Commercial Real Estate Investment Update - Bruce Petersen Executive Managing Director
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Commercial
Real Estate
Investment Update
Bruce Petersen
Executive Managing Director
USAA Real Estate Company
June 5, 2012
Presentation Overview
1. Why Real Estate?
2. Refresher on Real Estate Terminology
3. Investment Style
4. U.S. Commercial Real Estate Market Conditions
5. Status by Property Type
a) Apartment
b) Office
c) Retail
d) Industrial
6. REITs
7. Commercial Real Estate Outlook
2
Why Real Estate?
• Portfolio diversification
• Inflation hedge
• Strong cash flows with value appreciation
potential
3
Effectiveness as an Inflation Hedge
Some types of real estate provide better inflation protection than others…
Better inflation protection:
• Shorter lease terms reset faster (Apartment and Hotel)
• Percentage rent / revenue sharing (Retail)
• Leases with built-in rent escalations / CPI inflators
• Net leases (tenant pays operating expenses)
Lower inflation protection:
• Long term leases (Industrial & Office)
• Gross leases (no pass through of operating expenses)
• Flat leases (no rent bumps)
4
Refresher on Real Estate Terminology
Net Operating Income (NOI):
• Subtraction of the property’s operating expenses from total revenue
• Most widely-used indicator of the profit generation of a property
Capitalization Rate (Cap Rate):
• Cap rate = NOI ÷ Property value
• Net income per dollar of property value
• Similar to current yield
• Inverse of price/earnings (P/E) multiple
• Not all cap rates are comparable
5
Investment Styles for Real Estate
Although style classifications for equity and fixed income have been used for many years,
real estate investment styles are relatively new. The widely-recognized styles are…
CORE Definition High percentage of return from income; low volatility
Attributes • Major property types only – office, • Low leverage
industrial, retail, apartment • Primary markets
• High occupancy • Life cycle: Operating / Stabilized
VALUE-ADDED Definition Significant portion of return from appreciation; moderate volatility
Attributes • Major property types, plus specialty such • Moderate leverage
as senior living, hospitality, self-storage • Primary and secondary markets
• Moderate occupancy • Life cycle: Leasing / Repositioning
OPPORTUNISTIC Definition High percentage of return from appreciation; significant volatility (due to high
leverage, significant leasing risk, development, etc.)
Attributes • Non-traditional property types, including • High leverage
speculative development and land • Secondary and tertiary markets
• Low occupancy • Life cycle: Development / Newly
constructed
6
US Commercial Real Estate Conditions
• The commercial real estate recovery from 2008 continues
• Large divergence in pricing between high-quality, well
leased properties in major markets and the rest of the
market
• Investors continue to target core product located in top-
tier markets
• Investors hesitant about risky assets, especially those
with high vacancies, capital needs, or in
secondary/tertiary locations
• Cap rates have drifted lower for CBD office, apartment,
and retail properties, but have been mostly flat for
suburban office, industrial, and hotel properties
7
Deleveraging - Life after the Financial Crisis
2007 DEAL POST 2007 DEAL
Value: $100mm Value: $80mm
Equity: 20%
$20mm
New Equity: 45%
$20mm Original Equity: $20mm (gone)
Additional equity to Refinance Deal: $36M
2007 Value = $100mm
$36mm
Total Invested = $100mm
Post 2007 Value: $80mm
Debt: 80%
$80MM
Borrower Needs to Invest 1.8x of their
Original Equity in order to Refinance
Debt: 55%
$44mm
Asset
Values
Decline
Apartment Sector
9
Apartment – Market Conditions
• One of the best-performing sectors of the
commercial real estate market
• National vacancy rate is around 5%
– Third time in the last 30 years vacancy rate has
been that low
• Rent growth has remained positive and is
expected to accelerate
– Tight supply allows for greater pricing power for
landlords
• Supply will eventually catch up and level rent
growth
• Cap rates averaging 5.6% in major markets
10Apartment Supply and Demand Trends
400 8.0
Forecast
350
7.0
300
6.0
250
200
Thousands of Units
5.0
Vacancy Rate %
150
4.0
100
50 3.0
2.0
-50
1.0
-100
-150 0.0
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: CBRE-EA Completions Net Absorption Vacancy RateWhat is Driving the Apartment Demand?
