JANUARY 2018 R EAL E STATE C APITAL T RANSACTIONS

Transcription

1 C R E O U T L O O K JANUARY 2018 R EAL E STATE C APITAL T RANSACTIONS

2 2018 CRE OUTLOOK Historical and Projected Economic Indicators Economy HOUSTON SNAPSHOT U.S. SNAPSHOT Proj Proj Real GDP (3.0%) 1 1.5% 1 2.2% 2.2% Employment 0.5% 2 1.5% 1.0% - 2.2% 1.6% 3 1.4% 1.3% Energy Industry 5 (15.2) 14.6 Population % 0.7% Debt Availability Rate 6 6 Office Volume Pricing 75.4% 180.7% 9.6% 9.5% 12 bps 4 bps Retail Volume Pricing 53.3% 153.6% 11.0% 5.2% 19 bps 11 bps Hotel Volume Pricing 73.1% 28.7% 24.7% 4.0% 49 bps 28 bps 1 Gross Domestic Product by Metropolitan Area for 2017 will be released during September 2018 by the Bureau of Economic Analysis. National GDP growth for 2017 is annualized rate of growth realized during 3Q17. 2 Projected annualized seasonalized employment growth for the Houston MSA based on growth through October Projected annualized seasonalized employment growth for the U.S based on growth through November Average quarterly response from the Dallas Fed Energy Survey regarding employment (positive value indicates the net amount of respondents indicating they are hiring versus those laying off employees). 5 Population Estimates are released annually by the United States Census Bureau in March for the trailing twelve months of July of the prior year. 6 Pricing increased for short-term financing (one month LIBOR increased 74 bps year-to-date December 2017) but stayed flat for long-term financing (10-Year Treasury increased 3 bps year-to-date December).

3 2018 CRE OUTLOOK page 2 National Economy- Building off of a Strong 2017 The U.S. economy is projected to continue the momentum built in 2017 into 2018, resulting in anticipated Real GDP growth of 2.5%. Further expansion of the U.S. economy into 2018 is supported by a tightening U.S. labor market and increased growth internationally: U.S. unemployment rate has declined to 4.1% as of November 2017 lowest rate since YE The U.S. economy is projected to add 163,000 jobs per month in 2018 (1.3%). Wage growth has fluctuated around 3.3% since page 7 Debt: Attractive Debt Environment Into 2018 Commercial real estate debt will continue to remain widely available for all property types into 2018 with long-term financing, in particular, remaining at highly attractive interest rate levels. Commercial mortgage originations are on pace to increase in 2017 and are projected to maintain this level through Despite three increases in the federal funds rate during 2017 and likely two-to-three increases in 2018, long-term financing will remain at attractive levels as foreign demand for U.S. treasuries suppress long term rates. page 4 Houston Economy- Expansion Resumed Following the resumption of hiring in the energy industry during 4Q16, Houston s economy in 2017 is on pace to more than double the level of employment growth experienced in 2016: Houston is projected to continue 2017 momentum into 2018 projected employment growth of 40,900 (1.3%). Energy industry recovery is still in preliminary stages, a balanced global oil market (expected by June 2018) is required before Houston resumes a robust expansion. page 11 Equity: U.S. Volume Declining As Investors Increasingly Selective Investment volume for single-asset transactions declined markedly through the first three quarters of 2017 for Office and large format Retail; while Hotel volume experienced a slight increase. Declining investment volume is driven by increasingly selective investors (cycle is entering its eighth year) and sector specific concerns (uncertainty regarding sector specific trends in Retail and slowing RevPAR growth in Hospitality). Investment volume is expected to remain at 2017 levels in 2018 given continued macroeconomic growth, while pricing remains constrained due to stricter underwriting practices. Investment activity is projected to remain on par with 2017 levels as investors apply more scrutiny to underwriting given length of current cycle (eighth year). Sustained economic growth and tightening U.S. monetary policy continue to separate the United States economy from the other advanced economies of the World, leading to continued demand for core commercial real estate located in major markets and U.S. treasuries from foreign investors presenting an active equity and debt environment for commercial real estate in ALLIED ADVISORS 1

4 NATIONAL ECONOMIC OUTLOOK Accelerated Economic Growth National GDP growth gained momentum in 2017 with an expected growth rate of 2.2% for the year (assumed 4Q17 growth of 2.6%) up from a weaker 2016 increase of 1.6%. Reflective of improving conditions in the national economy, 2017 GDP growth was largely driven by: 1. A significant increase in gross investment (3.3% annual growth rate for first three quarters), 2. Exports expanded at an annual rate of 4.3% for the first three quarters outpacing import growth by 2.8 percentage points over the period longest streak in 3.5 years, and 3. Consumption expenditures are on pace to grow 2.5% in 2017 (0.2 percentage points above the compound annual rate for the period ). U.S. GDP is projected to expand by 2.5% in 2018 as global growth continues to strengthen IMF forecasts global growth to reach 3.7% in 2018 (compared to 3.6% in 2017). National GDP Growth Real GDP Growth (%) (1.0) (2.0) Real GDP Growth Real GDP Growth Proj. Annual Average Sources: U.S. Bureau of Economic Analysis and Survey of Professional Forecasters. Tightening Labor Market The current unemployment rate of 4.1% (as of November) is the lowest rate since December 2000 (3.9%) and is forecasted to constrict further to 4.0% by 4Q18. Employment for 2018 is anticipated to expand at an average of 163,400 per month, slightly less than the 178,000 average gain per month expected for this slight decrease in 2018 is typical of a labor market approaching full employment. Employment vs. Unemployment Rate Unemployment Rate (%) Proj. Unemployment Rate Employment Source: U.S. Bureau of Labor Statistics 4Q Proj. Projected Avg. Monthly Empl. Inc. (Thousands) Hurricanes Harvey and Irma had a one-time negative shock to employment growth in September dropping employment growth to 38,000 for the month. This effect on employment was temporary as growth in October and November have already recovered 90.8% of September s delta to average monthly growth. The National economy can be reasonably expected to experience a faster pace of growth over the short-term due to an increase in employment tied to areas impacted by hurricanes (e.g. construction jobs). The U.S. economy expanded at a moderate pace in 2017 and is positioned to experience growth at a similar, if not better, rate in A depreciating Dollar and a strengthening global economy is expected to boost exports, while increased domestic demand will be driven by corporate investment and a tightening labor market that is experiencing historically low unemployment. Further, business-friendly tax reform will provide companies with more capital for investment and make them more competitive internationally favorably positioning the U.S. economy in ALLIED ADVISORS

