PNC Real Estate Market Research: The Office & Industrial Markets

Transcription

1 PNC Real Estate Market Research: The Office & Industrial Markets September 22, 2015, 2:00 p.m. ET Operator: Ladies and gentlemen, once again, it is my pleasure to welcome you to today s PNC Real Estate webinar. Before we get started with today, let me quickly point out some of the ways that you ll be able to participate. Today s presentation utilizes a dynamic console that allows you to adjust and resize any of the windows available to you. To do that, you can drag windows around, or you can resize them by clicking on the lower right-hand portion of each of the windows to resize to your preference. We, of course, encourage you to get the most out of today s presentation by asking any and all questions that you may have, and you can easily do that by locating the Q&A window on the right side of your console. Type your questions in there, and then hit the submit button, and we ll be taking as many questions as we have time for at the conclusion of today. If you have any technical issues today, we would also request you submit that technical issue through that Q&A window, and we ll be more than happy to help resolve any problems you might be experiencing. And with that, let s go ahead and begin today s PNC Real Estate webinar. It s my pleasure to turn today s call over to Mr. Marc McAndrew, Executive Vice President of PNC Real Estate and Head of Real Estate Banking. Marc, with that, I ll turn it over to you. Marc McAndrew: Aaron, thank you. Good afternoon, everyone, and welcome to today s webinar on the office and industrial markets, hosted by PNC Real Estate and our market research team. First, I want to thank everybody for joining us today. You ve heard my name is Marc McAndrew, and I run Real Estate Banking here at PNC Real Estate. Before we get started with our presentation today, I do want to highlight PNC s ongoing commitment to providing you with market insights like you re about to hear today. From articles and reports to financial market commentary, webinars, we continue to choose topics and ideas based on input we get from our clients. So, at the end of today s session, please provide the feedback we need to make sure we re focusing on the right information for you and your company. All right, let s get started with the event today. I m excited to have Galen Raza-Self and Jeff Moses from PNC Real Estate s market research team as our presenters today. Today s webinar will focus on the office and industrial markets, including topics such as economic drivers, market conditions and metrics, valuations and current factors affecting space demand. 1

2 As we mentioned at the beginning, we ll facilitate a Q&A session at the end of the presentation. The one thing I will say upfront, the one question that we will not answer is, when will the Fed raise interest rates? Just before everybody asks the same question. So, with that, let me turn it over to the experts, and we ll take it from here. Galen, I ll hand it over to you to begin. Galen Raza-Self: Thanks, Marc. Well, the caption to this cartoon is a bit fuzzy. It wasn t too long ago that this situation existed in the office market. However, as we proceed through the office portion of our presentation, it should become more apparent that the office market has started to shift from a tenant s favor to the landlord s. While overall absorption, which is denoted by the dark orange bars in this chart, has been positive every quarter since mid-2010, it wasn t until about a year later when absorption consistently outpaced new deliveries, which are the dark blue bars. Overall absorption grew strongly in 2014, totaling about 83 million square feet, up nearly 43% from Year to date through second quarter 2015, overall absorption is up 46% to about 36 million square feet, mainly thanks to a strong rebound in second quarter after a seasonally weak first quarter. Although completions have slowed slightly over the past few quarters to about 13 million estimated square feet, they are higher than any point in the past five years. Green or LEED certified office space has represented about 3.5 million square feet of second quarter completions, three in Houston totaling just over 750,000 square feet, including Energy Center Three, which is a half-million-square-foot LEED Gold building that is wholly leased to ConocoPhillips. The office pipeline remains at relatively low levels, nationally, with about 133 million square feet underway, which equates to about 1.3% of the existing inventory. Using this metric, a few metros have a considerable amount of construction underway, such as Houston at about 4.3%, as well as more tech-oriented metros such as Seattle at 5.1%, Silicon Valley at 7.3%, and San Francisco at 3.7%. Across the nation, there are 30 markets with more than a million square feet underway. In total, these 30 markets represent about 118 million square feet of the 133 million that are underway. In addition, the pipeline is relatively well pre-leased, with about 63% of the space spoken for. None of these markets exhibit any significant speculative construction. A handful of them have pre-leasing rates below 50%, such as Austin, Long Island, which is standard about 39%, to Dallas and D.C., which are just a tick under 50% pre-leasing. As indicated in this slide, among leasing blocks of space over 20,000 square feet, a little over 43% were expansions, led by technology firms, which, in turn, accounted for about 32% of the demand for the expansion. Large leases in Silicon Valley included a pair of networking companies, Palo Alto Networks and Aruba Networks, speaking for nearly a million square 2

