Navigating the Narrow Shoals

Recession, Recovery& The Apartment Market

Peter C. Burley, CRESDCAA/CCIM - San Diego - September 30, 2010

Navigating the Narrow Shoals

Opinions expressed herein are those of the speaker and do not reflect those of any organization, vendor, data provider, partner, colleague, friend, or spouse. No statement should be construed as an offer or solicitation. Except as noted as source material, the speaker is solely responsible for the content herein.

Navigating the Narrow Shoals

Data, consultation, and support graciously provided by:

Moody’s Economy.comReis, Inc.Axiometrics Inc.Real Capital AnalyticsThe Counselors of Real Estate

Stuff Happens

A Little Worse than Expected

2005Q12006Q1

2007Q12008Q1

2009Q12010Q1

-8

-6

-4

-2

0

2

4

6 GDP (Annualized % Change)

Source: Moody's Economy.com; BEA

Stocks Tanked

1/3/2000 1/2/2002 12/26/2003 12/20/2005 12/17/2007 12/10/2009600

700

800

900

1000

1100

1200

1300

1400

1500

1600S&P 500 Index

Source: NYSE

Dot-Com BustFin. Meltdown

Soaring Profits Crashed

1995Q1 1997Q3 2000Q1 2002Q3 2005Q1 2007Q3 2010Q1500

600

700

800

900

1000

1100

1200

1300

1400US Corporate Profits (after Tax, $B05, SAAR)

Source: Moody's Economy.com; BEA

Credit Crunched and Remains Tight

2005Q2 2006Q3 2007Q4 2009Q1 2010Q2 2011Q3 2012Q4-30

-20

-10

0

10

20

30Commercial and Industrial Loans, (Bil. $, SA)

Source: Moody's Economy.com; FRB

Employers Took Action to Cut Costs

2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 2010Q10

100

200

300

400

500

600 Layoff Announcements (Ths)

Source: Challenger, Gray & Christmas, press release 9/1/2010

2005Q12006Q1

2007Q12008Q1

2009Q12010Q1

-2.5

-2

-1.5

-1

-0.5

0

0.5

1 Change in Total Employment (Mil., SA)

Source: Moody's Economy.com; BLS

Census Hiring

Job Growth Turned South

Unemployment Remains High

2000Q12001Q2

2002Q32003Q4

2005Q12006Q2

2007Q32008Q4

2010Q12011Q2

3

4

5

6

7

8

9

10

11 Unemployment Rate (%, SA)

Source: Moody's Economy.com

Consumer Issues

Consumers Have Been Shaken

2001Q12002Q2

2003Q32004Q4

2006Q12007Q2

2008Q32009Q4

2011Q12012Q2

20

30

40

50

60

70

80

90

100

110

120Consumer Confidence (Index, 1985=100, SA)

Source: Moody's Economy.com; Conference Board

And, Consumers Remain Pinched

2001Q12002Q2

2003Q32004Q4

2006Q12007Q2

2008Q32009Q4

2011Q12012Q2

45000

50000

55000

60000

65000

70000

75000

80000

7000

8000

9000

10000

11000

12000

13000

14000

15000

16000Household Assets ($Bil)

Source: Moody's Economy.com; BEA

Household Liabilities ($Bil)

Assets (L)

Liabilities (R)

Closed Wallets Are only Cautiously Opening

2005Q1 2006Q2 2007Q3 2008Q4 2010Q1 2011Q28700

8800

8900

9000

9100

9200

9300

9400

9500Personal Consumpton Expenditures (Bil. $05, SA)

Source: Moody's Economy.com; BEA

-$225B

Housing Market Issues

Housing Markets Are In the Well

1999Q22000Q3

2001Q42003Q1

2004Q22005Q3

2006Q42008Q1

2009Q22010Q3

2011Q44

4.5

5

5.5

6

6.5

7

7.5

8

8.5

9

New Existing

Source: Moody's Economy.com; NAR; BOC

Home Sales (Mil. Units, SAAR)

Despite Attractive Pricing

1999Q1 2001Q3 2004Q1 2006Q3 2009Q1 2011Q3120

140

160

180

200

220

240

260

New

Existing

Median Home Price ($Ths., SA)

Source: Moody's Economy.com; NAR; BOC

And, Despite Generationally Low Rates

1971Q21976Q2

1981Q21986Q2

1991Q21996Q2

2001Q22006Q2

2011Q22

4

6

8

10

12

14

16

18

39yr Avg=8.9%

Mortgage Interest Rates (%, NSA)

