SILICON VALLEY 2018 MARKET FORECAST REPORT

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3 SILICON VALLEY 2018 MARKET FORECAST REPORT

4 THE BEAT GOES ON BUT WATCH FOR TURBULANCE! FEATURED SPEAKERS: CHRISTOPHER F. THORNBERG, PHD Founding Partner Beacon Economics LLC MARC MAIONA CEO LeaseCalcs LLC GREGORY VALLIERE Chief Global Strategist Horizon Investments

5 OFFICE MARKET 2017 PREDICTION Gross absorp)on will balloon to 13.5M SF ACTUAL RESULTS Gross absorp)on was 13.03M SF a new record high

6 OFFICE MARKET 2017 PREDICTION 3.9M SF net absorp)on (Apple alone 3.1M SF in the Spaceship HQ) ACTUAL RESULTS 5.7M SF net absorp)on (including the Spaceship)

7 OFFICE MARKET 2017 PREDICTION Availability rate likely to increase to 14.5% ACTUAL RESULTS Availability rate only increased to 12.05% (11M SF)

8 R&D MARKET 2017 PREDICTION R&D gross absorp)on will top out at 7.0M SF ACTUAL RESULTS R&D gross absorp)on finished at 7.5M SF

9 R&D MARKET 2017 PREDICTION 2.0M SF nega)ve net second year of occupancy decline ACTUAL RESULTS 620K SF nega)ve net beier than predicted

10 R&D MARKET 2017 PREDICTION Availability rate likely to increase to 11.3% from 10.4% ACTUAL RESULTS Availability rate only increased to 10.6% from 10.4% (16.4M SF)

11 INDUSTRIAL MARKET 2017 PREDICTION New construc)on pushes gross absorp)on just above 3M SF ACTUAL RESULTS Gross absorp)on actually down year over year 2.25M compared to 2.43M in 2016 (7.4% decrease)

12 INDUSTRIAL MARKET 2017 PREDICTION Net absorp)on of no more than 500K due to low inventory and rollover ACTUAL RESULTS Industrial net absorp)on was only 670K SF

13 INDUSTRIAL MARKET 2017 PREDICTION Industrial availability rate will remain at or below 3.0% ACTUAL RESULTS Industrial availability finished at 3.19% (2.0M SF)

14 WAREHOUSE MARKET 2017 PREDICTION Gross absorp)on limited to <2.0M SF ACTUAL RESULTS 2017 Gross absorp)on: 1.9M SF

15 WAREHOUSE MARKET 2017 PREDICTION Net absorp)on probably no greater than 500,000 SF ACTUAL RESULTS Net absorp)on ended year at 155K SF

16 WAREHOUSE MARKET 2017 PREDICTION Availability rate could drop below 2.0% during the year ACTUAL RESULTS Availability ended year at 3.16% (1.2M SF)

17 OFFICE FORECAST! Gross absorp)on will be 8.0M SF! Net absorp)on will be 3.0M SF! Availability rate likely to decrease to 9.0%

18 R&D FORECAST! Gross absorp)on will top out at 9.0M SF! 1.5M SF posi)ve net following a 2 year occupancy deadline! Availability rate likely to decrease to 9.8%

19 INDUSTRIAL FORECAST!" Gross absorp)on 2.5M SF due to new construc)on!" Net absorp)on will increase to 750K SF based on product comple)ons!" Industrial availability rate to remain historically low below 3%

20 WAREHOUSE FORECAST!"!"!" Gross absorp)on limited to approximately 2M SF due to lack of supply Net absorp)on will be kept at 500K SF due to supply Warehouse vacancy to remain at historic Lows sub 3% due to absorp)on

21 CHRISTOPHER F. THORNBERG, PHD Founding Partner Beacon Economics LLC

22 Analysis. Answers The Economic Outlook Focus on Silicon Valley February 2018 Christopher Thornberg Founding Partner, Beacon Economics Director, UC Riverside Center for Forecasting and Development Beacon Economics, LLC Analysis. Answers.

