Commercial Real Estate Outlook Jed Smith, Managing Director Quantitative Research

National Association of REALTORS®

Lancaster County Association of REALTORS® C&I Regional Conference, May 7, 2014

THE ECONOMY: NOT AS BRIGHT AS THE PICTURE--BUT STILL EXPANDING

Real Estate Outlook Challenges: Jobs, Growth, and Confidence

• Short Term—Slow Expansion This Year. – Job growth: Up 1.6 percent. – GDP Growth: 2.3 percent vs. 1.9 percent last year. – Interest Rates: 2014 up approximately .5 percent. – Credit Easing Somewhat. – Residential Real Estate: Sales Flat, Prices Up. – Commercial Real Estate: Flat.

• Longer Term—Challenges. – Jobs and Unemployment: Slow Progress, Slow Growth. – Confidence/Discord/Unresolved problems (government debt,

excessive aversion to risk, slow expansion). – Change: Millenials and Residential Markets – Change: Commercial Markets.

U.S. Economy: Impact of The Great Recession

Great Recession—Effects Linger On

Employment and GDP Issues

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The Great Recession: Impact on GDP GDP in 2009 Dollars

Real GDP Real GDP W/O Recession

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1960- Jan

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Establishment Employment: 1960-2013

Economic Forecasting, Augury, and Fortune Telling Can We Really See the Future?

• Based on Relationships Between Various Parts of the Economy. – First Group of Inputs: Exogenous Factors—Monetary and Fiscal

Policy; Foreign Economies; Public Policies. – Second Group of Inputs: Understanding of the Economy:

Relationships Between Economic Variables, Behavioral Assumptions. – Third Group of Inputs: The Unknown Unknowns!

• Forecasts: Based on “All Other Factors Being Constant.” – Which They Never Are! – Best Estimates—Based on Assumptions. – Scenario Analysis and Alternatives.

• Major Drivers of Real Estate: Jobs and GDP Growth. – Offices—Jobs; Retail—Consumer Spending; Warehouses/Flex—

Industrial Output; Apartments– Family Formation and Economic Growth.

– Still Presenting Major Challenges.

Consumer Price Inflation: Less than 2% (% change from one year ago)

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1999 - Jan2001 - Jan2003 - Jan2005 - Jan2007 - Jan2009 - Jan2011 - Jan2013 - Jan

CPI: Year Over Year Percent Change

All items exlcuding fuel and energy All items

Interest Rates Projected to Increase, But Not a Major Problem

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2000 - Jan 2002 - Jan 2004 - Jan 2006 - Jan 2008 - Jan 2010 - Jan 2012 - Jan 2014 - Jan

30 Year Mortgage 10 Year Treasuries

Household Assets: Significant Recovery But Continues to Impact Economy Overall!

(in $ Billions)

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1999 - Q1 2001 - Q1 2003 - Q1 2005 - Q1 2007 - Q1 2009 - Q1 2011 - Q1 2013 - Q1

Household Assets

Financial Assets Real Estate

“It Was the Best Of Times, and the Worst of Times” Confidence—Relatively Low. Uncertainty—Relatively High

Consumer Confidence--Mediocre: 5 Years After Recession! Difficult Getting On Job Ladder.

22.9

12.8

7.4 5.8 5.8 5.6

7.4

Unemployment Rates, 2013

Jobs an Important Real Estate Driver Part-Time, Unemployed, and “Missing” Workers

• Job Problems for Many People. – Part Time Work,

Unemployment, Discouraged Workers.

– Mean Duration of Unemployment at 35 weeks; normally 20.

• Job Creation is Lagging—Why? – Consumer Demand? – Regulation? – Education--Misaligned? – Expectations? – Other?

• Bottom Line: Jobs and Real Estate Demand Go Together.