30yr Fixed

1yr Adj

Source: Moody's Economy.com; Freddie Mac

And, the Highest Affordability We Have Seen

2000Q12001Q2

2002Q32003Q4

2005Q12006Q2

2007Q32008Q4

2010Q12011Q2

100

110

120

130

140

150

160

170

180Housing Affordability (Index, SA)

Source: Moody's Economy.com; NAR

Commercial Property Dynamics

“We may never go back to the kind of pricing and availability of debt we had…”

-- PwC/Korpacz Real Estate Survey, 9/16/2010

Job Cuts a Direct Hit on All Sectors

2000 2002 2004 2006 2008 2010 2012 2014-12

-10

-8

-6

-4

-2

0

2

4

Total EmploymentOffice EmploymentIndustrial Employment

Annual Pct Change in Employment

Source: Moody's Economy.com; Reis Inc; PCB

OfficeAbsorption 2010-13.6m sf

Vacancy Rate:Q2:10 –16.7%Q2:11 – 17.0%

Rent: 2010: -2.7%2011: -2.1%

IndustrialAbsorption 2010-31.7m sf

Vacancy Rate:Q2:2010 – 14.1%Q2:2011 – 13.7%

Rent:2010: -5.4%2011: -4.7%

RetailAbsorption 2010-2.3m sf

Vacancy Rate:Q2:2010 – 13.1%Q2:2011 – 13.1%

Rent:2010: -2.6%2011: -0.1%

Source: NAR, August 26, 2010

Job Cuts a Direct Hit on All Sectors

Credit Remains Tight

2005Q2 2006Q3 2007Q4 2009Q1 2010Q2 2011Q3 2012Q4-10

-5

0

5

10

15

20

25

30 Commercial Real Estate Loans, (Bil. $, SA)

Source: Moody's Economy.com; FRB

Transaction Activity has been Limited

01Q202Q2

03Q204Q2

05Q206Q2

07Q208Q2

09Q210Q2

0

20000

40000

60000

80000

100000

120000

140000 Total CRE Transactions ($Mil)

Source: Real Capital Analytics (www.rcanalytics.com)

Commercial Properties Have Taken a Hit

1978 1983 1988 1993 1998 2003 2008-0.1

-0.08

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0.08

NPI (All)NPI (Apt)

NCREIF Property Index

Source: NCREIF

Commercial Property Pricing is off More than 40%

2001 2002 2003 2004 2006 2007 2008 200990

100

110

120

130

140

150

160

170

180

190

200

ApartmentIndustrialOfficeRetail

Moody's REAL CPPI (Index, 2000=100)

Source: MIT Center for Real Estate, Aug 2010

Commercial Property Pricing is off More than 40%

2007 2007 2008 2008 2009 2009 2010110

120

130

140

150

160

170

180

190

200

ApartmentIndustrialOfficeRetail

Moody's REAL CPPI (Index, 2000=100)

Source: MIT Center for Real Estate, Aug 2010

Apartment Fundamentals are Improving

2005:12006:1

2007:12008:1

2009:12010:1

-40000

-30000

-20000

-10000

0

10000

20000

30000

40000

50000

0

1

2

3

4

5

6

7

8

CompletionsNet AbsorptionVac %

Vac Rate (%)Completed/Absorbed (Units)

Source: Reis Inc

Apartment Rents Reflect Somewhat Better Times

2005:1 2006:2 2007:3 2008:4 2010:1-1.5

-1

-0.5

0

0.5

1

1.5

Asking

Effective

Rent Growth (% Chg/Qtr)

Source: Reis Inc

Concessions are Easing

Apr-08Oct-08

Apr-09Oct-09

Apr-10Aug-10

0

1

2

3

4

5

6

7

8Concessions (% of Asking Rent)

Source: Axiometrics Inc

Distress is a Bit Lower, But…

J '0

7 F M A M J J A S O N DJ

'08 F M A M J J A S O N D

J '0

9 F M A M J J A S O N DJ

'10 F M A M J J

0

1000

2000

3000

4000

5000

6000

7000 $ M

Source: Real Capital Analytics (www.rcanalytics.com)

Source: Real Capital Analytics (www.rcanalyics.com)

The Volume of Distressed Properties Has Not Subsided

J '0

7 F M A M J J A S O N DJ

'08 F M A M J J A S O N D

J '0

9 F M A M J J A S O N DJ

'10 F M A M J J

-10000

0

10000

20000

30000

40000

50000

60000

TroubledREORestructuredResolved

$ Millions

Source: Real Capital Analytics (www.rcanalytics.com)

