Linneman Re Letter

Volume 10, Issue 3

Fall 2010

No Double Dip On July 5th, 6th, and very early on the 7th of this year, I engaged in 70 minutes of rigorous stationary biking, a full cycle of weightlifting, and my daily stretching regimen. Oh sure, I had some hip pain and a sore knee, but at age 59, I was rocking and rolling. In this regard, I was not unlike the U.S. economy in 2005-April 2007, which was doing great in spite of some fundamental problems. Then in the course of a few hours on July 7th, I was unable to walk more than a few steps after having a hip replaced. Just like the U.S. economy in late 2008, my infirmity had taken me down a few notches!

My subsequent recovery was remarkably similar to that facing the U.S. economy: a satisfactory recovery to unremarkable mediocrity. As I describe my recovery, bear in mind that the U.S. economy shed 8.4 million jobs and 4.1% of GDP in roughly 18 months. This is a lot of economic damage. On July 8th, I was able to walk twice a day for 20 minutes, bearing weight on crutches, lifting light hand weights, and doing simple leg therapy. By July 19th, I did not need any pills or a cane, and was able to walk an hour twice a day at a 23-minute-mile pace. By August 19th, I biked at full resistance for 50 minutes, walked 15-minute-miles for an hour, actively lifted leg weights,
Thru Latest Available as of Sept 20, 2010 3.0 $420.5 20.5 1.9 960.1 $418 15.8 6.3 1,458.0 723.0 -50.0 261.0 681.0 15.8 4.5 20.0 93.9 -2.3 2.4 -190.2 $305.1 -$351.9

On the Road to Recovery

% Change in GDP since 2009:II Change in GDP since 2009:II (2008$ billions) % Change in After-tax Profits since 2008:II % Change in Workers' Total Compensation since 2009:II Monthly Sales of Autos & Light Trucks (SA, units in 000s) Change in Per Capita Disposable Income since Oct 2009 (2005 $) % Change in Commercial Investment in Equipment since 2009:II % Change in Private Domestic Investment since 2009:II Change in Household Survey Jobs since Dec 2009 (thousands) Change in Payroll Survey Jobs since Dec 2009 (thousands) Change in Unemployment rate since Oct 2009 (bps) Change in Employment - Education & Healthcare since Dec 2009 (thousands) Change in Capacity Utilization since June 2009 (bps) % Change in Durable Goods Production since June 2009 % Change in Non-durable Goods Production since April 2009 % Change in Single Family Starts (SAAR) since Jan 2009 % Change in Multifamily Starts (SAAR) since Oct 2009 % Change in Home Price (FHFA) since 2009: I % Change in M2 since March 2009 Change in Commercial Bank Commercial RE Debt since June 2009 ($ billions) Change in Federal Spending since 2008 ($ billions) vs Last 4 Qtrs Change in Federal Receipts since 2008 ($ billions) vs Last 4 Qtrs

Comment About previous peak Same as China Now highest in history About inflation 20-year avg = 1.26 million 1.3%

1.3%

(only 432,000 SAAR) (only 95,000 SAAR)

-4.9% 9.7% -14.3%

ﬁgure 1

Table of Contents
No Double Dip ............................................................................................1 In Memoriam: Ronen Katz ........................................................................2 Where is the Economy Heading? ................................................................4 But What About Jobs?...............................................................................16 The Federal Budget Deﬁcit: Will They Ever Learn? ................................21 The Sinking of Bismarck ..........................................................................24 More Stimulus? No Thanks. .....................................................................25 Financial Reform And Other Jokes ...........................................................27 The Search for Yield: Part II .....................................................................29 Real Estate Capital Markets Are Alive, If Not Quite Well .......................37 Construction Costs ....................................................................................43 Oil Spill Nonsense Numbers.....................................................................45 Market Close-up: Philadelphia Ofﬁce ......................................................46 Market Close-up: Seattle Industrial ..........................................................48 Market Close-up: Denver Multifamily .....................................................51 Market Close-up: Phoenix Hotel ..............................................................53 Ofﬁce Market Outlook ..............................................................................56 Industrial Market Outlook.........................................................................58 Multifamily Market Outlook.....................................................................59 Retail Market Outlook ..............................................................................61 Hotel Market Outlook ...............................................................................63 Seniors Housing And Care Market Outlook .............................................64 Vacancy/Occupancy and Absorption Projections .....................................68 Editorial Staff ............................................................................................97

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THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

