U.S.

Forecast Report
Office & Industrial June 2010

The Recovery is Gaining Ground

Downside risks remain
Kevin Thorpe, Chief Economist

It is said that there are two types of
economists: those who know they can’t
forecast, and those who don’t know
that they can’t forecast. Leaving aside
the exactitude of that saying, what we
economists do know is that historically,
the U.S. economy and property markets
follow certain patterns called business
cycles. According to the National Bureau
of Economic Research, the average length
of a U.S. recessionary cycle dating back
to 1854 is 2 years and 5 months. These
recessionary periods are typically followed
by a period of economic expansion which
lasts an average of 3 years and 2 months.
That pattern changed after World War II.
Since 1945, recessionary periods in the
U.S. have been shorter (lasting only 10
months) and the expansionary periods
longer (averaging 4 years and 9 months).
Although we are still experiencing
challenging times in the U.S. economy,
there is some comfort to be found in
studying the historical patterns. They
consistently show that through 32 business
cycles spanning over 156 years, that what
goes up, must come down, and vice versa.
Cassidy Turley uses econometric modeling
to help us predict market direction, and
economy has entered into the next cycle of
expansion. In April of 2010, the national
economy created 290,000 new jobs – a
monthly gain that rivals some of the
strongest employment growth during the
technology boom of the late 1990s and the
real estate boom of 2003 to 2007. While
it’s true that temporary hiring for the 2010
Census accounted for 66,000 of those
new jobs, the majority represent real, full-
time, private sector job gains. Moreover,
February and March payrolls were revised
significantly upwards, giving further
credence to the notion that the recovery is
evolving into a self-sustaining expansion.
More importantly, corporate profits have
been surging, up 9.2% in the fourth
quarter of 2009 compared to the previous
quarter, with a bigger gain expected when
the numbers roll in for the first quarter of
2010. Historically, corporate profits lead
job growth by 6 to 9 months. With real
personal consumption expenditures (i.e.,
consumer spending) growing at a healthy
clip of 3.6% in the first quarter of 2010,
businesses are likely to continue adding
to payrolls to keep pace with growing
demand.
There is one indicator preventing us
addition, the fiscal tightening in Europe
that is certain to follow will suppress short-
term economic growth in Europe and thus
constrain growth in U.S. exports overseas.
That, in combination with a stubbornly
high unemployment rate, leads us to
believe that the Federal Reserve will not
raise interest rates prior to 2011. Europe
is not alone in its growing concerns over
rising national debt. The U.S. debt-to-GDP
ratio will near 65% by the end of 2010.
Although this is not the “tipping point”
levels witnessed in Greece (105%), rising
debt levels do have U.S. policy makers
looking for ways to tighten our own belts.
Interestingly, despite the rising U.S. debt
levels, global investors continue to gobble
up treasuries. As recently as May 5, 2010,
investors purchased $17 billion of 30-year
government bonds at an average interest
rate of 4.5%. If global investors are the
barometer for the U.S. economy, then this
suggests the vast majority remain confident
that the U.S. is not heading down the same
path as Greece.
Profits Point to Job Growth
6% 50%
40%
4%

Corporate Profits (Y/Y%)

30%
our regression analysis is based on the from calling this a full fledged recovery:
Job Growth (Y/Y%)

2%
20%

notion that patterns from the past can be persistently low consumer confidence. The 0% 10%

used to help predict future values. Thus, if Conference Board’s Consumer Confidence -2%
0%

-10%
today’s U.S. economy does in fact conform index registered 63.3 in May. Although -4%
-20%
to business cycle patterns from the past, this is a marked improvement from the
-6% -30%
then our analysis should be reasonably reading of 25.3 in February of 2009, the 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

Job Growth Corporate Profits

accurate in forecasting economic and index is still well below its historical average Source: BLS, Dismal

property market trends. of 96. Until this index achieves a level

The Economy
Despite the mounting fiscal challenges
facing Europe and the decidedly downside
risk that it creates in our forecast, there
are strong indications that the U.S.
greater than 80, we cannot rule out the
small possibility of a double-dip scenario.
The European financial crisis and its
potential to spread to the U.S. will continue
to weigh on the minds of investors. In
Office Sector
The latest data suggest that the U.S. office
sector has started on the road to recovery.
The first step towards improved NOI
levels is the return of absorption, which
starts with job growth. The U.S. economy

