Real Estate Finance in 2014: Return to Normalcy

1. Real Estate Finance in 2014:Return to Normalcy

3. 2007: The “Beginning of the End” “…the end of an economic illusion, facilitated by a bubble, built on a delusion, perpetuated by greed, living on both borrowed time, and borrowed money”

4. We Told Ourselves: “This Time It’s Different” • U.S. housing bust pushed global economy into recession • Rental demand for commercial real estate “evaporated” • Federal Reserve flooded capital markets with liquidity, driving interest rates to near zero • U.S. government brokered mergers of shaky financial institutions (J.P. Morgan/Bear Sterns; B of A/ML) • U.S. government bailed out AIG, let Lehman fail, and allowed Goldman Sachs, Morgan Stanley, America Express, MetLife, et al to convert to bank structures and thereby qualify for bailout money

5. We Told Ourselves: “This Time It’s Different” (continued) • Overall, largest government intervention into the financial system and capital markets…ever • To date, solutions have been short-term in nature with no evidence of a long-term, systemic plan • What was initially a liquidity crises became a crises in confidence as “civil discourse” between political parties seemed impossible

6. Real Estate Finance 2012: New Realities

7. “Two Speeches for Audience to Chose From”For Speech A, text “A” to: 4-5-6-6-6 * For Speech B, text “B” to: 3-6-6-6 ** * 4-5-6-6-6 spells “gloom”; ** 3-6-6-6 spells “doom”

8. tenuous ten∙u∙ous [ten-yoo-uhs] -adjective • thin or slender in form, as a thread. • lacking in sound basis, as reasoning; unsubstantiated; weak: a tenuous argument. • thin in consistency; rare or rarefied. • of slight importance or significance; unsubstantial: He holds a rather tenuous position in history. • lacking in clarity; vague: He gave a rather tenuous account of his past life.

9. 2012: Between Uncertainty and Extreme Uncertainty

10. Becoming Resigned to Uncertainty

11. Emerging Trends in Real Estate 2013: “Recovery Anchored in Uncertainty”

13. “Signposts for 2013…First Thoughts” The 21 century became a teenager in 2013, and as with any young adolescent, it kept odd hours; tough issues seemed to get pushed off; and there were likely to be wild highs and lows

15. {au: ? or !} Real Estate Finance in 2014:Return to Normalcy

17. “If you laid all the economists end-to-end, they would never reach a conclusion” • George Bernard Shaw • “It has been said that the only purpose of economic forecasts is to make astrology look respectable” • Anonymous

18. Federal Open Market Monetary Policy • In December 2013, the FOMC began winding down its QE program by reducing asset purchases from $85 billion to $75 billion per month • The Fed also strengthened its forward interest rate guidance, making this a “Dovish Taper” • Policymakers noted that the fed funds rate would remain “at rock bottom levels well pastthe time the unemployment rate fell below 6.5%” • All-in, interest rates should remain at historical low levels through yearend 2014

19. Federal Reserve Board Beige Book • Showed economic activity expanded at a modest to moderate pace across Federal Reserve districts from mid-November through early January • In the real estate sector, home sales ended the year higher than a year earlier in most districts as momentum slowed in several districts • Residential construction was generally stronger, led by multifamily construction • Conditions were mixed for commercial real estate markets • Commercial real estate construction is on the increase broadly, and the outlook for 2014 is generally positive

20. U.S. economy: what to watch for • Risk spreads – narrower and steady • Inventories – building up in line with increased output • New factory orders – increasing, especially for capital goods • Unemployment claims – increased post-Sandy; now declining • Building permits – increasing moderately for single family residential and reluctantly for commercial real estate

21. 2011 • Defensive strategies; focus on core markets; multifamily favored property class • 2012 • Continued focus on core markets/property; slowing cap rate compression; commercial real estate yields remain attractive • 2013 • Core markets and property becoming “too pricey”; focus turns to secondary/tertiary markets and overlooked sectors as values in many markets have returned to 2006-2007 “high-water” mark

22. Say “Goodbye to 2013” • Continued improvement in fundamentals in all food groups • Property sales volume increasing • Vacancy rates down or declining • Equity and debt capital available from array of sources • Development activity is cautiously increasing • Federal Reserve began to “taper” bond purchases

23. Say “Hello to 2014” • The Real Estate Roundtable Sentiment Index • Views of CEO, President, and other top officers regarding current conditions and future outlook on real estate conditions, capital markets, and asset pricing • Participants note continued improvement in fundamentals, but remain cautious due to slow pace of economic recovery • New construction and an increased tolerance for risk suggest optimism beyond the core “gateway” markets and multifamily sectors • Rising interest rates could undermine improvements in NOI, potentially putting renewed downward pressure on asset values • For now, the strong availability of capital (increasingly flowing to riskier transactions) is helping to offset the recent run-up in long-term interest rates

