Commercial Real Estate and the Next Downturn 2018 Atlanta Fed Banking Outlook Conference

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1 Commercial Real Estate and the Next Downturn 2018 Atlanta Fed Banking Outlook Conference Presented By: Brian D. Bailey, CCIM, CRE Subject Matter Expert CRE

2 The views and opinions expressed are those of the presenter and are not necessarily those of the Federal Reserve Bank of Atlanta or the Board of Governors of the Federal Reserve System.

3 TODAY Economy National Unemployment State Unemployment Property Sector Vacancy/Occupancy Apartment Effective Rent Growth Supply Economy Property Sector Has The Downturn Started Cyclical/Idiosyncratic Risk Capital Markets Capital Markets Transactions Cap Rates Risk Premiums

4 UNEMPLOYMENT RATES Current: 8.2% Pre Crisis: 8.4% Unemployment Rate % Current: 4.1% Pre Crisis: 4.6% Current: As of 1/2018 Source: Bureau of Labor Statistics, STL FRB FRED

5 STATE UNEMPLOYMENT RATES 1Q Q 2017 (%) 12 Florida Georgia Tennessee Alabama Mississippi Louisiana 11.0 Unemployment Rate % Q Q Q Q Q Q Q Q Q Q Q Q 2017 U3 U6 Data 4Q/2017 Source: Bureau of Labor Statistics, STL FRB FRED

6 COMMERCIAL REAL ESTATE

7 OCCUPANCY RATES CURRENT VS. 20-YEAR AVERAGE (ATL, MIAMI, NASHVILLE, NATION) Source: AXIOMetrics, CBRE-EA, Risk Analysis Unit/Federal Reserve Bank of Atlanta

8 APARTMENT OCCUPANCY RATES Occupancy Range # of Markets 90% 25 90% to 92% 29 92% to 94% 75 94% to 96% % 106 Source: AXIOMetrics, Risk Analysis Unit/Federal Reserve Bank of Atlanta

9 ANNUAL EFFECTIVE RENT GROWTH ASKING RENTS & CONCESSIONS Rent Growth # of Markets 0% 54 0% to 2% 109 2% to 4% 112 4% to 6% 65 6% 48 Source: AXIOMetrics, Analysis Unit/Federal Reserve Bank of Atlanta

10 APARTMENT EFFECTIVE RENT GROWTH & OCCUPANCY COMBINED CHANGE Change Range # of Markets -3% 78-3% to 0% 115 0% to 2% 66 2% to 4% 52 4% 77 Source: AXIOMetrics, CBRE-EA, Mueller, Risk Analysis Unit/Federal Reserve Bank of Atlanta

11 NATIONAL NEW SUPPLY VS. LONG-TERM AVERAGE 20-YEAR AVERAGES VS. 2015, 2016, 2017 SUPPLY 75% Above Average 14% Above Average 7% Above Average 84% Below Average Source: CBRE EA, Risk Analysis Unit/Federal Reserve Bank of Atlanta

12 NEW SUPPLY VS. LONG-TERM AVERAGE CURRENT UNDER CONSTRUCTION VS. 20-YEAR AVERAGE Source: AXIOMetrics, CBRE-EA, Mueller, Risk Analysis Unit/Federal Reserve Bank of Atlanta

13 OUTLOOK High Rent Growth in Tight Market Multifamily Office Warehouse Retail Rents Rapidly Rise Toward New Const. New Construction Cost Feasible Long Term Average Occupancy Negative Rent Growth Below Inflation Rent Growth Downturn Recovery Upturn Mature Downturn Note: Depending upon economic conditions, indicators can remain stable or reverse Source: AXIOMetrics, CBRE-EA, CoStar, Federal Reserve, Mueller