• Steady decline in home
ownership since 2004: 69.2% to
66%
• Renters by choice
• Construction pipeline is projected
to remain low
12Office Sector
13Office – Market Conditions
• Office sector continues to face headwinds
• Improving office-using job market and thin
supply pipeline will keep fundamentals
moving in right direction
• National vacancy rate is 16%, unchanged
from last quarter
• Cap rates averaging 7%; lower in primary
markets
• Flight to Quality: Class A vs. Class B/C
• Markets with technology and energy
exposure have been best performers
• Large pricing spread between primary
and secondary markets
14Millions of Square Feet
-150
-100
-50
100
150
50
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Completions
2001
2002
2003
2004
2005
Absorption
2006
2007
2008
2009
2010
Vacancy Rate
2011
Office Supply and Demand Trends
2012
2013
2014
Forecast
2015
2016
2017
0.0
5.0
10.0
15.0
20.0
25.0
Vacancy Rate %
15Retail Sector
16Retail – Market Conditions
• National vacancy rate around 12.5% in Q1
– first decline in the vacancy rate since the
second quarter of 2005
• Cap rates have been flat; averaging 7.4%
– Prime grocery anchored centers continue to
compress
• New supply remains low
– Any increase in demand should produce
recovery with modest rent growth
• Store-closing announcements have declined
significantly
• High quality malls and power centers
continue to outperform neighborhood and
community centers
17Retail Supply & Demand Trends
120 14.0
Forecast
100 12.0
80
10.0
Millions of Square Feet
60
Vacancy Rate %
8.0
40
6.0
20
4.0
-20 2.0
-40 0.0
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: CBRE-EA Completions Absorption Vacancy Rate
18Industrial Sector
19Industrial – Market Conditions
• Fundamentals should continue to improve
in 2012
– Vacancy rate at 13.4%
– Demand has been strongest for R&D and
warehouse space
– New construction is minimal; but
speculative construction is back
• Rental rates hit bottom in 2011
– Rent growth is forecast to be positive in
2012
• Cap rates currently average 7.8%, but are
as low as 6.5% in top markets
• Major distribution markets are leading
recovery; Local and regional will follow
20Industrial Supply and Demand Trends
400 16.0
Forecast
300 14.0
12.0
200
Millions of Square Feet
10.0
Vacancy Rate %
100
8.0
6.0
-100
4.0
-200 2.0
-300 0.0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: CBRE-EA Completions Net Absorption Vacancy Rate
21REITs
22REIT Landscape
Non-traded
Public Private
Public
REITs REITs
REITs
23REITs
• Capital flows have been strong in 2012
– raising nearly $20 billion of debt and equity in the first
quarter
– on pace to top 2010’s record of $51 billion
• With access to low-cost equity and debt, REITs are
positioned to be active player with acquisitions and
development
• After an 8.3% return in 2011, the FTSE NAREIT
Equity index is up 6.1% since the first of the year
• Retail (11.0%) and Industrial (7.7%) have led the
individual sector performance year to date
• Rising rents will translate into dividend growth
24U.S. Commercial Real Estate
Outlook
25Outlook
Market Cycle
Pre-2008 2009 - 2011 2012
Overpriced Distressed Normalized
Transaction Led Real Estate Market
• Market fundamentals will continue to strengthen
across all property types
• Transaction activity will grow during 2012, driven
by demand for core income-producing assets, as
real estate remains an attractive alternative to
fixed-income instruments
26Outlook
• Lower cap rates in primary markets will likely hold
as buyers compete for high-quality properties in
primary markets
• Eventually, pricing in secondary markets will
improve as investors search for higher yields
• The slow liquidation of distressed assets will
continue, but new distressed situations will result
from maturity defaults of CMBS loans originated at
the peak of the market in 2005 to 2007
27Questions
2829
Appendix
30Opportunities
Apartment
• Late to the party for acquisitions of core assets in primary markets; prices on
the best assets have already been bid up to frothy levels
