Is Suburban Real Estate A Value Proposition Today? Guest Speaker:

Transcription

1 Is Suburban Real Estate A Value Proposition Today? Guest Speaker: Mark Eppli Interim James H. Keyes Dean of Business Administration, Robert B. Bell, Sr., Chair in Real Estate, and Professor of Finance, Marquette University

2 Is Suburban Real Estate a Value Proposition? Presented to: Urban Land Institute, Chicago Suburban Chapter Presented by: Mark J. Eppli Interim Keyes Dean and Bell Chair in Real Estate Marquette University March 11, 2014

3 Employment

4 Which is the real measure of unemployment.... Source: Vanguard s Economic and Investment Outlook, January 2014, 16.

5 .... reductions in the U.S. labor participation rate are coming from the young adult cohorts.... Source: Vanguard s Economic and Investment Outlook, January 2014, 16.

6 .... significant employment growth is needed to get back to trend levels....

7 .... another view of the numbers....

8 .... and job growth in Wisconsin and Illinois has lagged that of the U.S Employment Growth in Illinois, Wisconsin, and the United States (July 2003 July 2013) Illinois Wisconsin U.S. Source: U.S. Department of Labor and Marquette University.

9 The labor markets will firm up over the coming year increasing by about 225,000 new jobs per month in 2014, however, a surplus of employees will put a lid on inflation and will keep the Federal Reserve from tightening credit markets over and above the taper.

10 GDP

11 GDP growth has been constrained, growing 2.2% over the last three years....

12 .... GDP growth is also weak relative past economic expansions.... Source: WSJ, December 18, 2013, A1.

13 .... and economic growth in Wisconsin and Illinois has lagged that of the U.S GDP Growth for Wisconsin, Illinois, and the U.S., Wisconsin Illinois U.S. Source: Federal Reserve and Marquette University.

14 Personal Consumption Expenditures

15 ....since the Great Recession, personal consumption expenditure growth has been solid....

16 .... The Case Shiller home price index is up 13.6%, the best since 2006, and the S&P 500 stock index had its best year since 1997 with a 31.9% total return increasing household wealth.... Source: WSJ, December 10, 2013, A2.

17 .... and household debt service as a percent of disposable income has fallen to historic lows....

18 .... as consumer sentiment strengthens, consumption expenditures remain solid and can be expected to grow about in 2.75% in 2014.

19 Business Spending and Investment

20 After growing a modest 2.2% per year over the past two years, business investment will shine in Source: Wall Street Journal, 1/13/14, A2.

21 .... corporate profits continue to be very strong....

22 .... barring the January step back, the outlook is strong as well for 7.5% YOY growth business investment in 2014.

23 Residential Investment and Government Spending

24 While residential real estate is a small portion of GDP, it has swung wildly with solid growth in

25 .... the excess supply of homes have been absorbed....

26 .... pent up household growth has not been tapped.... Source: Joint Center for Housing Studies, State of the Nation s Housing: 2013.

27 .... and the supply of housing units having room to grow to meet prospective household growth suggesting a strong 5% growth in new construction....

28 .... government (all levels) expenditures will remain marginally above zero in

29 Expect growth of 3.00% in GDP Component Expected Growth Component Size Contribution to Growth Personal consumption: 2.75% 71% 1.95% Business spending and investment 7.5% 10% 0.75% Residential investment 5.0% 2.4% 0.12% State and local government spending 2.0% 12% 0.24% Federal government spending 1.0% 8% 0.08% Expected GDP growth in 2014 about +/ 3.0%

30 Expected population growth for Wisconsin and Illinois is well below the 29% national average Source: U.S. Census Bureau. Change: 2000 to 2030 State Change: 2000 to 2030 Number Change: 2000 to 2030 Percent Change: 2000 to 2030 Rank in percent change.new Mexico 280, Missouri 834, Wisconsin 787, Oklahoma 462, Kentucky 513, Indiana 729, Maine 136, Massachusetts 662, Rhode Island 104, Alabama 427, Kansas 251, Mississippi 247, Connecticut 283, Illinois 1,013, Michigan 755, Louisiana 333,

31 Interest Rates and Inflation

32 Low inflation tests world s central banks.... Source: Wall Street Journal, December 18, 2013, A1.

33 .... and U.S. inflation has remained stubbornly low....

