Strong conclusion to 2015, some caution ahead in 2016

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1 MARKETVIEW U.S. Office, Q4 215 Strong conclusion to 215, some caution ahead in 216 Vacancy Rate 13.1% Lease Rate $29.7 PSF Net Absorption 19.4 MSF Completions 12.1 MSF *Arrows indicate change from previous quarter. Despite financial market volatility in Q4, office-using employment posted the largest quarterly increase in more than a year (12, net new jobs), capping off a sixth consecutive year of office-using job gains. With ongoing financial market turbulence and concerns about slowing global growth in early 216, we will monitor any impact these factors may have on office demand thus far they have been limited. Net absorption reached 61.6 million sq. ft. in 215, its highest level since 26. Suburban absorption surged to 44.3 million sq. ft., while downtown absorption slowed slightly from 214, to 17.3 million sq. ft. Nearly 8% of markets tracked by CBRE Research posted positive absorption in Q4 215, and nearly 9% posted positive absorption for the year. The overall vacancy rate fell by 9 basis points (bps) in 215, matching the largest decrease of the current expansion. More than three-quarters of the markets tracked by CBRE Research posted vacancy declines during the year. Construction completions reached 35.7 million sq. ft. in 215, the highest total since 29 but still less than half of the previous, 28 peak of 75.9 million sq. ft. Of the 57 markets tracked by CBRE Research, 11 had no construction underway at year-end, down from 16 markets one year earlier. Rent growth slowed slightly to 4.% in 215 from 4.5% in 214. Six metro areas posted double-digit rent gains during the year all except Greenville, South Carolina are located in California. CBRE Research s Q4 215 underwriting survey concludes that investors remain confident in the future performance of office investments, as reflected in their willingness to transact underwriting at very competitive (low) cap rates and target IRRs. Unlevered target IRRs averaged 6.9% for CBD acquisitions and 7.7% for suburban. Office investment in Q4 215 remained high, at $38.5 billion a 1.9% gain over the prior year. While this investment total was impressive, it did reflect a noticeable slowing in investment momentum. The office market registered another strong year in 215, with further rent and occupancy gains and the highest level of net absorption in nearly a decade. However, financial market volatility and fear regarding a global economic slowdown have tempered the outlook somewhat in 216. Also, low energy prices remain a significant headwind for a handful of markets. Overall office market fundamentals remain strong, but the impact these risk factors have on hiring and leasing activity in the year ahead will bear watching. Nonetheless, our baseline scenario for 216 calls for further tightening in the overall office market, which has proven resilient through periods of economic growth, slowdowns and financial market volatility during the current cycle. Strong projected office-using employment Q4 215 CBRE Research 216 CBRE, Inc. 1

2 2, office-using jobs, San Francisco and San Jose posted the fastest office-using employment growth and also ranked second and third, respectively, for the absolute number of officegrowth, coupled with construction activity that remains below historical averages, signal likely additional decreases in vacancy during 216. With high construction costs remaining a deterrent in many markets and development activity dropping off significantly in the Houston market, new supply is projected to be flat in 216 which would be the first time in four years that completions have not increased. As the national office market tightens further, we expect rent growth in the range of 4%-5% a healthy rate, particularly given the current, low inflation environment. ECONOMIC TRENDS OFFICE-USING EMPLOYMENT INCREASES FOR SIXTH CONSECUTIVE YEAR Office-using employment overcame headwinds in late 215 to add 12, jobs in Q4, bringing the 215 annual total to approximately 433,8 net new jobs. The financial services and office-using services components have both expanded for the past six years, surpassing the period in both duration of expansion and total jobs added. Markets located in the West and South, including many with significant tech clusters, led office-using job growth in 215. Among markets with at least Figure 1: Office Employment 6.5% Above Previous Peak Office-Using Employment, Index (1=Peak, Q4 27) Q4 2 Q4 21 Q4 22 Q4 23 Q4 24 Q4 25 Q4 26 Q4 27 Q4 28 Q4 29 Q4 21 Q4 211 Q4 212 Q4 213 Q4 214 Q4 215 Source: U.S. Bureau of Labor Statistics and CBRE Econometric Advisors, Q Figure 2: Top 2 U.S. Markets for Office-Using Job Growth Q4 215 Office-Using Jobs, Year-over-Year Growth, % San Jose San Francisco Salt Lake City Austin Portland Raleigh Detroit Orlando Atlanta San Diego Phoenix San Antonio Dallas Charlotte Seattle Boston Cincinnati Baltimore Indianapolis Orange County Note: Ranking includes markets with at least 2, office-using jobs as of Q Source: CBRE Econometric Advisors, Q Figure 3: Top 2 Markets for Forecasted Office-Using Job Growth Office-Using Jobs Forecast, Two-Year Growth, % Orlando Tampa Phoenix Orange County Indianapolis Raleigh Oakland Fort Lauderdale Salt Lake City Nashville Dallas San Jose Kansas City San Diego Miami Detroit Cleveland Los Angeles Charlotte Seattle Note: Ranking includes markets with at least 2, forecasted office-using jobs in 217. Source: CBRE Econometric Advisors, Q Q4 215 CBRE Research 216 CBRE, Inc. 2