23 It has been an interesting year Analysis. Answers. 23

24 The Good, Bad, and downright Ugly The Good: Meet the new economy, same as the old economy 2017 solid year for growth: looked a lot like For all the sound and fury, very liile happened outside of the tax plan 2018 likely to be beier: the tax cut s)mulus will boost the economy S)ll a low chance of recession in next 24 months The Bad: Brakes and Growing Imbalances Labor shortage Issues (par)cularly in California) Aggressive Fed: rising rates, flaiening yield curves Consumer savings rate declining Another bubble star)ng to form The Ugly: 2018 will be seen as a historic turning point LiIle effort to deal with underinvestment in infrastructure, rising wealth and income inequality, healthcare cost infla)on, housing Sharp growth in en)tlement spending and government deficits coming Breakdown in basic norms of poli)cal leadership, complete distrac)on from the issues we need to deal with Analysis. Answers. 24

25 GDP Growth: 2017 back to 2.5% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% Real GDP Growth (Y-o-Y) 1997Q1 1999Q1 2001Q1 2003Q1 2005Q1 2007Q1 2009Q1 2011Q1 2013Q1 2015Q1 2017Q1 Analysis. Answers GDP FD PCE Fixed Inv Struct Equip IPP Res Invent Net exports Government

26 Oil and Exports Weekly US Oil ProducRon 2250 US Exports (Real) Analysis. Answers. 26

27 Retail Sales Retail Sales (Y-o-Y to Dec) Auto Sales SAAR 16.0% % % % % % % 2.0% 0.0% Dec-12 Jun-13 Dec-13 Jun-14 Online Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Brick & Mortor Jun-17 Dec Jan-11 Sep-11 May-12 Jan-13 Sep-13 May-14 Jan-15 Sep-15 May-16 Jan-17 Sep-17 Analysis. Answers. 27

28 Consumer Spending 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Jan-10 Y-o-Y Growth Real Consumer Spending Sep-10 May-11 Jan-12 Sep-12 May-13 Jan-14 Analysis. Answers. Sep-14 May-15 Jan-16 Sep-16 May % 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Consumer Savings Rate (% of DPI) 1998Q1 1999Q3 2001Q1 2002Q3 2004Q1 2005Q3 2007Q1 2008Q3 2010Q1 2011Q3 2013Q1 2014Q3 2016Q1 2017Q3 28

29 No Debt Overhang 140.0% 130.0% 120.0% 110.0% 100.0% 90.0% 80.0% Debt to DPI Income 1998Q1 1999Q4 2001Q3 2003Q2 2005Q1 2006Q4 2008Q3 2010Q2 2012Q1 2013Q4 2015Q3 2017Q2 Analysis. Answers. 18.5% 18.0% 17.5% 17.0% 16.5% 16.0% 15.5% 15.0% 14.5% 14.0% Household Financial ObligaRon RaRo 1980Q1 1982Q4 1985Q3 1988Q2 1991Q1 1993Q4 1996Q3 1999Q2 2002Q1 2004Q4 2007Q3 2010Q2 2013Q1 2015Q4 29

30 Labor Markets Net Change Payroll Jobs % 2.0% 1.5% 1.0% 0.5% 0.0% Growth Payroll Employment (Y-o- Y) Jan-11 Aug-11 Mar-12 Oct-12 May-13 Dec-13 Jul-14 Feb-15 Sep-15 Apr-16 Nov-16 Jun-17 Analysis. Answers. 30

31 Why Slowing Job Growth? Dec-00 May-02 JOLT Job Openings Rate (% of Jobs) Oct-03 Mar-05 Aug-06 Jan-08 Jun-09 Nov-10 Apr-12 Sep-13 Feb-15 Jul Oct-98 Jul-00 Apr-02 Unemployment Jan-04 Oct-05 U6 Jul-07 Apr-09 U3 Jan-11 Oct-12 Jul-14 Apr-16 Analysis. Answers. 31

32 Consequences Real Wage Gains Jan-98 Aug-99 Mar-01 Oct-02 May-04 Dec-05 Jul-07 Feb-09 Sep-10 Apr-12 Nov-13 Jun-15 Jan-17 Median Real Analysis. Answers. 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% Labor Force Growth Jan-80 Jan-83 Jan-86 Jan-89 Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16 32

33 Demographic Limits 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% US PopulaRon of Year Olds Analysis. Answers Growth Share % 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% PopulaRon by Age by NaRvity (Millions) Under 5 years 5 to 9 years 10 to 14 years 15 to 19 years 20 to 24 years 25 to 29 years 30 to 34 years 35 to 39 years 40 to 44 years 45 to 49 years 50 to 54 years 55 to 59 years 60 to 64 years 65 to 69 years 70 to 74 years 75 to 79 years 80 to 84 years Na)ve Foreign 85 years and over 33