14 CAPITAL & FINANCE

CRE TRANSACTION VOLUME Data: Q4 2017 Source: Real Capital

15 CRE TRANSACTION VOLUME Data: Q Source: Real Capital Analytics, Risk Analysis Unit/Federal Reserve Bank of Atlanta

16 NATIONAL CRE CAP RATES QUARTERLY AVERAGES % 9% 8.58% 8% Cap Rates % 7% 6.75% 6.72% 6.60% 6% 5% 5.62% 4% 10Q1 11Q1 12Q1 13Q1 14Q1 15Q1 16Q1 17Q1 Office Industrial Retail Apartment Hotel Yield 10 Yr T (10Q1: 3.83%, 174Q: 2.40% Data through 4Q 2017 Source: RCA, Federal Reserve Bank of Atlanta

17 NATIONAL CRE CAP RATES QUARTERLY AVERAGES % 9% 8.58% 8% Cap Rates % 7% 6% 5% Change Since Yr Treasury Yield -1.4% Apartment -1.2% Retail -1.5% Office -1.7% Industrial -1.4% Hotel 0.7% 6.75% 6.72% 6.60% 5.62% 4% 10Q1 11Q1 12Q1 13Q1 14Q1 15Q1 16Q1 17Q1 Office Industrial Retail Apartment Hotel Yield 10 Yr T (10Q1: 3.83%, 174Q: 2.40%) Data through 4Q 2017 Source: RCA, Federal Reserve Bank of Atlanta

18 CRE CAP RATES SPREAD ABOVE 10-YR TREASURY Basis Points Hotel 555 Ind. 434 Office 412 Retail 395 Apt Q1 02Q1 03Q1 04Q1 05Q1 06Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1 13Q1 14Q1 15Q1 16Q1 17Q1 Office Industrial Retail Apartment Hotel Yield 10 Yr T = 2.4% Data through 4Q 2017 Source: RCA, Federal Reserve Bank of Atlanta

19 CRE CAP RATES SPREAD ABOVE 10-YR TREASURY Basis Points Current vs. Average Apartment -3 Retail 25 Office 20 Industrial 1 Hotel Q1 02Q1 03Q1 04Q1 05Q1 06Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1 13Q1 14Q1 15Q1 16Q1 17Q1 Office Industrial Retail Apartment Hotel Hotel 555 Ind. 434 Office 412 Retail 395 Apt Yr T Yield = 2.4% Data through 4Q 2017 Source: RCA, Federal Reserve Bank of Atlanta

20 THE 2008 DOWNTURN

21 SHIFT HAPPENS

22 RISK Property Sector Overbuilding Greater Efficiency Amazon Affordability Higher Rents Increased Costs Cybersecurity Property Sector Capital Markets Capital Availability Heightened Value Levels Rising Cap Rates Reduced Regulatory Environment Current Prevailing Market Sentiment What Can Go Wrong Current LTV Environment Capital Markets

23 CURRENT LEVERAGE LEVELS A FALSE SENSE OF SECURITY? Market participants say: Average loan LTV = 58%. A low leverage environment equates to safety and what can go wrong. Current Future NOI $100,000 $100,000 Cap Rate 5.50% 7.00% Value $1,818,182 $1,428,571 ($389,610) 58% $1,054,545 $1,054,545 LTV Based on New Value 74% Current Future NOI $100,000 $100,000 Cap Rate 4.00% 5.50% Value $2,500,000 $1,818,182 ($681,818) 58% $1,450,000 $1,450,000 LTV Based on New Value 80% All else remaining equal, a 150 basis point increase in CRE Cap Rates moves the LTV upward notably in both scenarios. The implications may be greater for smaller markets

24 STRATEGIES TO MINIMIZE RISK Property Sector Enhanced Market Knowledge Greater Due Diligence Monitoring Changing Dynamics Actively Monitoring Concentrations Property Geography Tenant Property Sector Capital Markets Stress Testing Going-In & Exit Cap Rates Stress Testing LTVs Against Changing Property Values Asking What Can Go Wrong Capital Markets

Commercial Real Estate: 2007 déjà vu?

September 11, 2018 11:00AM to 12:00PM CST Commercial Real Estate: 2007 déjà vu? Options to Join Webinar and audio Click on the link: Session Link Connect to audio Call Using Computer (preferred method):