CAP RATE REPORT 1Q GLOBAL INSTABILITY LEADS TO INCREASED CAUTION; CAP RATE COMPRESSION SLOWS Prepared by: Hasan Rahim Real Estate Market Analytics PNC 300 Fifth Avenue Pittsburgh, PA 15222 (412) 762-8683 Hasan.Rahim@pnc.com PNC and PNC Bank are registered service marks of The PNC Financial Services Group, Inc. PNC Bank and certain of its affiliates, including PNC TC, LLC, an SEC registered investment advisor wholly-owned by PNC Bank, do business as PNC Real Estate. PNC Real Estate provides commercial real estate financing and related services. Through its Tax Credit Capital segment, PNC Real Estate provides lending services, equity investments and equity investment services relating to low income housing tax credit ( LIHTC ) and preservation investments. PNC TC, LLC provides investment advisory services to funds sponsored by PNC Real Estate for LIHTC and preservation investments. Registration with the SEC does not imply a certain level of skill or training. This material does not constitute an offer to sell or a solicitation of an offer to buy any investment product. This document is for general informational purposes only and is not intended as specific advice or recommendations. The information contained herein is gathered from public sources believed by PNC to be accurate and reliable at time of publication, but neither PNC nor any of its affiliates is providing any guaranty or warranty as to the accuracy, completeness or reliability of that information or of the conclusions presented in this document. Forecasts and other forward looking statements are based on current expectations and serve as an indication of what may occur. In addition, markets do change. Given the inherent uncertainties and risks associated with forecasts and forward looking statements, actual events and results may differ materially from those reflected or contemplated. Opinions expressed herein are subject to change without notice. The information set forth herein does not constitute legal, tax or accounting advice. You should obtain such advice from your own counsel or accountant. Any reliance upon the information provided herein is solely and exclusively at your own risk. The PNC Financial Services Group, Inc. All rights reserved. VOLUME: Commercial Real Estate (CRE) sales totaled $97.7B during 1Q16, down 33.2% from last quarter and 17. annually, according to Real Capital Analytics (RCA). RCA noted that while double digit drops in transaction volume are troubling, transaction activity in 1Q16 is still elevated. The slow start to can be attributed to increased caution by investors regarding asset pricing, coupled with negative macro factors, including volatility in the debt markets and global economic instability. JLL noted in their 1Q16 Investment Outlook that despite the sluggishness in the CRE capital markets, property markets remain strong. JLL forecasts that the increased caution by investors is expected to impact 2Q16 transaction activity, but an uptick in volume is anticipated in the latter half of the year. This is the result of an expanding pipeline in the multifamily, office, and retail sectors. Pricing for all properties appreciated 5. YOY and is 14. above its peak per the Moody s/rca CPPI index. The apartment sector led the way this quarter with $36.6B in sales, (the second largest quarterly volume since ), followed by the office sector which posted $29.0B in sales. CAP RATES: According to the 1Q16 PwC Real Estate Investor Survey, average cap rates decreased in 12 of the markets and property types reviewed, held steady in 10, and increased in 12. Changes for each property segment are discussed within the report INCREASED UNCERTAINTY LEADS TO AIR OF CAUTION AMONG INVESTORS: As mentioned above, investors have become more cautious in the face of increased macroeconomic uncertainty. PwC notes that investor enthusiasm for the CRE sector has moderated since the end of, but remains cautiously optimistic in their sector outlook. Additionally, investors are concerned about overpaying for assets, as pricing for CRE assets is close to peak levels in most sectors and markets. The increased cautionary sentiment has resulted in a fundraising slowdown for closed-end real estate funds, according to Preqin s 1Q16 quarterly update. Per Preqin, fundraising in 1Q16 totaled $21.0 billion, in line with 4Q15 s fundraising amount, but a 4 decrease from 3Q15 s $41.0 billion. Dry powder continued to rise towards record levels (totaling $230 billion), as large investors struggled to deploy capital at target return levels. JLL notes that discipline in how institutional capital deploys funds may act as a leading indicator for liquidity and future risks of distress across markets. As cap rate compression slows and investors utilize more conservative underwriting standards, PwC notes that the increased caution in investor sentiment may continue for. FOR PROFESSIONAL USE ONLY: Outside of property fundamentals, the continued appetite for certain transactions and aggressive efforts to employ capital has impacted capitalization rates. While anecdotal stories of exceptionally low rates may have a basis in fact, each rate will represent conditions particular to that transaction. Care needs to be used in appropriately extending rates beyond the related sale.
