Active Private Equity Real Estate Strategy E-Book

David J. Lynn

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Frank J. Fabozzi Series
• Sprache: Englisch

Seitenzahl: 348

Veröffentlichungsjahr: 2009

Beschreibung

Proven private equity real estate investing strategies The subprime fallout and credit crisis have triggered a major transition in U.S. real estate. With tightening lending and underwriting standards, speculative investments and construction projects are likely to limited, resulting in constrained supply and healthier fundamentals over the long term. Looking forward, market participants anticipate that the coming years will be fraught with challenges as well as opportunities. Active Private Equity Real Estate Strategy is a collection of abridged market analyses, forecasts, and strategy papers from the ING Clarion Partners' Research & Investment Strategy (RIS) group. Divided into two comprehensive parts, this practical guide provides you with an informative overview of real estate markets, forecasts, and recent trends in part one, and presents specific active strategies in private equity real estate investing in part two. * Includes a simulation of the economy in recession and the expected effects on the commercial real estate industry * Offers examples of portfolio analysis and recommendations using ING Clarion's forecasts and Modern Portfolio Theory * Focuses on multifamily, hotel, land, and industrial investments * Demonstrates the use of the various tools available to the private equity real estate investor Written with both the individual and institutional real estate investor in mind, this book offers specific private equity strategies for investing in real estate during volatile times.

Leseprobe

Table of Contents

The Frank J. Fabozzi Series

Title Page

Copyright Page

Preface

Disclaimer

Acknowledgements

About the Authors

PART ONE - Market Analysis and Forecasts

CHAPTER 1 - Overview of the U.S. Real Estate Market

OUTLOOK FOR U.S. ECONOMY: NEAR-TERM SLOWDOWN

U.S. REAL ESTATE: FINDING VALUEIN A CHANGING MARKET

CHAPTER 2 - Forecasting the U.S. Market

FORECASTING METHODOLOGY

CHAPTER 3 - Recession Simulation and It’s Effects on Real Estate

IMPACT OF THE LAST RECESSION (2001) ON COMMERCIAL PROPERTY MARKETS

METHODOLOGY

CAP RATES AND TOTAL RETURNS

CHAPTER 4 - Subprime Fallout

HOW DID WE GET TO THIS POINT?

NEAR-TERM IMPACT ON THE COMMERCIAL REAL ESTATE MARKET

CHAPTER 5 - Capital Markets

WIDENING CREDIT SPREADS

TIGHTENED UNDERWRITING CRITERIA

DECLINING TRANSACTION VOLUMES

SHRINKING CMBS AND SECURITIZATION MARKETS

INCREASED REAL ESTATE ALLOCATION

CHAPTER 6 - The Bid-Ask Problem and Game Theory

EVIDENCE OF A BID-ASK SPREAD

GAME THEORETIC EXPLANATION OF THE BID-ASK SPREAD

HOW WILL LIQUIDITY RETURN?

