BKPerspective Real Estate USA 2012

on Real Estate | U.S.
2012
P e r s p e c t i v e o n R e a l E s t a t e 2 01 0
ACKNOWLEDGEMENTS
We would like to acknowledge the following data sources used in completing this report: CB Richard Ellis Econometric Advisors (CBRE-EA), Commercial Mortgage Alert, The Conference Board, CoStar, Federal Financial Institutions Examination Council (FFIEC), IBM Benchmark, International Monetary Fund (IMF), Jones Lang LaSalle, Moodys Analytics, Mortgage Bankers Association, National Association of Real Estate Investment Trusts (NAREIT), National Council of Real Estate Investment Fiduciaries (NCREIF), National Federation of Independent Business (NFIB), Real Capital Analytics (RCA), REIS, Standard & Poors, TD Economics, U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS), U.S. Census Bureau, U.S. Federal Reserve We would also like to thank the many individuals who are employed by these parties as well as the real estate owners and managers who helped us with insights and guidance along the way.
Copyright 2012 by Bentall Kennedy (U.S.) LP All rights reserved The information and statistics contained in this report were obtained from sources deemed reliable. However, Bentall Kennedy Group does not guarantee the accuracy or completeness of the information presented, nor does it assume any responsibility or liability for any errors or omissions. All opinions expressed and data provided herein are subject to change without notice. This report cannot be reproduced in part or in full in any format without the prior written consent of Bentall Kennedy Group.
2 |
Bentall Kennedy (U.S.) LP
Contents
Chapter 1 Executive Overview Chapter 2 Economic Outlook Chapter 3 Capital Markets Chapter 4 Property Sector Fundamentals
Apartment Office Retail Industrial 5 9 21 27 28 32 34 36 39
About Bentall Kennedy Group
| 3
P e r s p e c t i v e o n R e a l E s t a t e 2 01 2 - U. S.
4 |
Bentall Kennedy (Canada) LP
Executive Overview
Economy Poised to Drive Performance in 2012

More than three years have passed since the Great Financial Crisis of 2008 and yet the recessionary conditions from this event feel like they have not ended. Optimism ran high that 2011 would see a sustainable upswing in global economic growth. But circumstances proved to be far more turbulent than investors expected due to the escalation of the European debt crisis, political brinkmanship in the U.S., a devastating tsunami in Japan and a slowdown of the powerhouse Chinese economy. Annualized U.S. GDP growth averaged less than 1.0% during the first two quarters of 2011 and improved to a still-uninspiring 1.8% in the third quarter of the year. Real GDP did finally return to its prerecession peak in 3Q 2011 but the 15-quarter period needed to regain the peak was the longest in the post-war era. The U.S. economys performance in the final months of 2011 suggests that growth is accelerating and we expect this trend to continue in 2012. While significant risks remain, they are much more balanced than they were a year ago. The European debt crisis and U.S. budget deficit are the primary obstacles to stronger global and domestic economic growth. But U.S. business and consumer confidence are slowly improving in spite of these issues and the preliminary report on December 2011 employment shows the creation of 200,000 jobs, one of the strongest gains of the recovery. Unemployment fell to 8.5% in December, nearly a full percentage point lower than it was a year earlier. It is possible that healthy corporate balance sheets and an improving business climate could motivate employers to ratchet up hiring at a faster-than-expected rate in 2012, fueling a stronger economic recovery. A well structured and broadly supported plan developed to resolve Europes debt issues could be the catalyst for even stronger growth. Demographics and technology will be influential drivers of the pace and course of the economic recovery and expansion. The large Echo Boom generation is flowing into the labor force and benefiting disproportionately from recent hiring. Technology is heavily integrated into this generations lifestyle and, as they represent an increasing share of consumer dollars, the demand for technology products will grow. Echo Boomers will also continue to be the primary driver of apartment demand growth.
The strong 'valuation effect' that drove returns in 2011 is unlikely to be repeated in 2012 but there is no reason to expect that commercial real estate is not in store for another strong performance.
| 5
The Baby Boom generation has not lost its relevance and will hold a leadership role in the work force for years to come. This generation will also be an important business driver as firms look to capitalize on the needs of this group as its members transition out of their careers and into retirement. The range of industries affected will be wide, including retail, leisure and hospitality, and healthcare. Aging Baby Boomers will also fuel growth in the technology sector both as they adopt new technologies to enhance their lifestyles and also as firms invest and innovate to meet the rising need for healthcare. Clearly technology will be a pivotal driver in the next economic cycle as it influences consumer behavior, gives rise to new types of office and industrial tenants, and spurs productivity. Technology is unlikely to be the death knell for any particular type of commercial real estate at least not over the next few years but the most successful property investors and managers will be those that proactively make tactical and strategic adjustments to capitalize on the changing landscape created by technological innovation. There is already clear evidence that metropolitan areas with higher exposure to new technology industries are recovering at an aboveaverage rate. Vacancy rates fell for most types of real estate in 2011 as demand strengthened and construction activity remained low. Stronger economic growth in 2012 should only accelerate this trend. To date, apartments have been the clear winner in the recovery as demographic trends, falling homeownership, and an uncertain but growing economy
produced a steady flow of new renters. The other property types do not benefit directly from all of these tailwinds but office and industrial properties have nevertheless steadily improved. Lower retail vacancy rates have been more elusive but retail properties should recover in a more convincing fashion in 2012. Rents are already steadily increasing for apartments and landlords should slowly gain pricing power in the other property types over the coming months. Capital markets were volatile in 2011 but this volatility combined with extremely low yields offered by most assets classes resulted in strong real estate investment performance. The dollar volume of commercial real estate sales increased by 67% in the first 11 months of 2011 versus the same period in 2010 and cap rates compressed. The yields offered by commercial properties remain very high in comparison to U.S. Treasuries and should continue to lure investors in 2012. Even as the net operating income generated by most types of commercial real estate languished, rising investor interest drove very strong investment performance among institutional quality property portfolios. For the year ending in 3Q 2011 the NCREIF Property Index total return was 16.1%, up from less than 6.0% a year earlier. The strong valuation effect that drove the bulk of this increase in returns is unlikely to be repeated in 2012 but with interest rates remaining low for the foreseeable future and NOI having a more positive effect on property performance, there is no reason to expect that commercial real estate is not in store for another strong performance.
6 |
P e r s p e c t i v e o n R e a l E s t a t e 2 01 2 - U. S .
| 7
8 |
Economic Outlook
The Global Economic Recovery Stumbles

The global economic outlook sharply deteriorated in 2011 as some of the risks that surfaced in 2010, such as the potential for sovereign debt defaults, intensified. As the deleveraging cycle grinds on, it is important to note that many of these risks remain extensions of the financial crisis that began three years ago. They should also serve as a reminder that this was not an ordinary cyclical recession and that the road to a full recovery will be bumpy and take time. In such an environment, investors should be aware that the macroeconomic tail risks will remain unusually high.
Shaky U.S. and European growth prospects continue to be the primary issue for the global economy, not only because of the large direct impacts these regions have on global growth, but also because of the indirect implications they have for other advanced and emerging economies. In the Euro zone, economic conditions have weakened significantly as a number of headwinds exert increasing resistance on growth. The recent escalation of the European sovereign debt crisis will continue to curtail consumer and business confidence in many European countries and it is possible that a recession may already be occurring in the region. With soft global demand for Euro zone exports and fiscal tightening in some major markets, growth prospects in Fig. 2.1 Europe are likely to remain restrained well into Real GDP Growth & Outlook 2013 (see Fig. 2.1). The successful implementation of structural reforms, completion of the deleveraging cycle and a return to corporate profitability should usher in stronger growth in the Euro zone in the longer run. But in the short to medium term, political tension among European leaders is likely to remain high and possibly grow. The lack of progress in bringing about structural changes in some European countries is leading to increased liquidity pressures at some European banks and exacerbating divisions within the European Central Banks governing council. In this turbulent environment, a European financial crisis (with contagion effects to global capital markets), a run on the Euro and even a potential break-up of the ECB are major risks to the economic outlook.
10 8 6
Investors should be aware that the road back to normal will be bumpy and slow with the macroeconomic tail risks remaining unusually high.
10 8 6 4 2 0 -2 Emerging & Developing Economies* Advanced Economies Euro Area 2000 2002 2004 2006 2008 2010 2012F
Source: IMF
Y/Y % Change
4 2 0 -2 -4 -6
-4 -6
Forecast:TD Economics Dec 2011; *IMF Sept 2011
| 9
Led by China, growth in emerging markets continues to significantly outperform the developed world. But a key concern is Chinas economic reaction to weakness in the U.S. and European economies. Similar to most of its advanced Western counterparts, the Chinese government has lost some maneuvering room relative to the policy actions it implemented in the aftermath of the 2008 financial crisis. Stubbornly high inflation and the need to control ballooning credit mean that the government will be cautious in propping up domestic demand. Accordingly, with relatively softer factory output and export growth, the pace of the Chinese economic expansion is likely to moderate to around 8.5% in the near to medium term. Though still very healthy by Western standards, moderating Chinese growth is a reminder of the highly correlated nature of todays global economy. Slow growth across larger economies will impact other markets, not just by constraining their exports but also by softening the previously rapid increase in commodity prices. The latter could prove to be a positive for some developing countries. Over the first half of 2011, many of these economies were trying to engineer an economic slowdown to stave-off high inflation and accelerating currencies. But while some of these emerging countries concentrated their efforts on the monetary front, their fiscal policies were lax as their governments reacted slower than their central banks. A moderate decline in commodity prices (or even an easing in upward pressure) would help to cool inflationary and currency pressures in developing economies, and delay any excessive monetary tightening that would inadvertently constrain growth. On the other hand, softer commodity price pressure over the near term would have negative ramifications on growth in major resource-dependent economies such as Australia, Canada and Brazil. Growth in emerging markets should improve by 2013 and accelerate beyond 2014 as the recovery in developed countries will likely be on firmer footing by then. But even over the longer term, emerging markets are unlikely to see their exports soar again, fueled by consumer borrowing in the West as had
occurred during the last decade. Instead, growth in emerging markets will need to rely more on domestic demand. While this is certainly a very large source of potential growth, it will take years, if not decades, for consumers in emerging markets to reach the same spending power as their Western counterparts. In addition to the elevated economic risks that are noted above, it is important to mention that geopolitical tensions in the Middle East will continue to have a significant impact on the global landscape, particularly in relation to the price of oil. Given a high level of uncertainty together with the increased interconnectivity of global capital markets, financial volatility will remain a major theme for investors over the forecast horizon.
U.S. Economy Improving but Risks Remain