3 feet at phase two of Midland Equity and Beacon Capital s office campus in Santa Clara, while up the coast in Seattle s South Lake Union sub-market, Amazon took Troy Block North Tower for about 400,000 square feet. And then, down in Austin, Apple signed for a little over 200,000 square feet and Solar Wind signed an expanded lease for about 118,000 square feet. Rounding out the large-block leasing are firms that are in banking, finance and insurance, as well as the healthcare sectors. While the amount of office per employee is continuing to decline, this graph nicely captures the interplay between office job growth and the steadily declining office vacancy rate, which ended second quarter at 11.4%, down about 60 basis points from a year ago, and down roughly 100 basis points from two years ago. Newmark Knight Grubb Frank and DTZ, which is now Cushman & Wakefield, reported that during second quarter, vacancies tightened in over 80% of the office markets that they track. In addition, Jones Lang LaSalle indicated that amenity-rich, low-vacancy, high-cost markets such as New York City or San Francisco are compelling tenants to explore other markets, like Portland, Seattle and Salt Lake City. During second quarter, the nation s 10 largest office markets represented a larger portion of the nearly quarter-million office jobs created at about 29% versus 18% in the first quarter. Now, depending on your political affiliation and your portfolio, your view of Washington, D.C. s office jobs creation may differ, but it is worth noting that D.C. sprang back to life with just under 19,000 office-using jobs during the second quarter, which represents about 90% of its trailing 12-month number. Atlanta and Dallas followed at about 12,000 and 13,000, respectively. Meanwhile, Philadelphia experienced its second consecutive quarter of losses, shedding about 4,500 office-using jobs, and the nation s largest office market, New York City, gained less than 1,000 office jobs, while Northern New Jersey turned positive for the first time in a year with about 6,500 jobs. And despite the continuing turmoil in the energy market, Houston added just over 3,200 jobs during the second quarter. Another factor helping drive down office vacancy rates is the adaptive reuse of older office buildings, as shown in the slide are a sample of recent office conversions that PNC was involved in through the use of historic tax credits. Collectively, these eight properties represent about 2.6 million square feet of office space that was converted into 1,950 apartments, 261 hotel rooms and about a quarter-million square feet of updated office space. They include notable former headquarters structures such as East Ohio Gas in Cleveland, the Texaco building in Houston, Commerce Bank Tower in Kansas City, and Alcoa, right here in Pittsburgh. Nationally, office rents have continued to trend upwards, with growth ranging from a low of 0.7% reported by Reis, to 1.3% as shown by CBRE. As indicated a few slides ago, the declining vacancy rates have enabled landlords to begin raising rates. 3

