Wisconsin Real Estate Trends Conference Commercial Real Estate: Distress & Opportunity 9/17/2009 www.greenstreetadvisors.com Adam Markman Managing Director amarkman@greenst.com 949-640-8780
Expected Unleveraged Returns Based on the weighted average major-property-sector cap rates and growth rates shown below, it is possible to calculate the expected unleveraged returns (IRRs) that real estate investors can currently expect to achieve. Private Market Real Estate vs. Fixed Income Nominal Economic Projected NOI Growth Cap Rate Cap Rate '09 '10 '11 '12 '13 '14 '15 Long Term 8.6% 7.6% -3.4% -3.8% -1.1% 1.1% 2.4% 3.1% 3.1% 1.4% The Unleveraged Returns Currently Available on Real Estate vs. Baa Rate 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 8.8% Unleveraged IRR 6.4% Long-term Baa Rate Major Property Sectors are Apartment, Industrial, Mall, Office & Strip Retail. Each sector is given a 20% weight. As of 9/1/09 9/17/2009 www.greenstreetadvisors.com 2
Return Premium on Real Estate IRRs less Baa Bonds Current valuation levels can be assessed by comparing prevailing return premiums (i.e. expected IRRs less Baa rates) vs. historic norms. Risk premiums that have been higher than the historic norm have typically preceded periods of outsized appreciation in real estate values, and vice versa. The current spread of 247 bps suggests that private market real estate is cheap compared to long-term bonds. 400 bp Return Premium on Real Estate Unlevered IRR Expectations Minus Baa Rate 300 bp 200 bp 100 bp 0 bp Average: 140 bps Cheap Pricey -100 bp 1-86 1-88 1-90 1-92 1-94 1-96 1-98 1-00 1-02 1-04 1-06 1-08 As of 9/1/09 9/17/2009 www.greenstreetadvisors.com 3
Average Premium to NAV Observed NAV premiums/discounts in the public market have historically been reliable predictors of future changes in private-market prices. While false signals can occur, large premiums usually precede rising property values, and vice versa. 40% Average Premium to NAV 30% 20% 23% 10% 0% Avg: 0.9% -10% -20% -30% -40% -50% 1-90 1-91 1-92 1-93 1-94 1-95 1-96 1-97 1-98 1-99 1-00 1-01 1-02 1-03 1-04 1-05 1-06 1-07 1-08 1-09 As of 9/10/09 9/17/2009 www.greenstreetadvisors.com 4
Three Year Forward Earnings Yield AFFO yield is the REIT industry s proxy for the earnings yield on the broad market. Despite wide swings, earnings yields on REITs and stocks have been about equal. Currently REITs are priced to yield 170 bps less than the broader stock market, suggesting that public real estate is pricey compared to the S&P. 3YR Forward Earnings Yield 13% 11% 9% 7% 7.7% 6.0% 5% REITs (AFFO Yield) 3% S&P 500 1-93 1-95 1-97 1-99 1-01 1-03 1-05 1-07 1-09 As of 9/4/09 9/17/2009 www.greenstreetadvisors.com 5
RMZ Index After reaching an all-time high in early March 07 the RMZ lost a staggering 76% of its value over the next two years before bottoming out in early March 09. Since then the market has rallied 92%. MSCI US REIT Index (RMZ) 1400 1200 1000 800 600 552 400 200 288 0 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 As of 9/10/09 9/17/2009 www.greenstreetadvisors.com 6