In Memoriam: Ronen Katz On September 19, 2010, a truly gifted and exceptional young man, Ronen Katz, lost his life in an automobile accident. We extend our sincerest condolences to his family, whom Ronen deeply loved and respected. In my 33 years of teaching, I have come in contact with more than 4,000 young people. Yet, Ronen was truly a once in my lifetime encounter. Many are smart; many are ambitious; many work hard; a fair number are articulate; a few are humorous and good-natured; even fewer have judgment; and still fewer are kind and of generous spirit. But Ronen was the only one who was at the top of the list in each of these traits. My sense of loss is immense, as it is for my colleagues and many others he touched. Ronen was a rare individual who possessed all of the requisite tools for a lifetime of success in business, but more importantly, he possessed the goodwill and generosity of spirit for a lifetime of success as a person. He had a greater impact for good in his 27 years than most achieve in 80 years. Ronen understood that you help others not because it benefits you, but rather because you can. Ronen attended the University of Pennsylvania’s Wharton School from 2001 to 2006 and received three degrees: a bachelor of science in economics and a bachelor of science in engineering, both magna cum laude, and a master of science in engineering. In parallel, from 2003 to 2006, Ronen interned at Linneman Associates and made meaningful

contributions to more than a dozen issues of The Linneman Letter. Yet, his workload never seemed to overwhelm him, and his temperament was always predictably charming and easy-going. My colleagues and I all kept in touch with Ronen on a personal basis even after he graduated from Penn, and moved on to Merrill Lynch, and then Angelo Gordon. We valued Ronen as a friend and a fellow professional. Despite his obvious intelligence, he was humble. No task was below him. He saw the big picture, asked insightful questions, and understood that every piece of the puzzle mattered. We may have taught Ronen some things, but we learned much from him as well. Because I believe Ronen deserves to have his name mentioned each year at the Zell-Lurie Real Estate Center’s annual awards event at Wharton, I have established a scholarship in his name as a way to remember an extraordinary young man. Contributions in Ronen’s memory may be sent to: The Ronen Katz Memorial Scholarship Fund c/o Sarah Ashraf Zell/Lurie Real Estate Center at Wharton 1400 Steinberg Hall-Dietrich Hall 3620 Locust Walk Philadelphia, PA 19104 Contributions are fully tax-deductible. Please make checks payable to The Trustees of the University of Pennsylvania.

and was back to my normal daily stretching routine. All the while, I was painfully frustrated by this slow (and erratic) progress from pitiful to mediocre (after all, at 59, I am still destined to play in the NBA). But by any objective standard, it was a successful recovery process, with a very long road remaining to achieve full strength. Similarly, the U.S. economy went from a super high (in spite of enormous faults) to a terrible bottoming, caused by government panic and the absence of economic rules. Since then, entrepreneurship, democracy, population growth,
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productivity increases, and the continued influx of vitality from immigrants, have provided the first halting steps of a slow and very painful recovery. These fundamentals – not grandstanding government spending and interventions that drain the lifeblood from the private sector – will drive the long recovery. Much like my post-hip replacement recovery, when viewed objectively in terms of the amount of damage, the recovery to date is remarkable. The economy has begun a return to mediocrity, but has a long way to go until it is anywhere near the norm.

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Volume 10, Issue 3
Quarter-to-Quarter GDP Change
1.5 1.0 0.5 Percent 0.0 -0.5 -1.0 -1.5 -2.0 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10

Fall 2010

ﬁgure 2

Per Capita Gross Domestic Product
60 50 $ Thousands 40 30 20 10 0 1969 1974 1979 1984 1989 1994 1999 2004 2009 (Real - 2008 $)

ﬁgure 3

Though real GDP has rebounded 3% from its bottom, real per capita GDP remains approximately 2.9 standard deviations below its historical trend. Similarly, even as real retail sales per capita have rebounded by 6.1%, they remain 2.7 standard deviations below their historical trend. Real home prices have also improved, yet remain some 2.8 standard deviations below their historical trend, while durable and non-durable industrial output have risen by 15.8% and 4.3%, respectively, yet remain 1.7 and 2.4 standard deviations below their historic trends. Real per capita household net worth also has risen by 6.1%, yet remains 2.2 standard deviations below its historical trend. Payroll employment has risen by about 723,000, yet remains 3.1 standard deviations below its historical trend, while the unemployment rate has fallen by 50 basis points (bps), yet remains above its 30-year norm by 330 bps, or two standard deviations. Consumer sentiment is up by 125 bps, but remains 1.3 standard deviations below its norm, while multifamily and single-family housing starts remain 1.7 and 2.1 standard deviations below their respective historical norms. Median weeks unemployed has flattened, yet remains 6.3 standard deviations above its norm; capacity utilization has risen by 680 bps, yet remains 1.5 standard deviations below its norm. Auto and truck sales remain 1.3 standard deviations below

