Current Market Intelligence - Copy Edited 090426 (DBM-Court Final)

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In Today’s Waters… What’s the Strategy?

Board a cruise shipRig to a battleship or

Just plain abandon ship?

Some of our customers are taking this approach…

• There is a war attacking our business. Everything we value in real estate is being challenged:

• Cash flow potential

• Tax benefits

• Capital appreciation opportunity

• Leverage capability

• We believe an ostrich approach burying ones head in the sand hoping to avert problems is prescription for failure.

Volatile market conditions require clarity, vision ,and action...not passivity.

Advantages are maximized in an environment of fear and inactivity.

Lack of clarity breeds opportunity for the discerning investor.

Today’s market signals are alarming…we find potential opportunity abounding..

It will take more than traditional market cycle responses. Rapid utilization of existing financial resources can allow investors meaningful participation in what will be one of the biggest wealth transfer cycles in modern-day history.

Adoption and implementation of the right investment strategy will determine our financial futures, our ability to provide for our businesses, our children, and our grandchildren.

Real Estate battlegrounds under attack. Market Obstacles

I. Cash Flow Integrity: Tenant Strength is weakening Tenant base is eroding Absolute decrease in rental ratesInflux of capital is being required to salvage income

streams

II. Tax Benefits: Capital Gain treatment has been lowest in history and in question

Carried Interest Compensation Tax will be increasing

Depreciation Modifications are likelyIII. Capital CAP Rates rising (Value Erosion) Appreciation Values will fall for the next 12-36…48 months? Challenges: NOI rapidly declining

IV. Leverage: Money no longer cheap (CMBS Loans virtually non-existent) Capability Distressed Assets plague portfolios Eroding: $1.4 Trillion in loan maturities creating refinancing nightmares

I. Cash Flow Integrity of the Office Market.How has unemployment effected the office market?

The safe tenant sectors are in education, health, and government.

= 1 employee

Office Rule:

Every 200 sf.

• Current Unemployment: 8.5% (5.1 Million Jobs Lost)• 1990 recession lasted 32 months• 2001 recession lasted 50 months• We are in month 19 (Dec 2007-Current Day)

Early 2010 Recession Recovery Myth is in Question:

Source: Co Star 2009 Economic Outlook Report Private Webinar

Percentage of Workforce vs. Month Recovery

Absorption vs. Job Growth

What is wrong with this picture???

The Vacancy Rate is a Useless Matrix today…

The job loss total is not reflective of the negative absorption that is in the market.

With over 5.1 million jobs lost we should have a 450 million square foot office vacancy …not 20 million as reported.

We are projecting a national increase in vacancy by 300 basis points from the turn of the year…to 18.2% in 2010.

• Accelerated depreciation on space has tax ramifications for tenant• Established tenants are hoping to rehire• Major tenants are fighting bigger fires• Tenants are hesitant to send out signals of instability• Owners are not eager to recognize tenant failure• Value erosion disclosure is not a major objective of ownership

Co Star CEO Andrew Florance

Reasons for unlisted/undetected space availability:

Historical National Office Vacancy 1980-2009

• Vacant inventory has not been reported…leaving more value erosion to come.

• Leasing momentum is waning: “musical chair tenancy” with tenants moving from one

building to another (changing classes or location with incentives)

• Dallas Office Vacancies Rising ( 16.2 % expected 19.4% over the next year)

Spread between Vacancy Rate and Actual Available:

National Office Class A (PSF) Price Erosion:

National Office Class B (PSF) Price Erosion:

National Office Class C (PSF) Price Erosion:

Historic Office CAP Rates:

Office Recession Comparables:

I. Cash Flow Integrity in Industrial Real Estate:

As inventory is consumed what happens to additional warehouse demand?

Warehouse appears to be vulnerable to downward pressures due to retail lull.

How will the changing costs of transportation and imports effect the industrial market?

Oil prices directly affect distribution cost:

• 69% jump from $32-$54 a barrel

• Mexico is the second largest supplier of crude to the US, delivering 1.2 million barrels

per day…but its production in its Cantrell Fields of offshore Yucatan are falling off a

cliff…the country will become a net importer soon.