5 2018 CRE OUTLOOK NATIONAL ECONOMIC OUTLOOK Wage Growth The three-month moving average of median wage growth was 3.4% in October, continuing its pattern of hovering around 3.3% since Though an improvement from the initial years of the recession, the hovering pattern remains slightly below the long-term average wage growth of 3.6%. Historical Wage Growth Three-Month Moving Avg. (%) Wage Growth LT Average (since 1997) Wage growth can be expected to increase in 2018 as the labor market continues to tighten and progress toward full employment. Tax Reform The current tax reform bills in both the Senate and House have the potential to provide a boost to the U.S. economy in 2018 by creating a more favorable tax environment for businesses through lowering the corporate and pass-through tax rates. These tax reforms are expected to make U.S. firms more competitive internationally and free up additional capital for investment and employment. Source: Federal Reserve Bank of Atlanta National Economy Performance Indicators 1 Data Since March 1994 December 2016 November 2017 maximum (outer ring) minimum (inner ring) median (middle ring) Flows Job finding rate Payroll employment Private job openings rate Em ployer B ehavior Initial claims (percent of labor force) Private hires rate Average hourly earnings growth Hiring plans Wa ge s Employment Cost Index growth Job availability Work part-time for economic reasons (percent of labor force) Private quits rate Utiliza tion Marginally attached workers (percent of labor force) Employmentpopulation ratio, ages Unemployment rate Firms unable to fill job openings C onfide nc e /Pe rc e ptions 1 The labor Market Distributions Spider Chart monitors labor market developments by comparing current conditions to past time periods. Indicators are rank-ordered over a fixed sample period (uses data since March 1994) and assigned to the value of their cumulative distribution function. The inner ring represents the minimum of zero and the outer ring represents the maximum of 100. The three dashed rings represent the 25 th, 50 th, and 75 th percentiles of the distributions, respectively. Source: Federal Reserve Bank of Atlanta ALLIED ADVISORS 3

6 HOUSTON ECONOMIC OUTLOOK Major National Economic Hub Illustrative of the underlying strength of the Houston economy, the Houston MSA benefited from the second largest population increase in the nation in 2016, adding125,005 individuals (1.9%) resulting in nation-leading population growth of 824,296 (12.2% increase) residents between 2010 and % of Houston s population increase since 2010 (50.5% in 2016) has been from net in-migration (international and domestic), illustrating Houston s continued attractiveness as a major economic hub in the United States. Houston Population Growth Annual Increase in Population 200, ,879 (2.6%) 159,419 (2.5%) 143,350 (2.3%) 150, ,005 (1.9%) 100,000 50, Natural Inc. Net Intl. Migration Net Domestic Migration Source: U.S. Census Bureau Houston is projected to add between one million and two million residents per decade between 2010 and 2050 based on the Greater Houston Partnerships April 2017 projections. Employment Growth Into 2018 The Houston MSA added 37,000 jobs year-to-date October 2017 (1.2% increase) and 47,700 jobs over the trailing twelve months (1.6% increase). This increase in employment comes after a 16,000 (0.5%) increase in 2016 Houston experienced only one calendar year of negative employment (in 2015), losing just 800 jobs (0.03% decline). Hurricane Harvey is expected to provide a short-term increase in employment due to increased construction the hurricane, itself, was only a one-time temporary shock to employment in September that was largely accounted for by growth in October (Houston lost 20,100 jobs in September but gained 27,300 jobs in October on seasonalized basis). The Bauer Institute for Regional Forecasting projects Houston employment to expand by 40,900 (1.3% increase) in 2018 with a range between 65,800 (2.2%) to 30,300 (1.0%). This projection is dependent on where WTI oil prices stabilize at in 2018 ($55.00 per barrel before moving to $ $65.00 per barrel for the high scenario and $45.00 per barrel for the low scenario). Growth of one million residents per decade is based on Houston maintaining annual net migration of just half of its pace in addition to the metro s natural increase (births minus deaths), providing a conservative long-term estimate. Houston s diverse economic base allowed Houston to maintain net economic growth between 2015 and 2016 (gaining 15,200 jobs over the period), despite the ongoing low oil price (since 1Q15). Through October 2017, Houston is progressing towards normalized growth (approximately 60,000 jobs per year) and the city is well positioned to continue this growth through 2018 following rising confidence and hiring within the energy industry in ALLIED ADVISORS

