1. Global Research and Consulting Econometric Advisors CBRE Econometric Advisors Around the Bend The Shape of the Recovery U.Conn, November 11, 2009 William Wheaton Professor, Department of Economics MIT

2. CB Richard Ellis | Page 2 Global Research and Consulting Econometric Advisors The Global Outlook  The rest of the world does not have Housing and Debt market woes quite like the US  The rest of the world is recovering sooner and likely stronger than the US.  But with expanded trade, the world can only go so far without the US.  Property markets outside of the US already show signs of mending.  Long term good news: high global Savings = Plentiful Capital  Long term concern: slowing demographics

3. CB Richard Ellis | Page 3 Global Research and Consulting Econometric Advisors GDP Growth, G-8 vs. EM: Continued Synchronization? Y/Y Source: IHS Global Insight, August 2009 Forecast ?

4. CB Richard Ellis | Page 4 Global Research and Consulting Econometric Advisors Consumption growth, G-8 vs. EM Y/Y Forecast Source: IHS Global Insight, September 2009

5. CB Richard Ellis | Page 5 Global Research and Consulting Econometric Advisors Savings Rates (total), G-8 vs. EM: Plenty of Capital % Source: IHS Global Insight, August 2009 Forecast

6. CB Richard Ellis | Page 6 Global Research and Consulting Econometric Advisors Hence Long Term Rates remain low Source: IHS Global Insight, August 2009 Forecast %

7. CB Richard Ellis | Page 7 Global Research and Consulting Econometric Advisors Trade (I + M) as % of GDP: increasing “openness” % Source: IHS Global Insight, August 2009 Forecast

8. CB Richard Ellis | Page 8 Global Research and Consulting Econometric Advisors Slowing/negative Population Growth Rates Forecast Source: IHS Global Insight, September 2009 Y/Y

9. CB Richard Ellis | Page 9 Global Research and Consulting Econometric Advisors Office Vacancy Rates stabilizing: except for US Source: CB Richard Ellis, July 2009

10. CB Richard Ellis | Page 10 Global Research and Consulting Econometric Advisors Office Rents show a bottom in A-P, not US, EU Rent Index 100 = 2001.1 Asia North America Pacific Source: CBRE Research and Consulting, July 2009 EU

11. CB Richard Ellis | Page 11 Global Research and Consulting Econometric Advisors Cap Rates Starting to fall : except for continued US rise Source: Real Capital Analytics, Oct 2009

12. CB Richard Ellis | Page 12 Global Research and Consulting Econometric Advisors So Capital Values stabilizing: except for the US Source: CB Richard Ellis July 2009 Index, 100=2001.2

13. CB Richard Ellis | Page 13 Global Research and Consulting Econometric Advisors The US Economic Outlook in more detail  Trade, exports, low dollar – are big recovery drivers  Business Investment and Inventories – also big recovery driver.  Housing – surprise – a huge recovery driver.  The big question is consumption. Will consumers save more or spend less?  Another jobless recovery – why?

14. CB Richard Ellis | Page 14 Global Research and Consulting Econometric Advisors US Trade Flows are Turning positive Change from previous month (Millions of $) Source: BEA

15. CB Richard Ellis | Page 15 Global Research and Consulting Econometric Advisors Business Investment + Clunkers + stimulus =3.5% Source: BEA and CBRE Econometric Advisors Contribution to Headline GDP Growth (%)

16. CB Richard Ellis | Page 16 Global Research and Consulting Econometric Advisors Sources: Bureau of the Census, BEA, CBRE Econometric Advisors Housing GDP Contribution Turns Positive Next Year Housing starts increase from 570 ths in 2009 to 1250 in 2012 HH growth + demolitions + 2 nd homes = 1.3m units!

17. CB Richard Ellis | Page 17 Global Research and Consulting Econometric Advisors “Jobless Recoveries”: getting worse Sources: Bureau of Labor Statistics, CBRE-EA.

18. CB Richard Ellis | Page 18 Global Research and Consulting Econometric Advisors But a Labor Force shortage still looms with BB Retirees Sources: BLS, BOC, CBRE-EA

19. CB Richard Ellis | Page 19 Global Research and Consulting Econometric Advisors The Outlook for Consumer Driven Real Estate  Retail sales recover – but more slowly – with consumer balance sheet issues  Internet competition threatens traditional shopping.  Housing Rents and Prices move together not apart!  Why haven’t apartments benefited from housing’s foreclosure misery?

20. CB Richard Ellis | Page 20 Global Research and Consulting Econometric Advisors 2009:Worst Year ever for retail Absorption SQFT X 1,000 % Source: CBRE Econometric Advisors

21. CB Richard Ellis | Page 21 Global Research and Consulting Econometric Advisors Internet Sales: recovering fastest, LT threat Yr/Yr Growth (%) Source: BOC

22. CB Richard Ellis | Page 22 Global Research and Consulting Econometric Advisors Rents follow Home Prices: Always Sources: Bureau of the Census, CBRE Econometric Advisors Why won’t apartments benefit from foreclosures?

23. CB Richard Ellis | Page 23 Global Research and Consulting Econometric Advisors 1996-2005: 1m renter household decline 2006-2011, 5m increase Dramatic movements Homeownership 1995-2011 Sources: Bureau of the Census, CBRE Econometric Advisors

24. CB Richard Ellis | Page 24 Global Research and Consulting Econometric Advisors Homeownership change explains Rental Demand Sources: Bureau of the Census, CBRE Econometric Advisors

25. CB Richard Ellis | Page 25 Global Research and Consulting Econometric Advisors But Conversions (supply) moves with demand Sources: Bureau of the Census, CBRE Econometric Advisors

26. CB Richard Ellis | Page 26 Global Research and Consulting Econometric Advisors Sources: BOC, S&P Case Shiller, FHFA Sales Duration Points to stabilizing price (and rents)

27. CB Richard Ellis | Page 27 Global Research and Consulting Econometric Advisors The Outlook for Business driven Real Estate  Rebuilding Inventories and trade gives industrial a shot in the arm.  But we have way too much (obsolescent) industrial space.  But Financial job growth is slowing dramatically – why?  Any financial jobs are dispersing out of the traditional money centres.  At least Office is not overbuilt (as in the 1980s).