-5000

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The Jobs Problem The Missing 12 Million

Unemployed Part Time--Economic Out of Labor Force

The Forecast Relatively Low Growth—Subject to Uncertainties

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2006 -Q1

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GDP Growth: Actual and Projected

Actual Growth Projected Growth

2011 2012 2013 2014 2015

Annual Growth Rate

Real GDP 1.8 2.8 1.9 2.3 2.9

Employment 1.2 1.7 1.7 1.6 1.9

Unemployment 8.9 8.1 7.4 6.5 6.3

Interest Rates

30-Year Government Bond 3.9 2.9 3.4 4.0 4.8

30-Year Mortgage 4.7 3.7 4.0 4.7 5.5

RESIDENTAL MARKETS

• Residential—Drives the Overall Real Estate Market.

– Currently Flat in Sales, Prices Up.

– Mixed Messages.

– Consumer Concern.

Home Sales and Prices

• Sales: Projected Flat

• Prices: Modest Increases.

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50000

100000

150000

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250000

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2002 -Jan

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2014 -Jan

Home Prices, Actual and Projected

Price Projected Price

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6000000

7000000

8000000

2000 -Jan

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2014 -Jan

Existing Home Sales

Sales Projected Sales

Commercial Sector Forecast

Commercial Sector —Follows Residential, May Lag a Year or So

130

212

362

423

571

174

67

147

233

299

355

400 420 430

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Commercial Sales in Billions Actual and Projected Source: Urban Land Institute

NATIONAL LEVEL

COMMERCIAL REAL ESTATE TRENDS

What is the Commercial Market?

• Commercial Space: Approximately 82 Billion Square Feet.

• “On Market Space”: Offices, Warehouses, Retail, etc. Approximately 47.5 Billion Sq. Ft.

• “Other”: Includes education, Medical, Religious, Public Assembly.

• Apartments: Approximately 27 Million Units.

• Total Value – $6-8 Trillion “On Market”; plus – $3 Trillion of Apartments. – Other Types of Space are not normally sold.

• Estimates are Approximations from Best Available Data: EIA, Government, and Other Sources.

• Majority of Buildings Relatively Small. • Bulk of Space is in Relatively Large Buildings.

Square Foot Range Percent of Buildings Percent of Floor Space

1,001 to 5,000 53.22 10%

5,001 to 10,000 19.51 10%

10,001 to 25,000 16.67 18%

25,001 to 50,000 5.37 13%

50,001 to 100,000 3.03 14%

100,001 to 200,000 1.52 14%

200,001 to 500,000 0.54 10%

Over 500,000 0.16 11%

Billion Square Feet

2013 Floor Space, Estimated

Office 14.01

Mercantile 12.84

Warehouse and Storage 11.56

Lodging 5.85

Food Sales 1.44

Food Service 1.90

Subtotal 47.59

Other 34.62

Total 82.21

Commercial Real Estate A Function of Jobs and Growth

• Commercial Building Sales. – Market Drivers.

– Expanding After Some Difficult Years.

– Prices Rising.

– Capital Increasingly Available.

• Prices Increasing.

• Foreign Interest in U.S. Properties Continues.

• New Construction—Slow Recovery.

• Rents Increasing.

Commercial Real Estate Sales Sales Volume Recovering

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$60,000,000,000

$80,000,000,000

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'01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

Quarterly Commercial Sales

Offices Industrial Retail Apartments Hotel

A Closer Look at Sales Industrial, Hotels, Retail—Somewhat Less---WHY?

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Commercial Real Estate Sales

Offices Industrial Apartments Hotel Retail

Commercial Real Estate New Construction--Recovering

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2000 - Jan 2002 - Jan 2004 - Jan 2006 - Jan 2008 - Jan 2010 - Jan 2012 - Jan 2014 - Jan

Non Residential Construction $--Millions

JOBS AND COMMERCIAL REAL ESTATE SOURCE: REAL CAPITAL ANALYTICS

Atlanta

Dallas/Houston/Austin

Philly/Baltimore

Boston

Chicago

Denver

Jacksonville / N. FL

Las Vegas

Los Angeles Metro

Miami/S. FL

New York Metro

Orlando/Central FL

Phoenix

Sacramento/Central CA

San Diego

San Francisco Metro

Seattle

Tampa/SW FL

DC Metro

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-30% -20% -10% 0% 10% 20% 30% 40% 50% 60%

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Commerical Property Price Index

Trough to Current09Q2 - 13Q1

PROPERTY PRICES VS JOBS GROWTH

Apartments: Construction Continues

• The Millennials.

