1. © JR DeLisle, Ph. D. Real Estate Outlook 2010: No Bottom, No Net presented to: Seattle Chapter of the Appraisal Institute Fall Conference by: Jim DeLisle, Ph.D. December 1, 2009 jrdelisle@jrdelisle.com Annotated. Select View Notes in PPT to read my text.

2. © JR DeLisle, Ph. D. Presentation Overview I: Outlook 2010 Prelude II: Economic and Capital Markets III: Real Estate Capital Markets IV: Commercial Real Estate Market Update V: Implications for Seattle Real Estate Market

3. © JR DeLisle, Ph. D. Three Major Attributes of Real Estate Revisited Three major attributes of real estate... – L, – L. L L L....... ulnerable,....... ulnerable. The 2009 regime of real estate... – D....... istressed,....... istressed. Three major attributes of real estate... – L, – L. The 2010 + regime of real estate... Liability, Litigation, Liquidity (NOT!) L, L, L Butt, what the “L”?

4. © JR DeLisle, Ph. D. Commercial Real Estate: How we Got Here Tax Recovery: ACRS Deregulate Fin Inst. Foreign $’s Pension $’s Tax Reform Record Const. RE Collapse Thrifts Collapse RTC UPREITs CMBS Defensive Capital $’s 9/11 Recession ERISA Tax Reform NCREIF Total Return Value Change

5. © JR DeLisle, Ph. D. How We’re Doing: Institutional Real Estate Source: NCREIF The Good News…. It’s not as bad as it was The “Bad News” Implicit Cap Rates 200bp below averages

6. © JR DeLisle, Ph. D. The Three C’s of our Disconnect Credit Crisis –Easy Credit –Cheap Credit –Plentiful Credit Crisis of Confidence –Consumer Confidence –Corporate Confidence Crisis of Collateral –Value attributable to delinking spatial market/capital market –Values correction as “marked to market” –Re-pricing of Risk

7. © JR DeLisle, Ph. D. Rising Rents Values Spatial & Capital De-connect and Re-connect Warranted Construction: Expanding Demand Capital Market Bubble Market Inefficiency Spatial Market Capital Market Cap Rate Rise Interest Rates/Debt Rise Vacancy Up Rents Down BV (Bubble Value) Debt -20%+/- Bubble Cap R -20%+/- Bubble Market -10-20%+/- Softening -40-60%

8. © JR DeLisle, Ph. D. What Happened: Commoditization of Pricing Market Risk/Return Long-Term Recent: Risk/Return 5 yrs

9. © JR DeLisle, Ph. D. Who Responded to the Survey? Experience of Respondents What Specializations? JRD Prediction Number with Same Company will decline….. Others: Regulator, pension advisor, government, right-of-way, lender appraisal department, lawyer, student Seattle MAI Respondents

10. © JR DeLisle, Ph. D. When National & Seattle Markets Bottom Out? National Seattle Respondents Seattle

11. © JR DeLisle, Ph. D. Part II: A Growing Consensus on Economy Seattle Respondents

12. © JR DeLisle, Ph. D. Breaking News on Real Estate & the Economy

13. © JR DeLisle, Ph. D. The Good News: Employment Losses Slowing Source: economy.com Net Employment losses Unemployment Jobless Claims Slowing? 10% The glass is half-full syndrome; wishful but tentative….

14. © JR DeLisle, Ph. D. Business Cycles: An Historical Comparison Click for annotation

15. © JR DeLisle, Ph. D. Critical Elements to Sustainable Recovery The Future Remains Uncertain Few degrees of freedom; stars must stay aligned…. Seattle MAI Respondents

16. © JR DeLisle, Ph. D. Federal Stimulus Funding: Pledged & Provided

17. © JR DeLisle, Ph. D. US Recovery Status

18. © JR DeLisle, Ph. D. Business Inventories and Business Spending Business SpendingBusiness Inventories Good News: Manufacturing up

19. © JR DeLisle, Ph. D. Small business report tighter credit Reactions –Cutting payrolls –Reducing inventory –Reducing capital spending Outlook –No near-term improvement Focus on Small Business Source: economy.com Credit Remains Tight for Business

20. © JR DeLisle, Ph. D. Housing Activity and Delinquency Rates Construction Housing Index Delinquency & Default

21. © JR DeLisle, Ph. D. Residential Delinquencies, Foreclosures & Charge-Offs Loan Charge-Off Rates to Rise Source: economy.com Delinquency Rates Residential Foreclosures

22. © JR DeLisle, Ph. D. Consumer Confidence, Spending & Credit Consumers Contracting Source: economy.com Consumers are over 70% of GDP…. As of October 2009, recent uptick in retail sales on Year over Year; partly weak 2008… Butt…

23. © JR DeLisle, Ph. D. Global and Domestic Business Confidence Source: economy.com U.S. Business Confidence Some improvement…. But, deficit….