CONCLUSION

PART TWO - Active Strategies

CHAPTER 7 - Residential Land Investment

THE MARKET

THE ENTITLEMENT PROCESS

INVESTMENT RISKS

TARGET MARKET SELECTION AND RANKING

CHAPTER 8 - The U.S. Hotel Market and Strategy

BACKGROUND

U.S. HOTEL MARKET OUTLOOK

CONCLUSION

CHAPTER 9 - Global Gateway Industrial Market Investment

BACKGROUND

FACTORS INFLUENCING PORT EXPANSIONS

A MORPHOLOGY OF MODES

LEADING GLOBAL GATEWAY MARKETS

OPPORTUNITIES IN EMERGING FACILITIES

CONCLUSION

CHAPTER 10 - The Opportunity in Senior Housing

BACKGROUND

TARGETED SENIOR GROUPS

DEMAND FACTORS

SUPPLY FACTORS

SEGMENT PERFORMANCE

RISK FACTORS

SECTOR OUTLOOK

STRATEGIC OPTIONS

CHAPTER 11 - Active Portfolio Management Using Modern Portfolio Theory

THE INVESTMENT UNIVERSE BY SECTOR, REGION, AND METRO

HYPOTHETICAL FUND PERFORMANCE EXPECTATIONS

HYPOTHETICAL FUND SECTOR EXPOSURES

HYPOTHETICAL FUND INVESTED MARKETS VS. NATIONAL AVERAGE

SECTOR REBALANCING STRATEGIES

REGIONAL REBALANCE STRATEGIES

IDENTIFICATION OF HYPOTHETICAL SALES CANDIDATES

ACQUIRING $1 BILLION OF NEW INVESTMENTS

CONCLUSIONS

CHAPTER 12 - Derivatives in Private Equity Real Estate

BACKGROUND

CURRENT STATE OF THE DERIVATIVES MARKET

RISKS

STRATEGIC APPLICATIONS TO REAL ESTATE INVESTMENT

ADDITIONAL CONSIDERATIONS

CHAPTER 13 - Opportunities in Infrastructure Investment

BACKGROUND

RETURNS

RISKS

EXPANDING INVESTMENT UNIVERSE

CONCLUSION

APPENDIX A - Typical Land Development Pro Forma Analysis—Three Scenarios

APPENDIX B - U.S. Hotel Chain Scales

APPENDIX C - Modern Portfolio Theory in Real Estate Portfolio Analytics

APPENDIX D - Commercial Real Estate Indexes

APPENDIX E - Example NPI Forecast Methodology

Selected Bibliography

Index

The Frank J. Fabozzi Series

Fixed Income Securities, Second Edition by Frank J. Fabozzi Focus on Value: A Corporate and Investor Guide to Wealth Creation by James L. Grant and James A. Abate Handbook of Global Fixed Income Calculations by Dragomir Krgin Managing a Corporate Bond Portfolio by Leland E. Crabbe and Frank J. Fabozzi Real Options and Option-Embedded Securities by William T. Moore Capital Budgeting: Theory and Practice by Pamela P. Peterson and Frank J. Fabozzi The Exchange-Traded Funds Manual by Gary L. Gastineau Professional Perspectives on Fixed Income Portfolio Management, Volume 3 edited by Frank J. Fabozzi Investing in Emerging Fixed Income Markets edited by Frank J. Fabozzi and Efstathia Pilarinu Handbook of Alternative Assets by Mark J. P. Anson The Global Money Markets by Frank J. Fabozzi, Steven V. Mann, and Moorad Choudhry The Handbook of Financial Instruments edited by Frank J. Fabozzi Interest Rate, Term Structure, and Valuation Modeling edited by Frank J. Fabozzi Investment Performance Measurement by Bruce J. Feibel The Handbook of Equity Style Management edited by T. Daniel Coggin and Frank J. Fabozzi The Theory and Practice of Investment Management edited by Frank J. Fabozzi and Harry M. Markowitz Foundations of Economic Value Added, Second Edition by James L. Grant Financial Management and Analysis, Second Edition by Frank J. Fabozzi and Pamela P. Peterson Measuring and Controlling Interest Rate and Credit Risk, Second Edition by Frank J. Fabozzi, Steven V. Mann, and Moorad Choudhry Professional Perspectives on Fixed Income Portfolio Management, Volume 4 edited by Frank J. Fabozzi The Handbook of European Fixed Income Securities edited by Frank J. Fabozzi and Moorad Choudhry The Handbook of European Structured Financial Products edited by Frank J. Fabozzi and Moorad Choudhry The Mathematics of Financial Modeling and Investment Management by Sergio M. Focardi and Frank J. Fabozzi Short Selling: Strategies, Risks, and Rewards edited by Frank J. Fabozzi The Real Estate Investment Handbook by G. Timothy Haight and Daniel Singer Market Neutral Strategies edited by Bruce I. Jacobs and Kenneth N. Levy Securities Finance: Securities Lending and Repurchase Agreements edited by Frank J. Fabozzi and Steven V. Mann Fat-Tailed and Skewed Asset Return Distributions by Svetlozar T. Rachev, Christian Menn, and Frank J. Fabozzi Financial Modeling of the Equity Market: From CAPM to Cointegration by Frank J. Fabozzi, Sergio M. Focardi, and Petter N. Kolm Advanced Bond Portfolio Management: Best Practices in Modeling and Strategies edited by Frank J. Fabozzi, Lionel Martellini, and Philippe Priaulet Analysis of Financial Statements, Second Edition by Pamela P. Peterson and Frank J. Fabozzi Collateralized Debt Obligations: Structures and Analysis, Second Edition by Douglas J. Lucas, Laurie S. Goodman, and Frank J. Fabozzi Handbook of Alternative Assets, Second Edition by Mark J. P. Anson Introduction to Structured Finance by Frank J. Fabozzi, Henry A. Davis, and Moorad Choudhry Financial Econometrics by Svetlozar T. Rachev, Stefan Mittnik, Frank J. Fabozzi, Sergio M. Focardi, and Teo Jasic Developments in Collateralized Debt Obligations: New Products and Insights by Douglas J. Lucas, Laurie S. Goodman, Frank J. Fabozzi, and Rebecca J. Manning Robust Portfolio Optimization and Management by Frank J. Fabozzi, Peter N. Kolm, Dessislava A. Pachamanova, and Sergio M. Focardi Advanced Stochastic Models, Risk Assessment, and Portfolio Optimizations by Svetlozar T. Rachev, Stogan V. Stoyanov, and Frank J. Fabozzi How to Select Investment Managers and Evaluate Performance by G. Timothy Haight, Stephen O. Morrell, and Glenn E. Ross Bayesian Methods in Finance by Svetlozar T. Rachev, John S. J. Hsu, Biliana S. Bagasheva, and Frank J. Fabozzi The Handbook of Municipal Bonds edited by Sylvan G. Feldstein and Frank J. Fabozzi Subprime Mortgage Credit Derivatives by Laurie S. Goodman, Shumin Li, Douglas J. Lucas, Thomas A Zimmerman, and Frank J. Fabozzi Introduction to Securitization by Frank J. Fabozzi and Vinod Kothari Structured Products and Related Credit Derivatives edited by Brian P. Lancaster, Glenn M. Schultz, and Frank J. Fabozzi Handbook of Finance: Volume I: Financial Markets and Instruments edited by Frank J. Fabozzi Handbook of Finance: Volume II: Financial Management and Asset Management edited by Frank J. Fabozzi Handbook of Finance: Volume III: Valuation, Financial Modeling, and Quantitative Toolsedited by Frank J. Fabozzi Finance: Capital Markets, Financial Management, and Investment Management by Frank J. Fabozzi and Pamela Peterson-Drake

Copyright © 2009 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Active private equity real estate strategy / David J. Lynn [et al.].

p. cm.—(The Frank J. Fabozzi series)

Includes index.

eISBN : 978-0-470-52207-3

1. Real estate investment—United States. 2. Commercial real estate—United States. 3. Residential real estate—United States. 4. Private equity. I. Lynn, David J.