34 .... with ample labor, unit labor costs are wellbehaved....

35 .... and stable commodity prices...

36 .... and banks are easing lending standards.... Source: WSJ, 1/31/2014, C2.

37 .... with greater demand for commercial real estate loans....

38 .... with labor and commodity prices in check, interest rates will remain in check rising modestly (0.5%) if at all Components of an Interest Rate Rate = 4.55% % Jan 03 Jun 03 Nov 03 Apr 04 Sep 04 Feb 05 Jul 05 Dec 05 May 06 Oct 06 Mar 07 Aug 07 Jan 08 Jun 08 Nov 08 Apr 09 Sep 09 Feb 10 Jul 10 Dec 10 May 11 Oct 11 Mar 12 Aug 12 Jan 13 Jun 13 Nov % 0.57% Real Rate of Return Inflation Premium BBB Risk Premium Source: St. Louis Federal Reserve and Marquette University.

39 The male and female brain Male Female Source: Economist, 12/7/2013, 81.

40 Senators casting the same vote, it looked like the female brain in 1989 and now like the male brain, hmmmm. Source: Economist, 12/7/2013, 30.

41 Greenspan and the thoughts on how the human brain reacts to euphoria and risk..... First he drew the conclusion that the nonfinancial sector of the economy had been healthy. The problem lay in finance.... studying the results of herd behavior provided him with some surprises. I was actually flabbergasted, he says. It upended my view of how the world works..... He concluded that fear has at least three times the effect of euphoria in producing market gyrations. Source: Wall Street Journal, 10/19 20, 2013, C11.

42 Commercial Real Estate

43 Commercial real estate transaction volume is back to 2006 levels.... Mortgage Bankers Quarterly Databook.

44 .... commercial real estate bank lending is back as well....

45 .... more generally, multifamily and commercial real estate debt is expanding for the first time since Multifamily and Commercial Real Estate Lending (billions per quarter)

46 Is the Midwest Property Market a good Value Proposition?

47 Unlevered total property returns (IRR) compared to other investments. Market Index Comparisons (through 2013Q3) 1 Year 3 Year 5 Year 10 Year 20 Year National Property Index 11.0% 12.7% 3.4% 8.7% 9.1% NAREIT 6.2% 12.8% 6.0% 9.7% 9.9% S&P 500 Index 19.3% 16.3% 10.0% 7.6% 8.8% Barclays Government Bond 2.0% 2.9% 5.7% 4.5% 5.7% CPI 1.1% 2.3% 1.3% 2.4% 2.4% Source: NCREIF Third Quarter 2013 Real Estate Performance Report.

48 Long term investment returns by broken down by income and growth. Long Term Investment Returns Investment Returns Total Return Yield Growth U.S. Equities ( ) 10.00% 3.50% 6.50% U.S. Long Term Bonds ( ) 5.50% 5.50% 0.00% Real Estate Returns IRR Cap Rate Growth National Property Index (( Q3) 9.14% 7.53% 1.52% Examples Boston Apartment Market 7.50% 4.25% 3.25% Milwaukee Apartment Market 8.00% 6.50% 1.50%

49 Annual GDP, Jobs, and Population Growth for the U.S., Wisconsin, and Illinois Growth Summary GDP Jobs Population United States 2.7% 0.5% 1.0% Wisconsin 1.7% 0.2% 0.5% Illinois 1.4% 0.1% 0.3% Sources: Data from previous slides

50 Property returns by property type National Property Index Returns By Property Type (through 2013Q3) National Property Index Apartment Industrial Office Retail 1 Year 11.0% 10.8% 11.7% 9.7% 13.2% 3 Year 12.7% 13.7% 12.7% 11.6% 13.5% 5 Year 3.4% 4.3% 2.7% 1.9% 5.6% 10 Year 8.7% 8.4% 8.1% 8.2% 10.5% 20 Year 9.2% 10.0% 9.6% 8.9% 9.5% Source: NCREIF Third Quarter 2013 Real Estate Performance Report.