their norm in spite of a notable rebound, and the number of industry sectors adding jobs remains 0.4 standard deviations below its norm. Home value relative to disposable income stands at 3.0 standard deviations below its norm, while real after-tax profits remain 0.8 standard deviations below the historical trend. The only notable metric which is stronger than the historical trend is real financial sector profits, which has aggressively rebounded in the The only notable past year due to an artificially low Fed funds rate, and stands metric which is at 0.8 standard deviations stronger than the above the historical trend. historical trend is All this is to say that in real financial sector spite of substantial recovery, profits,… the pain remains, and the U.S. economy has a long way to go before achieving mediocrity, much less a position of strength. The rebound to date is only reflective of the severity of the collapse. My hip will get better absent a serious infection or dislocation (which I have thankfully avoided). So too, the U.S. economy will avoid a double dip so long as the government allows fundamentals to work. The recovery to date has been muted by uncertainty about healthcare, financial regulations, tax policies, and the November elections. Uncertainty is the enemy of growth, and enormous uncertainty remains because of both the nature of any recovery and today’s political framework. We hope that the November elections bring back a degree of certainty to the socio-economic-political framework by restoring a split government. Empirical evidence confirms that unified governments (of either party) are characterized by less economic growth. This is doubly true of unified governments with veto-proof super majorities, because such governments are free to bring about “much needed changes.” But this creates an atmosphere of uncertainty – the enemy of risk-taking, investment, expansion, and growth. This is particularly true as the “much needed changes” are inevitably just different rather than “much improved.” This has been amply demonstrated by the recently enacted healthcare and financial “reforms.” The simple truth is that when it comes to government, gridlock is good for the economy, as it assures a relatively stable set of rules, something sadly lacking in recent years. We still believe that the U.S. economy will add 3-3.5 million jobs for each of the next three years, placing us
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Volume 10, Issue 3 Fall 2010

among the most aggressive forecasters. But even this strong rebound would leave the unemployment rate at 7% in three years, well above the historic norm of 6.2%. Stated differently, even three years of extraordinary and sustained job growth will leave us with a disappointing economy, and miles away from a strong economy (usually thought of as an unemployment rate below 5%). Hence, our prognosis is still a robust recovery to mediocrity. Even if the U.S. unemployment rate remains at 9.5% over the next three years, the U.S. economy will add approximately 1.5 million jobs a year. Were this to occur, the U.S. economy would still be extraordinarily weak despite adding 4.5 million jobs over three years. Such a recovery would generate modest space absorption, and would leave real estate rent and occupancy fundamentals some 5 million jobs short of those found in early 2008. So why does it still feel so bad if we are recovering? Because it is still bad! Really bad. That is what a 9.5% unemployment rate means. We have a lot of pain to endure before the economy improves, and political gimmicks are not the road to success. The only route to a lasting recovery is hard work by the private sector conducted within the framework of a stable and predictable government.

We still believe that the U.S. economy will add 3-3.5 million jobs for each of the next three years, placing us among the most aggressive forecasters. But even this strong rebound would leave the unemployment rate at 7% in three years, well above the historic norm of 6.2%.

U.S. Gross Domestic Product
16 14 12 $ Trillions 10 8 6 4 2 0 1984 1989 1994 1999 2004 2009 (Real - 2008 $)

ﬁgure 4

Real GDP Growth Rate
10 8 6 Percent 4 2 0 -2 -4 -6 -8 1984 1989 1994 1999 2004 2009 Quarterly Annualized Growth

ﬁgure 5

Real GDP Growth Rate
10 8 6 Percent 4 2 0 -2 -4 -6 1984 1989 1994 1999 2004 2009 Year-Over-Year Percent Growth

ﬁgure 6

Where is the Economy Heading? With development non-existent, real estate’s nearterm future is all about the strength and timing of the economic recovery. A modest recovery has occurred since the recession ended in June 2009. And only a weak recovery will continue as long as dollars are directed from the private to the public sector, and until the “rules of the game” stabilize. Real GDP has risen 3% since the second quarter of 2009, and is only 1.3% off of the fourth-quarter 2007 peak. A robust job recovery to mediocrity is underway, with 723,000 and nearly 1.46 million jobs added from the December 2009 low point through August 2010, according to the Payroll and
4

