STAYING ON TRACK KENNETH P. RIGGS, JR. DEL KENDALL CFA, CRE, MAI, - - PowerPoint PPT Presentation

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NCREIF Summer Conference 2019 STAYING ON TRACK KENNETH P. RIGGS, JR. DEL KENDALL CFA, CRE, MAI, FRICS, CCIM MAI, CRE, FRICS President of Situs RERC Managing Director riggs@rerc.com dkendall@rerc.com EVALUATE OPTIMIZE MANAGE

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STAYING ON TRACK

NCREIF Summer Conference 2019

KENNETH P. RIGGS, JR.

CFA, CRE, MAI, FRICS, CCIM President of Situs RERC riggs@rerc.com

DEL KENDALL

MAI, CRE, FRICS Managing Director dkendall@rerc.com

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KEY THEMES

  • Economy: GDP grew at an annual rate of 3.2% in 1Q 2019 (advanced estimate), the best first quarter since
  • 2015. About 263,000 jobs were added in April and the unemployment rate fell to 3.6%, a 50-year low. The

current U.S. economic expansion phase is on track to become the longest in history at the beginning of the third quarter.

  • Treasury Rates: The quarterly average U.S. 10-year Treasury rate dropped from 3.04% in 4Q 2018 to 2.65%

in 1Q 2019. Situs RERC forecasts the rate to end 2019 around 2.7%. Long-term interest rates relative to GDP are expected to remain low. The 10-years as of June 11, 2019 was 2.14%.

  • Capital Universe: There continues to be a huge amount of capital availability and dry powder amid . Private

equity funds are expected to find it more difficult to place capital as the market comes closer to fair value. Private equity funds are taking longer to close – about 18 months.

  • CRE Returns: Although NPI-ODCE returns have been strong over recent years, it is important to note that

annual returns have been decreasing since 2015. With the economy on the verge of entering its longest expansion in US history, CRE returns are expected to gradually regress. With capital appreciation expected to decline over the forecast period, and cash flow hitting a steady but slower level of growth, CRE will rely

  • n income to drive total returns moving forward.
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GLOBAL LONG-TERM INTEREST RATES & GDP

Sources OECD, 1Q 2019.

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HISTORICAL U.S. 10-YEAR TREASURY RATES

Note: 10-year Treasury data are based on quarterly averages. Source Federal Reserve, current as of 1Q 2019. 2 4 6 8 10 12 14 16 19821 19851 19881 19911 19941 19971 20001 20031 20061 20091 20121 20151 20181 Percent Recession Treasury

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0.5 1 1.5 2 2.5 3 3.5 4 2Q 2015 3Q 2015 4Q 2015 1Q 2016 2Q 2016 3Q 2016 4Q 2016 1Q 2017 2Q 2017 3Q 2017 4Q 2017 1Q 2018 2Q 2018 3Q 2018 4Q 2018 1Q 2019 2Q 2019 3Q 2019 4Q 2019 1Q 2020 2Q 2020 3Q 2020 4Q 2020 1Q 2021 Lower Case [Fcst] 10-Year Treasury [Actual] Base Case [Fcst] Upper Case [Fcst]

ACTUAL 10-YEAR TREASURY RATES VS. SITUS RERC TREASURY FORECAST

Note: Data based on quarterly average. Shaded area indicates forecast. Sources Situs RERC, Federal Reserve, 1Q 2019.

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CRE & INVESTMENT ALTERNATIVES

16% Market Indexes YTD6 1-Year Trailing 3-Year Trailing 5-Year Trailing 10-Year Trailing 15-Year Trailing

NCREIF NPI1 1.80% 6.83% 7.07% 9.13% 8.51% 8.81% NCREIF NFI ODCE1 1.20% 6.55% 7.01% 9.18% 7.73% 7.17% NAREIT Index (Equity REITS)2 17.17% 20.46% 7.84% 10.00% 18.80% 8.84% Consumer Price Index3 0.05% 1.63% 2.13% 1.46% 1.78% 2.05% Dow Jones Industrial Average2 13.10% 11.26% 16.37% 12.39% 15.97% 9.02% NASDAQ Composite4 16.49% 9.43% 16.65% 12.98% 17.59% 9.45% NYSE Composite4 12.64% 2.76% 7.55% 3.91% 9.81% 4.46% S&P 5002 13.65% 9.50% 13.51% 10.91% 15.92% 8.57%

1Q 2019 1Q 2018 1Q 2016 1Q 2014 1Q 2009 1Q 2004

10-Year Treasury Bond5 2.65% 2.76% 1.92% 2.76% 2.74% 4.02%

1NCREIF NPI is a property-level (unleveraged) total return index, gross of fees; NCREIF NFI-ODCE is a fund-level (leveraged equity) total return index, net of fees. 2Based on total return index, and includes the dividend yield. 3Based on the published data from the Bureau of Labor Statistics (seasonally-adjusted). 4Based on price index, and does not include the dividend yield. 5Based on average quarterly T-bond Rates. 6Year-to-date (YTD) averages are not compounded annually except for CPI and NAREIT.