7 2018 CRE OUTLOOK HOUSTON ECONOMIC OUTLOOK Houston Employment Since 2016 Nonfarm Employment (Millions) Q16 2Q16. 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Source: U.S. Bureau of Labor Statistics TTM +/- TTM Proj. Excl. Harvey Employment Emp. Proj. Excl. Harvey Diverse Economic Base While Energy (including natural gas, petrochemicals, refining, transmission, and alternative energy) is Houston s most recognizable industry, Houston s economy is supported by multiple major industries as illustrated by resilient growth during a sustained period of low oil prices. Health Care - Led by the world renowned Texas Medical Center ( TMC ) and expansive population growth, employment in health care and social assistance sector has increased 3.2% over the trailing twelve months October times the national average in the sector. TMC s planned 30-acre TMC3 campus will further position Houston as a leader in medical research (estimated to have a $5.2 billion impact on the City). Port of Houston - Houston was second in the Nation in 2016 in exports, exporting $84.1 billion in goods and is currently undergoing a $700 million modernization program. Houston previously led the nation in exports between 2012 and 2015 prior to the decline in the price of oil late TTM +/- (Thousands) Energy Industry Hiring Again The energy sector continued to experience increased business activity and employment through 3Q17 following an initial resumption of hiring during 4Q16, per the Dallas Fed Energy Survey. Business activity has increased for all firms (Production and Support Services) for six straight quarters indicating a modest but strengthening ongoing recovery within the sector. Energy company outlook increased during 3Q17 simultaneous to declining uncertainty uncertainty index declined from 35.0 to 4.9 signaling growing confidence regarding improving business conditions. Basic 2 vs. Non-Basic 2 Houston Employment 3 Oct TTM Index (Jan = 1.0) Basic Non-Basic Basic - Energy 1 Index represents the net positive and negative responses from survey participants. 2 NAICS Employment Industry Supersectors and Sectors: Basic includes Mining and Logging, Manufacturing, Wholesale Trade, Construction, and Professional and Business Services; Non-Basic includes Retail Trade, Transportation and Utilities, Information, Financial Activities, Education and Health Services, Leisure and Hospitality, Other Services, and Government; Basic - Energy includes a subset of Industry Supersectors with a high exposure to the energy industry: Mining and Logging and Manufacturing. 3 Not seasonalized. Source: U.S. Bureau of Labor Statistics ALLIED ADVISORS 5

8 HOUSTON ECONOMIC OUTLOOK 2018 CRE OUTLOOK Nascent Energy Recovery Reflecting increasing confidence within the energy sector, employment within Houston s base industries directly tied to energy increased 4.1% for the trailing twelve months October 2017, but is 16.3% below peak employment experienced during December West Texas Intermediate ( WTI ) has increased 6.5% year-todate December 2017 to $57.22 per barrel, but the market for oil is not expected to balance until YE 2018 per OPEC s official summit in November 2017 (OPEC extended their output reduction agreement through YE 2018 as a result). However, U.S. oil production (U.S. is now a swing producer) is one of the largest threats to a balanced global oil market in 2018 U.S. oil producers increased production in September in response to WTI at the highest level since April Based on futures prices, the price for WTI is expected to fluctuate around $55.50 per barrel through Given U.S. Shale has an estimated break-even cost of between $30.00 to $50.00 per barrel in 2017, this is a level supportive of continued employment growth in Houston in 2018 but with a more robust recovery following a balanced oil market. Exceptional GDP Growth... Houston s economy has historically outperformed the national average Houston s GDP increased 3.1% annually between 2002 and 2016 (2.2 times the gateway market average of 1.7%). Houston continues to outperform the nation in GDP growth over the current cycle (since 2010), with annual average GDP growth of 2.9% versus the gateway market average of 1.9%....And Employment Growth Houston leads the gateway markets in employment growth since 2006, with an employment index of 1.25 as of October 2017 compared to a value of just 1.10 for gateway markets. Over the same period, Houston employment increased by 611,600, second among gateway markets only behind New York which gained 967,800 (yet the market is three times larger). Houston s growth is extraordinary when oil is doing well and flat to near average when oil prices are depressed allowing for nation-leading, longterm growth. Houston vs. Gateway Real GDP Houston vs. New York Employment Real GDP (% Change) 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% Real GDP Index (2002) Employment Change (,000) Employment Index Houston % Chg Houston Index Gateway % Chg Gateway Index New York Change Houston Change Gateway Index New York Index Houston Index Source: U.S. Bureau of Economic Analysis and U.S. Bureau of Labor Statistics. Source: U.S. Bureau of Labor Statistics. 6 ALLIED ADVISORS