The U.S. economy fell short of consensus growth expectations during 2011 but continued to make progress toward an eventual recovery. There was cause for optimism heading into the year as job growth improved in late 2010 and that momentum carried into 2011. More than 215,000 jobs a month were created during the three months ending April 2011, the strongest growth rate in nearly a year.
Fig. 2.2 Probability of a U.S. Recession in the Next 6 Months
50 45 40 US credit downgrade Consumer confidence dips Stock values fall Debt concerns spread to Italy Earthquake strikes Japan Greece credit downgrade Debt crisis persists Stock values fall
Percent (%)
35 30 25 20 15 10 5 0
Jan 11
Feb 11
Mar 11
Apr May 11 11
Jun 11
Jul 11
Aug 11
Sep 11
Oct 11
Nov 11
Source: Moody's Analytics, Bentall Kennedy Research
10 |
Economic Outlook
Through the course of the year, however, a number of significant challenges took their toll on the economy. The March 2011 earthquake and tsunami in Japan disrupted trade flows and auto sales. During the summer, the nation was held hostage by the debate over raising the U.S. debt ceiling, a spectacle that culminated in the downgrade of U.S. credit by Standard & Poors. Meanwhile, the European debt crisis flared, and the probability of a sovereign debt default by a major European Union nation rose. Pair these disruptions with the still-lingering U.S. housing downturn and it is not surprising that business and consumer confidence remain shaky and growth lackluster. According to Moodys Analytics, the probability of a double-dip recession surged during 3Q 2011, rising from less than 25% early in the year to 45% in September (see Fig. 2.2). This increase was tied closely to the U.S. credit downgrade and the subsequent dip in equity values. The level of economic distress does appear to be easing, however, and stronger financial markets helped lower Moodys probability of a recession to 34% in November. Even with this improvement, significant economic and financial market volatility, uninspiring growth, and the failure of consumer confidence to rally significantly keep the risk of another recession elevated as we head into 2012.
Fig. 2.3 Private Versus Public Sector Employment
20 15 10 5 0 -5 -10 -15 -20 82 84 86 88 90 92 94
Although risks abound, major indicators continue to reflect improvement in the U.S. economy. A doubledip recession, while possible, remains less likely than a continuation of this slow recovery. Real GDP grew at a 1.8% annualized rate in 3Q 2011, an acceleration from the less than 1.0% annualized rate experienced in the first half of the year. Panic during the summer months eased to worry as sovereign debt fears mellowed, stock values rebounded, and confidence improved. Importantly, the level of real GDP finally exceeds the previous high reached in 4Q 2007 but the 15 quarters needed to regain the real GDP peak represents the longest period in the post-war period. While the pace of job creation has been disappointing and employment is still more than 6 million jobs below its pre-recession peak, payrolls have increased for 15 straight months. The 200,000 job increase in December was the fourth largest gain of the year and the year-over-year growth rate of 1.3% was on par with the strongest growth rate of the recovery. A closer look at the employment statistics shows that private sector job growth has been even stronger, at 1.8% year-over-year as of December (see Fig. 2.3). Federal, state, and local government job cuts have been a significant drag on the economy, with employment in these sectors declining
Y/Y % Change in Employment
Federal Government State & Local Government Private Sector
96
98
00
02
04
06
08
10
Source: Bureau of Labor Statistics
| 11
by 1.3% during the same period. This is a significant departure from the prior three U.S. economic recoveries where government employment was a source of stability and growth, primarily due to expansion in the much larger state and local government subsector. Aside from government job cuts, growth has been broad based. Retail trade, manufacturing, and even construction employment are on the rise. Officeusing employment was up 1.6% during the 12 months ending in December as growth of 2.7% in the professional and business services sector more than offset losses in the information sector and minimal growth in the financial activities sector. Paramount to the continued recovery will be improvement in business and consumer confidence. U.S. consumers continue to face high unemployment, falling home prices, persistently high energy prices, and a virtually constant barrage of negative news about the U.S. and European debt crises. Geopolitical tensions in the Middle East also remain a very real concern. The loss of household wealth has been monumental. According to the Federal Reserve, household net worth declined by $2.4 trillion in 3Q 2011 and it is now $9.4 trillion below its 2Q 2007
peak despite the recovery of nearly $7 trillion in wealth since 1Q 2009. This loss continues to depress consumer confidence. The Conference Boards Consumer Confidence Index rose to 64.5 in December 2011, its highest level since April 2011, and a considerable improvement from its low of 25 in February 2009; however, even with recent increases, the Index continues to show consumers are far from exuberant. The Consumer Confidence Index averaged about 100 during 200407 and 80 over the past 10 years (see Fig. 2.4). Looked at another way, consumer confidence has only recovered to what was its lowest level between 2001 and 2008. Similarly, small businesses remain more cautious about the future than they were prior to the recession, although their level of pessimism, as measured by the NFIB, has eased since mid-2011. Employers optimism will remain tenuous until demand for their goods and services stabilizes and grows and the political and regulatory environment becomes clearer. Until that time, these factors will constrain the pace of hiring, perpetuating the cycle of uncertainty among consumers and businesses. According to advance estimates from the U.S. Census Bureau, retail sales in December were up 6.5% on a
Fig. 2.4 Crisis of Confidence Persists But Recent Signs of Improvement

160 140 110 105 100 95 90 60 40 20 0 Jan 00 Jul 00 Jan 01 Jul 01 Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Jul 04 Jan 05 Jul 05 Jan 06 Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 85 80 75
Consumer Confidence (left) Small Business Optimism (right)
Index 2005 = 100
120 100 80
Sources: Moody's Analytics, The Conference Board, NFIB
12 |
Index 2005 = 100
Economic Outlook
nominal basis versus 2010 and are 5.9% above their November 2007 peak. Real retail sales, however, remain modestly lower than they were four years ago. Declining unemployment has and should continue to boost consumer confidence and retail sales. Unemployment dropped to 8.5% in December 2011, a significant decline from the 10.0% peak reached in October 2009. Still, the current level of unemployment remains indicative of a relatively weak labor market, particularly since much of the decline over the past few months is due to contraction in the labor force. A more convincing recovery in the job market will be needed to boost confidence and fuel stronger growth in retail spending. For now, it seems unlikely that the economy will get much of a boost from consumers in the near term, despite encouraging holiday sales activity relative to 2010. Bentall Kennedy agrees with the consensus view of stronger GDP growth in 2012. U.S. businesses are well positioned for growth with low borrowing costs, high profit levels, and sufficient excess capacity to increase production when the economy demands it. Businesses continue to increase their investments in equipment and software at a healthy pace, a trend that has historically corresponded with job growth. Consumers will likely take their cue from the job market and as job gains continue and the unemployment rate eases, confidence will build and consumption will increase.
Another significant downside risk comes from the possibility of a dramatic near-term shift away from the strongly expansionary fiscal policy reflected in the massive U.S. budget deficit. This could occur either through an agreement to cut spending or through gridlock leading the way to the expiration of all Bushera tax cuts. We have been saying for over a year that the U.S. must get serious about closing its extraordinary budget deficit, but, just as with Europe, this change should not come as a sudden shock to the system. On the upside, it is entirely possible that the renewed job growth of the past few months will continue and strengthen further in 2012. If year-overyear job growth moved above 2% (roughly 250,000 jobs per month) then real GDP growth would likely come in above 3%, consumer confidence would strengthen further, and the housing recovery would exceed currently bleak expectations. Another upside comes from Europe doing better than muddling through. While it is hard to see it today, a well structured and accepted debt deal in Greece and improved confidence in the fiscal plans of Spain and Italy could ease a major expected constraint on global growth, allowing the strength in the emerging markets to push global growth well above expectations. Euro zone strength would also likely lead to recovery of the Euro versus the U.S. dollar, further supporting U.S. export growth.
Risks More Balanced in 2012

