates may point to perceived risks on the horizon. Furthermore, the renewal of combative trade rhetoric on China by the current administration increases uncertainty around further economic growth and present threats to the commercial real estate market. These political dynamics, coupled with weakened transaction volume and quieting real estate fundamentals across all segments, portends a shaky investment environment in the mid-term.

PROPERTY PRICES

Ten-X All Property Nowcast Continues Its Horizontal Movement

The Ten-X Nowcast – which gauges CRE property valuations on a contemporaneous basis using Google trends, Ten-X proprietary data from transactions on its platform, and survey data done in conjunction with Situs/RERC – grew just 0.8% from a year ago in April, on the back of a 0.1% monthly decline. Despite slowing fundamentals as the cycle marches on, pricing is up year-on-year across the majority of segments. The office and apartment sectors are seeing the biggest gains in the low and mid-2% range year-on-year, while retail and industrial pricing is up less than 1%. On an annual basis, office and retail pricing have cooled markedly from March, as slowing fundamentals continue to weigh on the sector. Hotel pricing was the only one to decline year-on-year in April, though it was stagnant on the month.

Pricing Showing Continued Lethargy to Start Second Quarter Office was the most noteworthy segment in April, dropping 0.8% on the month and slowing annual growth in the segment to just 2.6%. This is the softest reading since mid-2018 and unwinds the inexplicable run in office pricing we have been seeing despite very weak fundamentals. Office pricing was weakest in the Southwest, which had been running particularly hot, with monthly declines in the Southeast and West as well. The Northeast and Midwest posted gains in the month. The Hotel nowcast declined 0.1% month-on-month in April leaving the price index up just 0.8% year over year. According to the nowcast, hotel pricing has been flat since early 2016, when RevPAR growth peaked for the cycle. April’s weak hotel nowcast was attributable to softness in all the major metrics: buyer behavior on the Ten-X Commercial platform, Google keyword searches and survey results. Pricing was down in all regions save the Midwest. Industrial pricing was essentially flat year-over-year, according to the Ten-X Commercial Industrial Nowcast, with a 0.2% monthly gain pushing pricing into positive territory following a decline that began in mid-2017. Industrial fundamentals remain solid but have downshifted in recent quarters from their previously robust state, with vacancies rising slightly and rent growth slowing. The nowcast’s decline has captured the impact of this shift on pricing well. Industrial pricing was weak in April across all regions save the Northeast, which has been the most robust area recently. The Ten-X Commercial Retail Nowcast fell 0.2% in April, bringing the price index to its lowest annual pace of growth in this cycle, up 0.9%. The weakness of pricing corresponds to reduced transaction volume in the segment, which was temporarily boosted last year by a spate of M&A activity. The national drop in April masked regional differentiation, with the Southeast and West posting healthy increases, a moderate gain in the Southwest and declines in the Northeast and Midwest. The Ten-X Apartment Nowcast posted the strongest April results, with a 0.5% gain. This places the apartment pricing index up 2.1%, in line with the recent range. Apartment pricing is up in all regions save the Midwest, although that region had

the strongest annual gain of 7.9%.

CAP RATES & SPREADS

Spreads Slackened in First Quarter amid Interest Rate Decline The 10-year US Treasury rate fell some 40 bps in the first quarter to about 2.7%, its first decline since mid-2017. On a monthly basis, interest rates rose to the 3% range in the latter months of 2018 but have slowly come down since then, and are now holding in the mid-2% range as of May. In that span, cap rates shifted across all segments save for multifamily. The Federal Reserve announced plans to take a less aggressive approach to raising interest rates in 2019 and has thus far kept its promise, holding its benchmark rate between 2.25% and 2.5% at its May meeting, citing lack of inflationary pressure. The country is now well clear of the government shutdown earlier this year, though political tensions remain which may derail the economy in the future. President Trump’s recent announcement of additional tariffs on Chinese goods and China’s retaliation have brought the trade war back to the public consciousness. This will have ramifications across the financial markets and likely affect investor confidence. Furthermore, recent partial yield curve inversions have sparked some recessionary anxiety.

Cap Rates Seeing Some Movement in First Quarter but Remain Low by Historical Standards Changes in cap rates were varied, though the fall in treasury rates has allowed for a rise in spreads across all segments. Per Situs/RERC, the office sector saw the greatest change in cap rates, rising 30 bps from the prior quarter. Cap rates in the industrial sector are the furthest off their long-term average, by more than 120 bps following a 10 bps drop in the first quarter. Cap rates in the sector are now also at a 10-year low. Hotel cap rates also declined from the prior quarter, but remain some 70 bps above their minimum at 7.5%. Apartment cap rates are unchanged from the fourth quarter, while retail cap rates rose 10 bps, although they have yet to break from the low to mid-6% range they have occupied since the end of 2017.

Cap rate spreads across all sectors have widened since the prior quarter as the result of a steep drop in interest rates. On average, spreads rose about 41 bps on the quarter. On an annual basis, risk premiums were up some 11 bps in the apartment and retail sectors, while industrial spreads were down nearly 20 bps from a year ago. Hotel spreads have seen the greatest divergence from their year-ago level at nearly 40 bps, while office spreads are unchanged from a year ago.

Rising Cap Rate Spreads Edging Nearer to Historical Averages The 40 bps drop in the 10-year US Treasury rate has widened cap rate spreads across all sectors, particularly ones which saw a rise in cap rates in the first quarter. As a result, all spreads are up from the prior quarter and closer to their 10-year average. Retail and hotel spreads have historically trended closest to their 10-year average, though retail came closest this quarter at less than 40 bps. Industrial spreads have diverged starkly from their 10-year averages in recent quarters, and are still some 130 bps off their historical average despite their recent rise. Despite the continued economic expansion and booming labor market, the heightened uncertainty in the market is giving way to lower interest rates, which have brought spreads higher and resulted in an improved barrier to price changes.

TEN-X STRATEGIC INSIGHTS

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PLATFORM SPOTLIGHT: HOTEL

Hotel Activity Improving in First Quarter, Some Assets Selling Far Beyond Reserve Each quarter we take a closer look at the performance of one of the major CRE sectors on the Ten-X Platform. This spotlight focuses on the US hotel segment. The hotel sector was not immune to the decline in portfolio and entity-level transactions in the first quarter of 2019, and saw a similar decline in overall deal volume in the national marketplace. On the Ten-X Platform, the hotel sell-through rate reflects the ratio of asset sale price-to-reserve price, and is off to a slow start in 2019. The overall hotel trade rate on Ten-X fell during the 2016-2018 period amid a shift in asset blend, but improving investor interest is helping drive a stronger trade rate near 55% thus far in 2019. Hotel Property Display Page (PDP) views are at their highest level on record, standing at just under 3,000 visits per asset on a 12-month rolling basis. PDP views began to rise in early 2019 after hitting a valley in the months prior, and vault visits are seeing a corresponding trend up. In the first quarter, hotel vault visits averaged about 221 per asset, slightly below their peak levels in 1Q’17. One of the biggest successes for Ten-X in the first quarter was selling a Microtel Inn in Baton Rouge, LA, which sold for nearly 57% higher than its reserve price. The Courtyard Marriott in Lafayette, LA was another notable transaction, selling for 24% higher than its reserve price.