4 A recent Savills Studley report noted that rent growth lagged in large markets that are more reliant on traditional tenants in markets such as New York City, Boston or L.A., while Reis and others have commented that technology-driven markets like San Francisco, San Jose, Seattle, have been experiencing the largest rent bumps. A recent Jones Lang LaSalle report indicated that tenant improvements are averaging about $31 a square foot, which is up roughly 5% from a year ago and up about 14% from two years ago. Tenant improvements are higher in markets with greater construction activity, particularly CBDs, which average just over $50 a square foot. While certain CBDs, such as Washington, D.C. was in the mid-$70s, Atlanta, New York City, Seattle and Chicago were also well above the $50 average. According to Real Capital Analytics data, office transaction volume grew 2.5% from first quarter to about $33 billion, and is up about 26% from a year ago. One interesting thing that we monitor is the flow of global capital into the U.S., and this has tended to favor the office sector, due in part to the familiarity with the office products, and the ability to invest large amounts of capital in individual assets. Large foreign investors in U.S. office tend to be based in Canada, Hong Kong, Singapore, China or Norway. Both RCA and Pricewaterhouse have indicated that CBD office cap rates continue to compress, albeit at relatively small rates, with current cap rates ranging from about 5.6% to 6.1%. The relatively small changes experienced over the past three quarters is signaling to us that the cycle is close to stabilizing. It probably won t compress much further. Among the 45 U.S. Class A CBD offices illustrated on this map, only a handful of primary coastal gateway markets, such as L.A., Miami and New York City, average sub-5% rates. In the next year, a 5% to 5.9% cap rate. Other primary gateway markets include Boston, D.C., Chicago and San Francisco, who, in turn, were joined by secondary markets such as Seattle, Orange County, Denver, Austin and Atlanta. The majority of the 45 markets represented on this map by the light and dark orange dots may present opportunities to reposition assets or adaptively reuse them. Interestingly, suburban properties constituted the majority of second quarter s transaction volume. This is likely attributable to investors searching for higher yields and more attractive pricing relative to CBD markets. While the range between PWC and RCA is tighter for suburban office at 6.5% to 6.8%, one cannot be indiscriminate when pursuing assets here. Among the 43 U.S. Class A suburban offices represented on this map, all but five Miami, San Diego, Orange County, L.A. and Seattle have average cap rates in excess of 6%. Between these two maps, they help demonstrate the valuation divide between CBD and suburban office assets, and the differences become even more apparent as you go into B and C class assets. As mobile devices, streaming video and cloud computing usage continue to grow, bandwidth has become a serious issue for companies of all sizes. Google wants companies and people to use the web, and is tackling this bandwidth problem by rolling out a national fiber network with more than 10 times the capacity of most Internet providers. 4

5 This map here, assembled by GeoTel, shows the 25 most fiber-connected metros in the nation, and the relative strength of which metros are likely to be expanded into by Google Fiber. Relevant factors include existing fiber network, proximity to a Google data center, population size, local government cooperation and areas not served by Verizon FiOS, which is a considered to be a strong competitor to Google Fiber. In 2012, Google Fiber began experimenting with its network in Kansas City, and expanded to Austin and Provo, Utah, in These three areas are shown by the Google Fiber rabbit here. Subsequently, Google announced plans to roll its network out in nine more metros Atlanta, Charlotte, Raleigh, Nashville, Salt Lake City, San Antonio, Phoenix, Portland and San Jose. Also of note is in August 2015, office REIT Parkway Properties announced that it signed a deal with Google Fiber to bring its services to Parkway tenants in Atlanta, Austin and Charlotte in There s potential to expand this service across the entire portfolio as Google Fiber expands its service area, as well. I d like to take a moment to discuss the shared office concept space, which is essentially leasing space wholesale from landlords, and subletting it at a margin in small blocks. While the shared office space has embraced online reservation tools, it can be divided into two groups. The first one is considered to be a traditional provider of executive suites and such. This has been around for quite a while, and they target corporations, small businesses and older workers in more of a traditional office or desk setup, and access to support service. Major players in the space include Regus, BusinessSuites, Premier Business Centers, and Servcorp. The second group, known as co-working, has begun to capture attention. It is a relatively new concept that targets start-up companies, freelancers and millennials with more of a collaborative community feel that embraces a work-live-play environment. Depending on the provider, users can lease a desk, a conference room or an office, by the hour, the week, the month or longer, directly from their smartphone. Larger providers with a national or regional presence in this space include WeWork, LiquidSpace, 42Floors, UberOffices, PivotDesk and ShareDesk. Of special note in the co-working space is WeWork. They re considered to be a leader among this group, and they lease about 3.5 million square feet of office space, mainly throughout the U.S., and although privately held, earlier this year it was valued at roughly $10 billion, which is larger than all but Boston Properties, which has a current market cap just over $18 billion with a 57-million-square-foot portfolio, and SL Green, which has about an $11 billion market cap, and has about 33 million square feet in its portfolio. So, WeWork has got a higher valuation than roughly the other 20-plus office REITs that are able, you know, to be invested in here. One of the unique things about WeWork is they 5

