1. Global Research and Consulting Econometric Advisors CBRE Econometric Advisors Client Conference 2012 October 2, 2012 Session 5 | Market Segments What Generates Performance: The Market, Location, and Property Features Presented by: Serguei Chervachidze, Capital Markets Economist Gleb Nechayev, Senior Managing Economist

2. Global Research and Consulting Econometric Advisors CBRE Econometric Advisors Client Conference 2012 October 2, 2012 Submarket Rent Growth: Can Investors Beat the Wider Market?

3. CBRE | Page 3 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 The Question Submarkets are small areas within an MSA with somewhat homogenous properties. How much of the yearly rent growth of the average property within a submarket is due to: Macro economic factors and the national cycle? The property market cycle of the encompassing MSA (its rent growth). Structural features of the submarket (such as location, building age, size…) that do not change? The residual is due to changing market forces within the Submarket that are different from the MSA The residual is due to changing market forces within the Submarket that are different from the MSA

4. CBRE | Page 4 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Submarket Data 731 submarkets, residing in 56 MSA, 1988-2011 Office: 573 submarkets, residing in 53 MSA, 1988-2011 Industrial: 674 submarkets, residing in 58 MSA, 1997-2011 Multi-Housing: 245 submarkets, residing in 50 MSA, 2000-2011 Hotel (full- service):

5. CBRE | Page 5 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Submarket Analysis: Regressions

6. CBRE | Page 6 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Example of Regression Analysis: OFC VariableCoeffStd ErrorT-StatSignif Y19990.17220.20290.84850.3962 Y20000.28890.20271.42500.1542 … Y2010-0.28430.2341-1.21470.2245 Y2011-0.27870.1971-1.41430.1573 Growth Market Rent0.95500.021843.88150.0000 Growth Market Rent x Bear0.07540.03002.51210.0120 R20.54 Adj. R20.50 AIC 3.71168 N Obs.9021 Eq (5): Dependent Variable: Submarket Rent Growth; Fixed Effects Panel Estimation Source: CBRE Econometric Advisors

7. CBRE | Page 7 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Submarket Analysis: OFC & IND Source: CBRE Econometric Advisors

8. CBRE | Page 8 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Submarket Analysis: MH & Hotels Source: CBRE Econometric Advisors

9. CBRE | Page 9 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Do These Differ by Bull/Bear Rent Phase? Note: Cyclical Structural Breaks are Identified using the Bai-Perron (2003) Structural Break Tests

10. CBRE | Page 10 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Submarket Analysis by Bull/Bear Phase: OFC & IND OFC: Market Rent Effect Bull: 0.91 Under Bear: 0.94 Difference: Weakly Stat Sig, p = 0.11 Source: CBRE Econometric Advisors

11. CBRE | Page 11 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Submarket Analysis by Bull Bear Phase: MH & Hotels Source: CBRE Econometric Advisors

12. CBRE | Page 12 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Conclusions  Market rent and macro trends drive vast share of submarket performance  Submarket-unique factors that are fixed over time have very small effect on rent growth Do property/submarket structural features matter? Not a lot!  In the down (bear) phase of the cycle, market rents have a stronger downward effect on submarket performance vs. the up (bull) phase  Remaining unexplained part of submarket performance (50% to 70%)— submarket-specific factors that are changing over time: Local supply dynamics: building a new road; new large development Local demand changes: Influx of high-tech firms to submarket; outflow of residents from one submarket to another  Office, Hotel, and Multifamily submarkets—highly integrated with markets 50%-60% of submarket variation in rents explained by market variation  Industrial—little integration Only 30% variation explained Is warehouse different? Homogenous property type?

13. CBRE | Page 13 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 How Do I Pick the “Right” Submarkets?  Step 1: Pick the right market by: Studying the macro environment very carefully Understanding rental fundamentals and factors that drive these fundamentals on the market level  Step 2: Within a chosen market, pick the right submarket by: Studying and understanding factors that change on the local (submarket) level (including supply)  Do not pick a submarket solely on the basis of some fixed characteristics that do not change over time. For example: –Invest only in industrial markets only with rail-road access –Edge-of-city multifamily properties on top of hills with a good view –Office properties within 20 miles of CBD These characteristics are responsible for a very small share of performance differences vs. the larger market over time

14. Global Research and Consulting Econometric Advisors CBRE Econometric Advisors Client Conference 2012 October 2, 2012 Property Rent Growth: How Much Does Property Characteristics and Location Matter? Cross-Section Analysis of Multi-Housing Property Performance Since 2007

15. CBRE | Page 15 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Property Data Summary 6,487 multi-housing properties in 352 submarkets across 10 markets property rent in 2007q1 and 2012q1 number of units in property number of stories in property age of property property zip code submarket rent in 2007q1 and 2012q1 market rent in 2007q1 and 2012q1 Source: Pierce Eislen

16. CBRE | Page 16 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Cross-Section Analysis: Questions 1) How much variation in submarket rent growth can be explained by variation in: market rent growth submarket characteristics that don’t change (distance to downtown, submarket size, 2007 rent level relative to market) 2) How much variation in property rent growth can be explained by variation in: market rent growth submarket rent growth property-specific characteristics that don’t change (age, size, number of stories, 2007 rent level relative to submarket)

17. CBRE | Page 17 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Property Data Summary Source: Pierce Eislen

18. CBRE | Page 18 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Market Data Summary Source: Pierce Eislen

19. CBRE | Page 19 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Explaining Submarket Performance Markets explain most of the variation in submarket performance and submarket characteristics explain only a fraction (although they are statistically significant) Smaller submarkets that are closer to downtown and whose average rent is higher than the market did better in the last 5 years

20. CBRE | Page 20 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Explaining Property Performance Market /submarket rent changes explain about 40% of variation in property rent growth Property rent increases by 1% with every 1% increase in market rent.