• Credit Squeezed companies have all but stopped exploration

• Exploration is down…US rig count cut in half by less than 1000

• Buy that Prius while you can…

Oil price appear to be basing in this 15 year OIX stock chart.

Overall National Industrial Capacity Dips since 1980’s

Historic National Retail Sales (5-Year)

Spread between Vacancy Rate and Actual Available: Industrial

Historic Quoted Industrial Rents

10-year Historic Quoted Industrial Sales (PSF)

10-year Historic Industrial Sales CAP Rates

Industrial Sales Characteristics & Recession Prognostics:

I. Cash Flow Integrity in the Retail Market

Gas and energy prices have impacted over 80% of the population.

Bankruptcies and store closings demonstrate the impact:

567 Circuit City

461 KB Toys

400 Ritz Camera

300 Starbucks

287 Goody's

175 Van Heusen

163 Ann Taylor (by 2010)

129 Boater's World

125 Pier One

118 Office Depot

115 Zale Corporation

100 Gap, Inc.

98 Club Libby Lu (Saks)

55 Select Comfort

50 Pacific Sunwear

50 Supervalu

50 New York & Co. (over the next five years)

48 Home Depot (Expo, YardBIRDS, Design Center, HDBath)

45 Cato

40 Kirkland's

40 Ruby Tuesday

40 Tween Brands (Limited Two, Justince)

35 Famous Footwear (Brown Shoe Co.)

30 S&K Famous Brands Inc.

30 Jo-Ann Stores

28 Yankee Candle

26 Cost Plus

25 Chico's FAS

25 Fred's

24 Blue Tulip Gift Shops

24 Sears

23 Sportsman's Warehouse

21 Z Gallerie

20 Oneida Ltd.

20 Wet Seal

19 Snyder's Drug Stores, Inc.

16 Iridesse (Tiffany & Co.)

15 Tim Horton's

13 OfficeMax

13 Stein Mart

12 Bealls

12 Kira Plastinina

11 Better Bedding Shops, Inc.

11 Filene's

11 Jimmy'Z (Aeropostale)

11 Macy's

11 Pamida

10 Bruno's

10 Bassett Home Furnishings

10 P.F. Chang's Pei Wei Restaurants

10 U.S. Cellular

8 Dillard's

8 Dominos

7 Eddie Bauer

7 Sweetbay Supermarkets

6 Rex Appliance & Electronics

5 Basha's Supermarket

5 Mark Shale

5 Borders

4 Applebees

4 Harry W. Schwartz Bookshops

4 Lucky Grocery Stores

3 Albertson's

3 Good's Furniture & Flooring

3 Lane Bryant

3 P&C Food Markets

3 Virgin Records

2 Krispy Kreme

2 L'Oreal Paris

2 Plan 9 Music

2 Storables

1 Fresh Market

1 Jewel-Osco

1 Sony PlayStation Store

1 Sony Style Store

1 Victoria's Secret

• Who is going to fill the anchor vacancies?• How are landlords going to handle the smaller

tenants who have contractual agreements as anchor tenants bail?

• We believe there is going to be a huge shift as a new demographic emerges to fill these vacancies.

I. Retail Cash Flow Integrity: (Circuit City Case Study)

November 2008:• 150 leases

broken• 155 stores closedJanuary 2009:• 567 Stores Closed

Co-Tenancy Issues:• 192 of 388 were co-tenant with Verizon Wireless• Smaller tenants have not even began to feel the full effects

Vacancy Rate in Circuit Shopping Centers

Rental Rate History in Circuit Shopping Centers

RTX price is topping under significant resistance in 15 year chart.

Spread between Vacancy Rate and Actual Available: Retail

The Diderot Effect

Home Demand as a Trigger for the Diderot Effect

Historical Graph of Home Values

Case-Shiller 10-City Composite Index

Japanese Housing Price Correction

United States vs. Japanese Housing Correction

Shiller Housing Index Percentage Change:

Housing Market Collapse Results:

• Average 25% Home-Equity Loss

• Add the 50% Loss in the Stock Market

• Add rising energy prices….job losses…etc.