Unlike last year, when we thought risks to the consensus were primarily to the downside, we believe risks are relatively balanced as we head into 2012. On the downside, clearly a failure of Europe to muddle through would significantly increase the risk of another recession in the U.S., probably accompanied by another financial crisis. Unlike many stock traders, we do not think you should buy the rumor and sell the news but rather in this case we think the devil is in the details and that investors should very carefully monitor the implementation of whatever deal is announced.
Drivers of Economic Growth

Demographic trends and technological innovations will play a significant role in the recovery and the next economic expansion. The generations that represent the bookends of the labor force will be particularly influential. The leading edge of the Baby Boom generation is now at retirement age while their children, the Echo Boom generation, now ages 17 to 30, represent an increasing share of the workforce, consumer dollars, and apartment demand. With Echo Boomers driving much of the trends in consumer behavior, technology is likely to have an even more rapidly increasing influence on the economy. This
| 13
CASE STUDY: ATLANTA VERSUS THE SAN FRANCISCO BAY AREA

A comparison of economic performance during the recovery in the San Francisco Bay Area 1 and Atlanta provides an example of the importance of technology. These two markets are roughly the same size, so a direct comparison of changes in employment levels is reasonable. During the national downturn, both areas were hit hard. Employment in Atlanta declined by 8.5% or 210,000 jobs, while employment in the Bay Area declined by 7.5% or 143,000 jobs (see Fig.2.5). Nearly all employment sectors experienced a decline in both metros but it was noteworthy that losses in the information and manufacturing sectors were less severe in the Bay Area than they were in Atlanta. The Bay Areas higher new technology exposure in these sectors was a major reason for the difference. The contrast in performance between Atlanta and the Bay Area has become starker since national employment began to recover in early 2010. From February 2010 to November 2011, employment in Atlanta declined by another 3,000 jobs, while the Bay Area has created 60,000 jobs. Once again this difference can largely be explained by the performance of technology-related sectors. Atlanta has continued to experience job losses in its information sector, which is comprised of more traditional employers in comparison to the Bay Areas technology and social media-heavy information sector, which has grown by more than 8.0% or 7,000 jobs. Similarly, business and professional services, which contains many technology jobs, has grown at a much faster rate in the Bay Area.
Fig. 2.5 Jan. 2008 to Feb. 2010 Employment Trends

25
Feb. 2010 to Nov. 2011 Employment Trends

70 Wholesale Trade Transportation & Utilities Retail Trade Professional& Bus. Services Other Services Natural Resources & Construction Manufacturing Leisure & Hospitality Information Government - State & Local Financial Activities Educational & Health Services Federal Government
Employment Change (jobs, 000s)

Atlanta Bay Area
60 50 40 30 20 10 0 -10 -20 -30 -40 -50
% of Retail Sales Change
-25 -50 -75 -100 -125 -150 -175 -200 -225
Atlanta
Bay Area
Source: Bureau of Labor
Aside from differences in sectors that are directly related to technology, construction jobs are a significant differentiator in the performance of these two areas. Atlantas construction sector, which is heavily dependent on single-family home construction, has continued to shed jobs at a steady rate. But construction has created slight job gains in the Bay Area due to a smaller drag from single-family construction and a growing need for commercial and multifamily space to support resurgent technology employers and their workers. Technological innovation has and should continue to serve as a growth driver in tech-heavy metro areas. In those metros where the latest technology firms are less prevalent, and where population growth and housing construction have historically been key drivers, growth will be limited in the near term, as the troubled housing market keeps construction activity low.
1 The San Francisco Bay Area is defined as the total of the San Jose Metropolitan Statistical Area and the San Francisco Metropolitan Division.
14 |
Economic Outlook
generation has grown up with technology as an integral part of how they live, from education to social interaction, and it is sure to remain a cornerstone of how they function in the business world and how they run their households. Technology will be an influential force in US economic growth and the effects will be self-reinforcing as people use and demand more cutting-edge technology. All else being equal, those metros with competitive advantages in technological innovation will create jobs at a faster rate than those without. In some instances, the impact of growing technology use and innovation will be direct in the form of increased office/R&D space demand and additional housing demand as payrolls expand. In other cases, the impact will be more subtle as technology impacts individual behavior in a variety of ways. As the Echo Boom generation enters the workforce, technology use will only increase. Echo Boomers have grown up with smart phones, the internet, and online social networking as a normal part of life. High levels of comfort with electronic communication and online commerce, and the ability to quickly adapt to new technologies are likely to be characteristics of these young workers, raising significant questions about how companies will use space in the future. Echo Boomers comfort level with technology will revive the debate about telecommuting and its impact on office demand and it will continue to spawn questions about the future of brick-and-mortar retail.
online security have steadily eased and connection speeds and site designs have improved, online shopping has grown not just among younger, tech-savvy consumers but also among older and/or previously skeptical buyers. In fact, as the Baby Boom generation ages and becomes less and less enamored with the prospect of traveling to a shopping center and then walking around to find what they need, it is likely they will become more active online shoppers. Smart phones will only accelerate growth in online shopping as consumers can complete transactions from the palm of their hand in minutes. This was evident during the most recent holiday shopping season. According to IBM Benchmark, online sales on Cyber Monday increased by 33% from 2010 to 2011 and the share of these purchases made on handheld devices nearly tripled. It remains doubtful that recent surges in online shopping foreshadow the slow and steady death of traditional retail. There is still no substitute for going to the store to make sure you buy the freshest produce or pick the clothing item with the highest quality, best fit, or most comfortable fabric. Further, online help and message boards can be useful for consumer research, but sometimes visiting a retailer and chatting with a live salesperson is still the best
Fig. 2.6 Internet & Mailorder Share of Retail Sales (excl. Autos/Gas)
13
Technology's Impact on Retail

Strong growth in online shopping is one clear way technology is having an impact on the economy. Internet and mail order sales are steadily capturing a larger share of total retail sales (see Fig. 2.6). Shopping online appeals to consumers because it offers convenience and the ability to hunt rapidly for the best prices across a broad range of retailers. Technological improvements and the rise of social media are only enhancing this appeal but it may also have something to do with growing fatigue over crowded roads and shopping centers. As fears about
Percent (%)
12 11 10 9 8 7 6 5 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Source: U.S .Census
| 15
way to go, at least for those of us over the age of 30. Some retail formats have attributes that are hard to envision the internet replacing, at least for now. The ability to pick up a gallon of milk or a loaf of bread or perhaps have a prescription filled on the way home from work are conveniences that are hard to replicate online. Additionally, traditional retail often offers an in-person social experience that many consumers enjoy. The most successful retailers are likely to be those that can blend a strong web-based strategy with a chain of convenient brick-and-mortar locations staffed with knowledgeable employees and a broad selection of items. In many instances, stores may simply become showrooms for web sales and retailers can place more emphasis on product display given the reduced need to store items in-house. A number of retailers already conspicuously provide their customers with in-store access to their websites to browse prices and models not available in the store. These strategies should be effective for retailers, but they may be bad news for retail landlords counting on a percentage of sales as part of their revenue. Alternatively, some types of retail space could become nothing more than online order fulfillment centers with a front counter and back-room storage. This would give consumers some of the benefits of online shopping paired with the instant gratification offered by traditional retail purchases.
spontaneity of an impromptu conversation at the water cooler or in the hallway at the office where invaluable brainstorming, idea sharing, and relationship-building take place. Technology can support quick spontaneous communication, but any extensive dialogue where body language and voice tone may have some value are still ideally done in person. Webinars and other types of videoconferencing still have to be planned at mutually agreed-upon times and are fraught with technical glitches. These technologies will improve, but it is hard to envision them supporting the same quality and level of spontaneous and open dialogue that coworkers benefit from in a shared office setting. It is telling that in one of the nations most tech-savvy locations the Bay Area plug-and-play co-working spaces are attracting startups looking for a more professional work environment than the living room couch. Further, these environments may also offer the opportunity to interact with other startups in similar industries. It seems likely that office space will continue to be in demand as the economy grows, regardless of technology. Real estate investors will, however, have to monitor the type of office space new firms demand. Recent trends suggest that technology tenants prefer more open work spaces that foster a collaborative work environment. Aesthetically, there is often a preference for higher ceilings and exposed brick and beams that many technology firms feel more appropriately matches their casual image. To date, technologys impact on office space seems to be more about employers desires to foster the right work environment and boost collaboration and efficiency rather than reducing the demand for space. Technology is clearly bolstering productivity and allowing individuals to do more work outside of the office. This has cut the man-power needed to complete certain business functions, but it should also drive a stronger rate of growth that generates more job opportunities for qualified individuals.
Technology's Impact on Office

