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Overview of the US Commercial Real Estate Investment Market January 20, 2009 1 Current economic environment… Economy is contracting Employment has declined for 11 consecutive months Financial Markets have collapsed 2 Recession with a capital “R” How’d we get here??? Current account deficit has been growing… 3 Source: Bureau of Economic Analysis, Cushman & Wakefield Federal fiscal deficit has been growing for decades… U.S. Federal Fiscal Deficit 4 Source: Bureau of Economic Analysis, Cushman & Wakefield Until recently stock market has been steadily rising… Dow Jones Industrial Average 5 Source: Dow Jones, Cushman & Wakefield Long-term interest rates have been falling… 6 Source: Moody‘s Economy.com, Cushman & Wakefield Household savings has been declining… 7 Source: Moody‘s Economy.com, Cushman & Wakefield Household debt has been growing… Billions of US Dollars Aggregate Household Debt Source: Federal Reserve Board 8 What has fueled this? ■ Fed Chairman Ben Bernanke: “A global savings glut.” ■ Mercantilist trade policies depress value of foreign currencies relative to the dollar - Encouraging U.S. consumerism - Discouraging U.S. savings - Depressing U.S. industrial production and exports ■ Result: Huge capital transfers from emerging to mature economies - Causing run-up in asset prices 9 What are the results? ■ Massive capital transfers from emerging to mature economies ■ Easy debt, excessive leverage, lax discipline by lenders and investors (e.g., example of residual values) ■ Causing huge bubbles in asset prices, including residential and commercial real estate ■ Over-leveraged financial institutions catastrophically vulnerable to pricing corrections ■ WE ALL SAW THE BUBBLE, BUT IGNORED THE INEVITABLE IMPACT ON THE FINANCIAL SECTOR 10 Business is retrenching, shedding jobs… 11 Source: US Bureau of Labor Statistics Retail sales are falling… Year-over-year change (3-month moving average) 12 Source: U.S. Census Bureau The response – massive monetary and fiscal stimulus… Economic Slow Down Period: Jul-95 to Mar-97 Cause: S&L Crisis Credit Crunch Period: Aug-98 to Jan-99 Cause: Asian Flu Recession Period: Sep-01 - 02 Cause: Tech Bubble Bursts and Sept 11 Credit Crunch and Recession Period: Aug-07 to ??? Cause: Residential Subprime Contagion 13 Source: US Federal Reserve Board Forecast U.S. Gross Domestic Product: 1980 – 2011 14 Source: Moody’s Economy.com, Bank of America, Cushman & Wakefield Capital Markets Group The U.S. Real Estate Market 15 Gateway CBDs holding up reasonably well… Q3-08 CBD VACANCY RATES 16 Suburban markets beginning to feel the pain… Q3-08 SUBURBAN VACANCY RATES 17 Suburban vacancies increased from year ago… Q3-08 SUBURBAN VACANCY RATES Change from One Year Ago 18 Global investment volumes declined substantially… Global Real Estate Investment 19 * Preliminary 2008 Volume Source: Cushman & Wakefield, PropertyData, RCA U.S. investment sales volumes returning to normal levels? 20 * Preliminary 2008 Volume Source: Real Capital Analytics, Cushman & Wakefield Capital Markets Group The market has its challenges… • There is a crisis of confidence and a perception that markets haven’t “bottomed out” – stalling any material sales activity. • Absence of available debt is severely reducing the pool of capable buyers. • Properties with assumable financing, or with available seller financing, and reasonable remaining term (minimum three years) fare better . • Foreign investors, once looking at the U.S. as a safe haven for real estate capital, face similar if not more severe credit issues. 