51 Property returns by location, ( a 1.7% lower return in the Midwest compounded annually for 20 years is 40%, and for 10 years is 18% in lost returns) National Property Index Returns By Region (through 2013Q3) National Property Index East Midwest South West 1 Year 11.0% 9.2% 10.9% 12.6% 11.8% 3 Year 12.7% 11.9% 11.4% 12.7% 13.9% 5 Year 3.4% 2.7% 3.5% 4.2% 3.5% 10 Year 8.7% 8.8% 7.1% 8.5% 9.3% 20 Year 9.2% 10.3% 8.0% 8.7% 10.0% Source: NCREIF Third Quarter 2013 Real Estate Performance Report.

52 Is the Midwest a value proposition or out of favor? U.S. Regional Type Quarterly Indices - Equal Weighted, Data through October of 2013 Midwest Composite Northeast Composite South Composite West Composite Index Value (2000 Dec = 100) CoStar Commercial Repeat Sales Price Index, December 2013.

53 Index Value (2000 Dec = 100) Which property type provides the greatest opportunity? Midwest Property Type Quarterly Indices Equal Weighted Data through October 2013 Midwest Office Midwest Industrial Midwest Retail Midwest Multifamily CoStar Commercial Repeat Sales Price Index, December 2013.

54 Property Markets

55 Apartments

56 Midwest apartments have performed on par with the rest of the U.S.... Apartment Total Returns By Region (through 2013Q2) Total Apartment East Midwest South West 1 Year 10.8% 8.6% 12.5% 12.1% 11.7% 3 Years 13.7% 12.6% 14.4% 13.9% 14.7% 5 Years 4.3% 2.3% 6.8% 5.6% 4.8% 10 Years 8.4% 7.4% 8.2% 9.0% 9.1% 20 Years 10.0% 10.1% 9.8% 9.5% 10.9% Source: NCREIF Third Quarter 2013 Real Estate Performance Report.

57 .... however, apartments in non prime markets are trading at a discount to prime markets.... Prime Multifamily and Non Prime Multifamily Market Equal Weighted Data through October Prime Multifamily Metros U.S. Multifamily Index Value (2000 Dec = 100) CoStar Commercial Repeat Sales Price Index, December 2013.

58 ....multifamily starts averaged 360,000 since 1956, a level we are now reaching....

59 ....minorities and seniors will drive most all household demand growth in the coming decade.... Source: Joint Center for Housing Studies, State of the Nation s Housing: 2013.

60 .... household type may predict housing tenure choice.... Households by Household Type 41,558 59,204 21,698 Married Couples Other Family Non Family Source: Census and Marquette University.

61 .... married couple households have declined dramatically over time % Percent "Other Family" and "Non Family" Households 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Source: Census and Marquette University.

62 .... and many non married families are income constrained.... Households by Household Type and Income Source: Census and Marquette University.

63 Not even the seasonal weakness normally observed during the fourth quarters of calendar years had much if any impact on the market dynamics. Vacancy declined by 10 basis points during fourth quarter to 4.1%.... over the last year the national vacancy rate fell by 50 basis points. Source: REIS Reports annual market summary, February 10, 2014.

64 Apartment fundamentals remain very strong and the Midwest appears to be a good value proposition.

65 Retail

66 Midwest retail has underperformed the U.S.... Retail Total Returns by Region (through 2013Q3) Total Retail East Midwest South West 1 Year 13.2% 12.0% 13.2% 14.1% 13.6% 3 Years 13.5% 12.7% 12.6% 14.3% 14.0% 5 Years 5.6% 5.5% 4.8% 5.7% 5.9% 10 Years 10.5% 10.8% 9.4% 10.2% 10.8% 20 Years 9.5% 9.2% 8.4% 9.2% 10.4% Source: NCREIF Third Quarter 2013 Real Estate Performance Report.

67 .... however, prime retail markets are trading at a significant premium to the non prime markets.... Prime Retail and Non Prime Retail Market Equal Weighted Data through October Prime Retail Metros U.S. Retail Index Value (2000 Dec = 100) CoStar Commercial Repeat Sales Price Index, December 2013.

68 .... real retail sales fundamentals remain solid....

69 .... spending has shifted to durable goods, which signals consumer confidence, but limits retail space needs Source: WSJ, January 15, 2014, page A2.

70 ....multi channel retailing the new normal (internet sales/total sales for Wal Mart $7.7B/$473B and for Best Buy $3.3B/$48B).... Source: WSJ, August 28, 2013, page A1..