Similar themes resonate with technologys impact on office space demand. Fears about telecommuting have been swirling for years, but thus far there appears to be no appreciable impact on space demand. Workers may telecommute periodically, but employers still must maintain space for those employees on the days they are in the office. It is unlikely that technology will ever replace the importance of a face-to-face meeting or the
16 |
Economic Outlook
The Echo Boom Generation

Beyond their impact on the rapidly expanding use of technology, the Echo Boom generation is sure to drive changes in what types of housing people live in. Much of this will be related to age as younger workers show preference for renting because they do not have the financial means to buy a home or a condominium. Also, the financial commitment of ownership may not fit their lifestyle as well as renting an apartment in an urban environment that offers proximity to work, friends, and nightlife. Echo Boomers experiences and observations over the past economic cycle will also drive these decisions. Echo Boomers watched as their parents worked hard to advance in their careers and provide a nice home for their families, only to see that investment of time and wealth rewarded by stress, job loss, and plunging home values. It is logical to think that Echo Boomers may question the wisdom of homeownership and that they may also seek a better work-life balance than their parents had. We expect these motives to support a strong pool of renters in the coming years as these experiential factors elevate the already higher propensity to rent among younger age cohorts. Couple this with the sheer volume of people entering into the prime renting age cohort of 25 to 34-yearolds over the next few years, and the result is a continuation of the very strong demand growth apartments have enjoyed during the recovery to date.
their career experiences. Some members of this generation may show an interest in downsizing their homes or moving to apartments. Others may find themselves saddled with a home that is worth less than the debt they owe on it after years of borrowing for home improvements, their childrens college education, or other expenses. Many not faced with that financial constraint may simply be very happy to stay in the home they raised their family in. What is clear is that the Baby Boom generation is large and they will live longer than the generations that preceded them. They may choose to stay in the workforce longer or those with the disposition and financial means to do so may live long and very active retirements. This is a major demand wave that retailers and the hospitality industry are trying to understand and capture. However, this generation will also have some very obvious needs, primarily related to healthcare. The demands on the healthcare industry for long-term medical treatments, orthopedic surgeries, and a whole host of other medical needs will keep rising. This trend will prop up demand for new medical centers and medical office space and also encourage continued innovation by biotechnology and pharmaceutical firms. Successful real estate investing in the coming years will depend upon a strong understanding of these technological and demographic forces and how they will drive growth. Attentive asset management and thoughtful acquisitions and dispositions will be necessary to ensure commercial real estate portfolios offer the right types of environments to lure new tenants. As the varying pace of the recovery indicates to date, location selection will also remain paramount as some metro areas and submarkets are better-positioned to capitalize on the needs of the population and the growth of the technology companies looking to serve them.
The Baby Boom Generation

Meanwhile, it is fair to say that the Baby Boom generation may also seek a better work-life balance than they had during the middle of their careers. They will probably look to leverage technology to spend fewer hours in the office, while continuing to make strong and positive contributions by leveraging
| 17
18 |
| 19
20 |
Capital Markets
Volatility Persists But Investor Interest Grows

Financial markets remained volatile during 2011, with the S&P 500 stock price index rising nearly 8% in the first four months of the year, only to be down 10% by the end of September. Investors poured in and out of stocks based on the headlines of the day and, with news largely negative in recent months, stock prices suffered. This volatility was evident as recently as November when a late-month rally saved the markets from what was shaping up to be a large drop in value. December was a quieter month and the S&P 500 index managed to close the year unchanged versus the end of 2010. Conversely, Treasury prices steadily rallied as investors sought safer investments and the Fed implemented its second round of quantitative easing (see Fig. 3.1). The 10-Year yield averaged less than 2.0% in September and December. The REIT market was not immune to volatility in the broader markets. After being up 12.6% for the year in May, the NAREIT All Equity price index was down 8.5% year-to-date as of Fig. 3.1 September. REIT prices Capital Market Trends rallied back in October and, after a brief setback in November, finished 1,600 S&P 500 Price Index 2011 with a 4.3% gain. 1,500 10 Year Treasury Rate Performance varied 1,400 across property types 1,300 with residential REITs 1,200 showing the best 1,100 performance of the 1,000 major property types on 900 the shoulders of strong 800 apartment property 700 fundamentals. Office and 2003 2004 2005 2006 2007 industrial REITs closed the year with negative total returns.
S &P 500 Index Level
The high volatility and/or low yields offered by other asset classes and modest improvement in real estate fundamentals have clearly been a boon to direct commercial real estate investment.
5.5
4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0

2008 2009 2010 2011
Sources: Standard & Poor's, Federal Reserve
| 21
10-Yr Treasury Rate (%)
5.0
In the context of weak retail property performance, expectations would have been for poor retail REIT returns as well, but stellar performance by the major regional mall REITs particularly Simon Properties that dominates this sector offset weakness in the shopping center and freestanding store subsectors. Strong locations, credit tenants, and a lack of new supply are benefiting major malls. According to data from NCREIF, regional and super-regional mall NOI rose 3.7% during the four quarters ending 3Q 2011, while NOI for all other types of retail was flat. The high volatility and/or low yields offered by other asset classes and modest improvement in real estate fundamentals have clearly been a boon to direct commercial real estate investment, particularly for well-leased assets in major markets. According to data from Real Capital Analytics, year-to-date transaction activity through September 2011 surpassed the full-year 2010 total. Through November 2011, $162.8 billion of property had traded, the highest level of activity since the first 11 months of 2007 and a nearly 67% increase from the same period in 2010. Strong increases were seen
across all major property types. Retail was on pace for more than twice the activity it experienced in 2010. Activity did slow later in 2011 as investors felt the effects of broader economic and financial market conditions. Transaction dollar volume fell nearly 19% between 2Q and 3Q 2011. That trend continued in October and November, putting 4Q 2011 activity on a pace to be lower than 4Q 2010 (see Fig. 3.2). Volume in November was down from a year ago, the first year-over-year decline since October 2009. Even with this slowdown, liquidity in the market was clearly at a more healthy level in 2011 than it had been for some time. A meaningful turnaround in property values has been less evident than the improvement in transaction volume. Indices such as the Moodys/REAL Commercial Property Price Index and the CoStar Commercial Repeat-Sale Indices have yet to show a convincing recovery trend in property values, although recent movements have been positive. According to these indices, values were still 30% to 40% off their peak levels at the end of 3Q 2011. Pricing bifurcation is clearly evident in the market. The NCREIF Property
Fig. 3.2 U.S. Transaction Volume (2001 - 2011*)

160 140 120
Fig. 3.3 U.S. Commercial Property Values

110
Property Value Index (2007Q3=100)
100 90 80 70 60 50 40
Moody's/REAL CPPI NCREIF Transaction Based Index NCREIF Price Index
Billions ($)
100 80 60 40 20 0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
* 2011Q4 Data Through November Source: Real Capital Analytics
01 Q2
02 Q2
03 Q2
04 Q2
05 Q2
06 Q2
07 Q2
08 Q2
09 Q2
10 Q2
11 Q2
* 2011Q4 Data Through November
Source: Moody's/REAL
22 |
Capital Markets
Index and NCREIF Transaction Based Index, which reflect trends in institutional-quality real estate, suggest values have been recovering since early 2010 (see Fig. 3.3). Meanwhile the Moodys/REAL and CoStar indices, which attempt to capture the overall market, have languished. Well-leased assets particularly those with solvent, institutional ownership in major US cities are seeing stronger investor interest than the broader market and their values have made significant progress towards a recovery. Conversely, where there is more distress and weaker investor interest, values have been bouncing along the bottom. The good news is that all of these indices did show varying levels of growth in 3Q 2011 and more recent monthly data have been positive, which is an encouraging sign as we head into 2012. A sub-index of the Moodys/Real Commercial Property Price Index gives us another look at pricing differences across markets. The groups six-city Trophy index (which contains properties sold in New York, D.C., Boston, Chicago, Los Angeles, and San Francisco valued at more than $10 million that are not in distress) increased by 32% from December
2009 to September 2011. The overall Commercial Property Price Index declined by 2.0% during the same period. These trends have obviously rewarded property owners in the major markets and attracted additional capital interest in the form of both acquisitions and development. Cap rates tell a more favorable story about how investors are valuing commercial real estate. NCREIF transaction-based cap rates spiked from 5.62% on a rolling four-quarter-average basis in 1Q 2008 to 8.15% in 1Q 2010 but they have steadily fallen since that peak, reaching 6.76% in 3Q 2011 (see Fig. 3.4). Declining property NOI was the trigger for some of this compression, but stronger investor interest as the financial crisis eased and the poor performance of investment alternatives were also significant drivers. The low current yields offered by other investments have helped lure capital into commercial real estate. Relative to their recent history versus the 10-Year Treasury rate, cap rates are extremely attractive. The 3Q 2011 spread between cap rates and the 10-Year was 433 basis points, nearly 200 basis points above
Fig. 3.4 U.S. Cap Rate Trends Relative To Treasuries