Sources BLS, Federal Reserve Board, S&P, Dow Jones, NCREIF, NAREIT, compiled by Situs RERC, current as of 1Q 2019.

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SITUS RERC RATINGS OF INVESTMENT ALTERNATIVES

Source Situs RERC, 1Q 2019. 2.00 2.50 3.00 3.50 4.00 4.50 5.00 5.50 6.00 6.50 7.00 1Q 2008 1Q 2010 1Q 2015 1Q 2019 Rating Stocks Bonds Cash CRE

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0.0 1.0 2.0 3.0 4.0 5.0 6.0 1 2 3 4 5 6 7 8 9 10 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Treasury (%) Availability & Discipline Rating Overall Availability Overall Discipline Treasury Rate

AVAILABILITY & DISCIPLINE OF CAPITAL

Ratings are based on scale of 1 to 10, with 10 being excellent. Shaded area indicates recession. Source Situs RERC, 1Q 2019.

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50 100 150 200 250 1994 1999 2004 2009 2014 2019 NPI Index Recession Price Index Value Index

SITUS RERC PRICE AND VALUE INDEXES

Note: Price index combines capital expenditures and capital returns. Value index represents capital returns only. Price Index from 1Q 1990 to 1Q 2019 = 135.46%. Value Index from 1Q 1990 to 1Q 2019 = 26.08%. Shaded area indicates recession. Sources Situs RERC, NCREIF, 1Q 2019.

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  • 100

200 300 400 500 600 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Spread Basis Points

Recession NPI-10YRT RERC GI-10YRT

SITUS RERC RATE SPREADS OVER 10-YEAR TREASURY

Note: 10-year Treasury data are based on quarterly averages. Shaded area indicates recession. Sources Situs RERC, Federal Reserve, current as of 1Q 2019.

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CRE PRICING: NATIONAL ALL-PROPERTY

The RCA CPPI is based on repeat-sales (RS) transactions that occurred at any time up through the month of the current report. Source Real Capital Analytics, 1Q 2019.

  • 20
  • 15
  • 10
  • 5

5 10 15 20 60 70 80 90 100 110 120 130 140 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1 2017Q1 2018Q1 2019Q1 Percent Index RCA CPPI (YoY) RCA CPPI

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PROPERTY TYPE OVERVIEW

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PROPERTY TYPE SUMMARY

Industrial

  • Most favorable near-term fundamentals of all the main property types
  • Vacancy rates expected to remain near record lows for warehouse and data centers
  • A rise in new business formation of small manufacturing companies that sell their goods via e-commerce will likely

increase demand in the flex sector

  • Industrial still has pricing power amid continued investor interest

Apartment

  • Outlook appears to be steady in the short term, with continued investor appetite and rising property values
  • As housing shortages continue in major markets, supply and demand characteristics will remain favorable
  • Overall average cap rates expected to stabilize or possibly increase in 2019
  • Given the transaction volume and pricing, apartments will likely continue to be a preferred property type for investors
  • A shift on the demand side with renters turning into homebuyers could have a major impact on this sector

Office

  • Steady employment continues to support the office sector; however, it is likely that tenants will reduce their space needs

as technology transforms the way work is done

  • Lack of newer, first-tier properties and nominal new construction may lead to slightly increasing rents in desired

submarkets

  • It will likely be more challenging to find the best-valued office markets
  • Structural changes to the office market (space optimization, technology) present headwinds for the sector
  • Newly constructed office space is still in high demand. Investors should be wary of the large expenses that are required to

modify existing buildings.

Retail

  • Structural changes to the sector, including e-commerce, oversupply of space, shifting consumer shopping patterns and

grocery delivery chains, present long-term challenges across all types of retail

  • Capital appreciation is expected to decrease over the next two years
  • Modest growth, with rents increasing by about 1.5% over the year
  • Technology and customer demands will change the retail landscape as service and experiential space becomes key for the

retail industry

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SITUS RERC TOTAL RETURN FORECAST BY PROPERTY TYPE (BASE CASE)

The total return forecast is Situs RERC’s proprietary model based on Situs RERC data and data from NPI-ODCE, and is for leveraged, institutional-grade properties. Total returns are derived from an income component and a capital appreciation/depreciation component. Shaded area reflects forecast. Source Situs RERC, NPI-ODCE, 1Q 2019.

  • 2%

0% 2% 4% 6% 8% 10% 12% 14% 16% 2016 2017 2018 2019 2020 2021 Total Return Apartment Base Case Industrial Base Case Office Base Case Retail Base Case Overall Base Case

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INDUSTRIAL PROPERTY TYPE FUNDAMENTALS

The information is provided "As Is" and without any representations, warranties or guarantees. Source CoStar Market Analytics (www.costar.com), 1Q 2019.

