CONTRARIAN REAL ESTATE INVESTING STRATEGIES FOR IDENTIFYING VALUE IN A MARKET THAT SEEMS FULLY PRICED AND FAIRLY CROWDED

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1 CONTRARIAN REAL ESTATE INVESTING STRATEGIES FOR IDENTIFYING VALUE IN A MARKET THAT SEEMS FULLY PRICED AND FAIRLY CROWDED ADAM DUCKER, MANAGING DIRECTOR TAYLOR MAMMEN, MANAGING DIRECTOR NREI WEBINAR MAY 9, 2017

2 ABOUT RCLCO RCLCO is the leading knowledge solutions provider to the real estate industry First call for those seeking strategic and tactical advice regarding property investment, planning, and development We provide end-to-end advisory and implementation solutions at an entity, portfolio, or project level Engaged on ~500 projects annually touching more than $5B in real estate Affiliated with more than 25 leading industry associations, including ULI, PREA, NMHC, etc. Office Locations: Los Angeles, CA; Austin, TX; Orlando, FL; Washington, DC, Mission: To help our clients make strategic, effective, and enduring decisions about real estate. Advisory Groups: Institutional, Urban Real Estate, Public Strategies, Community & Resort, Strategic Planning & Litigation Support

3 CONTRARIAN = IDENTIFYING UNDERAPPRECIATED OPPORTUNITIES High Investor Appetite Questionable Fundamentals; Great Fundamentals; but investors are still active highly favored by investors Weak Long-Term Structural Growth Poor Fundamentals; investors are out of the market Good to Great Fundamentals; which investors don t yet appreciate Strong Long-Term Structural Growth Low Investor Appetite

4 INVESTMENT OPPORTUNITIES PRESENT THEMSELVES IN EACH QUADRANT High Investor Appetite Dangerous territory Stable returns rely on improving operating performance, predictable investor appetite Weak Long-Term Structural Growth Returns from identifying good opportunities despite headwinds or where investors have been too quick to exit Outsized returns result from strong operating performance and improving values as investor appetite grows Strong Long-Term Structural Growth Low Investor Appetite

5 IDENTIFYING VALUE OF GEOGRAPHY / PRODUCT TYPE DYNAMICS WITHIN THE FRAMEWORK High Investor Appetite Dangerous territory Invest alongside structural trends Weak Long-Term Structural Growth Rely on expertise to identify and underwrite underappreciated opportunities Build the case! Strong Long-Term Structural Growth Low Investor Appetite

6 INVESTING ALONGSIDE LONG-TERM STRUCTURAL TRENDS Critical to identify: o What hasn t yet peaked (or maybe isn t proven) in terms of demand o What isn t or isn t likely to be oversupplied Opportunities: o Seniors housing o Industrial/logistics o Medical office o Housing (in general) Great Fundamentals; highly favored by investors Stable returns rely on improving operating performance, continued investor appetite Invest alongside structural trends

7 Population ('000s) Population Growth Rate LONG-TERM STRUCTURAL TRENDS Aging Population Requires More (and New Types of) Seniors Housing and Other Services 450, , , , , , , ,000 50,000 Projected Population and Growth Rate, Total Population and Age 75+; United States of America 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0 0.0% (f) 2025 (f) 2030 (f) 2035 (f) 2040 (f) 2045 (f) 2050 (f) 2055 (f) 2060 (f) Total US Population 75+ population Projected Total US Population Growth Rate Projected 75+ US population Growth Rate Source: US Census Bureau

8 LONG-TERM STRUCTURAL TRENDS No Matter What Happens to the ACA ( Obamacare ), We ll Need More Healthcare Facilities $900,000 Healthcare Spending by Age Group; United States of America $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $ Source: Centers for Medicare & Medicaid Services

9 LONG-TERM STRUCTURAL TRENDS ecommerce is the Only Type of Retail Experiencing Sales Growth in 2017 (Good for Industrial) 30% Retail Sales Growth; 1993 to February % 20% 15% 10% 5% 0% (5%) (10%) (15%) Warehouse Clubs + Superstores Grocery Dept Stores Ex Discount Discount Dept Stores GAFO* E-Commerce Source: Centers for Medicare & Medicaid Services

10 LONG-TERM STRUCTURAL TRENDS Housing in the U.S. is Only Just Recovering Housing Completions Relative to Household Formation 2,000 1,800 1,600 1,400 1,200 1, Average Average Average Average Total Completions ('000s) HH Growth ('000s) Completions:HH Growth Ratio Source: US Census; RCLCO

11 USING EXPERTISE TO IDENTIFY & UNDERWRITE UNDERAPPRECIATED OPPORTUNITIES Real estate is supremely inefficient (every parcel is different, many of them still great) Strong operators really do create value; characteristics of organizations that do this type of investing well: o Ability to ask tough questions of themselves & evolve o Creative capitalization o Discipline in underwriting o Actual asset management o Fine-tuned market observers Examples: o Suburban office o Retail o (Upscale/Luxury) Hotels Poor Fundamentals; investors are out of the market Returns from identifying good opportunities despite headwinds or where investors have been too quick to exit Rely on expertise to identify and underwrite underappreciated opportunities