Household Surveys, respectively. The private sector added 763,000 jobs since the December 2007 low-point, though it remains 7.7 million jobs below its peak. Global real GDP continues its rebound, fueled by positive second-quarter annualized growth in Chile (17.2%) and Mexico (12.8%) after both suffered declines in the first quarter, while China (10.3%), India (8.8%), Germany (8.7%), South Korea (5.6%), the U.K. (4.8%), France (2.5%), and Italy (1.5%) continue slow and steady recoveries. Notable exceptions include Greece (-7.2%), Iceland (-12.4%), Hungary (0%), and Japan (0.4%). Real U.S. household wealth, which bottomed in the first quarter of 2009 at $49.4 trillion (2008 $), has

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Volume 10, Issue 3 Fall 2010

since climbed $53 trillion (7.2%) through the second quarter of 2010, a year-over-year growth rate of 4%. Real tangible assets, including real estate and consumer durables, increased by $27.6 billion (0.1%) over the last year, and by $189.4 billion (0.6%) in the second quarter, while financial assets (including deposits, credit market instruments, and equities) increased by $1.6 trillion (3.8%) year-over-year and declined by $1.6 trillion (3.6%) quarter-over-quarter. During the recession, home equity as a percent of household net worth fell to its lowest level in 50 years. While it has increased modestly over the last two quarters, home prices still have a long way to go just to get back
Increase in World GDP

to the lower bounds of normality. This will not occur overnight, but will be dependent on supply and demand adjustment, which will take significant time. Total durable goods orders in July 2010 represent a 20% increase compared to the March 2009 low. Monthly automobile and light truck sales hit a low of 761,900 vehicles in February 2009, then rose to nearly 1.8 million vehicles in August 2009 (due in part to the Cash for Clunkers program), and stood at 960,000 in July 2010. During the recession, durable goods production fell by as much as 23.8% from December 2007 to June 2009, and non-durables were down 9.7% from December
U.S. Household Net Worth
80 70 60 $ Trillions 50 40 30 20 10 0 1952 1959 1966 1973 Total 1980 1987 1994 2001 2008 (Real - 2008 $)

8 7 6 5 Percent 4 3 2 1 0 -1 -2 1970 1974 1978

1982

1986

1990

1994

1998

2002

2006

2010

Net of Home Equity

ﬁgure 7

ﬁgure 10

4 3 2 Percent 1 0 -1 -2 -3 -4 -5 1Q05

Real Quarterly GDP Growth
40 30 20 Percent 10 0 -10 -20 -30 1Q06 U.S. Japan 1Q07 Brazil U.K. 1Q08 India China 1Q09 1Q10 -40 1983 1986

Change in Net Worth as a Percent of GDP

Source: tradingeconomics (China, Brazil, India); OECD (others)

1989

1992 Actual

1995

1998

2001

2004

2007

2010

5-Yr Mvg Avg

ﬁgure 8

ﬁgure 11

Unemployment Rates
14 25 12 10 Percent Percent 8 6 4 2 0 1992 1996 France 2000 Germany 2004 Italy 2008 U.S. 0 1952 1959 20 15 10 5

Home Equity as Percent of Net Worth
(Real - 2008 $)

1966

1973

1980

1987

1994

2001

2008

ﬁgure 9

ﬁgure 12

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Volume 10, Issue 3
Manufacturers’ New Orders
250 200 $ Billions 150 100 50 0 1993 1995 1997 1999 2001 2003 2005 2007 2009 500 400 300 200 100 0 1960 1967 1974 1981 1988 1995 2002 2009

Fall 2010

Industrial Production & Manufacturing Employment Indices
1960 = 100

Industrial Production Non-Defense Capital Goods Durable Goods

Manufacturing Employment

ﬁgure 13

ﬁgure 16

Industrial Manufacturing Production Index
20 15 10 Percent 5 0 -5 -10 -15 -20 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 Percent Year-Over-Year Percent Change 7 6 5 4 3 2 1 0 -1 1984

Quarterly Annualized Change in Output/Hour
All Persons - Business Sector

1989

1994

1999

2004

2009

ﬁgure 14

ﬁgure 17

Industrial Production Index
120 100 80 60 40 20 0 1973 1977 1981 1985 1989 1993 1997 Durable 2001 2005 2009 Non-Durable Durable and Non-Durable Manufacturers Units (Thousands) 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 1976 1982