24. © JR DeLisle, Ph. D. Global Recession Map Source: economy.com

25. © JR DeLisle, Ph. D. Part II Summary: The Economy Macro-economic Environment Economy showing some signs of turning Businesses struggling, credit tight Consumers bearish The Future Remains Uncertain

26. © JR DeLisle, Ph. D. Part III: Real Estate Capital Markets

27. © JR DeLisle, Ph. D. Current and Future National-Level Cap Rates Most common: modes Seattle MAI Respondents

28. © JR DeLisle, Ph. D. Current and Future Seattle-Area Cap Rates Seattle MAI Respondents

29. © JR DeLisle, Ph. D. CBA: Properties for Sale Output

30. © JR DeLisle, Ph. D. Seattle Capital Market: Agree/Not Seattle MAI Respondents

31. © JR DeLisle, Ph. D. Capital Markets & Capital Flows Investment Preferences –Core assets at distressed prices –Major markets, strong assets Timing –Still waiting for bottom –Indecisive; slower to act Opportunities –Cash –Distress –Takeovers Decreased capital flows –Investors still frozen –Debt limited sources & tighter –Access & yield for equity Capital Market Challenges –Refinancing: volume & status –Weakening fundamentals –Surge in distressed assets –Valuations & mark-to-market –Growing pressure to act.. PositivesNegatives

32. © JR DeLisle, Ph. D. Commercial Leverage: Problems & Implications Tightened Credit –Higher DCRs and LVs –Hard valuations, less financial engineering –Recourse debt –Real equity positions Outlook for Commercial Debt –Limited supply; flight to quality –Tighter; increased equity and recourse Refinancing Crisis –No obvious sources of debt –Banks struggling with carry-over problems –No CMBS resurgence

33. © JR DeLisle, Ph. D. Bid/Ask Spread: Trends and Value Pressures Bid/Ask De-Compression –Distressed Sellers will have to act –Distressed Assets will face melt-down risks Mark-to-Market Accounts –NCREIF - 35% w/o Distressed Sales –Going Forward: Three Strikes Comps Down as Assets Dumped NOI Erosion, Vacancy & Rents Debt & Equity Yields Up Appraisals under increasing scrutiny

34. © JR DeLisle, Ph. D. Distressed Asset Recovery by Source & Terms

35. © JR DeLisle, Ph. D. REITs –Have reversed downward spiral –Significant new capital raised through Sept 2009 –Low Dividends suggest accretive opportunities Global Investors –Western European –Middle East –Asia/Australia Domestic Funds –Significant growth in US –New Opportunity Funds –New Value-Plus Funds Players in Distressed Asset Market

36. © JR DeLisle, Ph. D. REITs: Back to the Future? Changing Game? –Through June, raised $12 billion in stock –Who? Office: Boston Properties, Vornado Realty Trust Retail: Regency Centers, Simon Property Group Challenges –Existing Leverage –Eroding Fundamentals –Falling Property Values Accretive? Buy at 8-10, payout 4-6

37. © JR DeLisle, Ph. D. REIT Snapshot

38. © JR DeLisle, Ph. D. REIT Stock Prices: Retail and Office

39. © JR DeLisle, Ph. D. Apartment, Hotel and Diversified REITs

40. © JR DeLisle, Ph. D. Part III Summary: Real Estate Capital Markets Macro-economic Environment Economy showing some signs of turning Businesses struggling, credit tight Consumers bearish Real Estate Capital Market Still shut down; some activity increasing Rising Cap rates, tighter credit, picky sources Major challenge in de-levering

41. © JR DeLisle, Ph. D. Part IV: Spatial Market Components of Spatial Market –Demand –Supply Market Balance

42. © JR DeLisle, Ph. D. Commercial Market Fundamentals Downtown Office Suburban Office Industrial Apartments Source: Torto Wheaton Research, REIS, 2009 Emerging Trends Retail Vacancy Rates Office Industrial Retail Apartments Development (msf)

43. © JR DeLisle, Ph. D. NCREIF Property Type Return Overview

44. © JR DeLisle, Ph. D. Risk/Return by Property Type by Regime

45. © JR DeLisle, Ph. D. Office Real Estate Overview –Corporations giving back space –Sublease activity increasing –Vacancy rates rising –Rents softening –Credit will be tightening –Construction declining Areas of Concern –Speculative projects –Commodity product –Capital Needs: Cap X, TI’s –Second and third tier markets –Emerging sub-markets Opportunities –Abandoned Projects –Entitled Projects –Capital Needs Projects –Asset Takeovers –Distressed Owners/REO