2009 Equity Offerings In 2009, U.S. REITs have raised nearly $15 billion of new equity, inducing a virtuous cycle of balance sheet repair and rising share prices. While many of these offerings have been costly based on implied cap rates, they have been a step in the right direction for reducing leverage and improving liquidity positions. Equity raises earlier in the year were at significantly higher implied cap rates than more recent offerings, as the REIT market has rallied over 90% from its March 09 low. Implied Cap Rates on Recent Equity Offerings 12.0% 11.0% 10.0% 10.1% 10.9% 11.2% 9.6%9.6% 11.0% 11.2% 10.1% 10.3% Average Implied Cap Rate = 9.1% 10.9% 9.6% 9.5% 10.4% 9.6% 9.0% 8.0% 7.0% 8.5% 8.3% 8.3% 8.5% 8.8% 8.8% 8.7% 8.4% 8.4% 7.7% 7.4% 8.8% 8.7% 8.9% 7.3% 7.5% 8.7% N/A 7.3% N/A 6.9% 8.1% 6.0% HCN DLR SPG AMB OFC KIM VTR PLD EQY DRH DRE WRI REG VNO HST LHO WRE CLI HCP ACC CPT SPG SLG BDN KRC DCT BXP CBL LHO ELS EDR HPT SKT PSB FRT BPO 1/28 2/10 3/20 3/25 4/1 4/3 4/7 4/8 4/9 4/14 4/16 4/17 4/21 4/22 4/24 4/24 4/30 5/1 5/5 5/6 5/6 5/7 5/12 5/28 5/29 6/2 6/5 6/10 6/11 6/23 7/21 8/9 8/10 8/10 8/10 8/11 As of 9/1/09 9/17/2009 www.greenstreetadvisors.com 7
Unsecured Debt Markets In August the unsecured debt market for REITs began to thaw. REITs raised $2.55 billion in unsecured debt last month. Amount ($000's) Effective Maturity Convert Price Ticker Date Rate Type Simon Property Group 3/20/2009 $650,000 10.4% 4/1/2019 Unsec. Ventas 4/7/2009 $200,000 6.50% 6/1/2016 Unsec. Digital Realty Trust 4/14/2009 $260,000 5.5% 4/15/2014 Convertible $43.00 Alexandria RE Equities 4/21/2009 $225,000 8.0% 4/15/2014 Convertible $41.40 Starwood Hotels 4/30/2009 $500,000 7.88% 5/15/2014 Unsec. Host Hotels 5/5/2009 $400,000 9.0% 5/15/2017 Unsec. Simon Property Group 5/11/2009 $600,000 6.75% 5/15/2014 Unsec. Mack-Cali Realty 8/5/2009 $250,000 7.88% 7/15/2019 Unsec. Simon Property Group 8/6/2009 $500,000 6.75% 5/15/2014 Unsec. Duke Realty 8/6/2009 $250,000 7.38% 2/15/2015 Unsec. Duke Realty 8/6/2009 $250,000 8.25% 8/15/2019 Unsec. ProLogis 8/11/2009 $350,000 7.63% 8/15/2014 Unsec. Weingarten Realty 8/13/2009 $100,000 8.10% 8/15/2019 Unsec. Federal Realty 8/17/2009 $150,000 5.95% 8/15/2014 Unsec. Westfield Group 8/19/2009 $700,000 7.50% 8/15/2014 Unsec. Total $5,385,000 As of 8/19/09 9/17/2009 www.greenstreetadvisors.com 8
CMBS Problems The making of a mess: the pace of commercial mortgage originations exploded between '05 and '07 at the same time that underwriting standards became extraordinarily loose. Think of this as commercial real estate s version of sub-prime lending. $250 BN CMBS Originations $230 $203 $200 BN The mortgage factory was at full output from $168 $150 BN 05-07. It has now shutdown. $100 BN $71 $78 $94 $52 $54 $50 BN $0 BN '00 '01 '02 '03 '04 '05 '06 '07 Sources: Mortgage Bankers Association, Wells Fargo, Eastdil Secured 9/17/2009 www.greenstreetadvisors.com 9
CMBS Problems The '05-'07 CMBS vintages were underwritten at very aggressive loan-to-value ratios amidst an environment where appraisals were often inflated and borrowing costs were well below current levels. Average LTV in CMBS Originations Average Interest Rate on Fixed Rate Originations 70% Actual LTV's rose even more 8.5% Current market at 60% LTV = 7.5% 69% than this, as appraisal inflation was rampant. 69% 8.0% 68% 67% 68% 68% 7.5% 7.0% 67% 66% 66% 66% 65% 6.5% 6.0% 65% 65% 5.5% 64% '00 '01 '02 '03 '04 '05 '06 '07 5.0% '00 '01 '02 '03 '04 '05 '06 '07 Sources: Mortgage Bankers Association, Wells Fargo, Eastdil Secured, Green Street 9/17/2009 www.greenstreetadvisors.com 10