• Development and non-core acquisitions are now the best opportunities
• Focus on markets with high barriers to entry and be prepared to sell when the
properties are stabilized to maximize value
Office
• Trophy assets in primary markets are still safe plays, but returns are slim
• The best opportunity is with high-quality, non-trophy assets in Tech and
Energy markets
• For those with a higher appetite for risk, value-add properties in good
locations that are underperforming for various reasons offer attractive returns
31Opportunities
Retail
• Grocery-anchored retail facilities with strong market positions and highly
regarded grocery chain anchors offer the best opportunities
• High-end retail and Class A malls should also perform well
• Community and neighborhood centers are still struggling and will lag behind
in the retail recovery
Industrial
• Both bulk and small warehouse space located on the path of goods
movement, near coastal and inland ports, near airports and intermodal
facilities should perform well
• Certain markets, such as Seattle, Portland, San Francisco, and Austin, with
their strong tech employment growth should provide an excellent opportunity
for investing in warehouse R&D assets
32Apartment – San Antonio Market
• Strong demand in the San Antonio
apartment market continues
• The vacancy rate for the first quarter
was 6.7%, down 40 bps from the 7.1%
registered at the end of 2011
• Average effective rent was $739 as of
the first quarter, an increase of 0.8%
from the fourth quarter
• Although new supply is picking up, net
absorption will remain ahead of supply
over the near term, and the vacancy rate
is forecast to fall to 6.0% by the end of
2012
33Office – San Antonio Market
• The San Antonio office market continues to recover, but the level of activity
has yet to resume normal levels
• The vacancy rate for the first quarter was 15.9%, down 30 bps from the
fourth quarter
• New leases and expansions signed in the first quarter created a positive
net absorption of nearly 180,000 SF
• This was the second consecutive quarter of positive growth and the
highest quarterly level of positive net absorption in four years
• But headwinds to the market are imminent over the next few quarters as
several blocks of office space will go dark; AT&T, Nationwide, NuStar and
KCI will all give back sizable amounts that will cause the city wide vacancy
rate to spike
34Retail – San Antonio Market
• As of the first quarter, the overall vacancy rate was 12.9% - unchanged from
the previous quarter and slightly improved compared to 13.0% recorded at
the close of 2010
• Rental rates showed some resiliency and increased two cents over the
quarter and twenty-four cents compared to last year at this time to reach
$18.19 per SF per year on a triple net basis – a year-over-year gain of 1.3%
• With the absence of any significant speculative construction, most of the
leasing activity has been focused on re-tenanting existing vacant spaces
• During 2011, retail properties achieved 372,000 SF of positive net
absorption, which is lower than the previous four-year annual average of
730,000 SF
• Local grocer H-E-B has dominated the vast majority of shopping center
construction and is set to open its largest location at Loop 1604 and Bandera
Road this spring
35Industrial – San Antonio Market
Market fundamentals continue to strengthen, but increases in rental rates have
been slow to appear…
• The San Antonio industrial market experienced an impressive 662,358 SF of
positive net absorption in the first quarter, which was the largest quarterly
gain since 2004
• As a result, the vacancy rate dropped to 11.9% compared to 13.2% in the
final quarter of 2011
• H-E-B’s new lease for 282,000 SF at Rittiman East was the biggest
contributor to the positive absorption, followed by Bergstrom Climate Control
taking down 145,000 SF at Port San Antonio
• The average asking price for industrial space was $5.56 per SF, unchanged
from last quarter
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