HD255.A58 2009

332.63ʹ 240973-dc22 2009014326

eISBN : 978-0-470-52207-3

Preface

Active Private Equity Real Estate Strategy is a collection of abridged market analyses, forecasts, and strategy papers from ING Clarion’s Research & Investment Strategy (RIS) group. ING Clarion is the U.S. arm of ING Real Estate, a global organization with offices in 22 countries and expertise in the development, financing, and investment management of quality real estate. In the United States, the company has employees in major markets who specialize in assembling and managing portfolios of real estate assets for institutional and individual investors.

We have written this book with a focus on the United States and from the perspective of the active manager of institutional assets, separate accounts, and private investors. Plan sponsors, consultants, broker-dealers, traders, and data providers may also find this book of interest.

This book demonstrates the use of a range of tools available to the private equity real estate investor, including scenario analysis, econometric forecasting, modern portfolio theory, macroeconomic projections, empirical research, and strategy formulation. It is not meant to be a comprehensive approach to strategy formulation for the real estate industry, but instead illustrates a cross section of private equity strategies across the various property types. Technical appendexes are provided for those who wish to delve further into the methodological underpinnings of the work.

We define strategy as a coherent, structured, and integrative pattern of decisions formulated as a means of investing in markets and assets to achieve above-average financial returns.

Our approach to strategy embodies three basic steps. The first step is to understand and establish clear goals and objectives. In strategic planning parlance, this is often referred to as the mission or mission statement. Working at both the corporate headquarters level and the regional business unit level, we formulate goals and objectives that are critical, measurable, fulfill our minimum profit targets, and are achievable.

The second step is to understand the market (both the macroeconomic environment and real estate markets). This is known as the situation audit. Changes in the external environment often present new opportunities and new strategies to reach return objectives. We also take into account the firm’s capabilities, core strengths, and limitations in order to select the opportunities with the greatest potential. This step, therefore, involves both the external and internal environments. The external environment encompasses two dimensions: the macroeconomic environment and the markets. The macroeconomic environment includes political, economic, social, and technological factors. This is also referred to as a “top-down” approach. “Industry factors,” owing to Michael Porter’s five forces framework, are often considered.1 These include barriers to entry, customers, suppliers, products, and competition. The real estate market analysis is fundamental and includes factors such as supply, demand, vacancy, rent levels and growth/decline, comparable properties, and forecasts of many of these factors at the national, regional, and metropolitan statistical area (MSA) levels. This may involve analysis of individual deals and comparable properties. This is often referred to as a “bottom-up” approach. The internal audit (often implicitly integrated but not explicitly explicated in our strategies) may involve factors such as the company culture, core competencies, organizational structure, access to capital, experience, reputation, operational efficiency, market share, relationships, and geographic resource location. Sometimes a strengths, weaknesses, opportunities, and threats (SWOT) analysis is a part of this phase of strategy development.

The third step is strategy formulation. Once a clear picture of the market is in hand, specific strategies, alternatives, and scenarios can be developed. While different firms have different alternatives depending on their particular situations, there are generic strategies in commercial real estate investing which are typically employed when defining strategic alternatives. These generic strategies are core, value-add, and opportunistic investing. The strategies presented in this book span the range. The strategies are expressed in both high-level conceptual terms, as well as pragmatic detailed tactics that can be understood at the functional/business unit level of the organization.

The chapters that make up this book were drafted over a period of 12 months, beginning in summer 2007. In some cases, they reflect an evolution of thinking on subjects, as demanded by the changing macroeconomic and market conditions of a particularly dynamic period.

There are two parts of the book. Part One provides an overall context discussion of real estate markets, forecasts, and recent trends. This section presents our view during that time period on the national and major urban area markets as well as our analysis of each real estate property type (sector). It illustrates techniques of market analysis and forecasting, which set the stage for detailed strategy development later on. Given the highly dynamic period during which these chapters were written, the analysis includes a simulation of the economy in recession and the expected effects on the commercial real estate industry.

Part Two of the book presents specific active strategies in private equity real estate investing around the United States. Each of these studies was developed to identify and analyze real investment opportunities. They focus on multifamily, hotel, land, and industrial investment, along with three niche plays: derivatives, seniors housing, and infrastructure. We also include an example of the application of Modern Portfolio Theory to a hypothetical core real estate portfolio.