6 also offer a group health insurance plan, and each location has a community manager that programs events like wine and beer tasting, book clubs, ping-pong tournaments, yoga, workouts, financial or life advisors, and movie or trivia nights. I thought it would be illustrative to close out the office portion of this presentation with some snapshots of past and present office space usage. Over the course of 60-plus years, we have come to revisit the layouts of the past. The far left image shows an open office floor plan in an I. M. Pei designed Gulf Oil office in Atlanta circa 1952, while the middle image shows a ubiquitous 1980s cube farm, and the third image shows some of PNC s new office space here in downtown Pittsburgh. In summary, PNC s outlook for the office space is positively influenced by an increasing number of office-using jobs, a relatively disciplined pipeline, low cap rates, and funding availability. While there is an ongoing risk of rising rates and property taxes, we think these are outweighed by positive market fundamentals. At this point, I ll turn the presentation over to Jeff, who will continue with our discussion in the industrial space. Jeff Moses: Thanks, Galen. You know, it s always interesting to make the transition from the office sector, which is readily visible, recognized, and has some sort of polish to it. Many of us have spent a considerable time in an office setting. What is our experience of being in a warehouse or a distribution center? Probably not much, but this certainly does not detract from industrial space as a property sector. The industrial sector is actually very influential, and important to our everyday lives, particularly as consumers. With that, I d first like to address a few economic variables, starting with GDP. During the second quarter of 2015, real GDP growth increased at an annualized rate of 3.7%, which was the second estimate, an improvement from the first quarter number of 0.6%. The increase in real GDP was primarily reflected in contributions from personal consumption expenditures, or PCE, exports, state and local government spending, residential and nonresidential fixed investments, and private inventory investment, which includes businesses looking to expand factories, buildings and other physical structures. Manufacturing production metrics signal mixed activity for the quarter. The Empire survey, which is the blue line on the chart, indicated that business conditions decreased from the first quarter. The general business conditions index was negative 1.9 at the close of the second quarter, compared to 6.9 for the first quarter. This index has been hovering near zero for the past three months, suggesting that activity has remained flat since April. The future general business index additionally showed some weakness, falling by nearly 5 points from the previous quarter to The Philadelphia Business Outlook, which is the orange line, reflected improved manufacturing conditions, with positive indicators for general activity, new orders and shipments. 6

7 The diffusion index of current activity jumped this quarter to 15.2 from a previous reading of 5 during the first quarter, which is the highest level for the index since September of The Institute of Supply Management Purchase Managers Index, which is the green line, was 53.5 in June, a 200-basis-point increase from March. Of the 18 manufacturing industries, 11 reported growth in June, which was up from 10 in March. These industries include furniture and related products, wood products, nonmetallic mineral products, miscellaneous manufacturing, food and beverage products, electrical equipment and components, transportation equipment, fabricated metal products, chemical products, computer and electronic products, and paper products. U.S. trade the average goods and services deficit decreased $2.2 billion to $41.8 billion for the second quarter. Average exports increased $0.2 billion to $189.1 billion, and imports decreased $2.1 billion to $230 billion. The decline in world trade reflects a combination of weaker-than-expected global economic growth in emerging markets and the U.S. Air freight slipped by 2.7% annually through May, compared to growth of 1.9% last quarter. As reported by the International Air Transport Association, or IATA, air freight volumes globally were up just 1.2% in June, compared to a year ago. Growth for the first six months of 2015 slowed to 3.5%, confirming the decreased volume, which is consistent with declines in trade activity. As discussed previously, overall positive readings in key economic drivers have led to continued improvement in the industrial market. I d now like to focus on the real estate fundamentals of the industry sector, beginning with demand. Quarterly industrial space demand, which includes warehouse and flex properties, rebounded in the second quarter of 2015 to total 57.6 million square feet, an increase of 16.3 million square feet sequentially. Flex space demand grew by 3.8 million square feet from the previous quarter, while warehouse space warehouse demand rose by 12.5 million square feet. Deliveries are up by 73.2% in the flex sector, and up by 22.2% for warehouse space. During the first half of the year, the nation s 10 largest industrial markets totaled a net absorption of 57.6 million square feet, which is up from 20.8 million square feet in the first quarter. These markets accounted for approximately 43.1% of the national total, up 110 basis points from the previous quarter. Large distribution markets that performed well include Chicago, Dallas Fort Worth, Houston and the Inland Empire. Metros that declined in performance from the last quarter include Los Angeles, Northern New Jersey, Atlanta and the San Francisco Bay Area. Vacancy rates the national industrial vacancy rate continues to improve, ending the quarter at 6.8%, a decrease of 20 basis points sequentially, and 90 basis points annually. The national rate is now 360 basis points below this cycle s 10.4% peak, which was in the third quarter of

