RENT GROWTH FADES: DEMAND REMAINS STRONG DESPITE RISING CONSTRUCTION; RENTS FLATTENING

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1 MULTIFAMILY MARKET REPORT: 4Q2013 RENT GROWTH FADES: DEMAND REMAINS STRONG DESPITE RISING CONSTRUCTION; RENTS FLATTENING EMPLOYMENT: Job growth was disappointing over the last two months, but is expected to improve in 2014 as many drags on the recovery diminish. The unemployment rate moved down to 6.6 percent in January as both jobs and the labor force expanded. VACANCY: Because completions rose in the second half of 2013, vacancy climbed 20 bps to 4.8 percent in 4Q2013. Given even more construction set to deliver in 2014, we project apartment vacancy to rise as high as 5.5 percent by the end of Prepared by: SUPPLY: Completions in 2014 will surge, causing rents to flatten and vacancy to rise in markets with insufficient demand. However, we do not see oversupply to be a concern on a national basis. Existing apartment inventory nationally remains constrained, with monthly completions still well below the 20-year average. As we had expected, 2013 witnessed rising levels of construction, but 2014 is set to experience even more deliveries. This increased construction will be a return to more normal levels, at least on a national basis. We continue to track markets and submarkets with the highest construction levels and inventory growth rates. DEMAND: Despite rising levels of new supply, newly completed properties continue to lease well. While concessions ticked up in 4Q2013, market rate apartment demand remained strong. We expect that net absorption will remain positive but fall behind completions in This positive, lower expectation is driven by healthy renter formation levels, but tempered by growing competition with both newly delivered rental apartments, as well as the for-sale housing market. Aimée LaMontagne Baumiller Real Estate Market Research PNC Real Estate 249 Fifth Avenue Pittsburgh, PA Aimee.Baumiller@pnc.com RENT GROWTH: Rent growth continues to fade, with some markets beginning to experience slight declines. On an annual basis, effective rent growth for market rate apartments ranged from 2.3 to 3.2 percent. On a quarterly basis, rent growth ranged from -0.9 to 0.8 percent in the fourth quarter. We expect effective rents to grow at a more moderate annual pace of 2.0 to 3.0 percent in CAP RATES: Apartment cap rates fell by four basis points in the fourth quarter, to average 5.74 percent. Many investors continue to move to secondary and tertiary markets in search of higher yields. Given rising interest rates and historically low cap rates, investors are placing greater importance on leasing fundamentals as a key driver of apartment prices, and will likely avoid markets where rent growth and occupancy levels could be impacted by a growing construction pipeline. PNC is a registered service mark of The PNC Financial Services Group, Inc. This document is for general informational purposes only and is not intended as specific advice or recommendations. The information contained herein is gathered from public 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 document. In addition, markets do change. Opinions expressed herein are subject to change without notice. The information set forth herein does not constitute legal, tax or accounting advice. You should obtain such advice from your own counsel or accountant. Any reliance upon the information provided herein is solely and exclusively at your own risk The PNC Financial Services Group, Inc. All rights reserved.

2 RENT GROWTH FADES 2 ECONOMY The January employment report was weaker than expected, with 113,000 jobs added (142,000 added in the private sector, 29,000 lost in the public sector). Employment for all of 2013 was revised upward to more than 2.3 million jobs for the year. As a result, the economy stands at having recovered 90 percent of all the positions lost during the recession. Sectors exceeding prerecession numbers include natural resources/mining (due to the booming oil and gas industries) as well as education/health services and leisure/hospitality. The unemployment rate shrunk in January to 6.6 percent due to both jobs and the labor force rising. PNC s economists believe that job growth will grow by a modest annual rate of 1.7 percent for 2014, with an average monthly job growth of 200,000 throughout the year. They expect the unemployment rate to continue declining, ending 2014 at 6.2 percent. While several factors have dragged on the recovery, they are largely ending, so economic growth should be stronger in 2014 than in Despite higher mortgage rates, continued job/income gains and pent up demand should propel the housing market forward, driving economic and job growth over the next year, especially with high housing affordability. Both the recovering single family housing market and the healthy apartment market are contributing construction jobs to the economy as projects break ground. In turn, job growth and household growth should contribute to increased rental and for-sale demand. The chart above illustrates the overall unemployment rate compared to groups that tend to lease investment grade apartments the most: households aged 25 to 34 (more transient) and those with a Bachelor s degree (more able to afford the higher market rate rents). While the younger group s unemployment rate closely tracks the national average, this prime renter cohort accounted for the majority of new positions over Additionally, the January 2014 rate (6.8 percent) is well below unemployment rates of 10 percent and higher seen in much of 2009 and the first half of Households with Bachelor s degrees or higher tend to have unemployment rates about half the overall rate (3.2 percent compared to 6.6 percent).