DAVID J. LYNN, PH.D. New York City, New YorkDecember 2008

Disclaimer

This publication is not investment advice or an offer or solicitation for the purchase or sale of any financial instrument. While reasonable care has been taken to ensure that the information contained herein is not untrue or misleading at the time of publication, ING makes no representation that it is accurate or complete. The assumptions used in making forecasts rely on a number of economic and financial variables. These variables are subject to change and may affect the likely outcome of the forecasts. The information contained herein is subject to change without notice. ING and any of its officers or employees may, to the extent permitted by law, have a position or otherwise be interested in any transactions, in any investments (including derivatives) referred to in this publication. ING may provide banking or other services (including acting as adviser, manager, lender, or liquidity provider) for, or solicit banking or other business from, any company referred to in this publication. Neither ING nor any of its officers or employees accepts any liability for any direct or consequential loss arising from any use of this publication or its contents. Copyright and database rights protection exists in this publication and it may not be reproduced, distributed, or published by any person for any purpose without the prior express consent of ING (and further, Wiley). All rights are reserved. Any investments referred to herein may involve significant risk, are not necessarily available in all jurisdictions, may be illiquid, and may not be suitable for all investors. The value of, or income from, any investments referred to herein may fluctuate and/or be affected by changes in exchange rates. Past performance is not indicative of future results. Investors should make their own investment decisions without relying on this publication. Only investors with sufficient knowledge and experience in financial matters to evaluate the merits and risks should consider an investment in any issuer or market discussed herein and other persons should not take any action on the basis of this publication. Additional information is available on request. At the date hereof, the authors, and/or the ING Group may be buying, selling, or holding significant long or short positions; acting as investment and/or commercial bankers; be represented on the board of the issuer; and/or engaging in market making in securities mentioned herein.

Acknowledgments

This book is a product of efforts of the Research & Investment Strategy (RIS) group at ING Clarion. The work was performed for our internal use, clients, trade and academic publications, and for new product and market development. While the authors listed were primarily responsible for the individual chapters, this undertaking was truly a collaborative effort and involved all members of the RIS team including Tim Wang, Ph.D., Matson Holbrook, Bohdy Hedgcock, Jeff Organisciak, Alison Sauer, and Yusheng Hao.

We draw regularly on the significant skills and experience of our colleagues across the firm, including Stephen J. Furnary; Jeffrey Barclay; C. Stephen Cordes; Douglas Bowen; William Krauch; Stephen Latimer; Frank Sullivan, Jr.; Stephen Hansen; Patrick Tully, Jr.; Craig Tagen; James Hendricks; Charles R. Lathem; Bruce G. Morrison; Stephen Spey; Robert Greer; Scott Harris; Jeb Belford; Edward Carey; Dean Rostovsky; David Confer; and Jeffrey Peshut.

We are also indebted to Jeremy Sumpter for his graphics and information research; Hannah Spencer and Sanela Ramovic for their editorial and administrative assistance; Suzanne Franks and the Marketing department for their keen insights; Nathaniel Kiernan and Michelle Gibbons for their thorough review; and the many other professionals at ING Clarion. Any inadvertent errors or omissions contained herein are entirely the fault of the authors.

Finally, we appreciate the cooperation of Real Estate Issues and Commercial Investment Real Estate in allowing works that were originally published elsewhere to be included in this collection.

About the Authors

David J. Lynn, PhD, MBA, MS, MA, CRE

Dr. David Lynn is an institutional real estate investor, strategist, and portfolio manager with extensive experience in national and international markets. At ING Clarion Partners, he is Managing Director and Head of the Research and Investment Strategy Group. In this capacity, he directs investment strategy for the firm’s private equity platform. He is a member of the Investment and Operating Committees, reviewing, recommending, and voting on all investment transactions of the firm. Dr. Lynn serves as an advisor for portfolio management of several of the largest core, value-added and opportunistic funds, including many large separate accounts. He advises on investment strategies (core, value add, opportunistic, niche plays), asset selection, portfolio analytics, market targeting, econometric forecasting, and market entry and exit. He assists the firm’s fund and product development initiatives. He directs real estate and economic market forecasts and formulates detailed investment recommendations for 50 major metros and hundreds of associated submarkets. His group provides real-time market intelligence for the U.S. and global markets. He also participates in numerous client presentations and consultations.

He has published widely on the subjects of real estate investment, development, economics, and land use. He is a noted market commentator on national and international real estate investment and is regularly mentioned and quoted in the media. Dr. Lynn has written over 15 articles, one book, and founded an academic journal. He has delivered presentations and papers at national and international professional conferences and meetings.

Dr. Lynn earned his PhD in Financial Economics at the London School of Economics, where he also earned a Master of Science specializing in Finance. His doctoral research focused on financial distress in emerging market countries. He earned an MBA as a Sloan Fellow from the Sloan School of Management, MIT, where he specialized in Finance and Real Estate. He earned a Masters in City and Regional Planning with an emphasis in Real Estate from Cornell University. His thesis research explored the application of strategic planning to the real estate industry. He earned a BA in Architecture from the University of California at Berkeley. He is a Counselor of Real Estate (CRE), a Certified Portfolio and Investment Manager (CPIM), a Chartered Management Analyst (CMA), a Homer Hoyt Fellow, an ISO 9000 Certified Auditor and a Certified Planner (AICP). He is a member of the American Real Estate Society (ARES), National Council of Real Estate Investment Fiduciaries (NCREIF), National Association for Business Economics (NABE), International Council of Shopping Centers (ICSC), Pension Real Estate Association (PREA), and the Urban Land Institute (ULI) (full member). He serves on the Editorial Board of the Counselors of Real Estate and the Advisory Board of PREA.