28. CB Richard Ellis | Page 28 Global Research and Consulting Econometric Advisors Trade is recovering, and growing in the long term Source: U.S. Bureau of Economic Analysis. Exports, Imports, and Inventory as % of GDP as % of GDP But Inventories are shrinking from Logistic efficiency

29. CB Richard Ellis | Page 29 Global Research and Consulting Econometric Advisors Inventories are best predictor of Industrial RE Demand Source: Bureau of Economic Analysis; Industrial Outlook XL, Fall 2009. Change in Bus. Inventories (billions 2005 $) Industrial Net Absorption (millions sf) Correlation=0.769 *Statistically significant at 0.001 level

30. CB Richard Ellis | Page 30 Global Research and Consulting Econometric Advisors Record vacancy pushes the start of recovery into 2011 Net Absorption, Completions (millions sf) Availability Rate Forecast

31. CB Richard Ellis | Page 31 Global Research and Consulting Econometric Advisors Finance is now a declining share of US Jobs Source: Bureau of Labor Statistics. Financial Employment as a Share of Total Employment Major US financial Centers loosing market share

32. CB Richard Ellis | Page 32 Global Research and Consulting Econometric Advisors Job Growth in the Office Market will come from Service Sector Source: Office Outlook XL, Fall 2009 Hence Office demand increasingly from Services Recovery, ie, positive job growth, comes in early 2010 for services, late 2010 for finance. Expansion, ie, growth beyond the previous peak, comes in 2012 for services, not over next ten years for finance.

33. CB Richard Ellis | Page 33 Global Research and Consulting Econometric Advisors Current Crisis not a Construction Crisis (whew!) Sources: McGraw Hill, CBRE Econometric Advisors.

34. CB Richard Ellis | Page 34 Global Research and Consulting Econometric Advisors Will the recovery in rents will be as slow as from 2001 (and 1992)? 15 qtrs 9 qtrs Source: CBRE Econometric Advisors Does sharper current drop = sharper recovery?

35. CB Richard Ellis | Page 35 Global Research and Consulting Econometric Advisors The Outlook for Capital, and Asset Values  Fundamentals hit hard in 2010-2014 as current rents roll into NOI.  A renewed appetite for risk will help curtail the rise in cap rates.  Some debt is now available, but is it enough?  So much of the rise in cap rates is based on the fear of a (forthcoming) debt rollover crisis.  But there are lots of Alternative solutions: Re-ignite CMBS (2 big new TALF deals) Use public debt markets (REITS) Equity –for- Debt!

36. CB Richard Ellis | Page 36 Global Research and Consulting Econometric Advisors Cap Rates hurt Values now, NOI declines loom Source: CBRE-EA, Investment Outlook Fall 2009, NCREIF; Base Case Scenario Cap rates have a strong initial impact, NOI declines through 2015.

37. CB Richard Ellis | Page 37 Global Research and Consulting Econometric Advisors Cap Rate Outlook: Stop rising in 2010, why? Source: CBRE-EA, Investment Outlook Fall 2009, NCREIF How high will institutional cap rates trend?

38. CB Richard Ellis | Page 38 Global Research and Consulting Econometric Advisors Source: CBRE Econometric Advisors, Federal Reserve Investor Appetite for Risk is returning Spread between corporate bonds and ten year treasury are falling corporate bond sales globally are brisk

39. CB Richard Ellis | Page 39 Global Research and Consulting Econometric Advisors Source: CBRE Econometric Advisors, Federal Reserve The Net growth of the stock of Debt is stuck The crunch in debt requires a deleveraging of the economy & property.

40. CB Richard Ellis | Page 40 Global Research and Consulting Econometric Advisors Almost a decade before we are back to peak values. Institutional Asset Values: back to the 1990s Source: CBRE-EA, Investment Outlook Fall 2009, NCREIF

41. CB Richard Ellis | Page 41 Global Research and Consulting Econometric Advisors Real Estate Round Table, Aggregate CRE Value: - 30% 2009-2010 Values 80% LTV Capital Stack: Debt and Equity $ 2008q1 Values 55% LTV Value Falls 30% 66% Equity loss Equity Other Debt Other Debt 2008q1: 3.2Trillion equity, 3.5 Trillion Debt CMBS

42. CB Richard Ellis | Page 42 Global Research and Consulting Econometric Advisors How will CRE Market be Refinanced at Rollover? Equity Re-Cap Gap = $16.5 Market Capital needs at Rollover Capital Stack: Debt and Equity $ 2008q1 Values Value Falls 30% Remaining Equity = $15 New 55% LTV Debt Plenty without CMBS ! Equity CMBS Other Debt

43. CB Richard Ellis | Page 43 Global Research and Consulting Econometric Advisors The “rollover crisis” is really an Equity Gap  Looks like lots of equity forming on the sidelines to purchase “A” properties at 30-40% distressed sale prices.  The problem is that “A” properties are not for sale at those prices! At least yet.  Current sales are “thin” and based mostly on problem properties.  MIT TBI index says that demand (purchases) are more willing, while supply (sellers) are less. Hence adjusting for Liquidity, prices actually rose a bit in 3q!  Maybe we will escape the crisis