Institutional Real Estate, Direct

In 2009, the U.S. institutional real estate market continued to experience increasing cap rates and weak property fundamentals (higher vacancy rates, increased tenant concessions and lower rental rates) across all property sectors with multifamily experiencing the most stable conditions on a relative basis. In 2009, investment activity was down significantly (89%) from peak levels seen in the second quarter of 2007 and off 71% from the same period in 2008. We believe current valuations have declined on average 30-35% from the peak in 2007 in all property sectors and with vintage, quality and location affecting this ranges, plus or minus. This low level of investment activity certainly makes it difficult to ascertain valuation parameters especially with the debt markets offering few options.

In 2009, the performance of the National Association of Real Estate Investment Trusts (NAREIT) and National Council of Real Estate investment Fiduciaries (NCREIF) indices continued to show differing results much like in 2008 performances. In 2008, the NAREIT index, which is an indicator of public real estate performance, was a negative <37.34> % while NCREIF, an indicator of private real estate performance, was a negative <6.5> %. From January through the end of September, the NARIET index was a positive 17.74% forecasting a recovery in the commercial real estate markets while NCREIF was a negative <15.85> %. We believe that the re-pricing of assets within commercial real estate will continue into 2010 along with an increase in transactions as the bid/ask gap continues to narrow between buyers and sellers.

Debt Availability Like last year, 2009 continued to be a difficult year for owners to access debt for commercial real estate assets (for acquisitions or refinancing) with the lone bright spot being the government-sponsored enterprises (GSEs) – Fannie Mae and Freddie Mac – for the multifamily market. Lenders continue to be selective on asset type, asset quality and sponsorship while at the same time decreasing loan-to-value ratios, increasing debt coverage ratios and going back to traditional underwriting standards not seen since the 1990s. We believe that until new debt sources are made available to fill the void left by the collapse of the Commercial Mortgage Backed Securities (CMBS) market, there cannot be a true recovery in commercial real estate (with the exception of the multifamily market).

U.S. Real Estate Fundamentals The U.S. economy has continued to suffer in 2009, particularly on the jobs front. The outlook on job losses is improving but there remains much uncertainty as to whether it can turn positive and ultimately be sustained into 2010 and beyond. Not surprisingly, through the nine months ended September 30, 2009, all property sectors have seen an erosion in fundamentals, with the weak retail market resulting in a national vacancy rate for the U.S. neighborhood and community shopping centers of 10.3 %. We are also experiencing similarly weak conditions in the office market, with the national vacancy rate at 16.5 %, up from 12.5 % two years ago and the industrial market where vacancy rates have increased significantly to 10.4% from 7.8% several years ago. Finally, although the multifamily market has held up better than other sectors, the national vacancy rate is still up to 7.8% up from 5.8% several years ago. The multifamily market is benefiting from the decline in home ownership resulting from the credit crisis as well as from an increase in demand due to positive demographic trends. Similar to last year, the silver lining on the U.S. commercial real estate market overall is that new supply is currently very limited in all property sectors due to the lack of construction financing.

The Opportunity We believe that there are some good opportunities for investment today, particularly in the multifamily sector, and we expect that to continue into 2010. The opportunity to buy assets well below replacement cost either through debt or equity exist today. With that said, current cash flow is what is driving valuations and the lending community. Going forward, investors will need to rely on investment managers' operating acumen to drive incremental cash flow growth, and not rely on high leverage or cap rate compression to drive appreciation returns.

Source:
1. National Association of Real Estate Investment Trusts
2. National Council of Real Estate Fiduciaries
3. Reis, Inc.

Past performance is not indicative of future results.