9 CRE DEBT MARKET OUTLOOK 2017 Attractive/Robust Debt Market Commercial mortgage origination is on pace through October 2017 to increase by 5.0% by year-end per the Mortgage Bankers Association ( MBA ) and is projected to remain at this level through Per the Federal Reserve s September 2017 data release, commercial real estate mortgage holdings of Banks and Insurance companies increased 4.5% and 6.8%, respectively, year-to-date 3Q17. Despite uncertainty around Dodd-Frank s implementation, CMBS issuance eclipsed 2016 volume of $70.0 million in October 2017 and is on pace to end 2017 near $90.0 million, per KBRA. Continued Low-Interest Rate Environment 2018 will continue to provide an attractive debt market for long-term fixed-rate financing as market conditions continue to restrain yield appreciation in long-term U.S. Treasuries despite two-to-three increases in the Federal Funds rate in Long-term U.S. Treasuries can be expected to rise only bps throughout There is a 56.1% chance the Federal Open Market Committee will increase the federal funds rate during their March 2018 meeting per CME Group. The impact of monetary policy to-date has had a disparate impact on short-term versus long-term financing. 10-Yr/2-Yr UST Spread vs. Eff. Fed Funds Rate 10-Yr UST - 2-Yr UST Spread Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 10-Yr UST - 2-Yr UST Effective Federal Funds Rate Source: Federal Reserve Bank of St. Louis One-Month LIBOR increased 74 bps year-to-date December 2017 while 10-Year U.S. Treasuries have increased 3 bps year-todate December The limited increase in 10-Year U.S. Treasuries is due to flattening of the Yield Curve: the Spread between the 10-Year and 2-Year U.S. Treasury has declined to 62 bps as of December 20, 2017, the lowest level since October The flattening of the Yield Curve is a product of increased demand for long-term U.S. Treasuries partially due to depressed yields in competing foreign bonds the spread between 10- Year German Bonds and U.S. Treasury Bonds currently stands at 204 bps as of December 20, Effective Federal Funds Rate Only a 32.2% chance that there will be only one increase in the federal funds rate in 2018, per CME Group. ALLIED ADVISORS 7

10 CRE DEBT MARKET OUTLOOK 2018 CRE OUTLOOK Moving Away from LIBOR Floating rate loans in the United States will be priced using the Broad Treasury Financing Rate ( BTFR ) benchmark instead of the London Interbank Offered Rates ( LIBOR ) benchmark starting in The change away from LIBOR can be expected to have a minimal impact on commercial real estate financing both in the short-term and long-term. The BTFR will be enacted by the Alternative Reference Rate Committee in 2018 (established by the Federal Reserve System in November 2014) and then monitored for three years ensuring a smooth transition. A majority of existing commercial real estate loans utilizing LIBOR will have matured (generally three-to-five year loan terms) before the change goes into effect and loans originated today utilizing LIBOR incorporate language to manage the transition to BTFR if the loan term crosses into 2022 clauses in loan documents dealing with the change should be scrutinized now to limit uncertainty. Projected Federal Funds Rate Following 2018 FOMC Meetings Probability of Federal Funds Rate 60% 50% 40% 30% 20% 10% 97.9% 0% Jan-18 Mar-18 May-18 Jun-18 Aug-18 Sep-18 Nov-18 Dec Source: CME Group The Commercial Real Estate Debt market will remain highly active in 2018 with continued availability of debt (fixed and floating) available from all debt providers while long-term rates in particular remain at highly attractive levels. Despite the beginning of 2017 being clouded by the implementation of Dodd-Frank, commercial mortgage issuance increased in 2017 across all debt sources. 8 ALLIED ADVISORS

11 2018 CRE OUTLOOK CRE DEBT MARKET OUTLOOK Debt Capital Availability 2018 Banks REITs CMBS Insurance Non-bank Inst Mezzanine Source: PWC Emerging Trends in Real Estate United States and Canada Debt issuance Outlook Debt will remain readily available for all property types and from all debt sources PWC s Emerging Trends in Real Estate survey indicates all debt capital sources to be at least as active in 2018 as in Long-term interest rates in particular will remain at attractive levels with limited potential to rise markedly during the first half of 2018 the December federal funds increase was already priced into U.S. Treasury yields and foreign demand for U.S. Treasuries mitigates future increases over the short-term, providing a highly attractive market for refinancing. Lender Activity going into 2018 CMBS Actively seeking all property types. Preference for LTV s 65.0% or lower but can go up to 75.0% dependent upon transaction. Half-term I/O available at 65.0% LTV depending on sponsor/property type/credit, with full-term available at lower leverage level. Pricing for full-leverage at 10-Yr Swaps Lenders particularly aggressive at sub-60.0% LTV s (both I/O and rate). Life Company Active on all property types, with varying activity for hotels (primarily full-service in top markets). Current spreads for 10/30 loan vary between depending on leverage (50.0% to 65.0%) and asset class. National/Intl s Bank Active on all property types. Pricing at L (sponsor specific) dependent on property type and market. Pricing for regional banks approximately 50 bps wider. Partial I/O available (12-18 months on a 3-1-1). Debt Fund Active on all property types. Pricing 350 to 550 spreads depending on property type and leverage/structure. Max LTV to 75.0%, potential to stretch to 80.0% depending on transaction and willingness to add mezzanine. Full-term I/O available. ALLIED ADVISORS 9

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13 TOP INVESTMENT MARKETS Investor focus is increasingly deal driven rather than market driven as frothy pricing in historically hot markets Broader National Investment Focus Investment focus in 2018 is trending to larger secondary markets, per PWC s Emerging Trends in Real Estate 2018 survey. The top seven ranked investment markets are secondary markets. Major markets rank lower in the investment list Los Angeles (8), Boston (9), D.C. (26), San Francisco (28), Chicago (35), and Manhattan (37). This shift has led to a diversifying investment strategy stretching broadly across market tiers, resulting in a clustered investment focus. The delta between the top ranked market and the 40th ranked market for 2018 is just 0.5 points, compared to the long-term average of a 1.28-point spread (see graph below). Investment Outlook Top Market vs 40th Market force investors to constrain investment parameters '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 Top Market Score 40th Market Score Source: PWC Emerging Trends in Real Estate United States and Canada 2018 This cluster insinuates not only a broader investment focus, but also implies that there is less of a consensus among investors of market movement and therefore which markets deserve more focus investors are focusing on the asset rather than the market. ALLIED ADVISORS 11