3 RENT GROWTH FADES 3 APARTMENT MARKET TRENDS Vacancy Vacancy remained mostly flat in the fourth quarter, at rates that are the lowest they have been in a decade. The subset of market rate apartment properties with 40 or more units (as reported by Reis) has an average vacancy of 4.1 percent, well below the ten-year national average (6.4 percent). Looking at the larger picture, the Census vacancy rate for all rental apartments with five or more units dropped to 8.8 percent for 4Q2013, a 40 basis point improvement over last quarter and below its ten-year average of 10.8 percent. Market rate apartments vacancy averaged 4.8 percent in 4Q2013, moving higher by 20 basis points from last quarter. This is largely a seasonal weakness, with 4Q generally being light in leasing activity. The trend of tightening vacancy rates over the last few years has been a result of constrained supply and a declining homeownership rate. However, both of these conditions could reverse to some extent over the next few years, as construction ramps up and the for-sale market strengthens, attracting some buyers from the renter pool. On the positive side, the impact of these two trends could be tempered by increasing condo conversions (which remove units from the rental apartment inventory), as well as rising interest rates (which could deter renters from buying homes). Additionally, the apartment market should continue to benefit from demographic trends that should help keep vacancy close to 5.0 percent over the long term. Third party analysts project continued strength through 2014, with vacancy in the 4.2 to 5.6 percent range. APARTMENT VACANCY RATES- 4Q2013 (bp change from year ago) Top Markets Vacancy Bottom Markets Vacancy Miami 2.9% (-10) Tucson 9.2% (-40) Oakland 2.9% (-10) Indianapolis 8.7% (+20) Minneapolis 3.0% (-10) Memphis 8.2% (-70) Newark 3.0% (-30) Birmingham 8.0% (+140) Edison 3.1% (+10) Tulsa 7.9% (+80) Portland 3.3% (-50) St. Louis 7.4% (+20) San Jose 3.4% (-30) Las Vegas 7.4% (-130) Providence 3.5% (+20) El Paso 7.3% (+100) Pittsburgh 3.5% (+80) Greensboro 7.2% (-50) San Francisco 3.6% (-60) Albuquerque 7.1% (+50) Source: CBRE-EA; PNC Real Estate Market Research Our vacancy/absorption analysis is presented on page 6. We expect vacancy on a national basis to rise to 5.5 percent by the end of 2014 as a surge in apartment deliveries enter the market. We see vacancy rising slightly higher in 2015 to 5.6 percent.

