Real Estate Outlook 2010: No Bottom, No Net presented to: Seattle Chapter of the Appraisal Institute Fall Conference by: Jim DeLisle, Ph

Real Estate Outlook 2010: No Bottom, No Net presented to: Seattle

Chapter of the Appraisal Institute Fall Conference by: Jim DeLisle, Ph.D.

Annotated. Select View Notes in PPT to read my text.

December 1, 2009 jrdelisle@jrdelisle.com

Presentation Overview

I: Outlook 2010 Prelude II: Economic and Capital Markets III: Real Estate Capital Markets IV: Commercial Real Estate Market Update V: Implications for Seattle Real Estate Market

Butt, what the “L”

Three Major Attributes of Real Estate Revisited

L, L, L

Liability, Litigation, Liquidity (NOT!)

Three major attributes of real estate . . . L, L, L.

Three major attributes of real estate . . . L, L, L.

. . . . . . . ulnerable, . . . . . . . ulnerable, . . . . . . . ulnerable.

The 2009 regime of real estate . . . D D D

. . . . . . . istressed, . . . . . . . istressed, . . . . . . . istressed.

The 2010 + regime of real estate . . .

Commercial Real Estate: How we Got Here

Total Return

Defensive Capital $’s

How We’re Doing: Institutional Real Estate

The Good News…. It’s not as bad as it was

The “Bad News”

Implicit Cap Rates 200bp below averages

Source: NCREIF

The Three C’s of our Disconnect

Credit Crisis Easy Credit Cheap Credit Plentiful Credit Crisis of Confidence Consumer Confidence Corporate Confidence Crisis of Collateral Value attributable to delinking spatial market/capital market Values correction as “marked to market” Re-pricing of Risk

Spatial & Capital De-connect and Re-connect

Values

Capital Market

BV (Bubble Value)

Debt -20%+/- Bubble

Cap Rate Rise Interest Rates/Debt Rise

Spatial Market

Cap R -20%+/- Bubble

Market -10-20%+/- Softening

Vacancy Up Rents Down

-40-60%

Capital Market Bubble

Warranted Construction: Expanding Demand

Rising Rents

Market Inefficiency

What Happened: Commoditization of Pricing

Market Risk/Return Long-Term

Recent: Risk/Return 5 yrs

Who Responded to the Survey

Experience of Respondents

What Specializations?

JRD Prediction Number with Same Company will decline…..

Others: Regulator, pension advisor, government, right-of-way, lender appraisal department, lawyer, student

Seattle MAI Respondents

When National & Seattle Markets Bottom Out

National

Seattle

Seattle Respondents

Part II: A Growing Consensus on Economy

Seattle Respondents

Breaking News on Real Estate & the Economy

The Good News: Employment Losses Slowing

Net Employment losses

Jobless Claims Slowing?

Unemployment

10%

The glass is half-full syndrome; wishful but tentative….

Source: economy.com

Business Cycles: An Historical Comparison

Click for annotation

Critical Elements to Sustainable Recovery

The Future Remains Uncertain

Few degrees of freedom; stars must stay aligned….

Seattle MAI Respondents

Federal Stimulus Funding: Pledged & Provided

US Recovery Status

Business Inventories and Business Spending

Business Inventories

Business Spending

Good News: Manufacturing up

Focus on Small Business

Small business report tighter credit Reactions Cutting payrolls Reducing inventory Reducing capital spending Outlook No near-term improvement

Credit Remains Tight for Business

Source: economy.com

Housing Activity and Delinquency Rates

Construction

Delinquency & Default

Housing Index

Residential Delinquencies, Foreclosures & Charge-Offs

Loan Charge-Off Rates to Rise

Delinquency Rates

Residential Foreclosures

Source: economy.com

Consumer Confidence, Spending & Credit

Consumers are over 70% of GDP….

Butt…

As of October 2009, recent uptick in retail sales on Year over Year; partly weak 2008…

Consumers Contracting

Source: economy.com

Global and Domestic Business Confidence

U.S. Business Confidence

Some improvement….