U.S. Auto and Light Truck Sales

1988

1994

2000

2006

ﬁgure 15

ﬁgure 18

2007 to January 2009. These declines in manufacturing production have reversed course, with durable goods production rising from the low of 78.6 in June 2009 to 90.9 as of July 2010, leaving it 9.8% off the peak. Nondurables have risen by 4.5% since April 2009, and are off the previous peak by 8.6% as of July 2010. The auto and light truck production index rebounded from a low of 3.6 in January 2009 to 8.4 in July 2010, in a recovery to extreme mediocrity. From the low of April 2009 through July 2010, total vehicle sales increased by 14.4% on a real dollar basis and by 22.4% on a unit basis. Within the various vehicle categories, monthly auto sales increased by 18.6%, from 397,000 vehicles in February
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2009 to 471,000 units sold in August 2010. During the same period, monthly unit sales of light trucks grew by 102,000 vehicles (26.9%), while heavy truck unit sales grew by 22.4% or an additional 178,000 units between February and August 2010. Consumer confidence has rebounded from its extreme cyclical low, but declined in July 2010. It reached a prerecession peak of 96.9 in January of 2007, before plunging to a low of 56.3 in February 2009, and stood at 67.8 as of July 2010. We expect it to return to a normalized level of 90-95 in mid-2011. The improvement in consumer confidence is mirrored in the business community, where the S&P 500 rose from

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Volume 10, Issue 3 Fall 2010

a low of 676.5 in March 2009 to a high of 1,217 in late April 2010. It has since hovered around 1,100 as the economy struggles with uncertainty. Housing Market. As the U.S. population continues to grow, more people have to be housed, either in multifamily or single-family homes. In the next two years, they will be housed in smaller single-family units than in the last decade. In the first quarter of 2000, the U.S. had approximately 133,000 (0.4% of the stock) too few rental units and approximately 125,000 (0.2%) too few single-family units. This shortage of multifamily units disappeared by the second quarter of 2001, and by the fourth quarter of 2004 for single-family units. By the first quarter of 2004,

excess rental units had risen to 821,000 (2.2%). They then fell to 521,000 (1.4%) units in the first quarter of 2006, before rebounding to a high of 1,206,000 (2.9%) in the third quarter of 2009. They have fallen to 991,000 (2.3%) by the end of the second quarter of 2010. This downward movement of excess rental inventories will continue, as multifamily development remains at approximately 100,000 units versus a 25-year norm of about 330,000 units a year. It is interesting to note that over the last decade, the U.S. rental stock grew by 4,000,000 units, while rental occupancy increased by just 2,525,000 units. That is, only about 63% of the units added over the past decade were net occupied.
S&P 500 Index

University of Michigan Consumer Sentiment
120 1984 = 100

1,600 1,400 1,200

100

1,000 800 600

80

60

400 200

40 1979 1984 1989 1994 1999 2004 2009

0 1955 1961 1967 1973 1979 1985 1991 1997 2003 2009

ﬁgure 19

ﬁgure 22

80 70 60 Percent 50 40 30 20 10 0 2000 2001

Gallup Poll - Satisfaction with America
140 12-Month Moving Average 120 100 80 60 40 20 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 1936 1948

S&P 500 P/E Ratio

1960

1972

1984

1996

2008

ﬁgure 20

ﬁgure 23

MSCI World Index
450 400 (Global Stock Exchanges)

70 60 50

CBOE Volatility Index

350 Index 300 250 200 150 2004

40 30 20 10 0 2005 2006 2007 2008 2009 2010 1991 1994 1997 2000 2003 2006 2009
Source: Chicago Board Options Exchange

Source: Morgan Stanley

ﬁgure 21

ﬁgure 24

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Volume 10, Issue 3 Fall 2010
300 250 $ Thousands 200 150 100 50 0 1968 1973 1978 1983 Existing 1988 1993 1998 New 2003 2008

Single Family Home Median Sale Prices
12 10

Multifamily Vacancy Rate vs 25-Year Historical Average

Percent

8 6 4 2 0 2000 2002 2004 2006 2008 2010

25-Year Historical Average

Actual Vacancy Rate

ﬁgure 25

ﬁgure 27

Excess Vacancy
1,200 Thousands of Homes/Units 900 600 300 0 -300 2000 2002 Multifamily 2004 2006 Single Family 2008 2010 Percent 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2000