21 There are now more sellers than buyers able to close… All Property Offerings & Closings* Credit Crunch US, Monthly In 2008: $250b offered $138b closed 22 ’07 *Excludes Privatizations Source: Real Capital Analytics, Inc. ‘08 Office properties have suffered the steepest decline… 23 * Preliminary 2008 Volume Source: Real Capital Analytics, Cushman & Wakefield Capital Markets Group Property yields returning to historic norms… Derived Office Cap Rate Spread to Treasuries 14% Average 10YR Treasury Yield: 93q4-08q4 Average: 5.25% 90q1-08q4 Average: 5.68% 12% 10% * 8% *4th Quarter Office Derived Cap Rate forecasted using RCA data. Source: NCREIF, Moody’s Economy.com, Real Capital Analytics, Cushman & Wakefield Capital Markets Group 08q1 07q1 06q1 Spread 05q1 04q1 03q1 02q1 01q1 00q1 10-yr Treasury Yield 98q1 97q1 96q1 95q1 88q1 87q1 86q1 85q1 84q1 83q1 -6% 94q1 Derived Office Transaction Cap Rate 99q1 -4% 24 93q1 -2% Average Cap Rate to Treasury Spread: 93q4-08q4 Average: 2.87% 90q1-08q4 Average: 2.57% 92q1 0% 91q1 2% 90q1 4% Average Cap Rate from NCREIF: 93q4-08q4 Average: 8.12% 90q1-08q4 Average: 8.25% 89q1 6% CMBS/conduit financing is essentially gone… 25 Source: Mortgage Bankers Association Re-pricing of capital & risk translates to falling property values… Opportunistic Capital Assumptions Post Credit Crunch Jun 25 2007 Scenario Property Cost Year 1 NOI NOI Annual Increases Initial Cap Rate Reversion Year 11 Cap Rate First Mortgage LTV Mezz LTV First Mortgage Loan Term Mezz Loan Term First Mortgage Amort Term Mezz Amort Term 10 Year Treasury Spread to First Mortgage Rate First Mortgage Rate Mezz Rate Year 11 NOI Residual Value Reversion Costs Leveraged Equity Return Hurdle $ 100.00 $ 5.89 3.00% 5.89% 6.89% 75.00% 5.00% 10 years 10 years Interest Only 20 years 5.09% 127 bps 6.36% 9.00% $ 7.91 $ 114.87 1.50% Oct 3 2007 $ $ 83.95 5.89 3.00% 7.01% 7.50% 65.00% 15.00% 10 years 10 years 30 years 20 years 4.51% 293 bps 7.44% 11.00% $ 7.91 $ 105.46 1.50% Jan 22 '08 no mezz Jan 23 '08 w/mezz Sep 16 '08 no mezz* Sep 16 '08 w/mezz* Theoretical Dec 3 '08 no mezz Theoretical Dec 3 '08 w/mezz $ $ $ $ $ $ $ $ $ $ $ $ 76.63 5.89 3.00% 7.68% 7.75% 60.00% N/A 10 years 10 years 30 years 20 years 3.54% 331 bps 6.85% 13.00% $ 7.91 $ 102.05 1.50% 77.77 5.89 3.00% 7.57% 7.75% 60.00% 15.00% 10 years 10 years 30 years 20 years 3.54% 331 bps 6.85% 13.00% $ 7.91 $ 102.05 1.50% $ $ 63.46 5.89 0/0/0/3 9.27% 8.00% 60.00% 0.00% 10 years 10 years 30 years N/A 3.31% 365 bps 6.96% 15.00% 7.46 93.19 1.50% 63.46 5.89 0/0/0/3 9.27% 8.00% 60.00% 0.00% 10 years 10 years 30 years N/A 3.31% 365 bps 6.96% 15.00% $ 7.46 $ 93.19 1.50% $ $ 54.82 5.89 0/0/0/3 10.74% 8.50% 60.00% 0.00% 10 years 10 years 30 years N/A 2.70% 580 bps 8.50% 15.00% 7.46 87.71 1.50% $ $ 54.82 5.89 0/0/0/3 10.74% 8.50% 60.00% 0.00% 10 years 10 years 30 years N/A 2.70% 580 bps 8.50% 15.00% 7.46 87.71 1.50% 10.50% 12.50% 14.50% 14.50% 18.00% 18.00% 20.00% 20.00% CHANGE IN VALUE -16.1% -23.4% -22.2% -36.5% -36.5% -45.2% -45.2% Debt Terms Price Change Component -9.0% -14.3% Equity Cost Increase/ Reduced NOI Growth Component -15.9% -13.4% * Mezz rates include amortized up front points. Source: Cushman & Wakefield Capital Markets Group 26