But, deficit….

Source: economy.com

Global Recession Map

Source: economy.com

Part II Summary: The Economy

Macro-economic Environment Economy showing some signs of turning Businesses struggling, credit tight Consumers bearish

The Future Remains Uncertain

Part III: Real Estate Capital Markets

Current and Future National-Level Cap Rates

Most common: modes

Seattle MAI Respondents

Current and Future Seattle-Area Cap Rates

Seattle MAI Respondents

CBA: Properties for Sale Output

Seattle Capital Market: Agree/Not

Seattle MAI Respondents

Positives

Negatives

Capital Markets & Capital Flows

Investment Preferences Core assets at distressed prices Major markets, strong assets Timing Still waiting for bottom Indecisive; slower to act Opportunities Cash Distress Takeovers

Decreased capital flows Investors still frozen Debt limited sources & tighter Access & yield for equity Capital Market Challenges Refinancing: volume & status Weakening fundamentals Surge in distressed assets Valuations & mark-to-market Growing pressure to act..

Commercial Leverage: Problems & Implications

Tightened Credit Higher DCRs and LVs Hard valuations, less financial engineering Recourse debt Real equity positions Outlook for Commercial Debt Limited supply; flight to quality Tighter; increased equity and recourse Refinancing Crisis No obvious sources of debt Banks struggling with carry-over problems No CMBS resurgence

Bid/Ask Spread: Trends and Value Pressures

Bid/Ask De-Compression Distressed Sellers will have to act Distressed Assets will face melt-down risks Mark-to-Market Accounts NCREIF - 35% w/o Distressed Sales Going Forward: Three Strikes Comps Down as Assets Dumped NOI Erosion, Vacancy & Rents Debt & Equity Yields Up Appraisals under increasing scrutiny

Distressed Asset Recovery by Source & Terms

Players in Distressed Asset Market

REITs Have reversed downward spiral Significant new capital raised through Sept 2009 Low Dividends suggest accretive opportunities Global Investors Western European Middle East Asia/Australia Domestic Funds Significant growth in US New Opportunity Funds New Value-Plus Funds

REITs: Back to the Future

Changing Game? Through June, raised $12 billion in stock Who? Office: Boston Properties, Vornado Realty Trust Retail: Regency Centers, Simon Property Group

Challenges Existing Leverage Eroding Fundamentals Falling Property Values

Accretive? Buy at 8-10, payout 4-6

REIT Snapshot

REIT Stock Prices: Retail and Office

Apartment, Hotel and Diversified REITs

Part III Summary: Real Estate Capital Markets

Macro-economic Environment Economy showing some signs of turning Businesses struggling, credit tight Consumers bearish

Real Estate Capital Market Still shut down; some activity increasing Rising Cap rates, tighter credit, picky sources Major challenge in de-levering

Part IV: Spatial Market

Components of Spatial Market Demand Supply

Market Balance

Commercial Market Fundamentals

Vacancy Rates

Development (msf)

Suburban Office

Downtown Office

Industrial

Retail

Apartments

Apartments

Industrial

Office

Retail

Source: Torto Wheaton Research, REIS, 2009 Emerging Trends

NCREIF Property Type Return Overview

Risk/Return by Property Type by Regime

Office Real Estate

Overview Corporations giving back space Sublease activity increasing Vacancy rates rising Rents softening Credit will be tightening Construction declining Areas of Concern Speculative projects Commodity product Capital Needs: Cap X, TI’s Second and third tier markets Emerging sub-markets

Opportunities Abandoned Projects Entitled Projects Capital Needs Projects Asset Takeovers Distressed Owners/REO

Retail Real Estate

Overview Retail sales tepid Inventories will be lean Credit tight, local and regional players Retailer contraction; unit profitability Defensive capital to protect markets Areas of Concern New unproven & unopened stores Underperforming existing units Unanchored Life-style centers Tenant Bankruptcies Mixed-use in marginal markets Niche Oversaturation