4 RENT GROWTH FADES 4 Supply On a national basis, multifamily completions are rising, but existing inventory is still very constrained. Overbuilding concerns are limited to a handful of markets experiencing more supply than demand. Completions in January 2014 (220,000 units) were 52.8 percent higher than they were one year ago, yet they remain below the 20-year average of 238,220 units. Based on the adjacent chart, it appears that the rising permits and starts should soon translate into higher levels of completions. In January 2014, permits and starts were up by percent and percent from their March 2010 troughs. As we had expected, 2013 welcomed increased construction back to normal levels. Construction is on track to rise further in 2014 before moderating in As noted in last quarter s report, the slowdown in completions during 2015 could coincide with strong job growth, resulting in increased demand to absorb excess supply from Note that the multifamily data in the chart above includes more than conventional market rate apartment properties, encompassing student, senior, and affordable housing, as well as for-sale condominium units. Hence, while permits and starts are close to the 300,000 level, this will not translate into as high of a number of conventional rental apartment properties. While the majority of multifamily completions currently are rental, during the housing boom ( ), rental apartments share of multifamily starts was less than half of all new projects. As the housing market recovers currently, we expect the share of rental apartments to decline and condo share to increase, softening the impact of overbuilding concerns. We continue to track markets and submarkets with the highest construction levels and inventory growth rates. As highlighted in our previous Markets with the Largest Expansion of Existing Supply, as of 12/2013 quarters reports, new Vac. BP Expansion Job Growth Y/Y Existing Vacancy Change, Units Under to Existing Units construction is picking up Market Inventory Rate Last 12 Mo. Construction Supply Planned 4Q12a 4Q13a 4Q14f to more normal levels, reaching high levels in some submarkets, particularly those that were the first to recover and/or have low barriers to entry. While we do not expect to see overbuilding on a national basis, new apartment supply concentrated in a few submarkets could warrant concern over the next few years. The accompanying tables list the top 25 construction markets and submarkets by degree of supply expansion. 1 Austin 187, % , % 11, % 2.8% 3.6% 2 Raleigh/Durham 132, % 20 9, % 8, % 2.4% 3.9% 3 Washington, DC 549, % 40 35, % 66, % 0.8% 1.3% 4 Salt Lake City 87, % 60 5, % 3, % 1.5% 2.2% 5 Nashville 110, % -80 6, % 5, % 2.3% 2.9% 6 Charlotte 133, % 0 6, % 13, % 2.6% 2.1% 7 Denver 276, % , % 14, % 2.4% 1.2% 8 Dallas 478, % , % 8, % 0.7% 2.5% 9 San Antonio 149, % 20 5, % 6, % 0.7% 1.6% 10 Seattle 370, % , % 28, % 2.6% 2.6% 11 Fort Lauderdale 170, % , % 11, % 2.4% 2.4% 12 Miami 295, % -10 9, % 26, % 2.4% 2.6% 13 West Palm Beach 98, % , % 10, % 2.4% 1.4% 14 Kansas City 137, % -30 4, % 6, % 0.7% 1.6% 15 Boston 448, % 10 13, % 32, % 1.8% 1.5% 16 Orlando 192, % -40 5, % 6, % 3.0% 1.5% 17 Greensboro 76, % -50 2, % 2, % 1.6% 1.9% 18 Phoenix 330, % -70 9, % 21, % 2.5% 1.5% 19 Indianapolis 138, % 20 3, % 4, % 1.3% 2.1% 20 Richmond 73, % -50 2, % 2, % 1.5% 1.4% 21 Baltimore 195, % 20 5, % 14, % 1.4% 1.6% 22 San Francisco 243, % -60 6, % 16, % 1.4% 1.4% 23 Minneapolis 267, % -10 7, % 10, % 2.0% 1.4% 24 Honolulu 87, % 20 2, % 17, % 0.8% 1.7% 25 Louisville 75, % 150 1, % 3, % 1.7% 1.5% Source: CBRE-EA; Moody's Analytics; PNC Real Estate Market Research

5 RENT GROWTH FADES 5 Washington, DC, Raleigh/Durham, and Austin account for 11 of the top 25 submarkets, as shown in the table below. Washington, DC is a market to watch, given rising vacancy and slowing job growth. Note on page 8, this market is beginning to experience rent declines. Raleigh/Durham and Austin are faring better in the face of large amounts of construction activity. Both markets have healthy job and household growth, which help to absorb the supply and keep vacancy rates low. Market Submarkets with the Largest Expansion of Existing Supply, as of 12/2013 Submarket Existing Inventory Vacancy Rate Vac. BP Change, Last 12 Mo. Units Under Construction Expansion to Existing Supply Units Planned Job Growth Y/Y 4Q12a 4Q13a 1 Austin Cedar Park 4, % 20 1, % 1, % 2.8% 2.9% 2 Washington, DC Loudoun County 12, % 160 3, % % 0.8% 3.9% 3 Denver Broomfield 7, % , % 2, % 2.4% 1.9% 4 Houston Spring/Tomball 5, % , % 1, % 3.0% 2.1% 5 Dallas Frisco / Prosper 6, % , % % 2.2% 1.3% 6 Washington, DC Navy Yard/Capitol South 9, % 210 2, % 5, % 0.8% 2.5% 7 Charlotte Uptown/South End 11, % , % 3, % 2.6% 2.6% 8 San Antonio Far North Central San Antonio 5, % 0 1, % 0 2.7% 0.7% 3.6% 9 Austin South Austin 12, % , % 1, % 2.8% 3.9% 10 Nashville Franklin/Williamson County 5, % , % % 2.3% 1.3% 11 Washington, DC Woodbridge/Dale City 12, % 80 2, % % 0.8% 1.2% 12 Orlando Downtown/North Central Orlando 8, % -20 1, % % 3.0% 1.4% 13 Washington, DC Frederick 9, % 150 1, % 2, % 0.8% 2.9% 14 Denver Tech Center 9, % 0 1, % % 2.4% 1.3% 15 Austin Downtown/University 18, % 20 2, % 4, % 2.8% 2.5% 16 Indianapolis Downtown 8, % 110 1, % % 1.3% 2.1% 17 Dallas Intown Dallas 25, % 60 3, % 2, % 2.2% 3.9% 18 Raleigh/Durham Northeast Raleigh 7, % -50 1, % % 2.4% 3.6% 19 Raleigh/Durham East Durham 5, % % 0 2.7% 2.4% 2.5% 20 Phoenix South Scottsdale 16, % 140 2, % 2, % 2.5% 2.0% 21 Raleigh/Durham North Cary/Morrisville 10, % 30 1, % 1, % 2.4% 3.6% 22 Dallas Richardson 12, % -80 1, % 0 3.6% 2.2% 2.0% 23 Salt Lake City West Valley City/Airport Area 9, % 100 1, % % 1.5% 2.9% 24 Nashville Central Nashville 12, % , % 2, % 2.3% 2.1% 25 Raleigh/Durham North Central Raleigh 10, % -10 1, % 1, % 2.4% 3.6% *Job Growth reported is at the metro level. Source: CBRE-EA (as of 12/2013); Moody's Analytics; PNC Real Estate Market Research 4Q14f As we had expected, this construction has acted to flatten rents in many markets. However, many markets still have a shortage of inventory, with opportunities for apartment development in areas with strong population and job growth. Completions picked up in 2013 and will expand further in As discussed above, rising levels of permits and starts are evident of upcoming completions in the overall multifamily market. Following these overall trends, we expect 2014 will experience a total of 265,000 completions.