3 using jobs added. Salt Lake City, Austin, Portland and Raleigh-Durham all of which have established or emerging tech concentrations, as well as costs of living and doing business that are lower than in the leading Bay Area markets also added office-using jobs at a rapid clip. Over the next two years, CBRE Econometric Advisors expects the fastest office-using job growth to occur in many Western and Southern markets that have been slower to recover but now are picking up steam such as Orlando, Tampa, Phoenix and Orange County. In many of the leading tech markets, growth will likely moderate from the breakneck pace of recent years, although markets such as Raleigh, San Jose and Seattle are still expected to rank among the 2 markets with the fastest office-using employment growth through 217. DEMAND TRENDS SUBURBAN MARKETS DRIVE HIGHEST NET ABSORPTION SINCE 26 Net absorption rebounded from a pause in Q3 to reach nearly 2 million sq. ft. in Q4 215, bringing the annual total to 61.6 million sq. ft. The suburban market accounted for the bulk of absorption, with nearly 16 million sq. ft. absorbed on net in Q4 215 its highest quarterly total since Q3 25. The suburban market s 215 total of 44.3 million sq. ft. was its highest annual figure since 26. Downtown absorption slowed slightly in 215, to 17.3 million sq. ft., but still registered its second-highest total since 26. Absorption was positive in most markets in 215, but remained highly concentrated in a small number of leading markets. The top five downtown markets for absorption in 215 (Midtown Manhattan, Seattle, Chicago, Washington, D.C. and Atlanta) accounted for more than half of total absorption among the downtown markets tracked by CBRE Research an outsized percentage relative to these markets 39% share of downtown inventory. The top five suburban markets (Houston, Dallas/Ft. Worth, San Jose, Phoenix and Los Angeles) accounted for nearly 4% of all suburban absorption during the year, despite representing just 23% of existing suburban inventory. Houston s high absorption total is largely due to the completion of space that was committed to prior to the drop in oil prices. These leading markets generally possess high concentrations of leading industries, a highly desirable quality of life, and/or low costs of living and doing business. Figure 4: U.S. Metro Office Supply and Demand Completions and Net Absorption (MSF) Completions (L) Net Absorption (L) Vacancy Rate (R) Vacancy Rate (%) Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Q3 212 Q4 212 Q1 213 Q2 213 Q3 213 Q4 213 Q1 214 Q2 214 Q3 214 Q4 214 Q1 215 Q2 215 Q3 215 Q4 215 Source: CBRE Econometric Advisors, Q Q4 215 CBRE Research 216 CBRE, Inc. 3