34 The Cure for Secular Stagnation Analysis. Answers. 34

35 Tax Reform vs Tax Cuts 35% 30% 25% 20% 15% 10% 5% 0% US Corporate Taxes as % Profit 1980I IV III II 1991I IV III II 2002I IV III II 2013I IV Federal Analysis. Answers. State & Local A. Most corpora)ons and households will pay less in taxes B. The plan will give a small short term boost to the economy C. Will add $1.5 trillion to $3.5 trillion to the debt over 10 Years D. The plan is regressive 35

36 Do Tax Cuts Spur Investment? Investment as % of GDP 12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 15.0% 25.0% 35.0% 45.0% EffecRve Corporate Tax Rate Analysis. Answers , , , ,600.0 CBO: Past and Projected Federal Budget Gap

37 Fed Tightening Interest Rates FFR 1 Yr Tr 10 Yr Tr Analysis. Answers Year Rate Spread

38 InWlation: Slowing CPI Core InflaRon Rate M2 Growth Y-o-Y 3.0% 12.0% 2.5% 10.0% 2.0% 1.5% 8.0% 6.0% 4.0% 1.0% 2.0% 0.5% 0.0% Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Sep-97 Sep-99 Sep-01 Sep-03 Sep-05 Sep-07 Sep-09 Sep-11 Sep-13 Sep-15 Sep-17 Analysis. Answers. 38

39 Slowing Lending Growth in Direct Bank Loans Net % Banks Responding Yes 15.0% 10.0% 5.0% Analysis. Answers. 1/1/17 1/1/15 1/1/13 1/1/11 1/1/09 1/1/07 1/1/05-5.0% 1/1/03 0.0% Demand 2016Q 2017Q 4 4 Standards 2016Q 2017Q 4 4 auto loans credit card loans construc)on & land development commercial real estate mulrfamily residenral structures C&I loans from large Firms C&I loans from small firms QM jumbo mortgage loans

40 Frothy Equities? Maybe Corporate Profits and Growth Jan-86 Dec-88 Shiller P/E RaRo Nov-91 Oct-94 Sep-97 Aug-00 Jul-03 Jun-06 May-09 Apr-12 Mar-15 Analysis. Answers. 40

41 Market correction? Not yet. 40% 30% 20% 10% 0% -10% -20% -30% Nominal Stock Market Growth (S&P 500) Jan-80 Jan-83 Jan-86 Jan-89 Jan-92 Jan-95 Jan-98 Analysis. Answers. Smoothed Annual % Jan-01 Jan Year Returns % Jan-07 Jan-10 Jan-13 Jan % 120.0% 110.0% 100.0% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% Debt to GDP RaRos 1988Q1 1990Q3 1993Q1 1995Q3 1998Q1 2000Q3 2003Q1 2005Q3 2008Q1 2010Q3 2013Q1 2015Q3 Financial Business 41

42 State Economic Performance 5 Year Change in Payroll Jobs by State New Jobs Ann Gr US Share Utah % 1.8% Nevada % 1.5% Florida 1, % 9.5% Idaho % 0.8% Colorado % 2.7% Oregon % 1.8% Washington % 3.2% California 2, % 16.1% Georgia % 4.1% Texas 1, % 11.2% Arizona % 2.3% South Carolina % 1.7% Tennessee % 2.5% North Carolina % 3.3% Montana % 0.3% 700, , , , , , ,000 - California: Change in Employment by Income (F.T.) <35K 35-65K k 100K+ Analysis. Answers. 42

43 Exports / Output California Exports (Nominal) $230,000 $210,000 $190,000 $170,000 $150,000 $130,000 $110,000 $90,000 $70,000 $50, Analysis. Answers. 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% -8.0% Real GDP Growth (y-o-y) 2006:Q1 2007:Q1 2008:Q1 2009:Q1 2010:Q1 2011:Q1 2012:Q1 2013:Q1 2014:Q1 2015:Q1 2016:Q1 2017:Q1 US CA 43

44 Bay Area Venture Capital Total Venture Capital ($ Billions) Bay Area Venture Capital Analysis. Answers U.S. Venture Capital Overhang * Cummula)ve Dry Powder 44