6 RENT GROWTH FADES 6 Demand Depending on the data source, net absorption in 4Q2013 either remained strong, at 50,627 units (Reis), or was seasonably weak at 13,212 units (CBRE-EA). Reis absorption number (investment grade complexes with 40+ units) is still ahead of completions, but its lead continues to narrow, as illustrated in the adjacent chart. CBRE-EA s absorption number (all multifamily, 5+ units), fell below their recorded completions (60,793 units) for the second time this year. Household growth is driving the absorption numbers, especially among single person households. This can be seen as a longer-term trend in the declining homeownership rate (which has moved from 67.9 percent to 65.3 percent over the last five years). The adjacent chart shows renter households growth over time. We are currently experiencing an above average growth rate in renter households, at 2.6 percent annually. While not all renters rent traditional apartments, this overall trend will help support the apartment market. This trend could be an indicator of a potential shift in consumer preference in favor of renting. While we do expect pent-up-demand for the single family housing market as it continues to recover, we do believe that the rental apartment market has strong demographic trends that will support demand over the long term. Our absorption and vacancy projections are detailed in the adjacent table. Based on our expectations for employment growth, demand, and new supply, we expect 155,000 units of net absorption for 2014, falling short of new supply (265,000 units). In 2015, we estimate slightly more demand and less supply, at 200,000 units of net absorption and 215,000 completions. Vacancy is expected to rise to 5.5 percent by the end of 2014, then to 5.6 percent in 2015.

7 RENT GROWTH FADES 7 Concessions Another indicator of the multifamily segment s firm recovery is concession data. As shown in the accompanying graph, concession levels have been on the decline since peaking at 7.3 percent in 4Q2009. Last quarter, concessions reached a record low of 1.2 percent; however, in 4Q2013, concessions grew slightly to 1.4 percent. Perhaps the modest decline in occupancy as tracked by Axiometrics impacted the need for landlords to offer concessions. Concession participation, a metric represented by the percentage of apartment owners offering concessions (second graph, adjacent), increased in 4Q2013 to 20.1 percent. While this metric had been declining since the beginning of the apartment recovery, this quarter s rise could be a blip or a response to some weakening in the ability of landlords to hold rents firm. The next few quarters will indicate whether this is a reversal of the trend. This upward movement in concessions came as no surprise to us, given the amount of new supply entering the market. As we had expected, both metrics (amounts and participation) moved upward. Looking ahead, we expect concessions to continue rising in 2014 as new product is delivered to the market. More competition will impact landlords ability to raise rents. Offering more concessions will translate into flattening rents.