24. Say “Hello to 2014” (continued) • Numerous “players” in the equity, debt, and property markets • Some think “Too many people, too many dollars, too few deals” • Some argue “we’re in a precarious position with the wind at our backs and capitalization and interest rates down…” for the moment and NOIs growing…slowly • Others caution “we’re in a precarious position with the wind in our faces, NOI growth “slack”, interest rates and cap rates ready to increase, and new supply on its way • Properties are “priced to perfection” or “priced to disappoint” • Too many people are focused on “buying yield, not creating yield”

25. “Logistics”,i.e., Fundraising • Remains challenging for the majority of private real estate fund managers • Results indicate you need to be “big and global” or a “nimble and a local sharpshooter” • Key factor investors consider include: track record (32%); experience (30%); returns (27%); strategy (18%); risk profile (18%); and fees (14%) • Largest domestic and foreign institutional investors, wanting greater control over investments, are focusing on direct investments, joint ventures, and other forms of structured transactions

26. Real Estate Equity Capital Markets

27. Property Transaction Trends • As of 3Q2013, transaction volume equaled $293+/- billion, 27% ahead of 2012 • Multifamily remains in the “wonder” zone with investor’s wondering if too much is under construction and if pricing is sustainable • Investors appear to be rotating to higher yielding, higher risk plays such as hospitality, retail, and niche property types • Geography continues to expand to include formerly overlooked secondary and tertiary markets

28. Transaction Volume

29. Ranking of Investment Categories and Strategies • Value-added Investments • Development • Opportunistic Investments • Core-Plus Investments • Core Investments • Distressed Properties • Distressed Debt

30. Real Estate Investment Trusts • Continue to enjoy broad access to capital from many public and private sources including common/preferred equity, unsecured debt, and balance sheet lenders • Continuing to recycle lower tier assets, supported by increasingly active CMBS market • REIT conversions for non-traditional assets such as infrastructure, billboards, correctional facilities in process • Dividend yields and valuations remain attractive • Non-Traded REITs having another record year

31. Real Estate Debt Capital Markets

32. Debt Sources • “New and improved CMBS”, a.k.a. CMBS 2.0 is taking market share from competitors • CMBS’s ability to process B and C quality property in secondary and tertiary markets is a competitive advantage not lost on borrowers • CMBS 2.0 has also learned to compete with commercial banks and insurance companies for mandates on core property in primary markets • No new credible source has entered the market since the end of the current crises as spreads are only marginally attractive compared to alternative investments

34. Cumulative Distress for All Property Types

35. 10-Year, 50%to 59% Loan-to-Value

36. CMBS Issuance: 1995 – 2014 (Projected) Source: Commercial Mortgage Alert.

37. Commercial Banks • Against a backdrop of deleveraging and reduced exposure to acquisition, development, and construction lending • 2011: commercial banks started to test the water • 2012: commercial banks began to put their toes in the water • 2013: switch from loan resolution to loan origination • 2014: anticipated profitability will allow increase in originations and growth of loan book

38. Life Insurance Companies • Will face stiffer competition in 2014 from both commercial banks as well as securitized lenders • Insurers “fighting back” with tighter loan spreads, higher leverage, and less recourse • Industry worries about a “race to the bottom” in the application of credit standards • Originations expected to equal $50 billion, long-term run rate for insurers

39. Debt Funds • Developed to fill lender gap • Provides higher yields than equity with (hopefully) less risk • Not the savior everyone expected…as yet • Over time, may grow from niche player to important part of the capital stack • Will need to develop its own infrastructure • Focused on institutional size property and “Best of Breed” borrowers • Global geographic focus: U.S.; Japan; UK, Europe

41. “Prediction is very difficult, especially if it’s about the future” • Economy continues to “grind it out” • Interest rates “flat” through 2014 • Real estate fundamentals continue to improve, benefitting from improving economy and little new construction • Transaction volume increases from $325 billion in 2014 • Fundraising remains challenging • Competition for investments increases; buyers resort to “hand-to-hand” combat

42. REITs remain ferocious competitors • Pension will increase allocations • Foreign investors focus on core assets in gateway markets (and political and physical safety) • Mortgage capital “abundant and cheap” • Mortgage delinquencies continue to decline • Refinancing dealt with promptly • Commercial banks: originations equal to $150 billion • CMBS: originations total $90 billion to $100 billion • Insurance: originations reach $50 billion

44. “Best Bets” • Infill locations in 24-hour markets • Develop industrial property in hubs near ports and airports • Develop multifamily property…carefully • Scour the secondary and tertiary markets • Single family housing funds…maybe • Buy and hold REITs • Non-performing mortgage loans (if you can get any) • Anything with an “R” in it: refinance; renovate; re-position; rehabilitate; re-lease; restructure; recapitalize; etc. • The “Age Game”: seniors, students, and medical office • Distressed: think Europe • Food trucks: combine social media and prime locations

45. “If it looks like a bubble, and floats like a bubble… • Summer 2013: inflection point or the pause that refreshes? • “Priced to perfection” or “Priced to disappoint” • Let’s role play for a minute; I’ll be the buyer and seller and the lender and the borrower

46. Real Estate Finance in 2014:Return to Normalcy