4 Figure 5: U.S. Suburban Office Supply and Demand Completions and Net Absorption (MSF) Completions (L) Net Absorption (L) Vacancy Rate (R) Vacancy Rate (%) Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Q3 212 Q4 212 Q1 213 Q2 213 Q3 213 Q4 213 Q1 214 Q2 214 Q3 214 Q4 214 Q1 215 Q2 215 Q3 215 Q4 215 Source: CBRE Econometric Advisors, Q Figure 6: Share of Suburban Absorption By region, the West and the South were the clear leaders in 215, together accounting for nearly three-quarters of net absorption in the markets tracked by CBRE Research. Despite having the largest inventory base, the East lagged with 13.5% of U.S. metro absorption, just barely surpassing the Midwest, which had the lowest inventory total among the four regions. Suburban absorption in the West and South dwarfed the other two regions, accounting for about 83% of the suburban total unsurprising, given that 215 s top five markets for suburban absorption are in these two regions. The East registered the largest amount of downtown absorption, with about one-third of the downtown total. The West trailed only slightly, with 29% of total downtown absorption, despite the East s inventory being more than 2.5 times larger. High-tech companies remained the greatest driver of major leasing activity in 215, although the sector s share decreased slightly from 214, to about 18.1%. The healthcare/life sciences share nearly doubled to 12.2%, as an aging population continues to fuel increased demand for related products and services. The business services sector registered the second-highest percentage-point increase in share of leasing activity between 214 and 215. After 62% Source: CBRE Research, Q % Figure 7: U.S. Leasing Trends by Industry High-Tech Healthcare/Life Sciences Business Services Financial Services Creative Industries Legal Government Insurance Energy 9% 4% 7% 7% Remaining Suburban Markets Houston Dallas/Ft. Worth San Jose Phoenix Los Angeles % 5% 1% 15% 2% Note: Includes the 25 largest transactions by sq. ft. each quarter for the 54 markets tracked by CBRE Research. Source: CBRE Research, Q Q4 215 CBRE Research 216 CBRE, Inc. 4

5 substantial job losses during and following the recession, the share of major leasing activity by the financial services and government sectors has appeared to stabilize during the past three years. SUPPLY TRENDS NEW SUPPLY UP, STILL LESS THAN HALF PRE-RECESSION PEAK New supply reached 35.7 million sq. ft. in 215, up nearly 5% from 214. Although this marked the fourth straight annual increase, deliveries totaled less than half the pre-recession peak of 75.9 million sq. ft. in 28. With only modest increases in downtown completions during the past two years, suburban completions have been the primary reason for the growth in new supply, more than doubling from 12.2 million sq. ft. in 213 to 28.3 million sq. ft. in 215. Development activity in Houston has been a major reason for the large amount of new suburban supply coming online. At year-end 214, the market accounted for 32% of all suburban space under construction in the markets tracked by CBRE Research. With the precipitous drop in oil prices, construction activity has ground to a halt. This, combined with much of last year s underway Figure 8: U.S. Downtown Office Supply and Demand Completions and Net Absorption (MSF) Completions (L) Net Absorption (L) Vacancy Rate (R) Vacancy Rate (%) Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Source: CBRE Econometric Advisors, Q Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Q3 212 Q4 212 Q1 213 Q2 213 Q3 213 Q4 213 Q1 214 Q2 214 Q3 214 Q4 214 Q1 215 Q2 215 Q3 215 Q4 215 Figure 9: U.S. Multi-Tenant Office Completions Completions (MSF) 1 9 Forecast Year Average Source: CBRE Econometric Advisors, Q Q4 215 CBRE Research 216 CBRE, Inc. 5