Opportunities Projects with Lost Anchors Entitled/Spec Projects Capital Needs Projects Asset Takeovers Distressed Owners & REO

Industrial Real Estate

Opportunities Projects w/ Lost Tenants Capital Needs Projects Changing H&B Use Distressed Owners & REO

Overview Absorption slowing Rents softening Construction moderating Changing Logistics Models Globalization Areas of Concern Overbuilt markets Functionally obsolescence Office Showroom/Flex Exports in Global Recession

Multifamily Real Estate

Overview Modal Shift: Rent vs. Own Concessions increasing Absorption slowing Vacancy rates rising Rents softening Areas of Concern Homogenized Product Product Positioning Re-apartmenting Density as an End vs. Means Parking: Shared

Opportunities Projects in pre-development Entitled but unfunded Repositioning Conversion (future) Distressed Owners & REO

Hotels

Opportunities Projects in development: not finished Entitled: not started Reflagging existing Distressed Owners & REO

Overview High risk/return profile Travel down Companies down-scaling Occupancy falling Rates slipping Areas of Concern Homogenized Product Poor Product Positioning Hotel/Apartment/Condo Hybrids Weak flags

Growth in Distressed Assets by Property Type

What’s Happening on the Distressed RE Front

Status and Location

Growth & Build-up

Source: Real Capital Analytics

Distressed Asset Spillover: Why it Matters

Phipps Tower: Crescent/Manulife

Wells Fargo Lead, Regions Follows

Two Alliance Center: Tishman

3630 Peachtree: Duke/Pope & Land

Bank of America Lead

Regions Lead

Terminus 200: Cousins

Sources: RCA, WSJ 4/21/2009

Distressed Loan Recovery by Property Type

Office 53% Industrial 66% Retail 72% Hotel 65% Apartment 63% Development 32% Land 45% Overall 60%

Part IV Summary: The Spatial Markets

Macro-economic Environment Economy showing some signs of turning Businesses struggling, credit tight Consumers bearish

Real Estate Capital Market Still shut down; some activity increasing Rising Cap rates, tighter credit, picky sources Major challenge in de-levering

Spatial Market Fundamentals continue to erode lagging economy Vacancy rates rising, rents falling Stagnant demand, leasing sluggish

Total Returns: Seattle vs

US

How Seattle Cap Rates Compare to US

Not as different as we thought

Challenge: Remove Volatility

Seattle Institutional Returns by Property Type

What’s Happening in Seattle

What’s it all About?

Seattle Real Estate Fundamentals: Yay/Nay

Seattle MAI Respondents

Additional Insights on Seattle Market

Seattle MAI Respondents

Seattle Market Risks: Significant/Not

Seattle MAI Respondents

Issues and Risks in Seattle

Issues

Risks

Seattle MAI Respondents

Part V. “Real” Opportunities in Seattle RE

Seattle MAI Respondents

Other Challenges: Players and Products

Players Emergence of new players will create further problems Many na?ve buyers will clog up the system Intermediaries will raise capital but struggle to deploy Infrastructure not in place to deal with sheer volume of deals New Funds Expect a spate of new funds, some with experience others not Closed-end fund structures will be popular Off-shore investors will be a major target for money managers Products A spate of new products will be introduced to lay off risk New Partnership arrangements will match expertise with capital

Seattle MAI Respondents

Challenges to Appraisers

Personal Showing value of services Survival Low fees and lower respect Valuation Determining market value Determining when distressed prices are the market Confirming details of all transactions Staying on top of market and explaining it Dealing with diverse leases and transactions

Seattle MAI Respondents

Conclusion: What to do

Back to School?

So, To Walk, To Talk, To Walk the Talk???That is the question…. There is no one answer…. Critical thinking and survival instincts will rule… If not, there’s always school…. Back to the Future…..

http://jrdelisle.com