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The Recovery is Gaining Ground
Downside risks remain (continued)
began producing office-using jobs again
in the fourth quarter of 2009. Since
October of 2009, 311,000 Professional &
Business Service jobs have been created.
Historically, the trend in office-using jobs
has led the trend in net absorption by
an average of 2-3 quarters. This puts
the national office market on track to
begin absorbing space again by the third
quarter of 2010. However, the level of
shadow space (the space that companies
are leasing but not using) is difficult to
measure, and that could throw off the
timing of the forecast. Nevertheless, the
trend in demand for office space is headed
in a positive direction, as evidenced by the
fact that declines have decelerated rapidly
for four straight quarters. Regardless of
quarterly nuances, 2010 is tracking to be a
year of positive absorption for the national
office market. With more new supply
(much of which is empty) still delivering
to the market, vacancy will not trend
downwards until 2011. Consequently,
even under a bullish scenario, the national
office market will remain oversupplied,
which suggests that sustainable rent
growth will not occur until the second half
of 2011, at the earliest.
Industrial Sector
In terms of improving demand, the national
industrial sector is trailing the office market
by 1-2 quarters. Whereas the U.S. was
churning out office-using jobs in the fourth
quarter of 2009, industrial employment,
which includes manufacturing, wholesale,
and transportation/warehousing, was
still contracting. However, 2010 has
been a rebound year, primarily for the
manufacturing sector. In fact, 44,000 new
manufacturing jobs were created in April of
2010. This, in combination with the ISM
U.S. Forecast Report
Office & Industrial June 2010
index registering a reading of over 50 for 8 That is not likely to happen until 2011.
straight months (an index greater than 50 Cap rates will continue to tighten for
is consistent with expansion) suggests the core markets, but with a greater share
industrial employment base will continue of value-add transactions in the mix, we
to grow in the coming months. Given expect the overall cap rate for both office
that absorption lags, we are projecting the and industrial properties to rise in 2011.
industrial market will not begin to absorb Quality real estate in top tier markets are
space consistently until the first quarter leading, and will continue to lead, the
of 2011. With over 40 million square feet recovery in commercial real estate, with
of new supply in the pipeline according secondary markets following suit in 2011
to REIS, Inc., we do not expect vacancy and more so in 2012.
to tick down until 2011, with rent growth
following in 2012.
*Value-add: Property with lease-up greater than 10%;
in-place tenants are below market by at least 10%;
Investment Sales property can be physically improved resulting in
The combination of still-tight lending higher rents; yields 12-15%.
conditions and weakened property *Core: Long-term credit leases prime locations, or if
fundamentals resulting from the recession secondary, lease term and credit overshadow location;
will continue to constrain sales activity yields 8-12%.
in 2010, although the overall volume will
be slightly higher than in 2009. Through
April 2010, national office sales volume
has totaled just $5.1 billion and industrial
volume $2.9 billion, compared to $55.4
billion and $15.5 billion, respectively,
during the peak year of 2007. Looking
one layer deeper, investment sales remain
a tale of two markets: core vs. value-
add. Investors are seemingly coming
out of the woodwork for core product,
particularly in top tier markets such as
Washington DC and Manhattan, which
is bidding values up. The value-add
product remains plagued by a clear lack
of incentive to sell in a down market. As
the economy continues to shift from
recovery to expansion, that will help
properties lease up. We will then see
the gap close between buyer and seller,
and more value-add properties will trade
hands. However, a sustainable period of
job creation is required before occupancy
levels make value-add attractive again.
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 U.S. Forecast Report
Office & Industrial June 2010

Office Sector Industrial Sector

Net Absorption vs. Office-using Employment Net Absorption vs. Industrial-using Employment

30 400
40 200
300
20 30
200 0
20
100
10
Millions

Thousands
10 -200
0

Millions

Thousands
0 -100 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 -400
05 05 02 05 06 06 06 06 07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 -200 -10 05 05 02 05 06 06 06 06 07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11

-10
-300 -20 -600

-400
-20 -30
-800
-500
-40
-30 -600
-50 -1000
Net Absorption Office-using Employment
Source: BLS; Cassidy Turley Research
Net Absorption Industrial-using Employment
Source: BLS; Cassidy Turley Research

$ Volume vs. Average Cap Rate $ Volume vs. Average Cap Rate

$60 12%
$250 12%

$50 10%
10%
$200
$40 8%
8%

Cap Rate
Billions
Billions

$150
Cap Rate

$30 6%
6%
$100
$20 4%
4%

$50 $10 2%
2%

$0 0%
$0 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
$ Volume Avg Cap Rate
$ Volume Avg Cap Rate

Source: Real Capital Analytics; Cassidy Turley Research

Source: Real Capital Analytics; Cassidy Turley Research

Vacancy vs. Asking Rents Vacancy vs. Asking Rents

$25 25% $7 25%

$6
$20 20% 20%
$5
Asking Rents
Asking Rents

$15 15%
Vacancy

15%
Vacancy

$4

$3
$10 10% 10%

$2
$5 5% 5%
$1

$0 0% $0 0%
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Asking Rent Vacancy Rate Asking Rent Vacancy Rate

Source: Cassidy Turley Research Source: Cassidy Turley Research

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 U.S. Forecast Report
Office & Industrial June 2010