• Triple whammy for the American consumer

• Severe implications for the CRE market

• Many of the buyers of houses in this bubble had less than 25% equity in their homes, and some with 3.5%.

• The result of all this was numerous bank failures including the following once familiar entities.

• As of February 7.5% of FHA Loans are seriously delinquent as of 2/28/09

• According to First American Core Logic 10,500,000 households had negative or near negative equity in December of 2008.

How the Housing Market Effects CRE:

• Lack of equity affects consumer confidence, impacting spending • Consumer spending impacts corporate earnings • Earnings dramatically impact commercial real estate.

Retail Sales Prices (PSF)

Retail Cap Rates

Retail Recession Implications & Prognostics:

I. Cash Flow Integrity in Multi-family Sector:

New multi-family construction and increasing market vacancies makes it difficult to accurately forecast rental rate erosion.

How is this going to effect apartments?

• Effective rents across the nation have dropped 1.5%-3%

• Dallas is adding an additional 13,000 units (from a projected 20,000 units)

to an already oversaturated market

• Sellers achieving less then 90% of there asking price

Institutional investors have increased as a proportion of sales to 20% since the peak.

Cross-Border investors were not major apartment buyers but pressure to sell US assets has chiefly come from a few Australian firms that were active at the peak.

Public REIT’s were not major buyers bug significant sellers at the market peak. Falling share and property prices are pressuring many to de-lever quickly, especially since September

Equity Funds were not as active for apartments as other property types but those that were, acquired properties using high leverage at the peak, making them particularly vulnerable in the downturn.

Private investors include a number of developers condo converters and TIC’s indicates that are quickly falling into trouble in addition to those that simply have the misfortune of having a mortgage.

Source: Real Capital Analytics

II. The Tax Benefit Attack:

Carried Interest Compensation

Treats payments to managers of funds (hedge, development) as capital gains (15%)

Currently designed to incentivize performance of managersNew Administration wants to treat these payments as regular taxes (39.6%)

Presidents Obama’s proposed budget “Would have a broad devastating impact on commercial real estate development.”

-Thomas J. BisacquinoPresident of the National Commercial Real Estate Development AssociationMarch 6, 2009: Suvapedia: A Journal of Land Surveying News and Information

According to Mr. Bisacquino, many developments will not be undertaken if this proposal becomes law, because of the tax effect it will have on developers.

• The old (Bush) Senate already voted down a bill to increase, but a new majority is poised to change the tax law.

• Obama and the Democratic majority will increase capital gains tax to 20% as promised in 2010.

Recession Comparisons:

2001-2003

Tech BustSlow job growthStock Market MeltdownSeptember 11thPro-Forma Underwriting

2008-???

Housing Market BustCredit Market CollapseCMBS Market ImplosionRecord UnemploymentEnergy CostsStock Market MeltdownWall Street Vacating CRELender Spread WidenedUnderwriting on ActualsTenants due-diligence on owners?DISTRESSED ASSETSRising CAP Rates (Value Erosion)Treasury Rates 0% (Complete Change in Monetary Policy)Federal Take Over of Banks, Auto….Healthcare?Deflation…coming soon: INFLATION

III. The Appreciation Assault

During the 1990’s we saw CAP rates with a range of 8-10%In the “Turn and Burn” years of 2005-2007 CAP compressed to 6%-7.5%

We are now moving for CAP rates with a range of 9-12%

Legendary hedge fund manager billionaire and left-wing activist George Soros told a Congressional committee (3/26/2009) that commercial real estate values will fall by at least 30%.“Right now we are in a period of deflation, but it could easily tip over, where you are facing inflation,” Soros said. “You are then faced with the prospect of draining money supply as fast as credit is created.”

“Estimates assume that declines in commercial property values of 35%-45% from the peak of 2007.

That would exceed the price drops in the downturn of the 1990’s.”