10 9
1,000 900 800 700 500 400 300 200 100 0
Cap Rate Spread Cap Rate 4 Qtr Moving Avg. 10-Year Treasury 25-Yr Average Spread
Cap Rate/Treasury Rate (%)
8 7 6 5 4 3 2 1 0 -1 -2
87 88 89 90 91 92 93 94 95 96 97 98 99 00
-100 -200
01
02
03
04
05
06
07
08
09
10
11
Sources: NCREIF (transaction-based cap rates), Federal Reserve, Moody's Analytics
| 23
Spread (bps)
600
Fig. 3.5 U.S. Commercial Real Estate Lending Environment

100
Property Value Index (2007Q3=100)
80 60 40 20 0 -20 -40 -60 -80
Net % of Banks Tightening CRE Lending Standards Net % of Banks Reporting Stronger Demand for CRE Loans
Loan Officer Survey showed a narrow majority of banks are both loosening their underwriting standards for commercial real estate loans and seeing growth in demand for these types of loans (see Fig. 3.5). Commercial real estate loan performance has been improving, with data from the Federal Financial Institutions Examination Council showing declining charge-off and delinquency rates at US Commercial Banks. These measures are still elevated relative to historical levels but have come off significantly from their recent highs. Improvement in the CMBS market has been less convincing and CMBS delinquency rates remain very high. According to the Moodys CMBS Delinquency Tracker, 9.29% of all loans were 60 days or more past due in October 2011, not far below the 9.36% cyclical peak reached in the prior month. The market was essentially frozen from the latter part of 2008 through early 2010, but activity has been increasing. Originations reached $32.7 billion in the US for the 12 months ending in December 2011, up from a low of around $560 million in mid-2009, according to Commercial Mortgage Alert; however, this is still well below the nearly $280 billion in issuance completed during the 12 months ending in August 2007. It is notable that originations in 4Q 2011 were by far the lowest of the year as economic and financial market uncertainty crimped the pipeline of new deals. CMBS should re-emerge as an important source of debt funding for commercial real estate investors, but some of the very high profile loan defaults underlying CMBS issuances from the peak of the cycle, persistently high delinquency rates, and broader financial market volatility have done little to encourage skeptical investors to return to the market. Real estate investment returns should only encourage additional capital to flow into the asset class. Institutional-quality real estate posted a stellar
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Federal Reserve Senior Loan Officer Survey
its average over the past 25 years. By comparison, real estate was selling at an average premium of just 164 basis points to the 10-Year from 2005 to 2007. Further, at the time of this writing, the 10-Year yield is more than 50 basis points lower than its 3Q 2011 level. Not only does the cap rate spread suggest current real estate yields are attractive, it also suggests that cap rates could remain stable even in the face of a relatively significant interest rate shock. The debt markets give us another perspective on the condition of real estate capital markets. According to the Mortgage Bankers Association, commercial and multifamily loan originations have been trending higher since early 2010 and activity in 3Q 2011 was the highest since 4Q 2007. All major types of lending sources increased their activity between 3Q 2010 and 3Q 2011, led by a 433% increase for commercial banks. Originations are still well off the levels of 200507, but appear to be returning to the levels of 200304. The October 2011 Federal Reserve Senior
24 |
Capital Markets
performance during the year ending 3Q 2011, with the total return for the NCREIF Property Index reaching 16.1% (see Fig. 3.6). This performance was driven largely by a recovery in depressed property values; however, stabilizing cash flows due to improved fundamentals are also having a positive impact. NOI increased during the period after declining in 2009 and 2010. NOI growth was driven primarily by the apartment market, which experienced a nearly 11.0% increase in NOI. The other property types are not as far along in their recovery as apartments. Office and industrial NOI fell by just over 1.0% and retail NOI rose modestly. Without significant NOI growth, office, retail, and industrial properties still managed total returns north of 15.0% largely due to the positive valuation effect created by strengthening investor interest (see Fig. 3.7). Volatility and low yields in other asset classes and the prospect of improving property performance encouraged investors to accept increasingly lower yields during the year ending in 3Q 2011.
More aggressive investors pushed values on institutional quality office, retail, and warehouse properties up by more than 8.0% despite the lack of NOI growth. Apartments experienced less of a valuation effect over the past year due to their already low yields and the rapid increase in prices driven by two years of rising NOI. As confidence in the recovery builds, investors should continue to target commercial real estate and transaction volume is likely to build off the growth experienced in 2011. Investor interest in secondary markets and properties with higher levels of vacancy may rise in 2012, but given the likelihood that financial markets will remain relatively volatile, quality properties in primary markets should continue to garner the lions share of capital. Investors should temper their expectations for valuation-driven returns in 2012 as the pace of cap rate compression slows. If the economy improves as expected in 2012, however, NOI growth should be a more significant driver of returns.
Fig. 3.6 Decomposition of NCREIF Returns*

20 15 10 5
Fig. 3.7 Decomposition of NCREIF Returns by Property Type - 2011*

20
15
Percent (%)
-5 -10 -15 -20 -25 -30 Income Return NOI Growth Valuation Effect Total Return
Percent (%)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
10
-5
Apartment
Industrial
Office
Retail
* Years ending in the third quarter
Source: NCREIF, Bentall Kennedy
| 25
26 |
Property Sector Fundamentals
Recovery in Fundamentals Slowly Gaining Hold

U.S. property markets tightened during 2011 as steady but unimpressive job gains drove increased demand for space. Apartment, office, and industrial vacancy rates were all lower in 3Q 2011 in comparison to 3Q 2010 (see Fig. 4.1). The retail vacancy rate inched higher during the same period, but fell slightly during the quarter. Preliminary data suggests apartment, office, and industrial vacancy rates continued to fall in 4Q 2011 and retail vacancy remained flat. The momentum of the property market recovery should build in 2012 as U.S. economic growth accelerates. Limited new construction has been a boon to U.S. commercial real estate markets and the lack of new supply will continue to be a positive factor over the coming year. During 2011, the inventory of space across the major property types grew at just a fraction of its pace over the past 10 years (see Fig. 4.1). Risks from new construction will remain limited as rent levels do not support development in the majority of property types and markets. That said, construction completions are likely to steadily increase over the next few years as developers look to capitalize on space shortages and aggressive pricing in some markets, and expanding owner/users support an increasing amount of activity. With vacancy rates still well above equilibrium levels in most major property types, rent growth will be far from robust in 2012. Industrial and retail rents continued to fall nationally during 2011, and only the apartment market registered meaningful growth. As commercial vacancy rates continue their slow declines, landlords should gain more pricing power in 2012. Apartments should see strong rent growth over the coming year with growing demand and vacancy rates below their pre-recession levels. In property types and markets where the rent recovery is still in its early stages, there is the potential for significant rent bumps, particularly in higher-growth technology markets. Commercial property markets will benefit from a number of tailwinds in 2012 and beyond. Stronger economic growth and favorable demographic trends will drive more substantive improvement in demand for space while activity on the supply-side remains relatively tame. However, significant risks continue to loom in the background. The still-unresolved domestic and European debt crisis and considerable geopolitical turmoil have the potential to sidetrack the recovery. Additionally, a lack of clarity on the political and policy environment could deter hiring until after the U.S. presidential election.
Fig. 4.1 Property Sector Summary Statistics

Property Type Apartment Office Industrial Retail 2011Q3 Stock* 2011Q3 9,837,685 3,577,546 12,730,225 2,759,474 5.6% 16.2% 13.7% 13.2%
** 2011Q3 forecast
Vacancy Year-Ago 7.1% 16.7% 14.5% 13.1%
Annual Supply Growth 2011** Past 10 Yrs. 0.4% 0.3% 0.2% 0.2% 0.9% 1.8% 1.4% 2.1%
Year-over-Year Rent Growth 2011Q3 2.3% 0.9% -1.2% -3.7%