71 The national vacancy rate for neighborhood and community shopping centers declined by 10 basis points during the fourth quarter to 10.4%.... down 30 basis points during 2013, and down just 70 basis points from the historical peak vacancy rate of 11.1% which was recorded during the third quarter of Source: REIS Reports annual market summary, February 10, 2014.

72 Retail fundamentals are very strong and the Midwest/non prime markets appear to be a good value proposition.

73 Office and Industrial

74 Midwest office returns have significantly underperformed the U.S..... Office Total Returns by Region (through 2013Q3) Total Office East Midwest South West 1 Year 9.7% 8.4% 6.5% 12.6% 10.6% 3 Years 11.6% 11.4% 6.5% 10.3% 13.3% 5 Years 1.9% 2.0% 0.4% 2.0% 2.1% 10 Years 8.2% 8.9% 4.8% 7.3% 8.6% 20 Years 8.9% 9.9% 6.2% 8.1% 9.3% Source: NCREIF Third Quarter 2013 Real Estate Performance Report.

75 .... similarly, Midwest industrial has underperformed the rest of the U.S.... Industrial Total Returns By Region (through 2013Q3) Total Industrial East Midwest South West 1 Year 11.7% 11.3% 10.2% 11.4% 12.4% 3 Years 12.7% 11.5% 11.0% 11.6% 14.3% 5 Years 2.7% 3.2% 1.7% 2.7% 2.9% 10 Years 8.1% 7.6% 5.9% 7.3% 9.4% 20 Years 9.6% 9.4% 7.5% 8.5% 10.9% Source: NCREIF Third Quarter 2013 Real Estate Performance Report.

76 .... and prime office markets command a premium over non prime markets.... Prime Office and Non Prime Office Market Equal Weighted Data through October Prime Office Metros U.S. Office Index Value (2000 Dec = 100) CoStar Commercial Repeat Sales Price Index, December 2013.

77 .... however, prime and non prime industrial market have seen similar levels of appreciation.... Prime Industrial and Non Prime Industrial Market Equal Weighted Data through October Prime Industrial Metros U.S. Industrial Index Value (2000 Dec = 100) CoStar Commercial Repeat Sales Price Index, December 2013.

78 .... capacity utilization remains solid, which is comforting to industrial space owners....

79 .... manufacturing hours worked provide a solid signal for industrial markets.... Source: WSJ, April 19, 2013, page A14.

80 .... and the Boston Consulting Group projects that U.S. manufacturing exports will increase by $ billion annually by the 2020, creating million jobs Source: WSJ, August 30, 2013, page B1.

81 .... however, Jones Lang LaSalle projects significant reductions in space per employee.... Source: ULI, What s Next?, page 46.

82 .... while office market fundamentals remain difficult, asking rents continue to rise.... Source: WSJ, January 6, 2014, A6.

83 The national [office] vacancy rate was unchanged during the fourth quarter at 16.9%....not since the third quarter of 2007 has the national vacancy rate declined by more than 10 basis points in any given quarter. Source: REIS Reports annual market summary, February 10, 2014.

84 Office fundamentals are weak and past poor performance in the Midwest may position narrow pockets/markets in the Midwest to be a good value proposition. Industrial fundamentals are strong but this strength appears to be priced into the Midwest market relative to prime markets in the U.S.

85 Summary I. Macro Economy A. Employment market confidence will create 200, ,000 jobs per month; B. Interest rates will remain in the % range increasing 0.5% if at all; and C. GDP growth will be solid at +/ 3.0%; II. Capital and Space Markets A. Debt markets are back with lenders easing underwriting standards and looking to lend more money; B. Interest rates will remain narrowly changed at current 4.5% 5.0%.

86 Summary (continued) III. Property Markets A. Apartment market fundamentals remain very strong, and the Midwest appears to be a good value; B. Retail market fundamentals are strong with and with limited new space coming on line, Midwest retail represents a good value; C. Office market fundamentals and prospects remain weak; and D. Industrial fundaments are solid but the value proposition for non prime market upside potential does not exist.

87 Is Suburban Real Estate A Value Proposition Today? Guest Speaker: Mark Eppli Interim James H. Keyes Dean of Business Administration, Robert B. Bell, Sr., Chair in Real Estate, and Professor of Finance, Marquette University