14 NATIONAL OFFICE MARKET Declining Volumes Chasing Yield... CBD transaction volume declined 16.1% during the first three quarters of 2017 to its lowest level since 2013 declining 35.4% and 40.7% during 2Q17 and 3Q17, respectively. CBD office buildings currently enjoy a price level 33.8% above prior-peak pricing experienced during December 2007, per RCA s Commercial Property Price Index ( CPPI ). Office Transactions CBD Vs. Suburban Volume ($B) Q YTD Volume - CBD Cap. - CBD Source: Real Capital Analytics Q YTD 8% 7% 6% 5% 4% Volume - Suburban Cap. - Suburban Alternatively, suburban office transaction volume increased 3.7% during the first three quarters of 2017 (increasing 8.8% and 11.1% during 2Q17 and 3Q17, respectively). Overall transaction volume is down 13.9% and 3.4% in major and non-major investment markets, respectively, through the first three quarters of Eight of the top ten non-major investment markets in 2016 have collectively recorded a 22.7% decline in volume. Avg. Cap. Rate Office Transactions Major Vs. Non-Major Market Volume ($B) Q YTD Volume - Major Cap. - Major Source: Real Capital Analytics Q YTD 8% 7% 6% 5% 4% Volume - Non-Major Cap. Non-Major...While Pricing remains Robust Despite the decline in investment volumes, pricing for U.S. office properties has remained strong. The average capitalization rate for an office building has increased marginally (4 bps) to 6.5% in 2017 indicative of a flight to quality. CBD office buildings continue to price at a 5.5% capitalization rate on average in 2017, the same level paid in Office Operating Fundamentals Square Feet (Billions) % 2.0% 1.8% 1.5% Net Absorption Completions Eff. Rental Rate Inc. Avg. Cap. Rate % Increase Source: REIS Typical of an extended market cycle and a sustained low-capitalization rate environment (due in part to increased foreign interest), the National Office Market experienced declining investment volume through the first three quarters of 2017 the first three-quarter decline since can expect to experience similar transaction volumes as investors continue to implement stricter underwriting through the current cycle; the only respite being the tax reform legislation, which can be expected to free up additional capital and boost the attractiveness of U.S. office properties heading into ALLIED ADVISORS

15 2018 CRE OUTLOOK NATIONAL OFFICE MARKET Foreign Influence Increasing / Flight to Quality Boasting an expanding economy and a liquid investment market, foreign investors continue to heavily invest in the U.S. office market, with an emphasis on CBD submarkets 77.6% of foreign investment in U.S. office buildings ($10.0 billion) are located in CBD submarkets. For the first time over the current cycle (since 2011), foreign investors are the leading investor type in CBD office building transactions year-todate 2017, resulting in net acquisitions of $5.3B for foreign investors and net dispositions of $4.9B for institutional investors. Foreign investors have increased investment in suburban submarkets in 2017 through third quarter (net acquisitions of $1.5B versus $0.7B in all of 2016) but still account for only a fraction of suburban transactions (13.0% of total). REIT s have aggressively pursued CBD office properties located in major markets in 2017, making net acquisitions of $1.0B versus net dispositions of major market and non-major market suburban office buildings will be an attractive market for investors to dispose of core office properties; however, stricter underwriting due to the current timing of the cycle and rising interest rates will limit additional compression in capitalization rates. Office Investor Appetite Transactions Greater than $15 Million OFFICE TRANSACTIONS REIT Private Other 25.8% 5.6% 28.0% 7.0% 22.0% 24.0% 8.8% 7.0% 33.0% International MAJOR METROS YTD 2017 YTD 2017 YTD % Institutional SUBURBAN CBD 5-Yr Average (Outer Circle) 2017 (Inner Circle) 2017 YTD Source: Real Capital Analytics International Institutional REIT/Public Private $5B $10B $15B $20B $25B $30B $35B NON-MAJOR METROS ALLIED ADVISORS 13

16 HOUSTON OFFICE MARKET 2017 Availability Sublease to Direct The Houston office market is in the midst of rebalancing following corporate restructurings and the delivery of 16.7 million square feet of office space since 2014 across Houston s major submarkets. Houston s major submarkets added 1.7 million square feet of available office space year-to-date November 2017 (4.0% increase). Available sublease space declined significantly in 2017 (down 1.7 million square feet for the year, a 16.8% decline), partially due to the conversion of existing sublease space to direct availability direct available square footage has increased by 3.4 million square feet for the year (10.6%). Houston Class A & B Office Fundamentals Avg. Rental Rate PSF $25 $23 $20 $18 $15 $13 $ Source: CoStar Class A Rental Rate Class A Occ. Class B Rental Rate Class B Occ. 91% 88% 86% 83% 81% 78% Houston s major submarkets have experienced a collective negative net absorption of 3.0 million square feet through November All eight of Houston s major submarkets have experienced negative net absorption in 2017 the CBD submarket accounts for 53.0% of Houston s cumulative negative net absorption. Avg. Occupancy 2018 Market Fundamentals Projection The Houston office market is projected to experience annual effective rental rate growth of 1.3% between 2018 and 2021 (0.6 percentage points below the national average of 1.9%) illustrative of the lingering impact the low oil price environment will have on the office market through the short term. Houston Office Fundamental Projections Square Feet (Millions) Source: REIS % 1.4% 1.2% 1.0% 0.8% Net Absorption Deliveries Effective Rental Rate % Inc. Investment Building Momentum in 2017 Following the Houston market recording its lowest transaction volume in multi-tenant office (valued greater than $10.0 million) since 2009 in 2016 ($253.0M), transaction volume through 3Q17 has already surpassed 2016 volume by 51.7%. Though 2017 showed signs of improvement, single-asset, multi-tenant office transaction volume (19 transactions) remains constrained due to the still nascent recovery in Houston office fundamentals 3Q17 trailing twelve month transaction volume remains 71.7% below the trailing twelve months 4Q14. Only ten transactions closed in 2017 involved an office building valued greater than $20.0 million. % Increase 14 ALLIED ADVISORS