45 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Jan-11 Sep-11 May-12 Jan-13 Sep-13 May-14 Jan-15 Sep-15 May-16 Jan-17 The Big Slowdown State and NaRonal Job Growth Nov Inland Empire 1,470, % 3.4% 3.2% Ventura 309, % 1.5% 2.2% Sacramento 978, % 3.1% 2.1% San Francisco 1,125, % 3.3% 2.0% Fresno 346, % 3.2% 1.7% San Jose 1,102, % 2.8% 1.7% Kern 260, % -0.5% 1.6% San Diego 1,457, % 2.3% 1.5% East Bay 1,162, % 2.9% 1.4% Stockton 231, % 2.8% 1.4% Sonoma 203, % 1.6% 1.1% Orange 1,600, % 1.6% 0.8% Los Angeles 4,465, % 2.3% 0.8% Analysis. Answers. 45

46 A closer look Dec-17 Y-o-Y Ch Total Nonfarm % NR/Construc)on % Manufacturing % Wholesale Trade % Retail Trade % Logis)cs % InformaRon % Financial Ac)vi)es % Prof Sci Tech % Management % Admin Support % Educa)on % Health Care % Leisure and Hospitality % Other Services % Government % Analysis. Answers Unemployment Rate East Bay 3.23 San Francisco 2.40 San Jose 2.87 Jan-97 Oct-98 Jul-00 Apr-02 Jan-04 Oct-05 Jul-07 Apr-09 Jan-11 Oct-12 Jul-14 Apr-16 Oakland (MD) San Francisco (MD) San Jose 46

47 Don t Go West, Young Man? 1.50% 1.30% 1.10% 0.90% 0.70% 0.50% 0.30% 0.10% -0.10% -0.30% -0.50% Net MigraRon as a % of Pop California Home Prices, Q County Median Price YoY Growth (%) Monterey 547, % Orange County 747, % Riverside 362, % San Bernardino 292, % San Diego 578, % San Francisco 1,274, % San Luis Obispo 575, % Santa Clara 1,058, % Los Angeles 588, % Analysis. Answers. 47

48 New Housing Supply How Much Housing Needed? Housing Needed to maintain 2% State Job Growth 4500 Method 1 Total 722, Per Year 206, Current 106,185 Shorpall 100, Method Total 911, Per Year 263,667 Current 106, Shorpall 157,482 0 West Bay Permits Q1-95 Q2-96 Q3-97 Q4-98 Q1-00 Q2-01 Q3-02 Q4-03 Q1-05 Q2-06 Q3-07 Q4-08 Q1-10 Q2-11 Q3-12 Q4-13 Q1-15 Q2-16 Q3-17 Analysis. Answers. 48

49 Don t Just Focus on Affordable Rentals % Renters Spending >30% of Income on Housing CA Change Less than $20k 92.7% 92.5% -0.2% $20k to $35k 89.0% 89.2% 0.2% $35k to $50k 67.3% 71.9% 4.6% $50k to $75k 41.1% 46.1% 5.0% $75k+ 10.5% 11.8% 1.3% All 56.8% 55.4% -1.4% Analysis. Answers. 49

50 Filtering Blockage Renters by Income: Struture Built Before 1970 Metro Household Income Less than $35,000 Household Income $35,000 to $74,999 Household Income $75,000 or More San Francisco 26.5% 22.2% 51.2% East Bay 31.4% 32.6% 36.0% San Diego 35.0% 33.5% 31.5% Orange 32.4% 36.3% 31.3% Los Angeles 40.2% 31.7% 28.0% Houston 45.4% 31.4% 23.2% Inland Empire 47.5% 30.7% 21.8% Phoenix 50.3% 28.2% 21.5% Dallas 46.6% 33.0% 20.4% Analysis. Answers. 50

51 The Big Picture Posi)ves: It will be a good year GDP Growth Outlook for 2018: 3% State revenues will look posi)ve Labor markets to remain )ght, constraining growth Rising wages to put pressure on profits Exports, business investment con)nue to pick up California housing shortages will constrain growth locally Nega)ves Fed will con)nue to )ghten, yield curve flaiening Markets looking frothy watch debt levels Consumer savings: entering dangerous waters Federal deficit will widen sharply Poli)cal uncertainty to dominate headlines Analysis. Answers. 51

52 The Great Disconnect What we are worried about The Number of Jobs Who pays for Healthcare Tax Levels Income Inequality Funded Govt. LiabiliRes Business Investment InflaRon The Cost of CA Housing What we should be worried about The Number of Workers What are we paying for? Tax Structure Wealth Inequality Unfunded Govt. LiabiliRes A Lack of Public Investment Slowing Lending The Supply of CA Housing Analysis. Answers. 52