– Student Debt.

– Unemployment.

– Family Formation.

– Residential.

– Preferences.

– Mobility.

– Financial Experience. 0

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Millions of Dollars Monthly

Price Index—Prices Up

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2000 - Jan 2002 - Jan 2004 - Jan 2006 - Jan 2008 - Jan 2010 - Jan 2012 - Jan 2014 - Jan

Commercial Property Price Index Source: Federal Reserve Board

Rents Increasing

Apartment Vacancy Rates—Low Relative to Experience

5.7

5.3

4.9

5.2

Avg Vacancy Rates, 2003-13 Avg Vacancy Rates, Past 19 Years Vacancy Rate 2013 Forecasted Vacancy Rates, 2014-16

Apartments: Average Vacancy Rates Source: Urban Land Institute

Rental Rate Changes

2.1

2.7

2.2

2.4

RR Change 2003-13 RR Change Past 18 Yrs RR Change 2013 Forecasted RR Change 2014-16

Apartments: Rental Rate Changes Source: Urban Land Institute

Apartments: Fundamentals Continue to be Favorable

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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U.S. Apartment Fundamentals

Completions Net Absorption Vac %

Source: NAR, Reis

Apartment Rents

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Asking Rent $ Asking Rent % Chg

Source: Reis

Apartments—Regional Variations, Overall Prices are Up

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U.S

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Apartment Sales as Percentage of Total Commercial Sales

$60,000

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Apartment Avg $/Unit

Industrial Space Tends to be Warehouses, Flex Space

11.9

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Avg Vacancy Rates, 2003-13 Avg Vacancy Rates, Past 20 years Vacancy Rate, 2013 Forecasted Vacancy Rates, 2014-16

Industrial: Average Vacancy Rates Source: Urban Land Institute

Rental Rate Changes Upswing as Economy Expands

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RR Change 2003-13 RR Change, Past 20 Yrs RR Change 2013 Forecasted RR Change 2014-16

Industrial: Rental Rate Changes Source: Urban Land Institute

Industrial Fundamentals

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U.S. Industrial Fundamentals

Completions Net Absorption Vac %

Source: NAR, Reis

Industrial Rents

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Asking Rent $ Asking Rent % Chg

Source: Reis

Commercial Office Buildings Vacancies Projected to Decline

14.9

14.1

14.9

13.7

Avg Vacancy Rates, 2003-13 Avg Vacancy Rate, Pst 20 Years Vacancy Rate, 2013 Forecasted Vacancy Rates, 2014-16

Offices: Average Vacancy Rates Source: Urban Land Institute

Commercial Offices Projected Rental Rate Changes

1.0

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3.5

RR Change 2003-13 RR change, Past 20 Years RR Change 2013 Forecasted RR Change 2014-16

Offices: Rental Rate Changes Source: Urban Land Institute

Commercial: Office Fundamentals

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U.S. Office Fundamentals

Completions Net Absorption Vac %

Source: NAR, Reis

Commercial Office Space—National Trends

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Office Sales as Percentage of Total Commercial Sales

$100

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Office Avg $/SF

Office Rents

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Asking Rent $ Asking Rent % Chg

Source: Reis

Retail: Vacancy Rates

10.5

9.8

12.0

11.1

Avg Vacancy Rates, 2003-13 Avg Vacancy Rate, Pst 20 Years Vacancy Rate, 2013 Forecasted Vacancy Rates, 2014-16

Retail: Average Vacancy Rates Source: Urban Land Institute

Retail: Rental Rate Changes

0.1

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RR Change 2003-13 RR Change, Past 20 Years RR Change 2013 Forecasted RR Change 2014-16

Retail: Rental Rate Changes Source: Urban Land Institute

Retail Fundamentals

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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U.S. Retail Fundamentals

Completions Net Absorption Vac %

Source: NAR, Reis

Retail Rents

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Asking Rent $ Asking Rent % Chg