Apartment Transactions

J FMAMJ JASONDJ FMAMJ JASONDJ FMAMJ JASONDJ F M A MJ J ASON D J FM A M J J ASON D J FM A M J J A0

2

4

6

8

10

12

closedoffered

2005 2006 2007 2008 2009 2010

Apartment Property Trades ($Bil)

Source: Real Capital Analytics (www.rcanalytics.com)

A Quick Look at the San Diego Economy

San Diego took a Big Hit in 2009

2001Q12002Q1

2003Q12004Q1

2005Q12006Q1

2007Q12008Q1

2009Q12010Q1

2011Q12012Q1

-3.5

-3

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

-2

-1.5

-1

-0.5

0

0.5

1

1.5

GMPEmpl't Growth

Gross Metro Product (% Chg) Total Empl't (% Chg)

Source: Moody's Economy.com; BEA; BLS

Growth Has Generally Outpaced the USBut the Contraction was Steeper

1995Q1 1997Q3 2000Q1 2002Q3 2005Q1 2007Q3 2010Q1100

105

110

115

120

125

130

135

140Relative Employment Growth (Index, 1995Q1=100)

Source: Moody's Economy.com; Burley

Like Much of California, Joblessness Remains High

1990Q11992Q3

1995Q11997Q3

2000Q12002Q3

2005Q12007Q3

2010Q12

3

4

5

6

7

8

9

10

11SD

US

Unemployment Rate (%)

Source: Moody's Economy.com; BLS

Spending is Down Sharply

2000Q12001Q2

2002Q32003Q4

2005Q12006Q2

2007Q32008Q4

2010Q12011Q2

30

32

34

36

38

40

42

44

46

48Retail Sales ($Bil., SAAR)

Source: Moody's Economy.com; BOC

Home Sales Have Improved

2000Q12001Q1

2002Q12003Q1

2004Q12005Q1

2006Q12007Q1

2008Q12009Q1

2010Q12011Q1

2012Q10

5

10

15

20

25

30

35

40

45

50 Existing Home Sales (Ths., SAAR)

Source: Moody's Economy.com; NAR; BOC

Home Prices Have Struggled

2000Q12001Q2

2002Q32003Q4

2005Q12006Q2

2007Q32008Q4

2010Q12011Q2

250

300

350

400

450

500

550

600

650Median Existing Home Price ($Ths., SA)

Source: Moody's Economy.com; NAR

Never a Very Affordable Market

2000Q1 2001Q2 2002Q3 2003Q4 2005Q1 2006Q2 2007Q3 2008Q4 2010Q140

60

80

100

120

140

160

180Housing Affordability (Index)

Source: Moody's Economy.com; NAR; BOC; BEA

SD

US

Foreclosures Have Spiked to New Highs

Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-100

2

4

6

8

10

12

14Notice of Trustee's Sale (#/1000, NSA)

Source: Moody's Economy.com; RealtyTrac

New Housing Stock Looks for a New Bottom

2001Q12002Q1

2003Q12004Q1

2005Q12006Q1

2007Q12008Q1

2009Q12010Q1

2011Q12012Q1

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

MultifamilySingle Family

Housing Completions (Units, SAAR)

Source: Moody's Economy.com; BOC

The San Diego Apartment Market

A Recent Employment Recovery has Contributed to “Stronger” Absorption

2006:12006:2

2006:32006:4

2007:12007:2

2007:32007:4

2008:12008:2

2008:32008:4

2009:12009:2

2009:32009:4

2010:12010:2

-1500

-1000

-500

0

500

1000

1500

-30

-25

-20

-15

-10

-5

0

5

10Absorption (Units) Empl't Change (1000s)

Absorption (L)

Employment (R)

Source: Reis, MEDC, Burley

Relatively Limited New Supply and Absorption has Begun to Recover

2006:12006:2

2006:32006:4

2007:12007:2

2007:32007:4

2008:12008:2

2008:32008:4

2009:12009:2

2009:32009:4

2010:12010:2

2010:2-1500

-1000

-500

0

500

1000

1500

3.2

3.4

3.6

3.8

4

4.2

4.4

4.6

4.8

5

Completions Net Absorption Vac %

Completions/Absorption (Units) Vacancy (%)