  • 6
  • 4
  • 2

2 4 6 8 10 12

  • 200
  • 150
  • 100
  • 50

50 100 150 200 250 300 350 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD 2019

Percent Millions of SF

Net Absorption Net Completions Vacancy Rent Growth (YoY)

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CRE PRICING: INDUSTRIAL

The RCA CPPI is based on repeat-sales (RS) transactions that occurred at any time up through the month of the current report. Source Real Capital Analytics, 1Q 2019.

  • 20
  • 15
  • 10
  • 5

5 10 15 60 72 84 96 108 120 132 144 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1 2017Q1 2018Q1 2019Q1 Percent Index RCA CPPI (YoY) RCA CPPI

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APARTMENT PROPERTY TYPE FUNDAMENTALS

The information is provided "As Is" and without any representations, warranties or guarantees. Source CoStar Market Analytics (www.costar.com), 1Q 2019.

  • 6
  • 4
  • 2

2 4 6 8 10 50 100 150 200 250 300 350 400 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD 2019

Percent Thousands of Units

Net Absorption Net Completions Vacancy Rent Growth (YoY)

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CRE PRICING: APARTMENT

The RCA CPPI is based on repeat-sales (RS) transactions that occurred at any time up through the month of the current report. Source Real Capital Analytics, 1Q 2019.

  • 20
  • 15
  • 10
  • 5

5 10 15 20 40 55 70 85 100 115 130 145 160 175 190 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1 2017Q1 2018Q1 2019Q1 Percent Index RCA CPPI (YoY) RCA CPPI

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OFFICE PROPERTY TYPE FUNDAMENTALS

The information is provided "As Is" and without any representations, warranties or guarantees. Source CoStar Market Analytics (www.costar.com), 1Q 2019.

  • 15
  • 10
  • 5

5 10 15

  • 60
  • 40
  • 20

20 40 60 80 100 120 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD 2019

Percent Millions of SF

Net Absorption Net Completions Vacancy Rent Growth (YoY)

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CRE PRICING: OFFICE

The RCA CPPI is based on repeat-sales (RS) transactions that occurred at any time up through the month of the current report. Source Real Capital Analytics, 1Q 2019.

  • 30
  • 25
  • 20
  • 15
  • 10
  • 5

5 10 15 60 70 80 90 100 110 120 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1 2017Q1 2018Q1 2019Q1 Percent Index RCA CPPI (YoY) RCA CPPI

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RETAIL PROPERTY TYPE FUNDAMENTALS

The information is provided "As Is" and without any representations, warranties or guarantees. Source CoStar Market Analytics (www.costar.com), 1Q 2019.

  • 6
  • 4
  • 2

2 4 6 8 50 100 150 200 250 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD 2019

Percent Millions of SF

Net Absorption Net Completions Vacancy Rent Growth (YoY)

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CRE PRICING: RETAIL

The RCA CPPI is based on repeat-sales (RS) transactions that occurred at any time up through the month of the current report. Source Real Capital Analytics, 1Q 2019.

  • 20
  • 15
  • 10
  • 5

5 10 15 20 60 66 72 78 84 90 96 102 108 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1 2017Q1 2018Q1 2019Q1 Percent Index RCA CPPI (YoY) RCA CPPI

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CLOSING OBSERVATIONS

REGULATORY FOCUS

Continue to watch for the impact of fiscal policies, including tax policies, in certain areas:

  • California Prop 13: On the ballot for 2020. This would dramatically increase taxes for commercial properties, some of which under the
  • riginal Prop 13 have not had their values reassessed since 1978. According to the San Francisco Chronicle, It could cost commercial

property owners an additional $11 billion a year in property taxes.

  • San Francisco Prop C: Currently in effect, the imposed tax is on businesses that receive income from the lease or sublease of commercial

space in San Francisco county. It is observed that many new leases pass the expense through to the tenants, though long-term in-place leases could have a bigger impact on the bottom line.

  • Seattle Taxes: In King County (Seattle) for any portion of a sale over $3.0M, beginning in 2020. For Seattle, if a 3% cost of sale was typical

in the past, it will be common to see a 5% cost of sale applied to valuations. This will start being captured in 2Q 2019 valuations.

  • Hawaii Tax for Rental Income: The statewide tax rate is 4.0% on all gross rents, but starting in 2019, Oahu and Kauai have a 0.5%

surcharge, and Maui has a 0.25% surcharge.

  • Chicago Fiscal Health: Chicago’s poor fiscal health could result in significant tax hikes. With a new Cook County assessor in office, Fritz

Kaegi, changes are expected, particularly to commercial properties. The assessor is also looking for legislative change that would require income-producing properties to disclose rent, income and expense information.

  • New York City’s pied-à-terre tax: A new tax on real estate transfers will take effect on July 1 (except for sales with signed contracts as of

April 1). While mostly targeting buyers of high-priced houses and condos, the Wall Street Journal estimates that nearly 40% (approximately $160 million per year) will be paid by owners of commercial properties.

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THANK YOU!