Tim Wang, PhD, Head of Macroeconomic Analysis and Strategy

Tim holds an MBA from New York University and a PhD from the University of Georgia. At ING Clarion, Tim concentrates on macroeconomics, investment strategy, market forecasts, asset allocation, and client services.

Matson Holbrook, Senior Associate

Matson holds an MS in Real Estate from New York University and a BS in Cartography and Geographic Information Systems (GIS) from the University of Wisconsin. Matson supports strategy development through market research and publications.

Bohdy Hedgcock, Associate

Bohdy holds a Masters in Urban Planning from the University of Colorado. Bohdy concentrates on both bottom-up and top-down analysis of economic, demographic, and market trends.

Jeff Organisciak, Senior Analyst

Jeff graduated from the University of Pennsylvania with a BA in Economics and Political Science. Jeff works primarily on fundamental U.S. market analysis and forecasting.

Alison Sauer, Analyst

Alison is a graduate of Tufts University where she earned a BS in Mathematics. At ING Clarion, she specializes in U.S. strategy, providing both bottom-up and top-down analyses of market trends.

Yusheng Hao, Analyst

Yusheng specializes in econometric modeling and risk management. He holds an MS in Financial Engineering from Baruch College, City University of New York.

PART ONE

Market Analysis and Forecasts

• “Overview of the U.S. Real Estate Market” analyzes the national and major metro markets, both in terms of macroeconomic fundamentals and real estate market drivers such as supply, demand, rent levels, and vacancies.

• “Forecasting the U.S. Market” projects real estate market fundamentals for major metros around the country. We forecast the NCREIF index based on our proprietary models using data from leading data and information providers.

• “Recession Simulation and Its Effects on Real Estate” analyzes the effects of two different types of economic downturns on property markets: a short and shallow downturn and a severe prolonged recession. This is scenario planning writ large with detailed simulations down to the property sector and metro level.

• “Subprime Fallout: The Impact on Commercial Real Estate” addresses the shock to the economy and investigates ramifications to the commercial real estate industry.

• “Capital Markets: Dramatic Shifts and Opportunities” assesses the current seizure in capital markets and the real and possible effects on commercial real estate. It looks at the challenges of reduced capital and also the potential opportunities created in the process.

• “The Bid-Ask Problem and Game Theory” assesses the dramatic fall in transaction volume since the beginning of the subprime fallout and the yawning gap between sellers and buyers. It utilizes a game-theoretic model to explain how this has occurred and how transactional liquidity may resume.

CHAPTER 1

Overview of the U.S. Real Estate Market

Tim Wang and David LynnSpring 20082

A major transition for U.S. commercial real estate occurred in 2007. Triggered by the subprime fallout and credit crisis, the outsized investment returns of the past several years came to an end. With tightening lending and underwriting standards, speculative investments and construction projects are likely to be more limited, resulting in more constrained supply and healthier fundamentals over the long term. Looking forward, we anticipate that 2008 and 2009 will be fraught with challenges as well as opportunities.

OUTLOOK FOR U.S. ECONOMY: NEAR-TERM SLOWDOWN

The U.S. economy is going through a slowdown, if not a recession, as a result of the subprime fallout and residential housing market downturn. Real gross domestic product (GDP) growth declined from 4.9% in the third quarter to 0.6% in the fourth quarter of 2007.3 Job growth, turning slightly negative in the first two months of 2008, has been decelerating since mid-2007 and is likely to be sluggish through year-end. In 2007, 1.1 million new jobs were created, compared to 2.1 million new jobs created in 2006.4 The 2007 year-end unemployment rate rose to 5.0% according to the Bureau of Labor Statistics, the highest level since 2005. While government and corporate spending remain solid, personal consumption is beginning to show weakness. Lackluster consumer spending could possibly lead to a mild recession in early 2008 (Exhibit 1.1).

EXHIBIT 1.1 Consumer Spending: Annualized GDP

Source: ING Clarion Research & Investment Strategy and Moody’s Economy.com, as of January 2008.

The credit crunch and housing market downturn are the biggest risks to U.S. and global economic growth. The largely stalled credit pipeline and financing activities have severely curtailed investment and M&A projects. The for-sale housing market continues to soften due to tightening lending standards, low affordability, and excess supply in many regions. Home prices have fallen approximately 10% year-over-year in most markets, causing negative wealth effects and weakening consumer spending power.5 Some potential buyers—even those with strong credit—are holding off on purchases, waiting for even bigger discounts. We expect that the housing market will not reach the bottom until 2009.