6 construction having now come online, has resulted in Houston accounting for only 12% of suburban construction underway at year-end 215. Figure 1: Share of Suburban Construction As with absorption, construction activity is disproportionately concentrated in a small number of leading markets. This trend is particularly pronounced in the downtown markets: at year-end 215, the top five markets (by number of square feet underway) accounted for roughly 6% of all downtown construction underway. These five markets (Midtown Manhattan, Downtown 46% 2% 12% 13% Remaining Suburban Markets San Jose Dallas/Ft. Worth Houston Phoenix Northern Virginia Manhattan, San Francisco, Seattle and Boston) 4% 5% have benefited from strong tech tenant demand as well as dynamic live/work/play environments that Source: CBRE Research, Q are attractive to millennial talent. At year-end 215, the five leading suburban markets for construction activity accounted for about 54% of all suburban construction underway. All but one of these markets (Northern Virginia) also ranked among the top five suburban markets for absorption, as developers have responded to strong tenant demand in these leading metro areas. San Jose alone accounted for one-fifth of suburban construction, spurred by sustained robust tech demand. As with absorption, Houston s share of construction activity likely will continue to fall as projects currently underway are completed. VACANCY AND RENTS DOWNTOWN AND SUBURBAN MARKETS POST FIFTH-STRAIGHT YEAR OF OCCUPANCY AND RENT GAINS With strong office-using job growth and still-low levels of new supply in most markets, the overall vacancy rate fell by 9 basis points (bps) to 13.1% in 215. The downtown and suburban vacancy rates fell by 8 bps and 9 bps, respectively, and both are now within one percentage point of their prerecession lows. Among the 57 markets tracked by CBRE Research, 77% posted year-over-year vacancy rate decreases in Q Bay Area markets San Francisco, San Jose and Oakland had the lowest vacancy rates in the nation at year-end, reflecting robust demand from the tech industry and the spillover of both tech and non-tech tenants into the Oakland market. Many markets that still have elevated vacancy rates are starting to show greater improvement. For example, vacancy rates in Cincinnati, Las Vegas, Phoenix and Detroit remained among the highest in the country in Q4 215, but all registered vacancy rate decreases of at least 12 bps during the year. Rent growth continued in both the downtown (5.%) and suburban (3.5%) markets in 215. Rents increased in 9% of the downtown markets and in more than 75% of the suburban markets tracked by CBRE Research in 215, indicative of the broadening of the office market recovery over the past few years. Reflecting tight market conditions, San Francisco, San Jose and Oakland ranked among the top five markets for metro, downtown and suburban rent growth, with all three registering double-digit increases in each of these three categories. San Diego, Orange County, Seattle and Salt Lake City also ranked high in at least one of these categories, illustrating the strong overall performance of the West region. Q4 215 CBRE Research 216 CBRE, Inc. 6

7 Figure 11: U.S. Office Vacancy Rates Vacancy Rate (%) Source: CBRE Econometric Advisors, Q Metro Downtown Suburban Q4 27 Q1 28 Q2 28 Q3 28 Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Q3 212 Q4 212 Q1 213 Q2 213 Q3 213 Q4 213 Q1 214 Q2 214 Q3 214 Q4 214 Q1 215 Q2 215 Q3 215 Q4 215 CAPITAL MARKETS OFFICE INVESTMENT GROWTH SLOWS, BUT CAPITAL MARKETS ENVIRONMENT STILL GENERALLY FAVORABLE The capital markets environment for the U.S. office market is generally favorable for owners, sellers, lenders and borrowers. Investment activity lost some of the momentum experienced earlier in the year, but the investment volume in Q4 was still one of the largest in recent history, at $38 billion. Buyer sentiment is generally favorable, based on investment activity and pricing trends. CBRE UNDERWRITING SURVEY REVEALS SUSTAINED CONFIDENCE IN CLASS A ACQUISITIONS CBRE Research s latest quarterly underwriting survey of Class A assets revealed sustained confidence, as well as continued competitiveness, in the office investment world. In Q4 215, buyers were using healthy rent growth forecasts for the first three years of the holding period (averaging 4.7% for CBD assets and 4.4% for suburban). Year-one rent growth underwriting changed only slightly from the Q3 survey and year-two declined, but year-three increased noticeably. Investors had the highest expectations for CBD rent growth in Orange County, Nashville, Boston, Dallas, Miami and Atlanta. For suburban acquisitions, buyers were underwriting the strongest rent gains in Orange County, Miami, Nashville, Phoenix and Atlanta all with average increases above 5.%. The target unlevered IRRs remained quite low and reflected about 28 bps of compression from Q3. Target IRRs averaged 6.1% for CBDs and 7.7% for suburbs. The markets with the lowest target IRRs were Miami, Denver, Boston, Manhattan and Los Angeles. In Q4 215, Class A office acquisitions were underwritten with cap rates averaging 5.9% for CBD properties and 6.5% for suburban properties. The CBD average edged up 21 bps from Q3, while the suburban average declined 29 bps. The markets with the lowest cap rates for CBD assets were Manhattan, Miami, Los Angeles and Washington, D.C. For suburban product, the lowest cap rates were found in Los Angeles, Dallas/Ft. Worth, Miami and Orange County. OFFICE INVESTMENT REACHES $38 BILLION IN Q4 215 AND $141 BILLION TOTAL FOR YEAR U.S. office investment remained high in Q4 215, at $38.5 billion. The quarterly total reflected a 1.9% gain over the prior year and a 12% rise over Q3 Q4 215 CBRE Research 216 CBRE, Inc. 7