17 2018 CRE OUTLOOK HOUSTON OFFICE MARKET CBD 2.3MSF / 7.9MSF 2.3MSF / 6.4MSF 2.4MSF ENERGY CORRIDOR 2.3MSF / 6.9MSF 3.1MSF / 6.6MSF 5.3MSF GALLERIA 0.9MSF / 4.6MSF 1.3MSF / 4.2MSF 1.3MSF WOODLANDS 0.3MSF / 2.2MSF 0.4MSF / 2.5MSF 4.5MSF WESTCHASE 1.4MSF / 3.9MSF 1.4MSF / 3.4MSF 1.7MSF GREENSPOINT 0.0MSF 1.0MSF / 5.4MSF GREENWAY PLAZA 0.2MSF / 2.0MSF 0.3MSF / 2.3MSF 1.1MSF WEST BELT 0.4MSF / 1.7MSF 0.5MSF / 1.1MSF 1.9MSF 47.0MSF (16.9%) 36.9MSF (13.3%) 24.1MSF (8.7%) 19.2MSF (6.9%) 17.7MSF (6.3%) 12.0MSF (4.3%) 0.7MSF / 6.1MSF 11.3MSF (4.1%) 6.5MSF (2.4%) Houston Office Transaction Volume 1 Volume ($B) QYTD Volume # of Transactions QYTD 1 Transactions statistics for multi-tenant office buildings valued more than $10 million. Source: Real Capital Analytics While single-asset, multi-tenant Houston office transaction volume remains low, institutional and international capital remains bullish on the Houston market as evidenced by multiple large acquisitions: Brookfield Asset Management acquired the 4.2M square foot Houston Center portfolio for $895.0M ($208 per square foot) in September 2017 and will execute a large scale renovation plan for the assets. With this acquisition, Brookfield Asset Management owns 28.4% of downtown Houston s Class A inventory by square footage # of Transactions 0% 20% 40% 60% 80% 100% Percent of Submarket Inventory Inventory SF (% of MSA) Avail. SF Sublet Avail. SF Direct As of 4Q 2016 Deliveries Since 2014 & U/C Occupancy As of 4Q 2016 Past Occ. Peak Source: Real Capital Analytics The Canadian Pension Plan Investment Board ( CPPIB ) and a joint venture between TH Real Estate and Silverpeak Real Estate each acquired a separate 24.5% interest in Greenway Plaza and Phoenix Tower in April 2017 valuing the properties at $1.1B ($210/SF). CPPIB followed this investment by acquiring Parkway Inc. (a Houston REIT owning 8.7M square feet of Class A Houston office) for $1.2B ($23.05/Share) in September 2017 (announced acquisition plans in June). While Houston has experienced rising employment (both overall and within the energy sector) through 2017, improvement in the office market fundamentals has lagged. Due in part to sizeable completions since 2014, available square footage in Houston s top submarkets increased 4.0% in Single-asset investment in Houston s office market remains at depressed levels as a result of the available square footage glut, but institutional capital is confident is Houston s long-term prospects as evidenced by their considerable acquisitions in Continued employment growth through 2018 will result in improving office market fundamentals and an improved capital market environment. ALLIED ADVISORS 15

18 NATIONAL RETAIL MARKET Softening Investment Market Transaction volume for single-asset shopping centers valued between $10.0M to $1.0B declined 5.2% year-to-date 3Q17 as activity softened investment volume peaked in 1Q16. Pullback from investors is evident in both major and non-major markets: Investors have adopted a flight-to-quality in major markets with pricing increasing in 2017 (average capitalization rate decreased 14 bps to 5.9%) as volume declined 8.1% year-todate 3Q17 and is 32.7% lower than peak volume during 4Q15. Transaction volume in non-major markets declined 2.8% yearto-date 3Q17 (11.8% lower than peak volume during 2Q16), but the average capitalization rate increased by 26 bps. Retail Transactions Major Vs. Non-Major Markets Volume ($B) Q16 YTD 3Q17 YTD Volume - Major Mkt Cap. - Major Mkt Source: Real Capital Analytics 8% 7% 6% 5% Volume - Non-Major Mkt Cap. - Non-Major Mkt Avg. Cap. Rate Retail Operating Fundamentals Square Feet (Millions) Source: REIS % 2.0% 1.5% 1.0% 0.5% 0.0% Net Absorption Completions Eff. Rental Rate Inc. Investor Pool Switching Reflective of a softening investment market, private investors have increasingly accounted for a greater share of investments (53.0% in 2015 to 58.0% in 2017) while institutional investors and REITs have become more conservative. Institutional investors significantly pulled back on acquisitions in major markets in 2017 (31.0% market share in 2016 to 17.0% in 2017), as REITs increased acquisitions in major markets with 2017 surpassing 2016 acquisition volume by 24.5%. Sector Uncertainty Affecting Investment Softening capital market environment for retail is partially a product of timing of the current cycle (increased conservatism later in a cycle), but is also reflective of a sector facing uncertainty and overwhelmed with bad news over the past year. % Increase The National Retail Market has continued to experience a weakening capital market environment into 2017 with transaction activity among single-asset transactions declining for the second year in a row. More so than other property types, retail has been negatively impacted and will continue to be through 2018, by increased conservatism among investors as the sector deals with continued uncertainty from a changing retail environment (online shopping and increasing preference towards smaller retail formats) in addition to a maturing market cycle. 16 ALLIED ADVISORS

