HIDDEN RISKS AND OPPORTUNITIES NAREIM - DALLAS CHRIS MACKE GLOBAL RESEARCH AND CONSULTING
Question 1 Where are we in the commercial real estate cycle? Property Fundamentals & Pricing: Much like the temperature in March, it depends on where you are in the U.S. NY San Fran Denver Houston Dallas Orange County CBRE Page 2
Question 2 Rising Interest Rates What percentage of your NOI rolls over in 1, 3, 5 years?? What percentage of your NOI is flat for next 1, 3 5 years?? What percentage of your NOI is NNN or Gross? What percentage of your debt is floating rate? What percentage of your debt is maturing in 1, 3, 5 years?? How sensitive is your portfolio? Do you want to be that sensitive? How confident are you in future interest rates????? CBRE Page 3
Why such a strong reaction to the fed s May press conference? CBRE Page 4
Mixed Fed Signals or mixed reporting? Just 21 days before CBRE Page 5
Everybody loves a forecast But CBRE Page 6
A not of caution on forecasts Professional Forecasts of Interest Rates and Exchange Rates: Evidence from the Wall Street Journal s Panel of Economists Karlyn Mitchell Department of Business Management North Carolina State University Douglas K. Pearce Department of Economics North Carolina State University March 2005 We use individual economists 6-month-ahead forecasts of interest rates and exchange rates from the Wall Street Journal s survey to test for accuracy. We find that none predicted directions of changes more accurately than chance. We find that the forecast accuracy of most of the economists is statistically indistinguishable from that of the random walk model when forecasting the Treasury bill rate but that the forecast accuracy is significantly worse for many of the forecasters for predictions of the Treasury bond rate and the exchange rate. CBRE Page 7
Very difficult to accurately forecast interest rates in an active monetary policy environment Tapering QE3 When will the Fed being slowing its bond-buying programs? September 67% October 7% December 22% January 4% Wall Street Journal, September 2013 CBRE Page 8
Why fed backtracked on taper and when will taper? CBRE Page 9
Watch Homebuilding Levels CBRE Page 10
or more congressional uncertainty? CBRE Page 11
Why forecasting interest rates so difficult Recency bias Minimal reward to depart from the herd Interest rates a function of so many factors: Monetary policy, economic growth both domestically and abroad, investor sentiment regarding safety, inflation expectations and many other sources Animal spirits And this doesn t even consider lender spreads, amortization periods CBRE Page 12
Quantifying Impact of Rising Cap Rates Rule of Thumb: If % change in revenue > or = to % change in cap rate no change in value If % change in revenue < % change in cap rate value will be less than original value all other things being equal If % change in revenue > % change in cap rate will will be greater than original value CBRE Page 13
Quantifying Impact of Rising Cap Rates Example A B Original Cap Rate: 5% 10% New Cap Rate: 6% 11% Change In Cap Rate: 1% 1% % Change in Cap Rate: 20% 10% Required Increase In Revenue: 20% 10% CBRE Page 14
Cap Rate Value Impact Varies Based On Original Cap Rate Original Cap Rate Change in Cap Rate (BPS) 100 150 200 5.0% 20.0% 30.0% 40.0% 5.5% 18.2% 27.3% 36.4% 6.0% 16.7% 25.0% 33.3% 6.5% 15.4% 23.1% 30.8% 7.0% 14.3% 21.4% 28.6% 7.5% 13.3% 20.0% 26.7% 8.0% 12.5% 18.8% 25.0% CBRE Page 15
Margin of Safety Market (CBD) Cap Rate 1 Dispersion (Bps) Forecast Rent Increase 2 Breakeven Terminal Cap Rate Marin of Safety (Bps) Los Angeles 4.75% 25 20.0% 5.7% 95 Orange County 5.75% 25 35.2% 7.8% 202 Portland 6.75% 50 21.9% 8.2% 148 San Diego 7.00% 25 28.2% 9.0% 197 San Francisco 3.75% 75 30.3% 4.9% 114 San Jose 7.00% 50 29.5% 9.1% 206 Seattle 5.38% 38 29.6% 7.0% 159 Denver 5.75% 25 23.8% 7.1% 137 CBRE Page 16
Investment style Depends On Your Assumptions and Certainty Value Add Opportunistic I N T E R E S T R A T E S How Certain Are You? Core Value Add ECONOMIC GROWTH CBRE Page 17
Inflation Risk By Property Type I m p a c t MFH Retail Ind. Ofc. Hotel ST Lease LT Lease Flat Rents Indexed Rents NNN Lease Gross Lease CBRE Page 18
Gateway VS Non-Gateway Office Markets CBRE Page 19
Question 3 Are Gateway Office Markets Too Pricey? Should We Buy In Non-Gateway Office Markets? CBRE Page 20
pricing premiums What Paying For? CBRE Page 21
Defining Gateway & Non-Gateway Office Market Dynamics Gateway Office Markets = Small Cap Stocks Greater growth Greater Volatility Non-Gateway Office Markets = Large Cap Stocks Slower growth Reduced volatility CBRE Page 22
liquidity was no better Source: Real Capital Analytics Crisis Liquidity is the percentage decline in transaction volume, on a square foot basis, from a market s peak to a market s trough CBRE Page 23
A Market Level Analysis of Crisis Liquidity Worse crisis liquidity than national average $ Sales volume decline from market peak to market trough Better crisis liquidity than national average Average national decline of 85% CBRE Page 24 Source: Real Capital Analytics
Accounting for transaction size Source: Real Capital Analytics CBRE Page 25
Surprising Declines In GW Pricing As Well Source: Real Capital Analytics CBRE Page 26
Gateway market liquidity did recover more quickly Source: Real Capital Analytics Recovery Liquidity is the change in transaction volume, as measured in square feet, occurring from the trough of a market cycle to the current period CBRE Page 27
Gateway market rents more volatile 1992 to 2012 CBRE Page 28
Christopher Macke Chris comes to CBRE with more than 20 years of real estate experience. His experience includes real estate development, financing, acquisitions and advising various regulatory agencies including being a Federal Reserve Beige Book contributor. He is a Senior Real Estate Strategist for the Investment Consulting group within the America s Research team. Chris delivers investment opinions and insights to institutional investors with the aim of helping them develop a house view. Chris holds a B.A. in Political Science from the University of Southern California, where he specialized in political campaign strategy and finance. He earned a Masters of Business Administration from Indiana University s Kelley School of Business specializing in Finance. chris.macke@cbre.com CBRE Page 29
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