8 RENT GROWTH FADES 8 Rent Growth Multifamily rent growth continues to slow down from its torrid pace recorded early in the recovery. Quarterly changes have become more or less flat, with one source reporting slight declines, as summarized in the adjacent table. While slowing, annual effective rent growth is still healthy, ranging from 2.3 to 3.2 percent. APARTMENT RENT GROWTH: 4Q2013 Annual Percent Change Quarterly Percent Change Source Asking Rent Effective Rent Asking Rent Effective Rent Reis 3.1% 3.2% 0.8% 0.8% CBRE-EA n/a 2.3% n/a 0.5% Axiometrics 2.1% 2.8% -0.7% -0.9% Average: 2.6% 2.8% 0.1% 0.1% The new supply additions have been the main reason for easing rent growth, as more competition impacts landlords ability to raise rents. Additionally, incomes aren t growing fast enough to keep pace with rent growth. In previous reports, we had warned of the increasing price sensitivity of renters, which would put pressure on rent growth. In contrast to the high-quality Class A assets, which likely have already reached peak rents, middle-market, Class B and C properties have more room for rent growth, as residents living in this stock generally cannot afford to rent the brand new Class A properties or purchase a home. Reis, CBRE-EA, and Axiometrics expect annual rent growth to range from 2.3 to 3.3 percent through Our outlook includes completions surging in 2014, then easing in With expected stronger job growth balancing our concerns about new supply and price sensitivity, we see rent growth continuing to slow in 2014, with annual rates between 2.0 and 3.0 percent. APARTMENT EFFECTIVE RENT GROWTH RATES- 4Q2013 Leading Markets Rate Lagging Markets Rate Denver 1.7% El Paso -0.2% San Jose 1.7% Washington, DC -0.1% Oakland 1.6% Albuquerque 0.0% Portland 1.5% Jacksonville 0.0% San Francisco 1.5% Hartford 0.0% Seattle 1.4% Philadelphia 0.0% Miami 1.3% Norfolk 0.1% Austin 1.2% New York 0.2% West Palm Beach 1.2% Louisville 0.2% Atlanta 1.1% Pittsburgh 0.2% Note: Rent growth rates reflect quarter-over-quarter change in same store effective rents. Source: CBRE-EA; PNC Real Estate Market Research We suspect that some markets with serious supply concerns (i.e. Washington, DC) could experience zero to negative rent growth.

9 RENT GROWTH FADES 9 APARTMENT SALES TRENDS Apartment investor activity totaled $32.1 billion in 4Q2013, rising 48.3 percent from last quarter and 10.8 percent from last year. This surge in transactions was largely boosted by portfolio transactions. Apartment prices rose by 12.0 percent for all of 2013, but were well behind increases posted by the office, retail, and hotel sectors. RCA notes that because the sector has fully recovered and reached record high prices in many markets, price appreciation has started to plateau, given relatively stable cap rates as well as minimal appreciation across markets measured by the Moody s/rca CPPI. Apartment prices per unit rose by 9.7 percent from last quarter, to $116,621, but dropped by 4.1 percent from one year ago ($121,669). Overall, apartment cap rates decreased slightly in the fourth quarter, falling four bps to average 5.74 percent. While many investors still favor mid/high-rise properties in primary markets, many more investors are shifting to higheryielding garden sector and to secondary or tertiary markets, which experienced the greatest increase in transactions and some of the highest price gains last year. The increase in the average cap rates in the non-major metros (adjacent) is attributed more to higher levels of activity and less to a pricing shift. Las Vegas, Orlando, and tertiary markets in the Southeast experienced the largest surge in transactions. Looking ahead, given rising interest rates and cap rates near historic lows, leasing fundamentals will be the most important factor driving apartment prices higher in most markets. Therefore, investors will likely avoid markets where rent growth and occupancy levels could be impacted by a growing construction pipeline.

10 RENT GROWTH FADES 10 MULTIFAMILY DELINQUENCIES Fannie Mae s Multifamily Serious Delinquency Rate (60+ days) moved down to 0.10 percent in January 2014 from its high of 0.80 percent three years ago. Freddie Mac s Serious Delinquency Rate continued its decline over the last year, and is roughly one-third of its peak three years ago, now standing at 0.05 percent. While elevated from late 2008 until recently, both agencies are now back in line with their historic norms. The overall delinquency rate fell to 7.43 percent as of December 2013, a continued improvement from its year-ago rate of 9.71 percent. The delinquency rate improved after $1.3 billion in loans were resolved and $1.6 billion were cured, despite $1.6 billion of newly delinquent loans. While multifamily CMBS delinquencies have declined over the last few years, they remain elevated compared to prerecession rates and are the highest of the commercial real estate sectors at percent.