MEASURING RETURNS ACROSS THE FOUR QUADRANTS OF REAL ESTATE : A UK CASE STUDY Alex Moss, Consilia Capital Malcolm Frodsham, Real Estate Strategies ERES Presentation 6 th July 2013

CONTENTS Purpose of the Study Background Methodology Results Summary and Conclusions 2 Consilia Capital

PURPOSE OF THE STUDY Consilia Capital The last three years has seen an increase in both investor interest in real estate, and new vehicles created for investment across all four quadrants (Public/Private, Debt/Equity) However, we do not believe that there has been a commensurate level of research identifying the expected level of risk and returns from vehicles in each of the four quadrants, both on a comparative basis and specifically relative to an underlying real estate benchmark The purpose of this study, which is the first in a series on this topic, is to generate a series of returns for each quadrant with the returns in the direct market as a common factor This study will present the methodology employed and quantify the returns in each quadrant over identifiable stages of the cycle

BACKGROUND Consilia Capital The traditional valuation metrics within each segment make no reference to the valuation levels in any other segment We seek to ascertain whether there are linkages between the quadrant returns If so, analysts that monitor pricing trends in one quadrant may be able to predict future price movements in another This paper considers the first stage of the portfolio construction process This requires return series for each quadrant that removes the impacts of differences in vehicle asset allocation and manager alpha

BACKGROUND INTER-RELATIONSHIPS Consilia Capital Any real estate investment, regardless of the quadrant in which it falls, is exposed to tangible real estate assets as well as to other influences that are specific to each quadrant Each segment is influenced by its own particular set of pricing drivers, so each segment will relate in a varying manner to the trends in prices and income on the underlying private real estate market The outcomes in each of the four quadrants will also indirectly influence the direct market and, potentially, the other segments too

BACKGROUND CONSTRUCTING INDICES FOR THE FOUR QUADRANTS Consilia Capital This study generates comparable return series for each of the four quadrants from a single common factor to returns: the ungeared market return The ungeared market return represents the underlying real estate market return before the influence on vehicle returns of: 1. Leverage / LTV / Seniority 2. The activities associated with the operation of real estate investment vehicles Asset allocation / stock selection (alpha) / style Liquidity mechanism (closed / open ended, bid-offer spread, equity raising) Costs Cash We have not de-smoothed the market return

METHODOLOGY Consilia Capital This study focusses purely on the UK market, over the period For consistency, we have taken the IPD All Property Index as a proxy for the returns available for the direct market In order to decompose returns and provide a framework for understanding the relationship between them we have then created synthetic across each of the four quadrants as follows: 1. Private Equity – applying a LTV proxy to the IPD ungeared returns, deduct costs and cash drag 2. Public Equity – applying the prevailing sector NAV discount / premium and a sector LTV proxy to the IPD ungeared returns 3. Private Debt - we have modelled the delinquencies using assumptions regarding movements in direct asset capital values and the interest received from estimates of fees and margins over swap rates. Marked-to-market the nominal debt using current lending costs. 4. Listed debt – As for private debt but marked-to-market the nominal debt using corporate bond yields For the actual returns we have taken the EPRA UK Total Return Index for listed real estate and the IPD AREF Pooled Funds Index for unlisted real estate.

METHODOLOGY Consilia Capital In order to better understand the performance of each of the quadrants at different stages of the cycle we have broken the twenty year period into the following five style periods: End Sep 1992–End Mar 1998Interest led recovery End Mar 1998-End Mar 2002TMT Boom End Mar 2002-End Dec 2006The Bull Market End Dec 2006-End Mar 2009The Bear Market End Mar 2009-End March 2012QE Driven Rebound

RESULTS THE UNDERLYING REAL ESTATE MARKET RETURNS Consilia Capital Total Return %pa Income Return %pa Capital Growth %pa Interest led recovery TMT Boom The Bull Market The Bear Market QE Driven Rebound Source: IPD Monthly Index

RESULTS QUADRANT ONE: PRIVATE EQUITY Consilia Capital Underlying IPD Monthly Index The average leverage of the IPD/AREF Pooled Funds Index To adjust for costs & fees we reduce the income return by 66bps* Assume the average cash holdings of Balanced Funds in the IPD/AREF Pooled Funds Index and a monthly LIBOR cash return Total ReturnIncome ReturnCapital Growth Interest led recovery TMT Boom The Bull Market The Bear Market QE Driven Rebound *IPF A Decade of Fund Returns 2012