Source: Reis Inc

Rents Begin to Recover

2006:1 2006:3 2007:1 2007:3 2008:1 2008:3 2009:1 2009:3 2010:1-1.5

-1

-0.5

0

0.5

1

1.5

2Quarterly Rent Growth (%)

Source: Reis Inc

Asking

Effective

Concessions are Off Their Highs

Apr-08

Oct-08Apr-0

9Oct-09

Apr-10

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

SD

Concessions (% of Asking Rent)

Source: Axiometrics Inc

San Diego is Sometimes A Tale of Two Markets (Occupancy)

Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-100.925

0.93

0.935

0.94

0.945

0.95

0.955

0.96

0.965

0.97Coastal NonCoastal MSA

Occupancy Rate (Avg %)

Source: Axiometrics Inc

San Diego is Sometimes A Tale of Two Markets (Rents)

Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-101350

1400

1450

1500

1550

1600

1650

1700

1750Coastal NonCoastal MSA

Effective Rents (Avg $/Mo)

Source: Axiometrics Inc

San Diego is Sometimes A Tale of Two Markets (Rents)

-7 -6 -5 -4 -3 -2 -1 0 1 2 3

Coastal

NonCoastal

MSA

2009

YTD 2010

Effective Rent Growth (%)

Source: Axiometrics Inc

Transactions are Down Sharply

Q1 '01 Q1 '060

0.5

1

1.5

2

2.5

3rolling 12-mo. totalquarterly vol.

Transaction Volume ($Bil.)

Source: Real Capital Analytics (www.rcanalytics.com)

Q2 '10

Transactions on the “Floppy Bottom”Q

1 '0

1 2 3 4Q

1 '0

2 2 3 4Q

1 '0

3 2 3 4Q

1 '0

4 2 3 4Q

1 '0

5 2 3 4Q

1 '0

6 2 3 4Q

1 '0

7 2 3 4Q

1 '0

8 2 3 4Q

1 '0

9 2 3 4Q

1 '1

0 2

0

0.2

0.4

0.6

0.8

1

1.2

Garden Mid/Highrise

Transaction Volume ($Bil)

Source: Real Capital Analytics (www.rcanalytics.com)

Private Investors, REITs Dominate BuyersPensions, REITs, Privates the Sellers

San Diego US

55%

34%

7%

30%

0.11

26% 11%

7%

7%3%

2%7%

inst'l

foreign

reit/public

user/other

condo converter

syndicator

fund

pvt out of state

pvt in state

San Diego US

44%34%

2%

2%22%

19%

32%23%

19%

2%

Buyers Sellers

Source: Real Capital Analytics (www.rcanalytics.com)

New Pricing Realities ?

Q1 '01 Q1 '064

4.5

5

5.5

6

6.5

7

7.5

8

8.5

San Diego 12-mo. avgSan Diego quarterly avgUS quarterly avg

Cap Rate (%)

Source: Real Capital Analytics (ww.rcanalytics.com)

Q2 '10

An Outlook

“We're still in a recession. We're not gonna be out of it for a while, but we will get out.”

-- Warren Buffett

Stuff Could Still Happen

Stuff Could Still Happen(An Alternate Scenario)

2005Q12006Q1

2007Q12008Q1

2009Q12010Q1

2011Q1-8

-6

-4

-2

0

2

4

6

Forecast

GDP (Annualized % Change)

Source: Moody's Economy.com; BEA

The Focus is on Jobs

2005Q12006Q2

2007Q32008Q4

2010Q12011Q2

2012Q32013Q4

2015Q1128

130

132

134

136

138

140

142

144

146Current ConsensusMild Second RecessionAborted Recovery

'08:Q1 '12:Q4 '13:Q2

'14:Q4

Total Employment (NonAg, Mil., SA)

Source: Moody's Economy.com

The Focus is on Jobs in San Diego Too

2005Q12006Q2

2007Q32008Q4

2010Q12011Q2

2012Q32013Q4

2015Q11180

1200

1220

1240

1260

1280

1300

1320

1340

1360Current ConsensusMild 2nd RecessionAborted Recovery

Total Employment (Ths., SA)

Source: Moody's Economy.com; BLS

'07Q3

'13Q4 '14Q2

Balance First, Improvement Later

2006 2007 2008 2009 2010 2011 2012 2013 2014-1000

-500

0

500

1000

1500

2000

2500

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

Completions (L)Net Absorption (L)

Completions/Absorption (Units) Vac %

Source: Reis Inc

Vacancy Rate (R)

forecast

photo: www.sandiegocoastlife.com