8 Forecasts from REITs indicate an average vacancy of 7.8% over the next four years, with CBRE figures averaging 9.6%. Warehouse vacancy, which is the blue line in the chart, is currently at 6.5%, a decrease of 10 basis points from the previous quarter, and down 80 basis points from the prior year. Flex space, which is the orange line, decreased 30 basis points sequentially and 120 basis points annually to 9.8%. The number of markets with lower vacancy on a year-over-year basis increased from last quarter. Of the 142 industrial markets that we monitor, 116 have lower vacancy rates than a year ago, compared to 106 for the first quarter. Markets with vacancy increases include Dallas Fort Worth, Minneapolis, Indianapolis and Kansas City. Small markets with less than 100 million square feet of inventory accounted for 65 of the 116 markets with lower vacancy rates, which increased by nine from the last quarter. Middle markets with greater than 100 million square feet of inventory reported 41 markets with lower vacancy, an increase of one from the first quarter. The nation s 10 largest industrial markets had an average vacancy rate 30 basis points below the national rate, an increase of 10 basis points from the prior quarter. Nearly all the major markets had lower vacancies from a year ago, with the exception of Dallas Fort Worth, which rose by 10 basis points. Rental rates the average industrial rent rose during the second quarter. However, it still remains 3.5% below the prior peak. Sequentially, it grew by 1.5% or $0.09 per square foot, and annually by 4.1% or $0.24 per square foot, to $6.11 per square foot. CBRE indicated that national industrial rent growth is forecasted to average annual growth of 1.3% through 2019, while REITs expect an annual rate of 3.7%. From the prior quarter, flex-based rent increased $12.02 per square foot, with rent growth of 1.5%, which is up 1.3% the previous quarter from the previous quarter. Warehouse space rent growth increased 20 basis points to 1.5%, ending the quarter at $5.25 per square foot, compared to $5.18 per square foot from the first quarter. Nine of the 10 nation s largest industrial markets posted positive annual rent growth. The San Francisco Bay Area had the largest increase, 12.5%, which is well above the national average of 3.3%. Cushman & Wakefield reported that as vacancies continued to tighten, the direct average asking rate in the Silicon Valley increased 20.3% over the last 12 months to close the second quarter at $1.54 per square foot per month. High-tech space, which posted $1.72 per square foot per month average asking rent, fueled much of this increase, jumping 22% on its own. Supply during the second, construction activity moved upward by 17.3 million square feet to million square feet. As a percentage of inventory, it is still minimal at 0.8%, an increase of 10 basis points from the previous quarter. 8

9 The number of markets with more than 1 million square feet of construction activity increased by 2 to 42. Additions to the list include Tulsa, Cleveland, San Antonio, San Diego, West Michigan and Boston, while St. Louis, Detroit, Greensboro Winston Salem and Des Moines fell below the threshold. CBRE forecasts completions on a national level averaging 41.3 million square feet, while REITs figures average 75.1 million square feet. Pre-leasing increased by 230 basis to 47.9%. The nation s major industrial markets accounted for approximately 52.4% of the pipeline. The metros with the highest concentration of new construction include the Inland Empire, Atlanta, Dallas Fort Worth, Houston and Philadelphia. For the second quarter, CoStar data indicates that the deliveries totaled 38.8 million square feet, which is up 7.3 million square feet from the previous quarter. Construction starts for the second quarter totaled 40.7 million square feet, up 16.2 million square feet from last quarter, and up 2.1 million square feet from a year ago. Cap rates cap rates for flex and warehouse sectors have posted quarterly and annual improvement per PricewaterhouseCoopers, and Real Capital Analytics. Cap rates declined across both sectors, indicating that investors still see plenty of value in the industrial sector. Buyers remain focused on the warehouse sector, as evidenced by the large transaction volume this quarter. Investors remain interested in warehouse products near ports, Los Angeles in particular, but are also interested in acquiring assets from secondary cities, such as Charlotte and San Antonio, as pricing and competition is softer, per PricewaterhouseCoopers real estate investor survey. Demand for flex and R&D product remains strong in major in-fill locations, given the supply constraint and healthy rent growth potential. Institutional quality sales volumes, according to Real Capital Analyst data, decreased from the first quarter s 19.2 billion or $77 per square foot to $14.8 billion or $79 per square foot. During the quarter, warehouse properties accounted for a majority of the volume, 79%, or up 54.6% from a year ago. Flex property sales totaled $3.2 billion, up 8.1% from the prior year. Los Angeles was the top market for industrial investment activity, with sales volume up $2.9 billion. It has held its position every year since 2009, according to Real Capital Analytics. Looking at the map on slide 30, the lowest cap rates of Class A supply are found in the coastal markets of Seattle, the San Francisco Bay Area, Southern California, and Northern New Jersey. The highest cap rates are concentrated in the Great Lakes, Ohio Valley Metros of Detroit, Cleveland and Pittsburgh, in addition to Southwest Central markets such as Albuquerque, El Paso and Oklahoma City. Next, I d like to transition to some current events affecting the industrial sector, specifically revolving around port activity. The Wall Street Journal reported that with the scale of global trade getting bigger, an issue facing many small and mid-sized U.S. ports is obsolescence. 9