Reported on 3/26/2009:

What else is causing value degradation…

DISTRESSED ASSETS:

Establishing a new basis near YOU.Since December 2008 To Feb 2009:

Troubled

Lender REO

Current Distressed

Increased from: 1043 Assets to 2293

$25.7 billion to $49.2 billion

$117.570 Billion

$ 11.980 Billion

$129.551 Billion

A View of the Sixty Billion Dollar Trouble Asset Class

Foreclosures are quick to pull down surrounding property values in both the residential and commercial marketplace.

New property owners who enter the market on a much lower basis WILL undercut rents to establish a strong tenant base….and destroy the ability for rental increases for some time.

Cash will remain king…giving TREMENDOUS opportunity for investors with liquidity to enter these markets…but poses a serious threat for those who are currently in the market.

Dallas Distressed Asset Market:

Every product type is plagued.

Snapshot of other Markets:

The graph illustrates both the estimated dollar value of the distressed situations (bars) as well as the relative size of the distress compared to the size of each market (diamonds). Distressed volume is scaled by comparing it to total transaction volume from 2005-2008 in each market.

Financing Practices Before the Credit Crunch:

• 70-90% LTV• Non-recourse• Interest Only Loans • CMBS existed = loose underwriting• Pro-forma Rents acceptable• Minimal equity requirements• Minimal Reserve requirements• Banks extensions based on these standards

Pre-Crisis Valuation 2007

NOI (Year 1 $6,000,000Growth Rate 3%Hold Period 7 Years

LTV 70%Interest Rate 5%

Going-in-Cap Rate 6%Exit Cap Rate 6%

Levered IRR 15.6%

Building Value $100,000,000

IV. Leverage Capability Erosion:

Current Loan Underwriting

• 50%-65% Loan to Value• Full recourse generally required• Interest Only Loans: RARELY EXIST• CMBS is DEAD-may return in another form• Underwriting actual project cash flow• Bank seeking maximum equity contribution• More reserves to cover risks/exposure • Banks extensions based on these standards

Post-Crisis Valuation 2009

NOI (Year 1 $6,000,000Growth Rate 1%Hold Period 7 Years

LTV 50%Interest Rate 7%

Going-in-Cap Rate 9.3%Exit Cap Rate 8.3%

Levered IRR 15.6%

Building Value $64,000,000

% Increase / (Decrease) (36%)

Financing Practices After the Credit Crunch:

Debt sources that no longer exist:

There is no one available to step up and fund these loans:

Two Potential Scenarios:

Even if there is adequate capital to keep existing loan inventory afloat, this inventory will saturate potential loan capacity restricting both future real estate development and growth …

Source: Foresight Analytics

If loans go to default, future loan maturity pressures are alleviated.

Significant devaluation will occur as these REO assets re-enter the market.

Option 1: Loan Foreclosure:

Option 2: Loan Modification / Restructure

…for the next decade.

Deutsche Bank: Of the $154.5 Billion of securitized commercial mortgages coming due between now and 2012, about two-thirds likely won’t qualify for refinancing.

The bank estimates the default rate of the $700 billion of CMBS could hit at least 30%, and loss rates which figure in the amounts recovered could reach more then 10%.

Source: Wall Street Journal

Debt Eats Equity in the Deleveraging Cycle

Matthew Anderson partner of Foresight Analytics:

“Besides securities backed by commercial real-estate loans, about $524.5 billion of whole commercial mortgages held by U.S. banks and thrifts are expected to come due between this year and 2012. Nearly 50% wouldn’t qualify for refinancing in a tight credit environment, as they exceed 90% of the properties value.”

Smaller Regional Banks are NOT immune from toxic assets:

In contrast to home mortgages –the majority of which were made by only 10 or so giant institutions –hundreds of small and regional banks loaded up on commercial real estate. As of Dec. 31, 2008 more than 300% of their risk-based capital is in commercial real-estate loans, including both commercial mortgages and construction loans.

This means there will less banks in the future to offer loans.

William C Dudley, president and CEO of the New York Fed explained to the Council on Foreign Relations in New York this month how bankers have become adverse to even lending to creditworthy lenders. “Essentially it is going to be like this,” Dudley said even if you think you are a good credit , I am not going to lend to you, because others may not share the same opinion. The problem is, if no one else thinks you are good, I may not be able to get my money back if I need it.