Recently, crude oil has exceeded $100 per barrel and retail gasoline prices remain elevated at over $3 per gallon, another drag on consumer spending. Although the core consumer price index (CPI) is running at about 2.5% annually, surging energy and commodity prices and the declining value of the U.S. dollar are adding inflationary pressures.6 A rising inflation rate could lead to higher interest rates thereby decreasing demand for commercial real estate.

U.S. REAL ESTATE: FINDING VALUEIN A CHANGING MARKET

U.S. Real Estate Fundamentals

U.S. commercial real estate fundamentals are generally sound with solid rent growth, albeit at a slower pace than in recent years, and stabilizing vacancy rates in most core markets. Within the next several months, demand for space is expected to soften, along with the slowing U.S. economy, before reaccelerating in 2010-2011. In 2008, vacancy rates have risen moderately. Rent growth is expected to remain positive during the economic slowdown, but will increase at a slower pace.

On the supply side, construction pipeline forecasts across all property types are below their long-term averages (Exhibit 1.2). Higher construction costs and more stringent local entitlement processes have restrained the supply pipelines. Although construction activity has picked up, demand is expected to outpace supply over the next five years, which should bode well for new and existing investments. Profitable opportunities should exist for selected core investments and well-sponsored value-added and development projects.

EXHIBIT 1.2 Construction Pipeline Forecasts (as of 2007)

Source: ING Clarion Research & Investment Strategy, TWR, REIS, and Smith Travel as of 2007Q4.

Private real estate investment continues to generate competitive risk-adjusted returns relative to other asset classes. In 2007, the private real estate index (NCREIF Property Index) achieved a strong total return of 15.9% (Exhibit 1.3). Office and hotel properties outperformed other property types. Office markets in the East and West and industrial markets in the West had significant gains. Looking forward, we expect that core real estate investment returns will likely be in the high single digits (between bonds and equities).

EXHIBIT 1.3 Historic Asset Class Performance (% annualized returns)

Source: ING Clarion Research & Investment Strategy, NCREIF, NAREIT, and MorningStar as of December 31, 2007.

EXHIBIT 1.4 Bright Spots in the Economic Landscape

Source: ING Clarion Research & Investment Strategy and Moody’s Economy.com, 2008.

Regional Outlook

We analyze major markets based on trends and forecasts in population growth, job growth, gross metro product (GMP), fundamentals of local economies, and health of the residential housing markets (Exhibit 1.4).

Despite the gloomy outlook of the U.S. economy in the near term, there are several expanding regions showing above-average growth and relatively healthy fundamentals (Exhibit 1.5). These markets are typically driven by high-tech, biotech, energy, commodities, international trade, housing affordability, and quality of life. Such factors may make these regions especially suitable for value-added and development investment projects.

Multifamily Market Outlook

Multifamily Market Fundamentals U.S. apartment market fundamentals are sound, supported by favorable demographic trends, a declining for-sale housing market, and a restrained construction pipeline. Members of the 75-million-strong echo boomer7 cohort are entering the workforce and will constitute the primary demand for apartments as the population of primary renters (age 19-35 years) expands by 3.2 million over the next four years. Because of tightening lending standards, fewer renters will be able to afford homes, helping to boost apartment demand in the near term.

EXHIBIT 1.5 Growth Drivers by Region

Source: ING Clarion Research & Investment Strategy as of January 2008.

During 2007, the national apartment vacancy rate dropped 20 basis points (bps) to 5.6% according to Reis, Inc.; however, that rate is forecast to edge up to over 6.0% in 2008 and 2009 as job growth slows. Effective rent growth in 2007 was strong at 4.5%, with markets such as New York, San Francisco, San Jose, Stamford, northern New Jersey, and Seattle experiencing the largest rent increases. Looking forward, we expect apartment rent growth to slow to approximately 3-4% annually over the next five years. Transaction volume in 2007 was $99.6 billion according to Real Capital Analytics (RCA), largely driven by the $22 billion Archstone-Smith Trust deal, compared to $91.7 billion in 2006.

Shadow Market Impacts Several markets, especially in Florida where condominium construction and conversion activities far outpaced demand, continue to be challenged with rising vacancy rates and depressed rent growth (Exhibit 1.6). Additionally, in markets where the for-sale housing sector is taking the hardest hit, some vacant, single-family homes are competing with Class A apartments, putting significant downward pressure on rent growth.

Multifamily Sector Outlook With the lowest cap rate among the four core property types, the apartment sector faces the greatest threat from rising cap rates. Moreover, job growth, the engine of apartment demand, has turned slightly negative for the first two months of 2008. The apartment markets with excess vacant condo or single-family homes will likely suffer the most (Exhibit 1.7).

After cap rate adjustments, new apartment investments in markets that are not suffering from excess shadow vacancy should perform well. Supply-constrained markets such as New York, San Francisco, San Jose, Los Angeles, Seattle, Boston, and northern New Jersey continue to be attractive. Furthermore, stressed assets such as vacant condominiums and selected land sites may offer opportunistic plays. Investment in Class B apartments in core markets can present opportunities, as these properties may attract echo boomers who are graduating from college.