Sources: CBRE-EA, REIS
* Apartments in units; all others in thousands of square feet
| 27
Apartment
The apartment sector is experiencing the strongest recovery of the major U.S. property types as demographic trends, the weak for-sale housing market, and an uninspiring, but growing job market have generated new demand. Vacancy rates have been tightening briskly (see Fig. 4.2). As of 3Q 2011, apartment vacancy was 2.4 percentage points below its 1Q 2010 peak and preliminary data suggest that the vacancy rate fell below its pre-recession level in the fourth quarter. Net absorption has been positive in the apartment market for 11 consecutive quarters. After almost two decades of rising homeownership, renting came into increasing favor as the recession hit and home values collapsed. The homeownership rate fell to 66.3% in 3Q 2011 after peaking at 69.2% in 2004. This unprecedented decline occurred as families lost their homes to foreclosure and others were scared off by tighter lending standards and fears about the stability of home prices. According to the S&P/Case-Shiller National Home Price Index, home prices fell by approximately one-third between 1Q 2006 and 3Q 2011, including a roughly 4.0% decline over the past four quarters. With the decline in home prices ongoing, many potential buyers are making the decision to stay on the sidelines and rent. Undoubtedly these trends were magnified by the economy. High unemployment and fear of job loss have discouraged households from making the longterm commitment to a mortgage, perpetuating the decline in home values. While economic conditions have improved, the recovery has not been strong enough to diminish potential homebuyers fears. Instead, meager job gains have primarily driven growth in new renter households. U.S. Census data also indicate a significant trend towards the doubling-up of households during the recession. Not only were individuals making decisions not to buy homes, they were also entering into multiple roommate situations, moving in with parents, or even entering into multiple family living arrangements. This trend reversed itself somewhat in 2011, but the Census Bureaus data still show a 10.7% increase in doubled-up households and a 25.5% increase in 25 to 34-year-olds living with their parents in comparison to 2007. Clearly an impactful level of demand will be created when more compelling economic news encourages these individuals to form new households. A deeper look at employment trends also shows that job creation has disproportionately benefited age groups with a higher propensity to rent. Younger workers were hit hard by layoffs during the recession, but since total employment bottomed in late 2009 (according to the BLS household survey), employment among 25 to 34-year-olds has increased 3.0%. Employment among all other age groups increased just 1.6% during this same period. Part of this growth is attributable to shifts in the age composition of the labor force, which has grown by 0.5% overall and by 1.9% for 25 to 34-year-olds during the recovery, but it is clear that hiring is benefiting younger workers and this has been a favorable trend for apartment demand. Growth in the number of potential workers ages 25 to 34 is a demographic phenomenon linked to the Echo Boom generation. The size of this age cohort had been flat to down on an annual basis since the bulk of the Baby Boom generation exited out of it
Fig. 4.2 Apartment Fundamentals

250,000
Change in Supply Change in Demand Vacancy
9 8 7
Change in Supply/Demand (Units)
200,000 150,000 100,000 50,000 0 -50,000 -100,000

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
5 4 3 2 1 0
Source: REIS
28 |
Vacancy(%)
around two decades ago. Over the next few years, the arrival of the Echo Boom generation will lead the size of this cohort back above its 1989 peak. If the economy is able to create enough jobs for this group, apartment demand will continue to increase strongly. After seeing the American Dream of homeownership turn into a nightmare of foreclosures and financial destruction, Echo Boom generation members are sure to have a skeptical view of homeownership. Bentall Kennedy expects that the propensity to rent will remain high among this group as they show preference to the personal and financial flexibility offered by renting. While all of these factors have bolstered the demand side of the apartment market, new construction has remained muted. The delivery of new apartments has steadily fallen over the past two years and average annual completions during 201011 were about 40% less than the average during 200709. Multifamily construction activity is increasing again but the property type is a long way from being flooded with new supply. Despite steady increases over the past two years, multifamily permitting activity in 2011 was 43% below the average level experienced during the previous 10 years (see Fig. 4.3).
Apartment fundamentals and the pace of recovery have varied significantly across markets. Demand growth over the past year has been strongest in New York, where uncertainty in the financial services sector is discouraging would-be homebuyers. New York is the only major market where the rate of apartment demand growth over the past year exceeds the current level of vacancy (see Fig. 4.4). Under these conditions the market will be incredibly tight for the foreseeable future. REIS projects that New Yorks vacancy rate will fall below 2.0% in 2013. Major Texas markets, which are benefiting from strong economic growth with the help of the energy sector, are also performing well. Housing bust metros such as Phoenix and Atlanta have also posted impressive demand-side growth, driven by modest job gains and a collapse in homeownership. The majority of markets have very low vacancy rates despite largely unimpressive demand growth, which should give even more pricing power to landlords in 2012. In the tightest markets, the only obstacle to robust rent increases may be the ability and/or willingness of renters to pay more in the face of a shaky and slow-growing economy, and increasingly attractive home values. Despite significant demand
Fig. 4.3 Multifamily Permits and Starts

1,200
Fig. 4.4 Metro Apartment Market Performance

4.0
Demand Growth 2010Q3 to 2011Q3
3 Month Moving Average of Starts and Permits (SA, 000s)
1,000
Multifamily Starts - 5+ Units Average Permits 2001 to 2010 Multifamily Permits - 5+ Units
3.5
New York
3.0 2.5
Dallas
Phoenix
Houston
800
Seattle Minneapolis Atlanta Orange County Boston Northern New Jersey Philadelphia Los Angeles Detroit District of Columbia Chicago
600
2.0 1.5 1.0 0.5 0.0

0.0 2.0 4.0
400
200
0
71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11
6.0
8.0
10.0
12.0
Source: U.S. Census Bureau
Vacancy 2011Q3 (%)

Note: bubble size = inventory Source: REIS
| 29
Apartment
recoveries in some housing bust rental markets, the deep employment losses suffered by these metros should temper the ability of landlords to push rents. Somewhat ironically, the failure of new home construction to rebound will also be a hindrance in markets where housing and construction have historically been crucial drivers of economic expansions. Markets with strong technology sectors should continue to perform well. Technology-focused economies such as Boston and Seattle are experiencing relatively healthy recoveries and solid apartment demand. As members of the Echo Boom generation reach apartment-renting age in increasing numbers over the coming years, the economy continues to recover, and households uncouple, growth in apartment-renting households is inevitable. The much-improved affordability of homeownership will eventually draw some renters back into the for-sale market, but Bentall Kennedy does not anticipate a return of the homeownership rate to pre-recession highs. Apartment construction completions should steadily rise over the next few years, but vacancy is at a very healthy level in most markets and there is no sign that construction is ramping up to levels that would prevent further improvement in the market. Rent growth should continue to strengthen, particularly if the economic recovery gains steam in 2012 as expected.
30 |
| 31
Office
The office market clearly improved in 2011, but the pattern of the recovery was mixed. According to CBRE Econometric Advisors, the office recovery paused in 3Q 2011, but the vacancy rate was still about 50 basis points lower than it was a year earlier. Weaker economic conditions during mid-2011 resulted in lower demand growth in 3Q 2011. Preliminary data suggest that vacancy fell again in 4Q 2011, leaving the rate lower for the second straight calendar year (see Fig. 4.5). Office-using employment is the primary indicator of office demand and, even with the recent slowdown, the recovery in this sector has been stronger than in most other employment sectors (see Fig. 4.6). Officeusing employment has grown by 2.6% since February 2010 (when total employment reached its trough), while all other sectors have grown by 1.9%. Growth in the professional and business services sector has been the primary driver of office-using job creation. Growth has been particularly strong in technologyheavy subsectors such as computer systems design and management and technical consulting services. As would be expected in a recovery where many employers are reluctant to make long-term investments, the temporary help services subsector has also grown rapidly. The other two major office-using employment sectors financial activities and information have performed poorly. Financial activities employment grew by just 0.1% in 2011 as financial market turmoil kept employers on edge and prompted a number of institutions to cut jobs. This lack of growth took a major source of demand out of the equation for many metros. When a path out of the debt crisis is clearly defined and financial markets stabilize, this sector could quickly become a significant source of demand. Information sector employment declined, with more traditional telecommunications, broadcasting, and publishing employers in this sector particularly hard hit, while internet and software company employment expanded. This dichotomy has driven differences in metro office market performance based on employment concentrations, with technology-focused markets experiencing stronger growth. Differences in the rate of job growth have been evident in the demand growth rates of the various
Fig. 4.5 Office Fundamentals

125,000 18 16
Fig. 4.6 Office Using Employment vs. Other Employment Sectors

4
Office Using Employment All Other Employment
Change in Supply/Demand (SF 000s)
100,000 75,000 50,000 25,000 0 -25,000 -50,000 -75,000 -100,000