Bankers are resistant to making loans to anybody.

What are banks trying to do right now?

• Empty their loan portfolios of non-cash flowing assets.

• Limit risk exposure rather than expand their loan portfolios

• Cash available for commercial real estate is shrinking…not expanding

• Debt cost is increasing…as is the value of liquidity

• Future CMBS Loan Maturities further exacerbates this recovery

• Bank’s current risk intolerance makes a 2010 recovery unlikely

Real Estate battlegrounds under attack. Market Obstacles

I. Cash Flow Integrity: Tenant Strength is weakening Tenant base is eroding Absolute decrease in rental ratesInflux of capital is being required to salvage income

streams

II. Tax Benefits: Capital Gain treatment has been lowest in history and in question

Carried Interest Compensation Tax will be increasing

Depreciation Modifications are likelyIII. Capital CAP Rates rising (Value Erosion) Appreciation Values will fall for the next 12-36…48 months? Challenges: NOI rapidly declining

IV. Leverage: Money no longer cheap (CMBS Loans virtually non-existent) Capability Distressed Assets plague portfolios Eroding: $1.4 Trillion in loan maturities creating refinancing nightmares

Questions and Considerations:

• What investment return did you expect from your property?

• Which of these four pillars seem secure enough to reach your objectives?

• How secure do you feel about your equity?

• Is your current real estate advisor informing you of these implications?

• Based on your position, how should you address the marketplace to maximize the opportunity ahead?

How to Survive in a Downward Market (2/1/2009)

Idea in Brief:

These days business competition feels much like boxing arena, where punches come from different directions, strategies change blow by blow and another challenger is always waiting to take you on. Compare the boxing match between Muhammad Ali and George Forman, two boxers who illustrate two fundamental approaches in mastering the uncertainty of today’s environment.

Agile firms: The Ali’s: quickly spot and exploit emerging business opportunities.

Ali won the famous “Rumble in the Jungle,” and the fight made clear just how great Ali was at taking a punch and also highlights the different, perhaps dangerous, change that Ali had made in his fighting style, by adopting the “rope-a-dope”, instead of his former style that emphasized movement.

Absorptive firms: The Forman’s

Have the strength and stamina to weather market shifts.

George Forman became the oldest man ever to win a major heavyweight title when, at 45, he knocked out 26-year-old Michael Moore in the 10th round.

What is your position today?

Are you adequately prepared for the coming monsoon?

A View of the Sixty Billion Dollar Trouble Asset Class

Debt sources that no longer exist:

Average Days on Market Before Sale: Industrial

Average Days on Market Before Sale: Office

Average Days on Market Before Sale: Retail

Getting Ready…

Are your advisors giving you vital information to best position your investment assets?

Which one of your properties is the weakest link?

The Agile Position: Get your properties prepared for the 2nd and 3rd waves of the storms ahead. TAKE ADVANTAGE of the greatest wealth asset transfer in your lifetime!!!

www.dvsvn.com

Court Bradley

Commercial Real Estate Advisor DataVest | Sperry Van Ness

[email protected]

Bruce Marshall

Managing DirectorDataVest | Sperry Van Ness

[email protected]

You cannot achieve maximum value without maximum competition.

Understanding the food chain in commercial property sales:

Maximum Competition = Maximum Value

www.dvsvn.com

The question I ask you if you are going to make a move in this market is your current broker maximizing your asset value with information, a national marketing platform and a pro-active willingness to split fees to his detriment but to your asset value maximization?

A train’s a-Coming!

• Success Ratio’s on Sales Offerings Today @ 25%• Market Prices Down 21% since Peak in 2005• Debt Capital Sources Evaporating• Cap Rates are rising at 15 Basis Points a Month• No Positive Debt Leverage Availability• Existing Loan Capacity used up on Existing Loans

Current Market Intelligence - Copy Edited 090426 (DBM-Court Final)

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Transcript of Current Market Intelligence - Copy Edited 090426 (DBM-Court Final)