10 Port operators, ranging from New York/New Jersey to Long Beach, California, have invested billions of dollars to dredge harbors, raise bridges, and build larger terminals in order to accommodate what they now call mega-ships. Shipping lines have been using vessels that carry twice as much capacity as they did 10 years ago in an effort to operate ships at top efficiency. More outdated ports could face the reality of being ignored by deep sea vessels used on major East West trade routes. Labor disputes are another issue facing ports, especially in the wake of the West Coast dock workers labor dispute earlier this year. The West Coast ports handle goods that account for 12.5% of the U.S. economy. A disruption in flow certainly hurts retailers, manufacturers and agricultural exporters. Think about it if you re a member of one of these three groups, how would you feel knowing that your products could not reliably get to market. This is especially true for major retailers during the peak time of demand during the holiday season. With increases in technology, ports have been considering automation to help alleviate this. I recently had the opportunity to tour the Port of Los Angeles/Long Beach, and it s amazing to see what technology has been put into place. Nearly all aspects of the process, from unloading the ships to moving cargo containers around the dock area, feature at least some form of automation. If you re a port operator, you have to ask yourself how much can machines more reliably do the job without the added cost of higher wages and more benefits. This could certainly add to the challenge, going forward, of labor and port management relations. This chart shows typical times for cargo originating from Asia. As you can see, the shortest shipping route to the U.S. takes 12 days via a West Coast port, while routes via the Panama Canal and the Suez Canal take 25 and 32 days, respectively. However, with congestion on the West Coast, East Coast ports could represent potentially a new winner. While these routes are longer, it allows shippers to have increased reliability and efficiency, especially with the Panama Canal expansion, which leads me to the next slide. A question I often get asked is what exactly is the Panama Canal expansion? The Panama Canal expansion, per the Panama Canal website, is the largest construction project at the canal since its original construction, at a total cost of $5.25 billion. The project will create a new lane of traffic along the canal with the construction of a new set of locks, doubling the waterway s capacity. Specifically, several components will include new locks, what they call the third set of locks, which is the construction of two lock complexes creating a third lane of traffic, the Pacific access channel, which is the excavation of a 3.8-mile-long channel with a new Pacific lock, dredging of the navigational channels along the waterway, and improvements to the water supply. What is the expected outcome? The existing locks allow the passage of vessels that carry up to 5,000 CEUs, which is a 20-foot equivalent unit, a measurement unit for cargo containers, which is the top ship in this chart here in the chart on this slide. After expansion, the capacity will be increased to up to 13,000 CEUs, which is in the picture on the bottom of the slide. 10