GLOBAL INSTABILITY LEADS TO INCREASED CAUTION; CAP RATE COMPRESSION SLOWS 2 The following examines trends within each property segment. The average cap rates were based on the 1Q16 PwC Real Estate Investor Survey and 1Q16 Real Capital Analytics (RCA). Sales volume figures were obtained from RCA data and represent transactions over $5.0M. Institutional quality sales volume declined 26.2% from 4Q15 to $29.0B and is down 10. from 1Q15 s $32.6B. Despite the recent drop, sales volume in 1Q16 is still at an elevated level. Sales of CBD properties accounted for $13.6B this quarter, a 31. decrease from 4Q15 and a 9.1% decrease from 1Q15. Suburban properties accounted for the bulk of office transactions this quarter, totaling approximately $15.4B, a 20. sequential decline and a 12. annual decline. The CPPI for the office sector softened this quarter, as prices softened 4.4% from last quarter. Over this period, the office CBD sub-index fell 6.3%, while the suburban office sub-index showed prices declined 2.3%. As of 1Q16, CBD office prices were 32. above their 1Q08 peak, while suburban office properties remain 11.3% below their 3Q07 peak. Despite the decline in volume, pricing in the office sector is holding firm. Both RCA and PwC indicated that CBD office cap rates posted sequential and annual decreases. Cap rates for suburban product ticked up on a quarterly basis per RCA and PwC. CBD office in Major Metro s continued to dominate the high-end transactions in 1Q16. CalPERS closed on the purchase of a 1.7 million SF office tower at 787 Seventh Avenue for $1.9 billion ($1,138 PSF) from AXA Financial and is one of the priciest single-building transactions in New York City history. The largest portfolio transaction in 1Q16 was the Douglas Emmett/Qatar Investment Authority JV acquisition of a Class A, 4 building office portfolio in Westwood for $1.34 billion ($777 PSF) from Equity Office Properties (a Blackstone affiliate). A decline in sales can be attributed to a variety of factors including volatility in the macro economy, scarcity of quality offerings, and caution over pricing levels. Per RCA, volume in secondary markets was more resilient to the softening in sales volume, declining only 2.0% YOY. This was driven by large portfolio acquisitions and increased activity concentrated in urban submarkets. Increased deal activity in Philadelphia, Atlanta, New Jersey, and Oakland helped secondary markets in maintaining their deal momentum. As noted by JLL in their 1Q16 Office Investment Outlook, secondary markets are recording stronger volume growth than primary markets, a trend that JLL expects will to continue through the year. OFFICE $90 $80 $70 $60 $ $40 Office Office CBD Office Suburban Note: Major Office Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles 11% 4% 11% 4% Office CPPI & Transaction Volume Through First Quarter 300 2 200 100 5.5 - PwC CBD Office 10 bps, +1. 5.2 - RCA CBD Office 70 bps, +11. 6.41% - RCA Total Office 4 bps, +0. CBD Office - United States Through First Quarter 5.33% - ACLI Office 59 bps, +10.0% Suburban Office - United States Through First Quarter 6.3 - PwC Suburban Office 2 bps, -0.3% 7.00% - RCA Suburban Office 42 bps, +6.4% 6.41% - RCA Total Office 4 bps, +0. 5.33% - ACLI Office 59 bps, +10.0%
GLOBAL INSTABILITY LEADS TO INCREASED CAUTION; CAP RATE COMPRESSION SLOWS 3 Sales volume, decreased 55.1% from 4Q15 to.8b and is down 43. YOY. Although the decline in volume appears to be steep, volume in 1Q16 is elevated compared to first quarter volumes in,, and. As noted in JLL s 1Q16 Industrial Outlook, investment strategies appear to have shifted as single-asset activity represented the bulk of investments in the industrial sector. This trend is expected to continue going forward as there is a scarcity of large-scale portfolio availabilities that meet the higher (+0 million) investment size standards associated with active cross-border buyers per JLL. The lack of quality portfolio offerings is expected to dampen investment by foreign investors, as evidenced by the minimal participation of cross-border buyers in 1Q16. Pricing for industrial assets, as measured by the Moody s/rca CPPI is up 0. YOY and is 1. higher than the peak pricing seen in. One of the largest industrial transactions that occurred this quarter included an entity led by Biynah Industrial Partners and Olympus Ventures acquiring a Class A industrial portfolio located in Indianapolis for $167 million ($43 PSF) from Transpacific Development Company. One of the largest property sales in 1Q16 was the RXR Realty/Westbrook Partners acquisition of the Hall Street Complex in Brooklyn, New York for $162 million (approx. $290 PSF). Many domestic investors have increased their focus on regional secondary markets to search for non-fully priced assets. Promising economic and demographic tailwinds have boosted the prospects of certain secondary markets such as Seattle, South Florida, and Washington DC. JLL reports that as the industrial sector investments grow in sophistication, buyers may begin to explore alternate strategies to gain exposure to the rapidly changing supply chain. This includes subsectors, such as urban infill, light industrial, and cold storage. Cap rates for the flex and warehouse sectors moderated on a quarterly basis, but have improved on an annual basis per PwC. Despite recent monetary policy tightening and increased macroeconomic volatility cap rates have remained stable in the industrial sector. A lack of institutional-grade industrial assets will continue to foster improvements in valuation throughout per JLL. INDUSTRIAL Industrial Major Industrial $25 Non-Major Industrial $15 $5 Note: Major Industrial Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles Industrial CPPI & Transaction Volume Through First Quarter 210 190 170 130 110 90 70 5.52% - PwC Warehouse 4 bps, -0. 6.9 - RCA Warehouse 82 bps, -13.4% Industrial Warehouse - United States Through First Quarter 7.11% -RCA Total Industrial 88 bps, -14.1% 6.21% - ACLI Industrial 27 bps, +4.2% Industrial Flex/R&D - United States Through First Quarter 7.1 - PwC Flex/R&D 0 bps, 0.0% 7.34% - RCA Flex 93 bps, -14. 7.11% - RCA Total Industrial 88 bps, -14.1% 6.21% - ACLI Industrial 27 bps, +4.2%
GLOBAL INSTABILITY LEADS TO INCREASED CAUTION; CAP RATE COMPRESSION SLOWS 4 Overall, 1Q16 retail investment totaled $15.7B, a 23. decrease from 4Q15 and a 29.0% decrease YOY. Mall properties led the retail segment volume this quarter at $8.3B, a 24.3% decrease from 4Q15, and 43.1% lower from a year ago. Volume for strip properties worsened 22. this quarter to $7.4B and was down 2.3% YOY. Despite the declining volume, RCA noted that a slowdown in portfolio and entity-level transactions contributed to this slowdown in volume. However, the slowdown in sales volume is not indicative of investor sentiment for the rest of. In JLL s 1Q16 Retail Outlook, they note that the current retail pipeline is strong and investment activity in this sector may improve going forward. The Moody s/rca CPPI index indicated that prices are up 7. YOY, but are still 2.4% off peak levels reached in. There were two notable California transactions this quarter. One involved a partnership between Pacific Retail Capital Partners and Silverpeak Real Estate Partners, which acquired a 1.4 million SF, super-regional mall in San Jose for $225 million ($286 PSF). Blackstone purchased a portfolio of 12 retail properties totaling 259,400 SF for 1 million ($771 PSF). These properties are part of the One Colorado shopping center in Pasadena s historic Old Pasadena neighborhood. Cap rates across the retail sector continued to post slight improvements or show signs of moderation. Both PwC and RCA noted that mall cap rates are the only subtype to post quarterly and annual improvements. Power centers and strip center cap rates are flat on a quarterly basis, but have improved on an annual basis according to PwC. Urban retail has seen a flurry of activity in per RCA, resulting in lower cap rates. RCA noted that this subtype is typically located in markets that have some of the highest prices in the USA. However, luxury shopping is declining on a global basis, impacting the desirability of urban retail product in select markets. Given the changing shopping patterns of today s consumer and decline in travel and tourism expenditure (a major facet of luxury shopping), upscale brands are experiencing difficulty maintaining storefront properties in prime urban retail corridors per JLL. These larger macro concerns coupled with high primary market pricing has led to an increase in secondary market activity, as the cheaper pricing is attractive to investors who favor this asset type. RETAIL $25 $15 $5 Retail Major Retail Non-Major Retail Note: Major Retail Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles Retail CPPI & Transaction Volume Through First Quarter 300 2 200 100 6.00% - PwC Mall 3 bps, +0. 5.6 - RCA Mall 3 bps, +0. 6.54% - RCA Total Retail 14 bps, -2.3% Retail Mall - United States Through First Quarter 5.31% - ACLI Retail 77 bps, +12. Retail Power and Strip Center - United States Through First Quarter 6.41% - PwC Strip Center 3 bps, -0. 7.24% - RCA Strip Center 43 bps, -6.3% 6.33% - PwC Power Center 2 bps, -0.3% 6.54% - RCA Total Retail 14 bps, -2.3% 5.31% - ACLI Retail 77 bps, +12.