21. CBRE | Page 21 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Explaining Property Performance (Cont.) Fixed property characteristics explain less than 10% of variation in property rent growth since 2007, but all of them are statistically significant.

22. CBRE | Page 22 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Summary of the Results  Markets explain about 70% of variation in submarket performance and submarket characteristics that are fixed in time explain less than 5% (but all of them are statistically significant: smaller submarkets that are closer to downtown and have average higher than the market did better over 2007-2012 period)  Markets/submarkets explain about 40% of variation in rent growth across properties and property characteristics explain less than 10% (but all of them are statistically significant: smaller, older properties with lower rents relative to market, further from downtown did better over 2007-2012 period)

23. CBRE | Page 23 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Implications for Investing Market rent growth matters a lot to submarket and property rent growth, but being in the right market and submarket is not even half of the story when it comes to explaining property performance Submarket and property characteristics that don’t change over time matter very little, but may help beat a benchmark Focus on property characteristics that do change over time – such as property management, renovations, etc.

24. Global Research and Consulting Econometric Advisors CBRE Econometric Advisors Client Conference 2012 October 2, 2012 What About Property Investment Performance? NCREIF Building Level Data

25. CBRE | Page 25 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 The Question—Updated Now we look at total return. How much of the building-level annual total return in NCRIEF NPI is due to: Macro economic factors and the national cycle? The property market cycle of the encompassing MSA (its rent growth). Structural features of property (such as location, building age, size…) that do not change? The residual is due to changing features of the individual property

26. CBRE | Page 26 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Property Level Returns Data: NPI Joint project with Jeff Fisher and NCREIFOffice building-level returns data from NPIBuilding-characteristics data exclusively from CBRE1,012 properties over 1989 – 2011Unbalanced panel with 5,881 observationsAverage years a building is the panel: 5.8

27. CBRE | Page 27 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Property Returns Analysis: Regressions

28. CBRE | Page 28 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Parsing Out Building-Level Returns: NCREIF OFC Source: CBRE Econometric Advisors

29. CBRE | Page 29 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 What’s Left To Explain?  Fixed property effects: only 20% of variation Unlike in submarkets, these matter a lot more because investment capital pays attention to these factors For two properties with the same rent growth, a new CBD office tower will get a lower cap rate than older suburban office park  Dynamic property effects: 53% of variation: These are factors that are property-specific and are changing over time Similar to dynamic submarket effects in rent studies (39% variation in office) Property management over time is key –Signing a lease at top rates right before recession –Blend and extend Other dynamic property effects include: –A good tenant leaving –Changes in the cost structure of the building –Changes in the immediate neighborhood of the property (a competitor tower built across the street) These are the key elements that will help drive successful investment strategy

30. CBRE | Page 30 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Fixed Effects: What Explains the 20% of OFC Investment Performance?  Stage 2 analysis: make a cross section of fixed effects from Stage 1  We regress the fixed effects from stage one on the various property and submarket characteristics in a cross section  This shows us what drives these effects:

31. CBRE | Page 31 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Stage 2: Explaining the 20%: Property/Submarket Characteristics FactorEffectSignificance Fund type (open end fund, closed end fund, separate account, etc.) Various EffectsMostly Statistically Significant Distance to CBDAverage Property Total Annual Return reduces by 111 bps for every 10 miles away from CBD Statistically Significant Pval = 0.016 Building sizeMaking a property larger by 100k square feet reduces annual total return by 75 bps Statistically Significant Pval = 0.05 Number of floorsNot significantNot statistically significant Pval = 0.17 Submarket Average Rent (1989-2011)A $10 sq. ft. average submarket rent increase implies a 150 bps increase in total annual return Statistically Significant Pval = 0.08 Submarket Average Stock (1989-2011)A 1 million sq. ft. increase in average submarket stock implies a 17 bps increase in average total property return Statistically Significant Pval = 0.08 R22% - 6%, depending on specification N Obs.1,136 Dependent Variable: Fixed Effects Coefficients from Stage 1; Cross-section Setup

32. CBRE | Page 32 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 Conclusions  Results generally in line with what we saw for rent growth analysis  The macro cycle has the strongest effect on investment performance (31% of variation): Consistent with our research that macroeconomic/capital markets factors drive asset pricing and appreciation returns  Market rent performance still matters, but less: 13%  Time-invariant unique building effects now explain more (20%) of variation, but still not a lot  The unexplained dynamic property effects remain key (53%): Need to manage the property with an understanding of market dynamics Tenants, nearby competitors, and other dynamic factors matter more than property amenities Factors that change on submarket level (e.g. demand/supply) matter more than fixed submarket characteristics  Further research is on-going: expect additional insights

33. CBRE | Page 33 Global Research and Consulting ● Econometric Advisors CBRE Econometric Advisors Client Conference 2012 So What Does It All Mean for Investing?  Study the macro/capital markets environment carefully: timing is crucial  Study market-level CRE fundamentals (rents and vacancies, demand/supply and their drivers)  Understand submarket/local/building-level dynamics: factors that are property/location/neighborhood unique and changing are the really hard part, since they are hard to measure.  Use good management to control building-level dynamics Length of lease, CAPEX timing, etc  Do not rely solely on picking submarkets/buildings on the basis of “unique” fixed characteristics: Edge city properties with good view, CBD high-rise properties only, etc  By picking a building at the wrong time and/or in the wrong market and/or with the wrong property/location/neighborhood dynamic will trump any investment returns advantages from getting the “right” fixed characteristics