11 Beneficiaries of the expansion will be ports that have been diligent in making sure that they will be able to accommodate the new mega-ships that will that will, come through the canal. Additionally, inter-modal shippers could rely more heavily upon shipping goods via canal rather than over land. Finally, I d like to take a moment to point out the research reports available on the real estate market research section of the PNC Real Estate Banking website. Here you ll find in-depth reports that cover what we have spoken about today, in addition to other commercial real estate property types. I would encourage you to check it out, and please feel free to contact us if you would like to be added to the distribution for our quarterly reports on all the major sectors. Now, we will move into the Q&A portion of the webinar. Vicente La Camera: Thanks, Jeff. My name is Vicente La Camera, Senior Vice President of Marketing for Corporate & Institutional Banking at PNC. I will be moderating the Q&A portion of today s presentation. We would now like to open up the session for questions. As a reminder, you can ask questions using the Q&A window located on your screen. If you do not see the Q&A window, simply click on the questions widget found in the lower-center portion of your screen. Let s take a look at our first question. I ll ask Marc to respond to this one. What does the construction loan market look like for spec office developments in gateway cities? Marc McAndrew: Thanks, Vicente, and thanks for giving me the easy question that came in. So, this is a question that we get all the time, and I think, you know, there s two questions. What does the spec office market look like in those gateway cities, and there are certainly people talking a lot about spec office, and spec is in the eye of the beholder, Vicente, so, you know, whether it s zero percent pre-leased or not, but let s assume that s what the question was geared towards. I do think that what we re seeing, at least so far, is that the loan market is going to require a lot of equity, upwards of 50% equity, and very large institutional sponsored to even consider speculative office development of any size. And in those gateway markets, those tend to be rather large buildings needing groups of banks to get together to do that. I do think the shadow banking market, or non-bank market, is also looking at some of that. But clearly where we are with absorption and supply and demand, there is plenty of talk in the gateway cities of some speculative office building. I would say banks are generally cautious and sponsor-dependent. Vicente La Camera: Thanks, Marc. Here s the next one, and I m going to give this one to Galen. Galen, is creative office the new norm? Galen Raza-Self: No, but it is a growing trend that will continue to attract technology, advertising, media, Internet or TAMI tenants, as well as more traditional ones. 11

12 It s important to remember that while employers are increasing the number of employees per square foot, and capturing unique spaces, these spaces are only part of the employee retention equation. Employee densification without incorporating other attributes such as private or quiet spaces for heads-down focused work, as well as, you know, recreational amenities, advancement opportunities, compensation, work life balance, will fail to lower employee turnover among millennials and may increase it among older generations of workers. Vicente La Camera: Okay. The next one is for Jeff. What are the drivers for industrial demand going forward? Jeff Moses: Really, the biggest driver, you know, what I ve been saying, is e-commerce, also known as online retailing, you know, buying your stuff online. Typically, you know, if you have a computer and, like, do some shopping, an easy place to do it is going online, like Amazon.com, ebay, anywhere you can order from a computer, have it on your doorstep, that s really the big thing and what consumers are looking for rather than getting in your car and driving to the mall, dealing with lines, finding parking. It s just as easy, many times, just to go online. You can find the selection you want, and it can be shipped to you very fast. And, really, as part of e-commerce, there is going to be a need for greater speed in delivering those products, you know, to the doorstep of the consumer, and also on more of the supply side, the more technologically advanced warehouse and distribution properties that will be multitiered in terms of logistics, getting products around the actual warehouse site. In addition to higher ceiling heights, approaching 40 feet, they can handle all this, you know, supply within the warehouse, in addition to just being more technologically advanced in the end. Vicente La Camera: Okay, thank you. Next one is an office market question, so, Galen, in terms of the office market, what physical factors should be kept in mind with employee densification? Galen Raza-Self: You know, I mentioned some of the factors in response to the other question here, but, you know, some of the more basic physical factors that should kept in mind, among landlords and tenants are, you know, the number of toilets or sinks that are needed on each floor, the availability of parking or mass transit. Does the building have sufficient fresh air intake to handle, you know, increased number of employees, and if it doesn t, can you add it or upgrade the existing? You know, in terms of life safety, egress, you know, can the fire staircases accommodate, you know, the increased number of employees in the building? Those are, you know, some of the ones that more readily come to mind. Vicente La Camera: Okay. I have another one for you, Galen. Are core assets still a relatively safe risk, or are they vulnerable to over-pricing? 12