Source: Reis

COMMERCIAL REAL ESTATE—INTERNATIONAL BUYERS

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Europe Middle East Australia Asia Latin America Canadabillions

DIRECT ACQUISITONS BY CROSS-BORDER INVESTORS IN THE US Trailing 12 month totals

International Transactions

Average Out to About 8 Percent of Market

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'01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 12 13

Commercial Sales: Offices, Retail, Apartments, Warehouses $---000

Domestic Buyer International Buyer

SOME COMPARABLE CAP RATES

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

OFFICE CAP RATES IN MAJOR GLOBAL MARKETS

Cap Rates: A Number of Markets

8.3% 8.2% 8.5%

7.5%

8.8%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

Office Industrial Retail Apartment Hotel

Cap Rates

Major Markets (RCA) REALTOR® Markets (NAR)

Sources: NAR, Real Capital Analytics

NAR Commercial Activity Survey 4th Quarter, 2013

• Sales Volume Compared with Previous Quarter: Up 4%. • Sales Volume Compared with Previous Year: Up 8%. • Sales Prices Compared with Previous Quarter: Down 0.4%. • Sales Prices Compared with Previous Year: Up 1%. • Expected Inventory Availability for the Next 12 Months: Up .1%. • Rental Volume Compared with Previous Quarter: Up .4%. • Rental Rates Compared with Previous Quarter: Up .3%. • Level of Rent Concessions Compared with Previous Quarter: Down

4%. • Volume of New Construction Compared with Previous Quarter: Up

2%. • Direction of Business Opportunities Compared with Previous

Quarter: Up 5%.

Lancaster Area: Overview

Employment Comparison

130000

132000

134000

136000

138000

140000

142000

144000

146000

148000

840

860

880

900

920

940

960

980

2000 - Jan 2002 - Jan 2004 - Jan 2006 - Jan 2008 - Jan 2010 - Jan 2012 - Jan 2014 - Jan

Employment: Lancaster Area Compared to U.S.

Lancaster Area U.S.

Pennsylvania Economic Activity Generally Consistent with U.S. Economic Activity

0

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40

60

80

100

120

140

160

180

1990 - Jan 1995 - Jan 2000 - Jan 2005 - Jan 2010 - Jan

Index of Coincident Economic Indicators Source: Philadelphia Federal Reserve

US PA

Construction: Lancaster Compared to U.S.

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2000 - Jan 2002 - Jan 2004 - Jan 2006 - Jan 2008 - Jan 2010 - Jan 2012 - Jan 2014 - Jan

Housing Permits

Central PA U.S.

Lancaster Area Better In Terms of Unemployment Rates

0

2

4

6

8

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12

2000 - Jan 2002 - Jan 2004 - Jan 2006 - Jan 2008 - Jan 2010 - Jan 2012 - Jan 2014 - Jan

Unemployment Rates

PA U.S. Harrisburg Lancaster

Home Prices: Lancaster Slow

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Trends in Home Prices FHFA Data

Lancaster PA US

Estimated Commercial Sales for Lancaster Area Includes Harrisburg, Lancaster, Reading, York

0

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100

150

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300

350

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2005 2006 2007 2008 2009 2010 2011 2012 2013

Lancaster: Estimated Commercial Sales Millions of Dollars

Apt/Office/Retail Other Small Commercial

Key Conclusions: Economy and Commercial Markets

• The Economy and Real Estate. – Relatively Slow Recovery and Job Growth. – We Would All Like Greater Optimism!

• Expansion: Retail Space—Probably Disappointing ; Warehouses--Mixed. – Effects of On-line Retailing, Slow Recovery. – Import trends. – The General Direction of the Economy.

• Apartment Outlook. – Continued Growth Possible. – Millennial Generation. – Population and Family Formation.

• Office Building Sector. – Using Less Office Space per Worker. – Cost, Lifestyle, Technology, Changing Nature of Work. – Class A Buildings—Growth Projected.

• Hotels/Motels/Lodging – Long Term Probably Growth—Affluence and Desire for Travel.