CMBS Problems Defaults have recently picked up, despite loose terms that called for little, if any, pay-down of principal. They will soon go off the chart. 100% % of CMBS Loans with Full or Partial Interest Only Feature 2.0% CMBS Delinquency Rate Watch Out: Interest reserves 86% 80% on low-cap-rate deals may begin to dry up 2-3 years after origination. 64% 76% 1.5% 60% 47% 1.0% 40% 34% 20% 20% 21% 23% 0.5% 0% '00 '01 '02 '03 '04 '05 '06 '07 0.0% '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 Sources: Mortgage Bankers Association, Wells Fargo, Eastdil Secured. Delinquency rates as of the end of the year; 09 is end of 1Q. 9/17/2009 www.greenstreetadvisors.com 11
CMBS Problems CMBS maturities will be ugly, but they re only the tip of the iceberg. Over $1 trillion of maturities occur by 12. $400 BN Total Commercial Mortgage Maturities $350 BN $300 BN $250 BN CMBS maturities are only the tip of the iceberg. $200 BN $150 BN $100 BN $50 BN $0 BN 2009 2010 2011 2012 2013 2014 2015 2016 2017 CMBS Banks Insurance Co. Sources: Mortgage Bankers Association, Wells Fargo, Green Street, Trepp, Bank of America, Deutsche Bank 9/17/2009 www.greenstreetadvisors.com 12
Where Will Real Estate be Priced? Maturities will be a mess: refinancing will require huge checks. Mortgage Proceeds on a Property Valued at $100 Million in '07 vs Now A 35-40% decline in value combined $120 $100 $80 $100 $75 with tighter loan terms translates into a $37 million shortfall (50% of the original loan amount) on maturity. Who will write this check? $63 $60 $40 $38 $20 $0 2007; LTV=75%* 2009; LTV=60% Property Value Mortgage * LTV calculated off the appraised value would have been lower. Appraised values were often inflated during the boom. 9/17/2009 www.greenstreetadvisors.com 13
Contact Green Street Advisors 567 San Nicolas Drive, Suite 200 Newport Beach, CA 92660 Contact: Adam Markman, Managing Director amarkman@greenst.com 949.640.8780 www.greenstreetadvisors.com 9/17/2009 www.greenstreetadvisors.com 14
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Boom and Bust Growth in direct property capital values since 2002, and subsequent value fall since peak % 100% 80% 60% 40% further value loss to Jun 09 Value loss from peak to Dec 08 Value growth since 2002 Net gains 20% 0% -20% -40% -60% -80% Source: IPD national property indices Germany Austria Switzerland KTI Finland Italy Portugal Netherlands Japan Sweden Denmark Australia Norway US Canada Spain UK New Zealand France Ireland South Africa 9/17/2009 IPD September 2009 on the pulse of the property world at www.ipd.com 16
NCREIF Historic Appreciation Returns NCREIF - ODCE Appreciation Returns 20.00% Annual % Change 10.00% 0.00% -10.00% -20.00% -30.00% 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009-40.00% Year 9/17/2009 Asset Management 17 PricewaterhouseCoopers
NCREIF Average Historical Cap Rates The long term median transaction cap rate since 1983 is 8.51% (current 7.3%). The long term median valuation cap rate from 1983 to current is 6.94% (current 6.1%). Transaction vs Current Value Cap Rates 11% 10% Cap Rates 9% 8% 7% 6% Cap Rates - All Sold Props Current Value (Appraisal) Cap Rates 5% Median Transaction Cap Rate 8.51% Median Valuation Cap Rate 6.94% 4% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year 9/17/2009 Asset Management 18 PricewaterhouseCoopers