8 215. Historically, the drive for year-end closings has made Q4 more robust than Q3 over 25-15, that gain has averaged 24%. This year there was less urgency to close deals by year-end, however, and general investment activity has moderated slightly. The Q4 215 total was still the highest office investment volume of any quarter since the torrid 26-7 years. For full-year 215, office acquisitions reached $141 billion, which is 15% higher than 214. Nearly all of 215 s year-over-year gains were experienced in the first half of the year. The annual investment volume was still 1% below the prior peak of $157 billion, achieved in 27. Among the major property types, office represented the largest share of investment, at 31%; multifamily was a close second, at 3%. Figure 12: Buyer Valuation Underwriting Survey for Class A Office Properties: Ranked by CBD and Suburban IRR Target Gross Asking Rent Future Rent Growth (%) ($/SF/Annum) Year 1 Year 2 Year 3 Unlevered IRR Stabilized Market Submarket Target (%) Cap Rate (%) Miami CBD Suburban Denver CBD Suburban Boston CBD Suburban Manhattan CBD Nashville CBD Suburban San Francisco CBD Suburban Chicago CBD Suburban Seattle CBD Suburban Houston CBD Suburban Dallas CBD Suburban Austin CBD Suburban Washington, D.C. CBD Suburban Los Angeles CBD/Non Core Suburban/Core Orange County CBD Suburban Atlanta CBD Suburban Phoenix CBD Suburban Charlotte CBD Suburban Averages CBD Suburban Holding Period (Years) Note: The survey provides a general picture of current underwriting pricing. It does not suggest that the underwriting for every transaction is at exactly these levels or should be, since each asset and investor is unique. Source: CBRE Research, Q The statistics displayed above represent estimates of current buyer underwriting assumptions for Class A assets in the CBD and suburban submarkets. The quoted rents reflect the level at which top-tier relevant transactions are being completed. Estimates are based on the expert opinion of CBRE brokers that handle deals in these particular markets. Q4 215 CBRE Research 216 CBRE, Inc. 8

9 In 215, suburban office investment represented 54% of all investment activity vs. 46% for CBD. During the prior three years, investment was almost evenly split between the two market segments. In Q4 215, however, acquisitions of CBD assets came to 48% of the total. It is too early to know whether the Q4 215 figures could represent a slight reversal of investment preferences (moving back toward CBD assets, away from suburban), but that possibility seems unlikely. Global capital coming into the U.S. for office investment remains a significant feature of the capital markets landscape, and Q4 215 was a particularly robust quarter, with $1.6 billion of office investment. The 215 cross-border total exceeded $26 billion a 42% gain over the prior year. Global capital flows into U.S. real estate are on a long-term upward trend, and the office sector is very likely to see increased investment in 217, especially with the change in the FIRPTA rules. (One of the principal changes means that pension funds are no longer penalized for taking majority ownership positions.) The largest country sources of capital for Q4 215 were Qatar, Canada, Norway and Germany. While cross-border investors are clearly net buyers of office space, with acquisitions more than twice dispositions in Q4 215 (and full-year 215), institutional capital (a category comprised predominantly of investment management firms and equity funds), public REITs and users were all net sellers in Q Private buyers (a group which includes non-traded REITs) were net buyers in Q4 215, but net sellers for the year. Figure 13: Leading Metros for Office Investment, 215 Invested Market Share (%) Rank Metro ($ billions) Metro Cumulative 1 New York Metro San Francisco Bay Area Los Angeles* Washington Chicago Boston Seattle Atlanta Dallas/Ft. Worth Miami/South Florida Houston Phoenix San Diego Denver Austin Source: CBRE Research, Real Capital Analytics, Q Includes entity-level acquisitions. *Includes Orange County and Inland Empire. Figure 14: U.S. Office Investment Sales Volume and Cap Rates Transaction Volume ($ Billions) Individual (L) Portfolio (L) Cap Rates (R) Cap Rate (%) Q4 25 Q4 26 Q4 27 Q4 28 Q4 29 Q4 21 Q4 211 Q4 212 Q4 213 Q4 214 Q4 215 Source: Real Capital Analytics, Q Totals exclude entity-level property acquisitions (M&A activity) Q4 215 CBRE Research 216 CBRE, Inc. 9