GLOBAL INSTABILITY LEADS TO INCREASED CAUTION; CAP RATE COMPRESSION SLOWS 5 Apartment volume this quarter totaled $36.6B, a 25.1% decrease from 4Q15, but a 15.0% increase YOY. The Garden sector continued to lead the way, with $25.0B in sales, a 19. decrease from last quarter, but a 33.4% gain on an annual basis. Total high-rise volume declined 35.3% to $11.5B in 1Q16, a 12.1% annual decrease. RCA noted that changes in deal activity should be viewed with caution rather than concern. Sales volume for 1Q16 represents the second-largest figure over the last 15 quarters, only eclipsed by the record setting volume in 4Q15. APARTMENT Apartment Major Apartment $60 Non-Major Apartment $ $40 Apartment CPPI & Transaction Volume Through First Quarter 400 3 300 2 200 Property prices continued to rise, as evidenced by the Moody s/cppi index for apartments, which is now up 9.4% YOY and is 39.0% above peak prices last seen in. The CPPI noted that apartment prices in Major Metro markets softened 0. from last quarter but is still up 7. YOY. Starwood Capital Group drove overall deal activity in 1Q16 with two significant portfolio transactions. Starwood Capital Group closed on their $5.4 billion, 69-property portfolio of 23,262 units from Equity Residential. Properties in this portfolio are located in Denver, South Florida, suburban DC, suburban Seattle, and the Inland Empire, CA. Starwood Capital Group also acquired a 71-property portfolio of 19,614 units from Landmark Apartment Trust. Properties in this portfolio are concentrated in the Southern United States, specifically in Atlanta, Charlotte, Nashville, Orlando, Raleigh, and Tampa in addition to holdings in Dallas and Austin. Cap rates for the apartment sector remain down on an annual basis, according to both PwC and RCA. Flattening cap rates and the slight volume decline suggests that buyers and sellers have different pricing expectations in the current market. RCA noted that the current disconnect between sellers and buyers is likely to persist, barring an external macroeconomic event forcing owners to sell. PwC reported that pricing is starting to get ahead of value and some apartment investors noted that capital has become more selective and pricing for weaker properties will not hold up. In their 1Q16 US Multifamily Investment Forecast Marcus & Millichap noted that job growth triggered the creation of new rental households, which helped drive down the national vacancy rate, resulting in rent growth. Economic tailwinds are expected to sustain the improving fundamentals in the apartment sector. In their 1Q16 Multifamily Investment Outlook, JLL noted that consistent job-growth gains have encouraged home buyers, resulting in an increase in existing home sales. This is expected to have a minimal impact on the rental apartment market, as many renters continue deferring home ownership. Multifamily rental product remains the favored housing choice among Millennials, providing a lift to apartment sector fundamentals. The upcoming supply increase threatens to dampen the apartment sector s outlook. JLL noted that select West Coast markets that saw the greatest YOY vacancy increases (Portland, Silicon Valley, Seattle, Denver) continued to experience healthy rent growth over the same time period, indicating that leasing fundamentals remain strong. JLL noted that these select markets represent a microcosm of national trends, indicating that there is potential for a muted softening in apartment fundamentals, despite the increase in supply. Note: Major Apartment Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles 4% 100 Apartment - United States Through First Quarter 5.3 - PwC National Apartment 0 bps, 0.0% 5.8 - RCA Garden Apartment 7 bps, +1.1% 4.43% - RCA Mid/Highrise 30 bps, +6.3% 5.5 - RCA Total Apartment 13 bps, +2.3% 5.2 - ACLI Apartment 7 bps, -1.3%