2 14
10 8 6 4
Y/Y % Growth
Vacancy(%)
12
-2
-4
-6 2 0 -8
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Source: CBRE-EA
Source: Bureau of Labor Statistics
32 |
metro office markets. Metro areas with vibrant technology sectors such as San Francisco and Seattle experienced strong demand growth over the past year, while most metros with lower technology concentrations such as Newark and Atlanta struggled (see Fig. 4.7). Technology has not, however, been the only driver. Houston posted stellar growth in office demand over the past year and a full percentage point decline in its vacancy rate due primarily to the expansion of the energy sector. Conversely, Washington, D.C. coped with weak demand due to belt-tightening by the Federal government and its contractors. Phoenixs sharp employment deficit relative to its pre-recession peak and only modest job creation have crimped office demand, in stark contrast to its apartment market, which was among the leaders in demand growth. The broader observation about the office market is that vacancy rates remain high in many metros areas and expectations for rent growth should be tempered. That said, not all markets are on equal footing and properties in tighter markets such as New York, San Francisco, and Boston should continue their
progress towards a full recovery in rents during 2012. The lack of a stronger economic recovery is a concern for the office market, but healthy corporate balance sheets and growing business investment bode well for future growth. Real corporate profits have nearly rebounded to their pre-recession highs and business investment in equipment and software has been steadily growing since 3Q 2009. Business investment in equipment and software usually foreshadows hiring in office-using employment sectors. Additionally, not unlike the apartment market, the office market is getting a significant boost from a dearth of new supply. As measured by CBRE Econometric Advisors, office space inventory grew by just 9 million sf in 2011, the smallest increase since the early 1990s. High vacancy rates and significantly reduced rents should continue to suppress new construction activity in the office market, allowing for additional improvement in vacancy and rents even in a relatively benign demand-side recovery.
Fig. 4.7 Metro Office Market Performance

4
San Francisco
3
Houston Philadelphia New York Boston Seattle Chicago Atlanta Dallas Washington D.C. Los Angeles Denver Newark Edison Phoenix
-1
-2
5 10 15 20 25 30
Vacancy 2011Q3 (%)

Note: bubble size = inventory Source: CBRE-EA
| 33
Retail
A recovery in retail property fundamentals has not been nearly as evident as it has been in the other property types. According to CBRE Econometric Advisors, retail property fundamentals improved slightly in 3Q 2011, with the vacancy rate falling 0.1 percentage points to 13.2%. 3Q 2011 was the first quarter of the year to experience positive net absorption. However, considering that the retail vacancy rate was at a record high level in 2Q 2011, this small improvement did little to brighten the outlook for retail properties. Preliminary data suggest the retail vacancy rate was flat in 4Q 2011, despite extremely low levels of new supply, and finished 2011 slightly above its level at the end of 2010 (see Fig. 4.8). Retail rents continued to fall at a fairly steady pace and were down nearly 4.0% for the year ending in 3Q 2011. Headline retail sales figures are encouraging. After enduring an unprecedented decline during the downturn, the level of spending has pushed back above its pre-recession highs on a nominal basis. Year-over-year retail sales growth of 6.5% in December 2011 is indicative of a very healthy market (see Fig. 4.9); however, real retail sales remain below their prerecession highs. Additionally, much of the growth in sales has been focused outside of traditional brickand-mortar retail stores. Growth in retail sales excluding autos and gasoline was a somewhat more pedestrian 5.5%. The growth rate drops even lower,
Fig. 4.8 Retail* Fundamentals
125,000 100,000 75,000
to 4.9%, when non-store retailers (i.e. internet and mail order) are backed out. Non-store retailers accounted for just under 12.0% of sales excluding autos and gasoline in December 2010, but they were responsible for nearly 29% of growth over the following 12 months. Internet shopping is clearly becoming an increasingly important force in retail. According to IBM Benchmark, Cyber Monday sales were up 33% between 2010 and 2011. The share of these online sales completed on mobile devices nearly tripled during the same period. Retail sales data also show consumers are avoiding purchases of items that are not necessities. The data suggest that growth in sales at furniture and home furnishings, electronics, and sporting goods, hobby, book, and music stores has been particularly anemic. Some of this activity (particularly books and music) is certainly being absorbed by online sales, but clearly, many traditional brick-and-mortar retail formats are struggling. As mentioned previously in this report, the increasing use of technology is influencing how consumers shop and this trend will have a varying impact on the different retail formats. The strong performance of regional and super regional malls over the past year is largely due to location and tenant quality, but it also seems logical that destination retail may have some resistance to cannibalization from the internet.
Fig. 4.9 Retail Sales Trends
14 12 10
400 350 300
Billions ($), SA
Vacancy(%)
50,000 25,000 0 -25,000 -50,000 -75,000 -100,000

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
* Data includes neighborhood and community
8 6 4 2 0
250 200 150 100 50 0 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Source: US Census Bureau
Source: CBRE-EA
34 |
The social experience of shopping (and perhaps dining and/or watching a movie) at these larger retail formats may be unique enough to fend off a dramatic loss of sales due to online shopping. On the other end of the retail spectrum, convenience retail, such as the neighborhood grocery store or drug store, is unlikely to be replaced by the web; however, standalone retail stores, strip centers, and power centers may be particularly vulnerable to growing internet sales. Many retailers work hard to keep traffic high at their stores by offering product demonstrations and free samples, but it seems inevitable that the internet will continue to grab an increasing amount of the retail sales pie. The challenge for retailers will be to successfully adapt and implement strategies that create synergies between their stores and websites. There are more immediate concerns for retail demand as well. The encouraging holiday shopping season aside, eroding household wealth and high unemployment are not a recipe for stellar retail sales and rising demand for retail space. In fact, much of the recent growth in retail sales has come at the expense of savings as growth in disposable personal income has stalled in recent months. The personal savings rate fell from about 5.5% in mid-2010 to 3.5% in November 2011. While this is still higher than the savings rate leading up to the recession, it is low enough to suggest that any new slowdown in
Fig. 4.10 Metro Retail Market Performance
1.5
economic growth would significantly impair the ability of households to spend. This concern is magnified by the growth in consumer credit over the past year. If economic growth improves as we suspect in 2012, there is a silver lining to recent data. Consumers have clearly shown an increased willingness to spend and households are operating on a less conservative basis than they were during the depths of the recession. Some of this may be out of necessity after a protracted period of limited spending, but it is also likely that recent improvements in consumer confidence are having a tangible impact on spending. Nationally, the demand for retail space grew at a slower rate than the three other major property types and there were no real bright spots at the metro level (see Fig. 4.10). Relatively healthy economies such as Boston and New York saw limited demand growth during the year ending 3Q 2011, but they do benefit from comparatively low vacancy rates. Even Seattle, where job growth was well above the national average in 2011, had demand growth of just 1.0% and this was one of the strongest growth rates of the major U.S. metros. Weak demand growth in Houston and Dallas was perhaps even more surprising given the growth of those economies. Housing bust metros such as Atlanta, Phoenix, and Riverside had declining or nearly flat demand during the period and relatively high vacancy rates, reflecting their still-weak economic condition. Demand will be the primary determinant of retail property performance in the coming year as new construction remains low. Similar to the other major property types, the retail market is benefiting from limited new construction. Retail construction completions dipped significantly in 2009 and activity was muted during 201011 (see Fig. 4.8). Retail vacancy rates have historically tracked very closely to the unemployment rate, which has recently seen one of its largest drops of the cycle. With the labor market expected to continue improving in 2012, recovery in the retail market should gain momentum. It seems likely that economies with high employment concentrations in technology or another expanding driver, such as energy in Texas, will put forth a better showing over the next 12 months, but the vast majority of retail markets are still a long way from a full recovery.
Washington D.C.
Seattle
1.0
Fort Lauderdale Houston Atlanta Dallas Chicago
0.5
New York San Diego
Boston
0.0
-0.5
Denver Los Angeles Riverside
-1.0
Philadelphia
Phoenix
-1.5
11
13
15
17
19
Note: bubble size = inventory
Vacancy 2011Q3 (%)
Source: CBRE-EA
| 35
Industrial
Despite the lackluster job market rebound, all of the major indicators that influence warehouse demand are rising, including industrial production, consumption, fixed investment, and trade. The industrial market posted its fifth straight quarter of falling vacancy in 3Q 2011 on the heels of solid net absorption and limited new construction. Absorption in 3Q 2011 was the strongest since 4Q 2007. Industrial users finally began to expand their operations after contracting in 2008 and 2009 and showing only a slight interest in growth during 2010 (see Fig. 4.11). Preliminary data suggest that this trend continued in 4Q 2011, bringing vacancy down to 13.5%, more than a full percentage point below its 2Q 2010 peak. Solid macroeconomic demand drivers such as consumption and fixed business investment paint a favorable picture for continued growth in industrial demand. But trade levels have been the most significant source of optimism (see Fig. 4.12). In particular, the real value of exported goods has reached an alltime high. Part of this increase is driven by surging fuel exports, which do little to bolster industrial demand, but broader export growth is clearly having an influence on the need for space. Consumption and import growth have shown signs of fading recently, but as job growth continues and the unemployment rate falls, the U.S. consumer is expected to become more active. The debt crisis in Europe is one of the greatest risks to the outlook for these industrial demand drivers. If there is a pronounced dip in the European economy, demand for U.S. goods will suffer and exports will decline. Industrial market performance at the metro level varies greatly (see Fig. 4.13). Trade flows and increased consumption have bolstered demand at major distribution hubs such as Northern New Jersey, Atlanta, and Dallas/Fort Worth. San Joses industrial demand posted a solid showing over the past year, largely on the back of growing technology companies. Demand in the Midwest generally appears to be languishing but the resurgent auto industry has given Detroit a lift, although the markets vacancy rate remains very high. Cincinnati was one of a very few U.S. industrial markets that saw declining demand for space year-over-year as of 3Q 2011. With the housing market still weak, markets that depend
Fig. 4.11 Industrial Fundamentals