53 # To view or download this presentation or for further information, visit: # Contact Christopher Thornberg Chris@BeaconEcon.com Our Services Economic & Revenue Forecasting Regional Intelligence Reports Business & Market Analysis Real Estate Market Analysis Ports & Infrastructure Analysis Economic Impact Analysis Public Policy Analysis Analysis. Answers. 53

54 Insert Logo Here MARC MAIONA CEO LeaseCalcs LLC

55 Lease Accounting: Market Impacts Lease Accounting. Simplified.

56 Lease Accounting: Market Impacts Agenda Lease Accounting: All leases on balance sheet for tenants. 6 Resulting Predictions Why we believe to be true. How the market will adapt. Marc Maiona Founder / President 28 Years CRE Leasing

57 Lease Accounting: Different Tenants Will See Different Future What is the tenant s real morvator? What part of your firm s financial statement results do you care most about --- what drives financial decision making for your firm? Are you balance sheet or P&L driven? If it s the P&L, is it the en#re P&L or really just EBITDA that drives decisions?

58 Lease Accounting: Different Tenants Will See Different Future Why it maoers When I know what part of your financial results are most important to your firm, I can design and nego)ate your leases to improve the results you care most about. Your exis)ng leases can oven be restructured to improve that por)on of your financial results you care most about.

59 Lease Accounting: Different Tenants Will Care About Different Impacts What are the impacts? Debt / liabilities on balance sheet Shareholder equity concerns Debt-to-Equity impacts EBITDA performance Net Income early in lease term Net Income later in lease term Net Income at adoption date

60 Lease Accounting: Not All Rent Is Created Equal 1 NNN Lease Structures Will Be Preferred If Not Required

61 Lease Accounting: Not All Rent Is Created Equal What will tenants ask for? Can landlords win, too? NNN charges not subject to capitaliza)on Gross / Modified Gross Leases: Remove service components Property Taxes & Insurance in Gross Leases are not services. Which tenants care? Which buildings have an advantage?

62 Lease Accounting: Tenants Already Shifting Strategies 2 Tenants Will Shift To Longer Initial Lease Term

63 Lease Accounting: Tenants Already Shifting Strategies Renewal Options and Reasonably Certain What cons)tutes a significant economic incen)ve? Discounts Penal)es Tenant improvement values / remaining useful life Strategic value 10 year lease treated as 20 year deal for accoun)ng Look what happens to the financials is it good or bad?

64 Lease Accounting: Go Ahead, Touch The Third Rail 3 EBITDA Focused Tenants Will Prefer Finance Leases

65 Lease Accounting: Go Ahead, Touch The Third Rail EBITDA Focused Companies: The Third Rail Goes Away Opera)ng Leases = Bad for EBITDA Capital Leases = Good for EBITDA Realiza)on that all leases come on balance sheet. Can drama)cally improve EBITDA performance poten)ally even just via favorable renewal op)ons.

66 Lease Accounting: Subleasing Before and After Rules Change 4 Subleases Will Accelerate & Then Be More Painful

67 Lease Accounting: Subleasing Before and After Rules Change Subleases the math changes. Loss Calcula)on Today Tomorrow PV of Head Lease Rents - PV of Sublease Rent + Write off of LHI Asset - Deferred Rent Credit Liability Reduces size of loss for sublessor = Loss on sublease is larger on day 1 of sublease. How big of a difference can timing have on financial performance?

68 Lease Accounting: Should I Stay or Should I Go? 5 Early Renewal vs. Relocation Decisions Will Change

69 Lease Accounting: Should I Stay or Should I Go? How Amendments May Change Stay or Go Decisions When do you have to book the impact? Amendments = Ink on paper New Leases = Possession

70 Lease Accounting: What Language Are You Speaking? 6 Deals Will Require Greater Financial Literacy

71 Lease Accounting: What Language Are You Speaking? What CFOs hear What CFOs care about Vacancy Rates Absorp)on Market condi)ons Construc)on ac)vity Expira)on date Availability Net Income EBITDA Shareholder Equity Debt / Equity Regulatory Capital Assets & Liabili)es

72 Marc Maiona (949) LeaseCalcs, Inc. All Rights Reserved

73 GREGORY VALLIERE Chief Global Strategist Horizon Investments