10 Five U.S. metropolitan areas accounted for more than 5% of all capital invested in U.S. office buildings in 215. New York remains the leader by a wide margin, with 22%. New York is also the favorite destination of cross-border capital, with Boston a distant second. CAP RATES STABILIZE CBRE s forthcoming H2 215 North America Cap Rate Survey reveals that both CBD and suburban office cap rates remained essentially stable from H1 215 to H CBD assets reflected very small decreases while suburban experienced very small increases, but none of the changes are considered significant. As investors moved further out on the risk curve, all classes of office assets in both CBD and suburban areas of Tier III metros (basically metropolitan areas with less than three million population) saw cap rates drop, albeit modestly. Over H1 216, CBD office cap rates are expected to remain stable in about two-thirds of U.S. markets. For Class AA assets, the balance leans towards minor drops in cap rates. For Class A, the balance is fairly evenly split between small declines and small increases. For Class B and C assets, however, few or no markets are expected to experience cap rate compression in H1 216, but about 24% of markets may experience cap rate increases. Cap rates for suburban office assets are expected to remain stable in about 71% of U.S. markets. For Class A suburban assets, market forecasts are fairly evenly split between small declines and small increases. However, for Class B and C assets, few or no markets are expected to experience cap rate compression in H1 216, while about 22% of markets are likely to experience cap rate increases. Similarly, Real Capital Analytics (RCA) statistics revealed little change in the aggregate cap rate, which averaged 6.68% in Q However, RCA s suburban cap rate declined 13 bps year-over-year, to 6.84%, while the CBD cap rate edged up 14 bps, to 6.2%. Figure 15: Office Cap Rates, H2 215 Segment CBD Suburban Class H2 215 (%) Change from H1 215 (bps) Spread Over 1-Year (bps) AA A B C AA A B C Source: CBRE Research, H For stabilized asset acquisitions. INSTITUTIONAL OFFICE RETURNS EDGE DOWN, BUT REMAIN FAVORABLE Returns for institutionally owned office assets remain solid. The NCREIF National Property Index return for the year ending Q4 215 came to 12.1% (income 4.8%, appreciation 7.5%). The current annual return is lower than the prior quarter (13.1% for year ending Q3 215), but still significantly above the long-term (2-year) average of 9.8%. Among the large metro areas, Oakland, Miami and Atlanta posted the best returns. The annual return for CBD office remained higher than suburban office (13.13% vs %), but the gap between the two narrowed in 215. And for the first time in recent history, quarterly office returns were higher for suburban than CBD (2.8% vs. 2.42%). MORTGAGE LENDING VOLUMES RISE The lending volume for office assets remained high in Q4 215, rising 23% year-over-year (based on dollar volume), according to the Mortgage Bankers Association s Quarterly Survey of Commercial/ Multifamily Mortgage Bankers Originations. However, the index slipped slightly (-1%) from Q3. The office lending momentum index was higher than the indices for the retail and hotel sectors, but lower than for multifamily and industrial. Q4 215 CBRE Research 216 CBRE, Inc. 1