300,000
Fig. 4.12 Industrial Demand Drivers

115 14 110 105
Exports (Goods) Imports (Goods) Fixed Investment Consumption (Goods)
250,000 200,000 150,000 100,000 50,000 0 -50,000 -100,000

12
Index (2007Q4=100)
Vacancy(%)
10 8 6 4 2 0
100 95 90 85 80 75 70 65
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Source: CBRE-EA
Source: Moody's Analytics, Bureau of Economic Analysis
36 |
on local population growth and home construction to drive the need for warehouse space should be slow to recover. However, markets with the infrastructure to tap into international trade flows and those with innovative technology economies should continue to do well. Final data are expected to show industrial rents fell slightly in 2011, but steady improvement in vacancy is forecast through 2015 as new supply remains at very manageable levels (see Fig. 4.11) and rents are expected to begin rising again in 2012. There are significant risks to this outlook, primarily due to the ongoing crisis in Europe. If Europe dips into another recession, trade flows are certain to reverse much of their recent gains. Additionally, a double-dip recession would likely be unavoidable in the U.S. if European economies contract significantly and demand for goods produced in the U.S. declines sharply. Keeping these significant risks in mind, the industrial market is poised for continued recovery including the resumption of rent growth in many metro areas in 2012.
Fig. 4.13 Metro Industrial Market Performance

3.0 2.5 2.0 1.5 1.0 0.5 0.0
Edisor San Jose Newark Houston Baltimore
Atlanta Fort Worth Detroit Dallas
Los Angeles
Chicago Boston
Minneapolis Philadelphia
Washington D.C.
-0.5
5 7 9 11
Cincinnati
13 15 17 19 21
Vacancy 2011Q3 (%)

Note: bubble size = inventory Source: CBRE-EA
| 37
38 |
Bentall Kennedy Group

Bentall Kennedy serves the interests of more than 500 clients across 142 million square feet of office, retail, industrial, residential and hotel properties totaling in excess of $26 billion throughout Canada and the US. Widely recognized as a highly disciplined fiduciary, Bentall Kennedy acts for prominent public and private pension funds, life insurance companies, endowments, foundations, trusts, high net worth families and sovereign wealth funds. In Canada, we offer a comprehensive, integrated menu of asset and portfolio management, property management, leasing and development services. In the U.S., we provide a full range of investment advisory services to clients coast-to-coast. Our continent-wide platform is executed by more than 1300 employees at 14 offices across Canada and in key U.S. markets. Our on-theground local knowledge of all of our markets is a key differentiator. As a North American leader in responsible property investing and a signatory to the United Nations Principles for Responsible Investment (UN PRI), Bentall Kennedy is committed to best-inclass environmental, social and governance practices. Bentall Kennedy is privately owned by Ivanho Cambridge (a subsidiary of the Caisse de dpt et placement du Qubec), British Columbia Investment Management Corporation (bcIMC), and senior management in Canada and the United States.
For more information about Perspective, please contact: Douglas Poutasse, EVP, Head of Investment Strategy and Research, Bentall Kennedy | dpoutasse@ bentallkennedy.com | 617 763 7970 Paul Briggs, VP, Head of U.S. Research, Bentall Kennedy (U.S.) LP pbriggs@ bentallkennedy.com | 617 790 0853
| 39

Vancouver 1055 Dunsmuir Street, Suite 1800 Vancouver, BC V7X 1B1 t 604 661 5000 f 604 661 5055 Calgary 240 4th Avenue SW, Suite 301 Calgary, AB T2P 4H4 t 403 303 2400 f 403 303 2450 Edmonton 10123 99th Street, Suite 100 Edmonton, AB T5J 3H1 t 780 990 7000 f 780 429 0827 Winnipeg 612 One Lombard Place, Suite 612 Winnipeg, MB R3B 0X3 t 204 589 8202 f 204 582 3115 Toronto 55 University Avenue, Suite 300 Toronto, ON M5J 2H7 t 416 681 3400 f 416 681 3405 Ottawa 45 OConnor, Suite 300 Ottawa, ON K1P 1A4 t 613 230 3002 f 613 563 3217 Montreal 1155, rue Metcalfe, Bureau 55 Montreal, QC H3B 2V6 t 514 393 8820 f 514 393 9820

Seattle 1215 Fourth Avenue 2400 Financial Center Seattle, WA 98161 t 206 623 4739 f 206 682 4769 San Francisco 235 Montgomery Street, Suite 965 San Francisco, CA 94104 t 415 536 4757 f 415 651 9572 Los Angeles 6320 Canoga Avenue, Suite 1420 Woodland Hills, CA 91367 t 818 577 2424 f 818 577 2425 Dallas Three Lincoln Centre, 5430 LBJ Freeway, Suite 1570, Dallas, Texas 75240 t 972 733 6450 f 972 733 6454 Chicago Two North Riverside Plaza, Suite 2150 Chicago, Illinois 60606 t 312 596 9140 f 312 596 9139 Washington D.C. 7315 Wisconsin Avenue, Suite 350 West Bethesda, MD 20814 t 301 656 9119 f 301 656 9339 Boston Two International Place, 17th Floor Boston, MA 02110 t 617 790 0850 f 617 790 0855
Landon Butler & Company

Washington D.C. 700 Thirteenth Street NW, Suite 925 Washington, D.C. 20005 t 202 737 7300 f 202 737 7604 Los Angeles 8413 Fallbrook Avenue, Suite 300 West Hills, CA 91304 t 818 932 9935 f 818 610 8405

BKPerspective Real Estate USA 2012

Загружено:

Сведения о документе

Исходное описание:

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

BKPerspective Real Estate USA 2012

Загружено:

Авторское право:

Доступные форматы

on Real Estate | U.S.

Bentall Kennedy (U.S.) LP

About Bentall Kennedy Group

Bentall Kennedy (U.S.) LP

Bentall Kennedy (Canada) LP

Economy Poised to Drive Performance in 2012

Bentall Kennedy (U.S.) LP

Bentall Kennedy (U.S.) LP

Bentall Kennedy (Canada) LP

Bentall Kennedy (Canada) LP

The Global Economic Recovery Stumbles

Forecast:TD Economics Dec 2011; *IMF Sept 2011

Bentall Kennedy (U.S.) LP

U.S. Economy Improving but Risks Remain

Source: Moody's Analytics, Bentall Kennedy Research

Bentall Kennedy (U.S.) LP

Y/Y % Change in Employment

Federal Government State & Local Government Private Sector

Source: Bureau of Labor Statistics

Bentall Kennedy (U.S.) LP

Fig. 2.4 Crisis of Confidence Persists But Recent Signs of Improvement

Consumer Confidence (left) Small Business Optimism (right)

Index 2005 = 100

Sources: Moody's Analytics, The Conference Board, NFIB

Bentall Kennedy (U.S.) LP

Index 2005 = 100

Risks More Balanced in 2012

Drivers of Economic Growth

Bentall Kennedy (U.S.) LP

CASE STUDY: ATLANTA VERSUS THE SAN FRANCISCO BAY AREA

Fig. 2.5 Jan. 2008 to Feb. 2010 Employment Trends

Feb. 2010 to Nov. 2011 Employment Trends

Employment Change (jobs, 000s)

60 50 40 30 20 10 0 -10 -20 -30 -40 -50

% of Retail Sales Change

-25 -50 -75 -100 -125 -150 -175 -200 -225

Source: Bureau of Labor

Bentall Kennedy (U.S.) LP

Technology's Impact on Retail

Bentall Kennedy (U.S.) LP

Technology's Impact on Office

Bentall Kennedy (U.S.) LP

The Echo Boom Generation

The Baby Boom Generation

Bentall Kennedy (U.S.) LP

Bentall Kennedy (Canada) LP

Bentall Kennedy (Canada) LP

Bentall Kennedy (Canada) LP

Volatility Persists But Investor Interest Grows

4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0

Sources: Standard & Poor's, Federal Reserve

Bentall Kennedy (U.S.) LP

10-Yr Treasury Rate (%)

Fig. 3.2 U.S. Transaction Volume (2001 - 2011*)

Fig. 3.3 U.S. Commercial Property Values

Property Value Index (2007Q3=100)

Moody's/REAL CPPI NCREIF Transaction Based Index NCREIF Price Index

* 2011Q4 Data Through November

Bentall Kennedy (U.S.) LP

Fig. 3.4 U.S. Cap Rate Trends Relative To Treasuries

Cap Rate/Treasury Rate (%)

Sources: NCREIF (transaction-based cap rates), Federal Reserve, Moody's Analytics

Bentall Kennedy (U.S.) LP