46. © JR DeLisle, Ph. D. Overview –Retail sales tepid –Inventories will be lean –Credit tight, local and regional players –Retailer contraction; unit profitability –Defensive capital to protect markets Areas of Concern –New unproven & unopened stores –Underperforming existing units –Unanchored Life-style centers –Tenant Bankruptcies –Mixed-use in marginal markets –Niche Oversaturation Retail Real Estate Opportunities –Projects with Lost Anchors Entitled/Spec Projects Capital Needs Projects Asset Takeovers Distressed Owners & REO

47. © JR DeLisle, Ph. D. Overview –Absorption slowing –Rents softening –Construction moderating –Changing Logistics Models –Globalization Areas of Concern –Overbuilt markets –Functionally obsolescence –Office Showroom/Flex –Exports in Global Recession Industrial Real Estate Opportunities –Projects w/ Lost Tenants Capital Needs Projects Changing H&B Use Distressed Owners & REO

48. © JR DeLisle, Ph. D. Overview –Modal Shift: Rent vs. Own –Concessions increasing –Absorption slowing –Vacancy rates rising –Rents softening Areas of Concern –Homogenized Product –Product Positioning –Re-apartmenting –Density as an End vs. Means –Parking: Shared Multifamily Real Estate Opportunities –Projects i n pre-development –Entitled but unfunded –Repositioning –Conversion (future) –Distressed Owners & REO

49. © JR DeLisle, Ph. D. Overview –High risk/return profile –Travel down –Companies down-scaling –Occupancy falling –Rates slipping Areas of Concern –Homogenized Product –Poor Product Positioning –Hotel/Apartment/Condo Hybrids –Weak flags Hotels Opportunities –Projects i n development: not finished –Entitled: not started –Reflagging existing –Distressed Owners & REO

50. © JR DeLisle, Ph. D. Growth in Distressed Assets by Property Type

51. © JR DeLisle, Ph. D. What’s Happening on the Distressed RE Front? Source: Real Capital Analytics Status and Location Growth & Build-up

52. © JR DeLisle, Ph. D. Distressed Asset Spillover: Why it Matters Terminus 200: Cousins Phipps Tower: Crescent/Manulife 3630 Peachtree: Duke/Pope & Land Two Alliance Center: Tishman Bank of America Lead Regions Lead Wells Fargo Lead, Regions Follows Sources: RCA, WSJ 4/21/2009

53. © JR DeLisle, Ph. D. Distressed Loan Recovery by Property Type Office53% Industrial66% Retail72% Hotel65% Apartment63% Development32% Land45% Overall60%

54. © JR DeLisle, Ph. D. Part IV Summary: The Spatial Markets Macro-economic Environment Economy showing some signs of turning Businesses struggling, credit tight Consumers bearish Real Estate Capital Market Still shut down; some activity increasing Rising Cap rates, tighter credit, picky sources Major challenge in de-levering Spatial Market Fundamentals continue to erode lagging economy Vacancy rates rising, rents falling Stagnant demand, leasing sluggish

55. © JR DeLisle, Ph. D. Total Returns: Seattle vs. US

56. © JR DeLisle, Ph. D. How Seattle Cap Rates Compare to US? Not as different as we thought Challenge: Remove Volatility

57. © JR DeLisle, Ph. D. Seattle Institutional Returns by Property Type

58. © JR DeLisle, Ph. D. What’s Happening in Seattle? What’s it all About?

59. © JR DeLisle, Ph. D. Seattle Real Estate Fundamentals: Yay/Nay? Seattle MAI Respondents

60. © JR DeLisle, Ph. D. Additional Insights on Seattle Market Seattle MAI Respondents

61. © JR DeLisle, Ph. D. Seattle Market Risks: Significant/Not Seattle MAI Respondents

62. © JR DeLisle, Ph. D. Issues and Risks in Seattle Seattle MAI Respondents Issues Risks

63. © JR DeLisle, Ph. D. Part V. “Real” Opportunities in Seattle RE Seattle MAI Respondents

64. © JR DeLisle, Ph. D. Players –Emergence of new players will create further problems –Many naïve buyers will clog up the system –Intermediaries will raise capital but struggle to deploy –Infrastructure not in place to deal with sheer volume of deals New Funds –Expect a spate of new funds, some with experience others not –Closed-end fund structures will be popular –Off-shore investors will be a major target for money managers Products –A spate of new products will be introduced to lay off risk –New Partnership arrangements will match expertise with capital Other Challenges: Players and Products Seattle MAI Respondents

65. © JR DeLisle, Ph. D. Personal –Showing value of services –Survival –Low fees and lower respect Valuation –Determining market value –Determining when distressed prices are the market –Confirming details of all transactions –Staying on top of market and explaining it –Dealing with diverse leases and transactions Challenges to Appraisers Seattle MAI Respondents

66. © JR DeLisle, Ph. D. So, To Walk, To Talk, To Walk the Talk???That is the question…. –There is no one answer…. –Critical thinking and survival instincts will rule… –If not, there’s always school…. Back to the Future….. Conclusion: What to do? Back to School? http://jrdelisle.com