19 2018 CRE OUTLOOK NATIONAL RETAIL MARKET Retailers have announced 6,879 store closings year-to-date November 2017, an increase of 224.0% over the same period This is the highest recorded number of store closings since at least 2000, previous record was 6,163 retail store closures in However, retailers have announced 3,422 store openings yearto-date November 2017, an increase of 49.0% over the same period An increase in both store closings and openings is illustrative of a sector retooling to adapt to a changing retail landscape (smaller footprints/more experiential retail). Challenges remain into 2018 Of the six retail formats in PWC s Emerging Trends in Real Estate 2018 survey, only Urban/High-Street Retail received a net buy response, indicating a continuing trend to urban/smaller format retail. The capital market environment for the retail sector is expected to remain soft, if not soften further, as investor sentiment continues to weaken survey respondents rated investment prospects for all six retail formats to decline in Real Buy/Hold/Sell Recommendations Urban/High-Street Neighborhood/Community Lifestyle Outlet Power Centers Regional Mall -70.0% -50.0% -30.0% -10.0% 10.0% 30.0% Net Sell/Buy Response Source: PWC Emerging Trends in Real Estate United States and Canada 2018 Retail Investor Appetite Transactions Greater than $15 Million 46.6% Private 52.0% 16.4% REIT Other 1.6% 2.0% 9.0% 9.0% International 22.0% 26.4% 15.0% 5-Yr Average (Outer Circle) 2017 (Inner Circle) Institutional RETAIL TRANSACTIONS > $15M, <$1B SMALL FORMAT MAJOR METROS YTD LARGE FORMAT 2017 YTD 2017 YTD 2017 YTD Source: Real Capital Analytics International Institutional REIT/Public Private $1B $2B $4B $6B $8B $10B $12B NON-MAJOR METROS ALLIED ADVISORS 17

20 HOUSTON RETAIL MARKET Significant Momentum Houston Shopping Center Hist. Performance 2.9 million square feet of shopping centers have delivered in 2017 and the current construction pipeline consists of just 1.1 million square feet, the lowest since 4Q12. Houston s shopping center construction pipeline peaked 2Q16 at 3.5 million square feet but Houston has successfully absorbed the deliveries with occupancy increasing to 93.2%, marking the highest level over the current cycle (since 2010). Square Feet (Million) YTD Nov Net Absorption Rental Rate % Chg. Deliveries Vacancy Rate 10% 5% 0% -5% Rental Rate % % Chg./ Vacancy Rate Houston shopping centers have registered a positive net absorption of 2.3 million square feet year-to-date November 2017, registering seven straight quarters of positive net absorption. Of the 1.1 million square feet of shopping center developments under construction, 64.7% is pre-leased. Houston area rental rates are projected to increase annually at a compound annual growth rate of 2.2% through 2021 per REIS, 0.5 percentage points higher than the national average of 1.7%. Driving these tightening retail metrics is Houston s robust population growth since 2010 Houston s population expanded by 13.9%, while the retail market only experienced a 5.7% increase of square footage over the same period. Source: CoStar Houston Retail Fundamental Projections Square Feet (Thousands) Source: REIS % 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Net Absorption Deliveries Effective Rental Rate % Inc Performance by Property Type 15.0% 10.0% 5.0% % Increase 0.0% -5.0% -42.9% -10.0% Vacancy Rate Rental Rate % Inc. Deliv. % of Category Source: CoStar 18 ALLIED ADVISORS

21 2018 CRE OUTLOOK HOUSTON RETAIL MARKET Increased Investment Investment in individual Houston shopping centers increased 136.4% to $704.1M for the trailing four quarters 3Q17. The increase in investment was driven by two trophy, mixeduse lifestyle centers located in highly desirable Houston submarkets with sizeable office portions totaling $317.5M (45.1% of the trailing four quarter investment volume): LaCenterra at Cinco Ranch A 412,000-square foot Class A mixed-use lifestyle center in Katy, Texas (273,522 square feet of retail and 139,378 square feet of office) acquired by PGIM Real Estate on behalf of institutional investors in September for $159.5M at a 5.5% capitalization rate. BLVD Place A 216,944-square foot Class A mixed-use lifestyle center in Houston s Galleria submarket (48,500 square feet of retail, a Whole Foods grocery store, and 168,444-square feet of office) acquired by Whitestone REIT in May for $158.0M (initial capitalization rate of 6.2%). Transaction included a 1.4 acre development parcel for a future retail/office development. These two transactions highlight the larger national trend towards high-density/mixed-use retail development. Excluding these two trophy, mixed-use retail transactions, investment in single-asset Houston shopping centers through the first three quarters of 2017 is still up 33.3% for the year and is 6.6% higher than 4Q16 (lowest recorded four-quarter investment period since 3Q11) signaling increased interest in the high performance of Houston retail. Houston Retail Transactions Transactions Greater than $15 Million $ $/SF $700 $600 $500 $400 $300 $200 $100 $0 Feb-13 Jul-14 Nov-15 Apr-17 Source: Real Capital Analytics Volume ($B) QYTD Volume # of Transactions QYTD # of Transactions The Houston Retail Market is better positioned than most to offset the changing retail landscape, due primarily to its dramatic population growth Houston s population growth rate has outpaced the retail delivery rate by a factor of 2.4 since Robust net absorption through November 2017, coupled with an improving regional economy, and improving energy industry since 4Q16 has resulted in increased investment focus in stabilized Houston shopping centers in Houston s retail sector is well positioned for further expansion and increased investor appetite in 2018 as Houston records further employment and population growth. ALLIED ADVISORS 19