11 At the end of Q4 215, the CMBS office delinquency rate reversed its downward trend and edged up to 5.31% (based on the CMBS 3+ day standard, as reported by Morningstar Credit Ratings, LLC). The rate reflects a 28-bps drop, year-over-year, and a 1-bp decline from the prior quarter. However, office delinquency rose in the last two months of the year. In the CMBS world, the office and retail sectors are likely the most at risk from the 26 and 27 vintage loans that will mature over the next two years the so-called wall of maturities. The two sectors are more vulnerable due to their large market shares in CMBS portfolios, the delayed recovery experience of the sectors especially lower-quality product and the recent payoff experience at maturity. Morningstar reported that of the $6 billion of maturing CMBS loans in 215, office had the lowest pay-off rate among the property sectors (81%) and the second-highest percentage (11%, after retail) of delinquent loans. The 215 CMBS loan default experience was far less detrimental than previously expected, however. The strong appetite for acquisitions, improving market fundamentals and generally favorable credit environment rescued many potentially troubled loans. Defaults are expected to rise in 216, but not dramatically. Of the estimated $81 billion in CMBS loan maturities in 216 (all property types), Morningstar forecasts a pay-off rate of 7% to 75%, based largely on the maturing loans current LTVs (loan-to-value ratios). Yet, 217 is likely to prove to be more problematic. MARKET OUTLOOK VACANCY EXPECTED TO NEAR PRE-RECESSION LOW IN 216 Although financial market and global risks to the U.S. office market cannot be ignored, our outlook for 216 reflects expectations for continued strong job growth and corresponding demand for office space. CBRE Econometric Advisors forecasts the net addition of approximately 574, office-using jobs in the year ahead, the highest annual gain since 2. This robust job growth is expected to fuel 52.5 million sq. ft. of net absorption in 216, a decrease from 215 s post-recession record of 61.6 million sq. ft., due to slower absorption in the suburbs. On the supply side, completions are expected to remain on par with 215, at approximately 35.7 million sq. ft. We project downtown completions to Figure 16: Institutional Returns for Major Office Markets Returns for Year Ending Q4 215 (%) Income Return Appreciation Return Total Return Oakland Miami Atlanta San Francisco Austin Boston-Cambridge San Jose New York City Orange County Los Angeles Charlotte U.S. CBD Portland Boston U.S. Dallas Chicago U.S. Suburban Seattle Phoenix Denver San Diego Washington, D.C. Houston Minneapolis Source: NCREIF, Q All returns are reported on an unlevered basis. Q4 215 CBRE Research 216 CBRE, Inc. 11

12 increase to nearly 1 million sq. ft., their highest total since 21, as projects in leading urban markets like San Francisco, Seattle and Boston come online. Suburban completions are projected to decrease slightly, to 25.7 million sq. ft. The anticipated decrease in overall suburban construction and absorption activity in 216 is largely attributable to Houston, one of the leaders in both categories in recent years, rather than to a weakening in the aggregate U.S. suburban market. With the sharp fall in oil prices and corresponding decline in tenant demand, the square footage under construction in suburban Houston fell by more than 1 million sq. ft. between year-end 214 and year-end 215. As projects underway are completed in 216, it likely will decrease further. Likewise, Houston s absorption, which has remained high due to the delivery of pre-leased space prior to the oil price slump, will likely weaken as deliveries slow. With strong hiring activity, and construction activity still below historical average levels, we expect the overall vacancy rate to decrease by another 5 bps in 216, to 12.6%, nearing the previous year-end low of 12.5% in 26 and 27. The vacancy rate in the downtown market, which has been ahead of the suburban market in recovery, is projected to fall into the single digits (9.6%) below the previous, 27 year-end low. Tightening market conditions should fuel rent growth of 4.6% in 216, with stronger growth in the previously struggling suburban market. Figure 17: U.S. Metro Rent and Vacancy Forecast Rent Growth (%) Rent Growth (L) Vacancy Rate (R) Vacancy Rate (%) Forecast Source: CBRE Econometric Advisors, Q Q4 215 CBRE Research 216 CBRE, Inc. 12