GLOBAL INSTABILITY LEADS TO INCREASED CAUTION; CAP RATE COMPRESSION SLOWS 6 Demand for hotel product declined significantly this quarter, totaling $5.6B, down 58. from to 4Q15 and 57.4% YOY. Full-service hotels remained the favored subtype at $3.8B, accounting for 69.2% of total 1Q16 sales. Volume in the limited-service segment totaled $1.7B, down 31. on a sequential basis and down 60.3% on an annual basis. According to the Moody s/rca CPPI index for hotels, prices have appreciated 9.1% YOY. Blackstone acquired a portfolio of four Club Quarters hotels for $405 million (approx. $329,805 per key), the largest transaction in 1Q16. Properties in this portfolio are located in Chicago, San Francisco, Philadelphia, and Boston. The largest single asset transaction in 1Q16 was Carey Watermark Investors 2 acquiring the Seattle Marriott Bellevue for $187 million (approx. $510,000 per key). The hospitality sector softened in 1Q16. While occupancy levels remained at peak levels, weaker ADR and room night demand growth coupled with increasing supply expansion downplayed RevPAR gains. For the quarter, Smith Travel Research (STR) tracked ADR advancement of 3.2% up to $120.92 and an occupancy decline of -0. to 60. overall. RevPAR growth for the quarter increased by just 2., the third sequential quarter of deceleration and markedly below the 8.3% and 6.3% annually gains posted in and, respectively. HOTEL $35 $25 $15 $5 Forecasts for the lodging segment remain positive, based primarily on the expectation for sustained Sources: PwC Real Estate Investor Survey (published semi-annually), Real Capital Analytics, American Council of Life Insurers, PNC Real Estate Market Analytics economic growth across the U.S. According to PwC s updated lodging outlook (released in May ), demand growth is expected to slow in 2017, just as the pace of supply growth accelerates above the long-tern average for the first time since. As a result, PwC s outlook anticipates declining occupancy; however, levels will remain near peak averages. Room rates are expected to continue to grow, although at a decelerating pace, driving more modest RevPAR increases, estimated at 3. for 2017. Hotel Note: Major Hotel Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles 1 14% 13% 12% 11% Hotel CPPI & Transaction Volume Through First Quarter 170 130 110 90 70 7.7 - PwC Full Service 15 bps, -2.0% 8.2 - RCA Hotel 4 bps, -0. 8.8 - PwC Limited Service Hotel - United States Through First Quarter 10 bps, -1.1% 5.42% - ACLI Hotel 83 bps, +13.3%
GLOBAL INSTABILITY LEADS TO INCREASED CAUTION; CAP RATE COMPRESSION SLOWS 7 NATIONAL CAP RATE ESTIMATES (1 Q ) Sources utilized in property type capitalization charts include: American Council of Life Insurers (ACLI): Publishes periodic reports on the commitment profiles and credit performance of commercial mortgages originated and held by life insurance companies. Beginning in 1965, ACLI data offers the longest aggregate time-series of loan performance spanning several CRE market cycles. Real Capital Analytics (RCA): Provides property-level transaction data on price and cap rates for any commercial property transaction valued over $5.0 million. PricewaterhouseCoopers (PwC) Real Estate Investor Survey: Publishes real estate survey information gathered from a cross section of major institutional equity real estate investors, who invest primarily in institutional-grade property. Survey information is gathered through on-line questionnaires and telephone interviews.
GLOBAL INSTABILITY LEADS TO INCREASED CAUTION; CAP RATE COMPRESSION SLOWS 8 All Properties CPPI & Transaction Volume $160 $140 $120 National (All-Property) Core Commercial Major Markets (All- Property) 300 2 0 $80 $60 $40 200 100 US Sales Transaction Volume By Property Type $80 $70 $60 Office ($29.0B) Industrial (.8B) Retail ($15.7B) Apartment ($36.6B) Hotel ($5.6B) $ $40 2001 2001 Note: Major Markets are Boston, Chicago, Washington DC, New York, San Francisco, and Los Angeles Note: Volume represents properties and portfolios valued at $5 million and greater. Hotel volume results from 2001 through modeled as a percentage of total volume.