12 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Cap Rate UNDERAPPRECIATED OPPORTUNITIES Investors Uniformly Assuming Significant Risk In Suburban Office Certainly Mispriced in Places 12.0% CBD and Suburban Office Cap Rates; 1989-Q % 8.0% % % % (50) 0.0% (100) BPS Spread (Right Axis) Office-CBD Office-Suburban Source: Real Capital Analytics

13 UNDERAPPRECIATED OPPORTUNITIES Retail is Under Threat and Not Favored, but Opportunities Clearly Exist 12.0% Vacancy by Retail Center Type 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% Q1 General Retail Mall Power Center Shopping Center Speciality Center All Retail Source: CoStar

14 (f) 2017 (f) 2018 (f) UNDERAPPRECIATED OPPORTUNITIES Supply Concerns Leading Investors Away From Hotels, But Likely Create Opportunity Around the Corner 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% Cap Rates by Property Type 140, , ,000 80,000 60,000 40,000 20,000 - Net Change in Hotel Keys All Hotels Full-Service Limited-Service Botique Source: Real Capital Analytics Net Change in Supply Avg Change in Supply Source: PKF Hotel Horizons Report

15 OUTSIZED RETURNS RESULT FROM LEVERAGING BOTH APPROACHES Difficult to identify: markets may be inefficient, but they re not stupid Difficult to underwrite: how do you know you re right, and everyone else is wrong? Difficult to finance: where are the comps? Examples we re seeing right now: o For-sale residential o Suburban apartments o Missing Middle residential products o Multitenant industrial o Hybridized product types Great Fundamentals; which investors don t yet appreciate Outsized returns result from strong operating performance and improving values as investor appetite grows Build the case!

16 Units (000s) Households UNDERAPPRECIATED TRENDS For-Sale Residential Potentially Coming Out of the Wilderness 2,000.0 U.S. Housing Starts 2, U.S. Home Ownership Rate 1, , , , , , , , Single-Family Housing Starts Increase in Households (3-Year Rolling Average) Homeownership Rate Source: U.S. Census Source: U.S. Census

17 UNDERAPPRECIATED TRENDS Investors Overly Focused on (Sexy) Urban Apartment Markets Despite Similar Performance of Other Place Types Average Effective Rent by Place Type, United States Source: Axiometrics; RCLCO Place Type Characterization System

18 UNDERAPPRECIATED TRENDS Market Has Turned Away Without Basis from Economic /Place Type Missing Middle Average New Multifamily by Place Type, Atlanta MSA Year Built Source: Axiometrics; RCLCO Place Type Characterization System

19 UNDERAPPRECIATED TRENDS & PRODUCT TYPES: MISSING MIDDLE Family Lifestage Distribution by Housing Type; United States Place Type of Current Residence; Millennials (25-34) 100% Multifamily Rental 8% 17% 27% 21% 27% 90% 80% 28.4% 31.0% 36.1% Single-Family Rental 4% 10% 49% 20% 18% 70% 60% Single-Family Owned 4% 31% 17% 48% 50% 40% 30% 71.3% 65.9% 60.1% All Households 3% 8% 32% 18% 40% 20% 0% 20% 40% 60% 80% 100% Post Grad Young Workers, No Kids Family Middle Aged, No Kids Older Workers & Retirees, No Kids Source: U.S. Census Image: Opticos Design 10% 0% Top 50 Metros Gateway Metros Philadelphia Suburban Urban Rural/Park/Institutional Source: U.S. Census

20 UNDERAPPRECIATED TRENDS Small-scale (Usually Multi-tenant) Industrial Exhibits Strongest Market Fundamentals Percentage Change in Industrial Inventory by Size Category; (YTD) 12.0% Average Industrial Vacancy by Size of Building; (YTD) 11.0% 1,000,000+ SF 7% 10.0% 9.0% 500,000-1,000,000 SF 16% 8.0% 7.0% 250, ,000 SF 8% 6.0% 5.0% 4.0% 150, ,000 SF 3% 3.0% 25, ,000 SF 1% 2.0% YTD 25, ,000 SF 150, ,000 SF 250, ,000 SF 500,000-1,000,000 SF 1,000,000+ SF Source: Costar Source: Costar

21 SOLUTION TREND UNDERAPPRECIATED TRENDS Evolving Trends in American Life Driving New and Creative Product Hybridization Increasing Residential Transience Rise of Work From Home/Sole Proprietorship Retail Box Store Obsolescence Short-Term Furnished Rental Residential/Office Hybrid Conversions Mall Anchor Medical Office Saul Urban Unban Suites; Washington, D.C. Novus Residences elofts; Alexandria, Virginia

22 UNDERWRITING CONTRARIAN STRATEGIES Contrarian investment strategies bear a higher burden of proof: o What we re observing really is a structural change. o I know about the threats, but this asset is different. Contrarian returns should earn higher returns (for the same level of risk): o Clearly delineate and understand the risks o Quantify and evaluate the risks o Answer whether the market pricing makes sense Contrarian investor characteristics: o Inquisitive culture o Research-driven approach o Appreciation for the cycle o Patient and flexible capital Investment vehicle/approach matters: o Fundraising, lifecycle, and approach make it difficult for commingled funds to be contrarian

23 CONCLUDING THOUGHTS/QUESTIONS So, how might you think of constructing a portfolio staking investments in these categories? How do we overlay thinking about market cycle and this approach? How do we use debt or creative capital stack formation with each? How do you underwrite a manager s contrarian strategy?