13 Galen Raza-Self: Yes, core assets remain a relatively safe risk. However, in some markets, you know, pricing has outpaced, you know, the market there, and it can be easy, if you re not careful to get caught up in the chase to acquire something, and, you know, it may be more lucrative to look for assets that, you know, can be repositioned or outside the primary markets, like [inaudible] going forward. Vicente La Camera: Okay. The next one is for Jeff. Can you provide some insight on the single-tenant industrial product? Jeff Moses: Sure. Really, my observation has been on build-to-suit projects, and the thing that comes to mind, the first being Amazon distribution centers. Really, a prime focus of Amazon is having a good logistics network of getting products to consumers. And typically, you re seeing them build their distribution centers in major strategic locations, the first being the Inland Empire, just being so close to the metro area of Los Angeles, many of the California cities, also Phoenix, Las Vegas. And, additionally, they ve had some...a hotbed of activity in New Jersey, where recently they signed a lease for 1.1 million square feet in Northern New Jersey, and this actually marks the second 1-million-square-foot building for Amazon within the state. Additionally, delivery companies have been getting part of the mix, too, particularly FedEx ground, and as, you know, more orders are placed online, there s going to be a greater emphasis on reliable, faster and more efficient shipping of goods to consumers. Vicente La Camera: Okay. Let s go to the next one, Jeff, also this one for you. What can you tell us about regional factors around the Columbus, Ohio, industrials market? Jeff Moses: Sure. Columbus is actually really an up-and-comer, and, you know, located very close to Pittsburgh, just a three-hour car drive away. There is a regional and geographic advantage that Columbus does have. It s located at the intersection of eight major highways, and several national rail lines, which are used for intermodal shipping. Metros within a 200-mile radius, you know, include, like I said, Pittsburgh, Cleveland, Detroit and Indianapolis. You know, based on the topography and the availability of land around Columbus, there certainly is the ability to continue to build. You know, it s a very flat lay of the land, so you can...there are no geographic restrictions. And it s also important to mention that, you know, just south in the metro is the Rickenbacker International Airport, which is one of the largest integrated logistics complexes in the U.S., and there are cargo carriers here, which include FedEx, UPS, rail providers such as Norfolk Southern and CSX, in addition to several trucking operations, too. Vicente La Camera: Okay. We have another one for office. How do 2015 office construction volumes compare to the pre-recession peaks? Galen, this is yours. 13

14 Galen Raza-Self: Sure. You know, the office construction pipeline is still at an historically low level. I believe I mentioned in the presentation, it s about 1.3% of existing inventory, which is, you know, certainly lower than the pre-recession peaks, and, you know, it s slowly growing, but it s probably going to take a quite a while for it to re-approach those levels. Vicente La Camera: Okay. Well, I think we are running just about out of time. So but we d like to thank Galen and Jeff for a great presentation today. You both provided really great insight and perspective. We would especially like to thank you, all of you, for attending. If we haven t had the chance to...the opportunity to respond to all the questions today, I m going to have the presenters respond directly to you for the ones that went unanswered. A PDF of today s presentation, as well as a CTP recertification credit, is now available for you to download from the green resource list file folder widget in the lower-center portion of your screen. You will also see a link to a short survey on your screen. Again, your feedback is important to us, and we greatly appreciate your thoughts on today s session and presenters. This concludes our presentation today. Thank you for joining us. The presentation you viewed was prepared for general information purposes only by PNC Real Estate and is not intended as legal, tax or accounting advice or as recommendations to engage in any specific transactions, including with respect to any securities of PNC, and does not purport to be comprehensive. The information contained herein is gathered from sources believed by PNC to be accurate and reliable at time of publication, but neither PNC nor any of its affiliates is providing any guaranty or warranty as to the accuracy, completeness or reliability of that information or of the conclusions presented in this presentation. In addition, markets do change. Under no circumstances should any information contained in the presentation, the webinar, or the materials presented be used or considered as an offer or commitment, or a solicitation of an offer or commitment to participate in any particular transaction or strategy. Any reliance upon any such information is solely and exclusively at your own risk. Please consult your own counsel, accountant or other advisor regarding your specific situation. Any opinions expressed in these materials or videos are subject to change without notice. PNC is a registered service mark of The PNC Financial Services Group, Inc. ( PNC ) The PNC Financial Services Group, Inc. All rights reserved. CIB RE REB PDF