THE DATA QUADRANT TWO: PUBLIC EQUITY Consilia Capital Underlying IPD Monthly Index LTV ratios of a leading UK company to replicate gearing The average discount to LTV is extracted from the equity market. To adjust for costs we reduce the income return by 100bps EPRATotal Return Income Return Capital Growth Interest led recovery TMT Boom The Bull Market The Bear Market QE Driven Rebound

THE DATA QUADRANT THREE: PRIVATE DEBT Consilia Capital Loans are assumed to be 5-year bullet loans, 60% LTV (no ICR restriction) Interest = 5-year swap rate plus margin* Fees are assumed at beginning of term* The probability of default is defined as the probability that the collateral value falls by an amount such that the equity is wiped out (no interest default) Defaults are estimated at the end of the 5-year period A 10% impairment charge is imposed if the loan defaults Example: Loan made in January 1990 Subsequent 5-year capital growth = -15.6% (source: IPD Monthly Index) Standard deviation of 5-year asset capital values = 6.3% pa (Source: bespoke research using IPD Annual Index) Probability of Default = 34.9% (probability that 5-year capital growth < -40%) Expected Loss = -10.8% (including 10% impairment charge) *De Montfort University

THE DATA QUADRANT THREE: PRIVATE DEBT Consilia Capital

THE DATA QUADRANT THREE: PRIVATE DEBT Consilia Capital ?

MARKING-TO-MARKET QUADRANT THREE: PRIVATE DEBT Consilia Capital Q: How can / should the debt be marked-to-market each period? 1. Adjust loan value for changes in interest rates 2. Adjust loan value for changes in risk of the loan / Expected Loss No real data on margin versus LTV over time Approach taken: As LTV changes through time the appropriate margin is increased by 1bp per 1% of extra LTV. For example A 60% LTV = 1.0% margin A 70% LTV = 2.0% margin Example: Loan made in January 1990, Swap rate = 12.4% Loan Amount Collateral value LTV Swap RateMarginMark-to- market Jan '90£60£10060% 12.4%1.0%£60.0 Jan ’91£60£8769% 12.8%1.9%£54.7 Jan ’92£60£8174% 10.0%2.4%£64.7 Jan ’93£60£7481% 8.7%3.1%£67.9 Jan ‘94£60£8075% 6.7%2.5%£87.5

RETURNS QUADRANT THREE: PRIVATE DEBT Consilia Capital We have assumed an equal value loan is made every month Return in any single month depends on the: Current swap rates and margins Average interest rate of made in previous 60 months Losses on loan made 60 months previously Change in mark-to-market value of loan principal SWAP, %Margins, % Income Return, % Losses (Write downs on loans made 5-years before), % Average Extra Margin, bps Capital Growth, % Total Return, % ’ ’ ’ ’ ’ ’ ’ ’

THE DATA QUADRANT THREE: PRIVATE DEBT Consilia Capital Total Return Income Return Capital Growth Interest led recovery TMT Boom The Bull Market The Bear Market QE Driven Rebound Assumptions: 5-year bullet loans, 5-year swap rates + margin + fees, debt marked to market at prevailing costs adjusted for average current LTV

THE DATA QUADRANT FOUR: PUBLIC DEBT Consilia Capital Total Return Income Return Capital Growth Interest led recovery TMT Boom The Bull Market The Bear Market QE Driven Rebound Assumptions: 5-year bullet loans, 5-year swap rates + margin + fees, debt marked to market at prevailing costs adjusted for average current LTV We have marked to market using the yield to maturity on corporate bonds

RESULTS FOUR QUADRANT Consilia Capital IPDPrivate Equity Public Equity Private Debt Public Debt Interest led recovery TMT Boom The Bull Market The Bear Market QE Driven Rebound

RESULTS FOUR QUADRANT Consilia Capital Interest led recovery Private Equity 9.5 Public Equity 27.3 Private Debt 11.6 Public Debt TMT Boom Private Equity 9.1 Public Equity 3.1 Private Debt 9.5 Public Debt The Bull Market Private Equity 15.5 Public Equity 32.0 Private Debt 4.0 Public Debt The Bear Market Private Equity Public Equity Private Debt -6.5 Public Debt QE Driven Rebound Private Equity 9.4 Public Equity 21.2 Private Debt 5.8 Public Debt 13.9

SUMMARY AND CONCLUSIONS Consilia Capital The four quadrants are bound together by their common exposure to the underlying commercial real estate market Investors must make careful and continuous assessment of the prospects in the direct market when assessing the prospects for any individual quadrant When assessed independently, from two different perspectives, credit and equity analysts can reach different valuation judgements Investors that monitor all four quadrants are more likely to identify the investment opportunities that most closely match their investment requirements Once a quadrant is selected investors must then choose from a wide array of individual investment vehicles comprising the investible universe