2009 2010 2011 Annual

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2009 2010 2011
U.S. Economy
Real GDP (%) -6.4 -0.7 2.2 5.6 3.0 3.1 2.5 2.6 2.9 -2.4 3.1 3.1
Non-Farm Employment (q) -2,205 -1,702 -1,035 -438 283 540 155 240 340 -5,870 -663 1,900
Office-using Employment (q) -550 -442 -377 23 74 189 54 84 119 -2,055 -232 665
Industrial Employment (q) -826 -638 -320 -170 32 103 29 46 65 -1,115 -126 361
Retail Employment (q) -252 -147 -103 -99 71 62 18 27 39 -669 -76 217
CCI 29.9 48.3 51.8 51.0 52.0 60.0 59.0 62.0 70.0 45.0 58.0 80.0
CPI Inflation (Yr/Yr Chg) -2.2 1.9 3.7 2.6 1.8 2.1 0.9 1.2 2.0 -0.3 1.9 2.5
Real Disposable Income (q%) -0.3 1.9 -0.3 0.9 1.0 0.8 2.0 2.5 3.1 1.1 1.6 2.8
Unemployment 8.2% 9.3% 9.6% 10.0% 9.7% 9.8% 9.9% 9.9% 9.9% 9.3% 9.8% 9.5%
ISM Manufacturing Index 35.9 43.0 51.4 54.6 58.2 58.4 58.4 57.9 57.9 46.2 58.2 58.5
Retail Sales (q%) -1.6 -0.1 1.8 1.8 1.0 1.5 0.9 1.2 3.0 -6.8 4.6 6.2
Existing Home Sales (b) 4,610 4,780 5,280 5,970 5,137 5,400 5,100 5,300 5,500 5,156 5,234 5,600
Existing Home Prices (b) 167.6 174.4 178.1 170.8 166.7 173 184 175 173 172.5 174.7 185
Housing Starts (b) 528 540 587 559 617 643 683 720 800 553 666 920
Fed Funds Rate 0.2 0.2 0.2 0.1 0.1 0.2 0.2 0.2 0.7 0.2 0.2 1.6
3 Month T-Bill 0.2 0.2 0.2 0.1 0.1 0.2 0.2 0.2 0.6 0.2 0.2 1.4
Corporate AAA Bond Yield 5.3 5.5 5.3 5.2 5.3 5.3 5.5 5.6 5.7 5.3 5.4 5.8
10-year Gov't Bond 2.7 3.3 3.5 3.5 3.8 3.8 3.9 4.1 4.2 3.5 3.9 4.6
30 year Gov't Bond 3.5 4.2 4.3 4.3 4.7 4.5 4.6 4.7 4.8 4.0 4.6 4.8
30-year Mortgage Rates 5.1 5.0 5.2 4.9 5.0 5.6 5.6 5.7 5.8 5.0 5.5 6.1
Office Sector
Net Absorption (m) -22.0 -18.6 -13.5 -7.8 -3.7 -3.26 7.12 3.35 5.96 -61.8 3.5 39.9
Vacancy 15.2% 15.7% 16.2% 16.5% 16.8% 17.0% 16.9% 17.0% 16.9% 15.9% 16.9% 16.7%
New Deliveries (m) (r) 12.5 17.1 8.5 7.2 6.1 – – – – 45.3 24.7 17.9
Asking Rents $22.17 $21.95 $21.73 $21.51 $21.62 $21.43 $21.39 $22.49 $22.54 $21.84 $21.73 $22.76
Effective Rents $18.63 $18.24 $17.88 $17.62 $17.64 $17.43 $17.34 $18.39 $18.39 $18.09 $17.70 $18.26
Investment Sales ($vol, bil) $3.7 $2.8 $4.8 $4.6 $4.3 $4.8 $6.0 $6.2 $13.0 $15.9 $21.3 $52.0
Cap Rates 7.8% 7.8% 8.3% 8.8% 8.6% 8.2% 8.3% 8.4% 8.6% 8.2% 8.4% 8.6%
Industrial Sector
Net Absorption (m) -38.2 -36.5 -43.4 -23.2 -28.7 -19.2 -14.2 1.8 -7.3 -141.3 -60.3 77.4
Vacancy 8.7% 9.3% 9.7% 9.8% 9.8% 10.0% 10.2% 10.2% 10.3% 9.4% 10.1% 10.0%
New Supply (Deliveries) – – – – – – – – – 32.4 15.3 28.9
Asking Rents $5.50 $5.40 $5.31 $5.21 $5.12 $5.14 $5.18 $5.15 $5.06 $5.35 $5.15 $4.99
Investment Sales ($vol) $1.5 $2.4 $1.8 $2.6 $1.8 $3.1 $2.4 $2.6 $3.3 $8.3 $9.9 $12.0
Cap Rates 8.5% 8.3% 8.4% 9.0% 8.6% 8.5% 8.5% 8.6% 8.7% 8.6% 8.6% 8.8%

Key
q = qtr/qtr chg, 000s q% = qtr/qtr % chg b = measured in 000s m = millions, sq. ft. r = Reis, Inc LLC

*Sources for economic indicators include: US Census Bureau, BLS, BEA, Dismal, The Conference Board, NAR, Department of the Treasury and the Federal Reserve; all
forecasts generated by Cassidy Turley Research.

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