22 HOTEL MARKET OVERVIEW 2018: Record Growth to Modest Growth Registering its eighth straight year of RevPAR growth, inflation adjusted RevPAR ( Real RevPAR ) is projected to increase 2.6% in 2017 as of November. Typical of this stage of the current cycle, hotel fundamental growth has slowed but the sector is projected to continue expansion at a healthy pace over the immediate future. Midscale and Economy hotels are projected to experience the largest increase in RevPAR in 2017 (3.5% each) and are projected to repeat this performance in 2018, expanding a further 3.8% and 3.2%, respectively the only two chain scales to exceed 3.0% RevPAR growth in 2017 (largely due to the increase in supply in the other chain scales). National Hotel Historical Fundamentals Hotel demand has outpaced new supply considerably between 2009 and 2016, with hotel demand (rooms sold) increasing by 27.3% and supply increasing by 6.1%. Supply growth is projected to nearly match demand growth in 2018 (1.9% versus 2.1%). This favorable demand/supply balance is projected to increase occupancy to 65.9% in 2018 the highest level since % Increase 7% 6% 5% 4% 3% 2% 1% 0% Proj Proj. 67% 65% 63% 61% 59% 57% ADR Occupancy RevPAR Occupancy Occupancy A result of record occupancy levels, 2018 room starts are projected to be at their highest levels since 2007 (139,200 rooms) answering a lack of new supply over the current cycle to meet increased demand and replace obsolete inventory. Counter to the national trend, Houston s hotel pipeline as of October 2017 (4,475 rooms under construction) is 22.1% lower than the prior year due, in part, to Houston entering the current cycle before the Nation. ADR is projected to increase 2.2% in 2018 (variance of 2.0% to 2.5% based on chain scale) and will be the main driver behind RevPAR growth through the remainder of the current cycle. Source: PWC Hospitality Directions National Hotel Supply Vs. Demand % Increase 5% 4% 3% 2% 1% 0% Proj Proj. 67% 65% 63% 61% 59% 57% Demand Growth Supply Growth Net Occupancy Occupancy Source: PWC Hospitality Directions The National Hotel Market continued to push record occupancy levels in 2017 as the sector enjoyed healthy demand growth for the eighth year in a row. RevPAR growth has begun to moderate in 2017 (dropping below 3.0% for the first time since 2009) as it is beginning to be solely driven by ADR as supply growth is projected to reach its highest level over the current cycle in The moderation of operating metric growth and timing of the current cycle has led to a price correction in Hotels nationally as investors apply stricter underwriting standards to hotel investments since the hospitality sector is the first to be impacted by softening market fundamentals (effectively operate with one day leases). 20 ALLIED ADVISORS

23 2018 CRE OUTLOOK HOTEL MARKET OVERVIEW Softening Investment Market Transaction volume for individual hotels is up 0.8% through the first three quarters of 2017 compared to 2016, but investment activity for the trailing four quarters remains 14.9% below current cycle peak during 2Q15. Investment shifted towards non-major markets in 2017 (as of 3Q17), with investment in single-asset volume increasing 9.8%. Conversely, investment volume declined 14.2% in major markets. In addition to declining investment activity, pricing has weakened in 2017, with the average capitalization rate for yearto-date 3Q17 registering 24.8 bps higher than the same period in Pricing increased the most for hotels in major markets, where the average capitalization rate increased 32.2 bps versus only a 15.5 bps increase in non-major markets. REIT s experienced the largest increase in acquisitions across capital sources through year-to-date 3Q17, already surpassing 2016 year end activity by 58.3%, but similar to the overall market, activity is still 46.7% below current cycle peak in Increased activity from REIT s has predominantly targeted nonmajor markets, where volume year-to-date 3Q17 is more than double 2016 volume. Hotel Transactions Major Vs. Non-Major Volume ($B) Q YTD Volume - Major Cap. - Major Q YTD 9% 8% 7% 6% 5% 4% Volume - Non-Major Cap. Non-Major Avg. Cap. Rate Source: Real Capital Analytics Hotel Investor Appetite Transactions Greater than $10 Million Private Other 40.6% 0.6% International 46.0% 16.8% 15.0% MAJOR METROS YTD 2016 REIT 17.8% 14.0% 25.0% 24.4% Institutional 5-Yr Average (Outer Circle) 2017 (Inner Circle) LIMITED-SERVICE FULL-SERVICE YTD YTD 2015 International Institutional REIT/Public Private $1B $2B $3B $4B $5B $6B $7B+ NON-MAJOR METROS YTD Source: Real Capital Analytics ALLIED ADVISORS 21

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