13 Figure 18: Lowest and Highest Vacancy Rates (%) Lowest Vacancy Rates Downtown Suburban Metropolitan OAKLAND 3.7 CAMBRIDGE 5.6 SAN FRANCISCO 5.9 MANHATTAN, MIDTOWN SOUTH 4.9 NASHVILLE & SAN JOSE 5.7 SAN JOSE 6.7 SAN FRANCISCO 5.6 SAN FRANCISCO 6.5 OAKLAND 7.1 CHARLOTTE 6.3 SALT LAKE CITY 8.6 MANHATTAN 7.2 MANHATTAN, MIDTOWN 7. OAKLAND 9.3 NASHVILLE 7.4 Highest Vacancy Rates Downtown Suburban Metropolitan ALBUQUERQUE 33.6 CINCINNATI 22.7 ALBUQUERQUE 22.4 TUCSON 3.5 DETROIT 2.1 CINCINNATI 2.6 NORFOLK 29.2 WESTCHESTER COUNTY 2. LAS VEGAS & WESTCHESTER COUNTY 2. ST. LOUIS 26.9 LAS VEGAS 19.9 PHOENIX 19.2 DALLAS/FT. WORTH 23.7 ALBUQUERQUE 19.3 DETROIT 19.1 Source: CBRE Research, Q Figure 19: Largest Quarterly Changes in Vacancy Rates (Percentage Point Change) Largest Decreases in Vacancy Downtown Suburban Metropolitan JACKSONVILLE -4.6 GREENVILLE -2. JACKSONVILLE -1.6 COLUMBUS -1.3 AUSTIN -1.4 AUSTIN -1.3 INDIANAPOLIS -1. SACRAMENTO -1.3 TAMPA -1.2 MILWAUKEE & SEATTLE -.9 TAMPA -1.2 SACRAMENTO -1.1 CHICAGO & OAKLAND -.8 SAN FRANCISCO -1.1 GREENVILLE -1. Largest Increases in Vacancy Downtown Suburban Metropolitan ALBUQUERQUE 1.5 WESTCHESTER COUNTY 1.8 WESTCHESTER COUNTY 1.8 LAS VEGAS 1.4 MINNEAPOLIS/ST. PAUL 1.3 HOUSTON 1. HARTFORD 1.3 HOUSTON 1.1 CINCINNATI.8 GREENVILLE 1. BOSTON.9 MINNEAPOLIS/ST. PAUL.6 CINCINNATI.9 CINCINNATI.7 SAN ANTONIO.5 Source: CBRE Research, Q Q4 215 CBRE Research 216 CBRE, Inc. 13

14 Figure 2: U.S. Office Vacancy Rates (%) Downtown Suburban Metropolitan Market Size Rank Q4 215 Q3 215 Q4 214 Q4 215 Q3 215 Q4 214 Q4 215 Q3 215 Q4 214 BALTIMORE BOSTON CAMBRIDGE * N/A N/A N/A N/A N/A N/A CHARLOTTE GREENVILLE HARTFORD LONG ISLAND 32 N/A N/A N/A LOUISVILLE MANHATTAN, DOWNTOWN N/A N/A N/A MANHATTAN, MIDTOWN ** N/A N/A N/A N/A N/A N/A MANHATTAN, MIDTOWN SOUTH ** N/A N/A N/A N/A N/A N/A MARYLAND SUBURBAN *** N/A N/A N/A N/A N/A N/A NEW JERSEY 8 N/A N/A N/A NORFOLK PHILADELPHIA PITTSBURGH STAMFORD 3 N/A N/A N/A VIRGINIA NORTHERN *** N/A N/A N/A N/A N/A N/A WASHINGTON, D.C. *** N/A N/A N/A WESTCHESTER COUNTY 43 N/A N/A N/A WILMINGTON EAST CHICAGO CINCINNATI CLEVELAND COLUMBUS DETROIT INDIANAPOLIS KANSAS CITY MILWAUKEE MINNEAPOLIS/ST. PAUL ST. LOUIS MIDWEST ATLANTA AUSTIN DALLAS/FT. WORTH FT. LAUDERDALE HOUSTON JACKSONVILLE MIAMI NASHVILLE ORLANDO PALM BEACH COUNTY 5 N/A N/A N/A SAN ANTONIO TAMPA SOUTH ALBUQUERQUE DENVER HONOLULU INLAND EMPIRE 46 N/A N/A N/A LAS VEGAS LOS ANGELES OAKLAND ORANGE COUNTY 14 N/A N/A N/A PHOENIX PORTLAND SACRAMENTO SALT LAKE CITY SAN DIEGO SAN FRANCISCO SAN JOSE SEATTLE TUCSON VENTURA COUNTY 52 N/A N/A N/A WALNUT CREEK 29 N/A N/A N/A WEST UNITED STATES * Included in Boston metro ** Included in Manhattan, Downtown *** Included in Washington, D.C. metro Boston metro figures include Boston Suburban, Boston Downtown and Cambridge Washington, D.C. metro figures include Maryland Suburban, Virginia Northern and Washington, D.C. Downtown Source: U.S. national totals provided by CBRE Econometric Advisors, all other figures compiled by CBRE Research, Q Q4 215 CBRE Research 216 CBRE, Inc. 14

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