Industrial Market Outlook

Industrial Market Fundamentals Supply and demand fundamentals of the industrial sector remained balanced through 2007. According to Torto Wheaton Research (TWR), the nationwide industrial vacancy rate was essentially static at 9.4%, but is expected to edge up to the long-term rate of 10% in 2008 and 2009 as the U.S. economy slows. Average rents rose 3.6% in 2007 and are expected to slow to an average annual growth rate of 3.0% over the next five years. On the supply side, industrial development activities are still modest nationwide, constrained by limited suitable building sites near coastal ports and soaring construction costs. In 2007, $48.0 billion of industrial properties were traded according to RCA, compared to $43.6 billion a year ago.

Expanding Global Trade and Strong Exports So far, the slowing economy has had a minor impact on the nation’s demand for warehouse space, which is fueled by expanding global trade. The depreciating U.S. dollar has boosted export growth by more than 12% annually since 2003 (Exhibit 1.8). West Coast warehouse markets such as Southern California, San Francisco, and Seattle experienced low vacancy rates and strong rent growth. In addition, vacancy rates in several R&D flex (San Jose) and manufacturing markets (Chicago and Charlotte) continued to improve.

EXHIBIT 1.6 Condominium Conversion and Shadow Market

Source: ING Clarion Research & Investment Strategy, REIS, and Witten Advisors, 2007.

EXHIBIT 1.7 SWOT Analysis of Multifamily Market

Industrial Sector Outlook With expanding global trade projected for the next few years, markets in coastal ports and intermodal hubs are expected to continue to benefit. Investments in supply-constrained coastal markets including Los Angeles, Orange County, Riverside, northern New Jersey, Seattle, and Miami remain attractive. Niche opportunities exist in markets such as Charleston, Houston, Savannah, Oakland, and Austin. R&D flex assets, especially in high-tech and biotech-concentrated markets such as San Jose and San Diego, may offer unique opportunities (Exhibit 1.9).

EXHIBIT 1.8 Export Growth

Source: ING Clarion Research & Investment Strategy and Moody’s Economy.com as of January 2008.

EXHIBIT 1.9 SWOT Analysis of Industrial Market

Office Market Outlook

Office Market Fundamentals The office sector is expected to face substantial headwinds in 2008 and possibly 2009 before recovering in 2010-2011. In 2007, several central business district (CBD) office markets experienced significant rent growth and declining vacancy rates, and the CBD office subsector achieved a remarkable 24.3% annual total return according to NCREIF. In particular, New York, San Francisco, Los Angeles, San Jose, Seattle, and Austin experienced notable declines in vacancy rates and near double-digit rent growth. Primarily driven by rising vacancy rates in suburban office markets, the 2007 national average vacancy rate edged up 50 bps to 13.1% according to TWR and is expected to spike to over 14.0% in 2008 and 2009 in response to a softer economy. Average office rents rose 9.8% in 2007 and are expected to increase by approximately 2-4% annually over the next five years. On the supply side, the construction pipeline will remain moderate through 2012. Driven by the sale and subsequent retrades of Equity Office assets, total office transaction volume surged to $215.4 billion in 2007 according to RCA, significantly more than the $138.2 billion in 2006.

Slow Growth of Office-Using Jobs The credit crunch and subprime losses are negatively impacting U.S. office employment, especially in the financial sector. Financial centers such as Manhattan, San Francisco, and Boston may be impacted as several large financial institutions have suffered huge losses. Although office employment growth is decelerating in the near term relative to 2006, demand for office space is forecast to reaccelerate in 2009-2011 (Exhibit 1.10).

EXHIBIT 1.10 Annual Office Employment Growth

Source: ING Clarion Research & Investment Strategy and Moody’s Economy.com as of January 2008.

Office Sector Outlook Sensitized by the subprime situation, investors are increasingly seeking safety in high-quality office properties in core markets; however, the office sector has historically been relatively volatile. Selectivity in regard to market, property location, and pricing is increasing in importance. Recent transactions in markets such as Midtown Manhattan showed negative spreads between cap rates and the 10-year Treasury yield. Double-digit rent growth assumptions in underwriting must be carefully evaluated. Better investment opportunities may exist in the top secondary markets (Exhibit 1.11).

Deep, supply-constrained markets, such as New York, San Francisco, Los Angeles, and Washington, DC, still have bright, long-term prospects.

EXHIBIT 1.11 SWOT Analysis of Office Market

Despite the near-term slowdown, most U.S. corporations (with the exception of financial institutions, home builders, and auto manufacturers) have strong balance sheets. Business services, information technology, finance, insurance, and management consulting are expected to regain robust job growth in 2009-2012. Consequently, knowledge-based and technology-concentrated office markets, including Boston, San Jose, Austin, and Seattle, are expected to continue to benefit. Furthermore, a modest office supply pipeline continues to justify value-added and development projects.

Retail Market Outlook

Retail Market Fundamentals The retail sector is under pressure due to falling home prices, a slowing job market, and the credit crisis. The residential housing downturn had an immediate impact on big-box retailers with those selling home furnishings, construction materials, and garden equipment experiencing the steepest declines. According to Reis, the national retail vacancy rate edged up 40 bps to 7.5% in 2007 and is expected to rise modestly through 2008 as consumer spending softens. Net absorption fell short of new construction, reflecting the hesitation from retailers and moderating retail sales. Average effective rent growth was only 2.9% in 2007, below the trend in recent years, and is expected to remain below 3.0% over the next three years.

Several West Coast markets, including Los Angeles, Orange County, San Jose, San Francisco, and Seattle, experienced low vacancy rates and strong rent growth in 2007. Overall, strong demographic trends, relatively low interest rates, rising wages, and resilient consumer spending should support the retail sector going forward. Transaction volume totaled $72.1 billion in 2007 according to RCA, compared to $54.8 billion a year ago.

Sluggish Consumer Spending In 2007, retail sales grew 4.1% according to Moody’s Economy.com, the slowest pace since 2002. We expect that 2008 will be a more challenging year for consumer spending (Exhibit 1.12). With a softening economy and fears of an imminent recession, retailers are focusing on same-store profitability and are expected to temper expansion plans over the next 12 months, negatively impacting rent growth. Most recently, major retailers including Macy’s, CompUSA, and Sharper Image announced the closing of hundreds of underperforming stores. Malls may experience rising vacancies as consumer spending continues to soften. Even upscale retailers such as Tiffany & Co. and Coach reported disappointing U.S. sales, suggesting pullback on the part of high-end consumers.

EXHIBIT 1.12 U.S. Retail Sales: Personal Disposable Income

Source: ING Clarion Research & Investment Strategy and Moody’s Economy.com as of January 2008.

Retail Sector Outlook Despite near-term weakness, the demand for retail space is expected to recover in 2010 and 2011, although the anticipated recovery is largely dependent on the rebound of economic growth and the housing market. Energy prices and inflation could continue to weigh on consumer sentiment. Markets such as New York, Washington, DC, Miami, West Palm Beach, Houston, and several West Coast metros continue to be attractive. Some retail stores may go out of business during 2008, providing value-added opportunities to upgrade tenant quality and mix. Because supply is forecast to lag demand over the next five years, opportunities exist for redevelopment and selective development in high-growth markets (Exhibit 1.13).

Hotel Market Outlook

Hotel Market Fundamentals The U.S. hotel sector has experienced strong growth and is in the middle of its current cycle that began in 2002. Advanced bookings from several large hotel chains suggest solid demand in 2008. According to Smith Travel Research, the 2007 national average occupancy rate stabilized at 63.2%. Revenue per available room (RevPAR) grew by 5.7% in 2007 and is expected to increase approximately 3-4% in 2008-2010 (if the economy can avoid a severe recession). Occupancy rates are expected to drop modestly in 2008, and RevPAR growth will be achieved mainly through increasing average daily rates (ADR).

EXHIBIT 1.13 SWOT Analysis of Retail Market

On the supply side, the hotel pipeline is still below its long-term average, although construction is projected to increase substantially after 2008. Luxury and Upper Upscale segments are relatively insulated because of high construction costs and more difficult local entitlement processes. Investors continued to show strong interests in hotel assets in 2007 with hotel transaction volume totaling $87.9 billion according to RCA, more than double that of 2006. A particularly notable transaction in 2007 was the $26 billion privatization of the Hilton Hotels by Blackstone.

Declining U.S. Dollar Fueling Hotel Demand The U.S. dollar has depreciated approximately 35% against major currencies since 2001 and is expected to remain weak for the foreseeable future.8 As a result, demand from international travelers continues to grow. Meanwhile, domestic travelers, concerned about reduced spending power overseas, are increasingly traveling within the U.S. International gateway cities and vacation destinations, including New York City, Los Angeles, Miami, Orlando, San Francisco, Honolulu, Las Vegas, and Washington, DC, should have high growth potential for business and leisure travel (Exhibit 1.14).

Hotel Sector Outlook Despite strong momentum, hotel returns could be at risk should a recession occur. The hotel sector is volatile because hotels operate essentially by one-night leases, and hotel demand is highly correlated with GDP growth. Businesses and consumers normally reduce travel during a severe economic downturn. Caution should be observed in core hotel investments over the next six months as the national economic downturn plays out. Nonetheless, a recession could present excellent opportunities to buy high-quality hotel assets at reduced prices. Further, the hotel sector still has room for potential cap rate compression if Treasury yields remain relatively low (Exhibit 1.15).

EXHIBIT 1.14 Overseas Visitors to Selected U.S. Destinations in 2006

Source: U.S. Department of Commerce, ITA, and Office of Travel and Tourism Industries, 2007.

EXHIBIT 1.15 SWOT Analysis of Hotel Market

Within the hotel sector, Luxury, Upper Upscale, and Upscale segments are projected to outperform the other segments over the next three years. Strong brand names have created customer loyalty, which facilitates pricing premiums. Business hotels and resorts in selected, supply-constrained markets may perform most favorably. Furthermore, we believe that many projects in the current pipeline will be delayed or canceled, creating opportunities for well-sponsored development projects to move forward. The extended-stay hotel segment is expected to perform well because current supply is significantly lagging demand. During the last recession, occupancy in extended-stay hotels remained relatively stable, suggesting that the segment may experience less volatility through an economic downturn.

CHAPTER 2

Forecasting the U.S. Market

David LynnWinter 2007-20089