Single Family Vacancy Rate vs 25-Year Historical Average

2002

2004

2006

2008 Actual Vacancy Rate

2010

25-Year Historical Average

ﬁgure 26

ﬁgure 28

Turning to single-family, the 125,000-unit shortfall in the first quarter of 2000 grew to an excess of 891,000 units (1.2%) by the first quarter of 2008. There has since been a downward drift to 588,000 (0.8%) excess units in the second quarter of 2010. This downward movement will continue, as single-family housing starts remain at a mere 432,000 as of July 2010, versus a 25-year average of 1.2 million units. Over the past decade, the singlefamily housing stock grew by 5,203,000 units, while only 3,235,000 (62%) units of new single-family housing were net occupied. On a long-term basis, there is no doubt that the average U.S. household size is shrinking – from 3.56 people per household in 1949 to 2.57 in 2009. However, over the last five or six years, and particularly in 2009, the marginal household size (annual change in population divided by the change in the number of households) has increased. That is, if we compare only the incremental population against new household formations each year, household formations are significantly lagging historical averages because of increasing marginal household size. This trend has been exacerbated by the recession, causing people to “double-up” with relatives and roommates. The 30- and 35-year historical average marginal household sizes through 2000 were 2.32 and
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3.5 3.0 2.5 Percent 2.0 1.5 1.0 0.5 0.0 1956

U.S. Homeowner Vacancy Rate

1961

1966

1971

1976

1981

1986

1991

1996

2001

2006

ﬁgure 29

5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0 1949 1957

Annual Percent Change

1965

1973 Population

1981

1989

1997

2005

Households

ﬁgure 30

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Volume 10, Issue 3
Residential Vacancy and Homeownership Model Estimates of Total U.S. Housing Inventory (000s) Single Family (owner) occupied Single Family vacant for sale Renter occupied (MF) Renter vacant Relevant Housing Seasonal Other (rented or sold + held off market) Non-Relevant Housing Total Housing Renter Occupied Renter Vacant Rental Total Calculated Rental Vacancy Reported Rental Vacancy Renter Vacant Normal vacant (25-year avg) at 8.3% Excess Vacant Rental Units Single family occupied Single family vacant Single family total Calculated Single Family Vacancy Reported Single Family Vacancy Single family vacant Normal vacant (25-year avg) at 1.8% Excess Vacant Single Family Homes 2000 70,701 1,161 34,592 2,989 109,443 3,506 6,156 9,662 119,105 34,592 2,989 37,581 8.0% 7.9% 2,989 3,122 (133) 70,701 1,161 71,862 1.6% 1.6% 1,161 1,286 (125) 2001 72,131 1,141 34,663 3,135 111,070 3,541 6,537 10,078 121,148 34,663 3,135 37,798 8.3% 8.2% 3,135 3,140 (5) 72,131 1,141 73,272 1.6% 1.5% 1,141 1,312 (171) 2002 73,327 1,253 34,793 3,539 112,912 3,506 6,467 9,973 122,885 34,793 3,539 38,332 9.2% 9.1% 3,539 3,184 355 73,327 1,253 74,580 1.7% 1.7% 1,253 1,335 (82) 2003 71,645 1,242 33,762 3,553 110,202 3,523 6,524 10,047 120,249 33,762 3,553 37,315 9.5% 9.4% 3,553 3,100 453 71,645 1,242 72,887 1.7% 1.7% 1,242 1,305 (63) 2004 72,666 1,273 33,204 3,904 111,047 3,696 6,890 10,586 121,633 33,204 3,904 37,108 10.5% 10.4% 3,904 3,083 821 72,666 1,273 73,939 1.7% 1.7% 1,273 1,324 (51) 2005 74,488 1,388 33,267 3,765 112,908 3,602 6,831 10,433 123,341 33,267 3,765 37,032 10.2% 10.1% 3,765 3,076 689 74,488 1,388 75,876 1.8% 1.8% 1,388 1,358 30 2006 74,883 1,580 34,406 3,685 114,554 3,908 6,911 10,819 125,373 34,406 3,685 38,091 9.7% 9.5% 3,685 3,164 521 74,883 1,580 76,463 2.1% 2.1% 1,580 1,369 211 2007 75,006 2,179 34,698 3,956 115,839 4,170 7,257 11,427 127,266 34,698 3,956 38,654 10.2% 10.1% 3,956 3,211 745 75,006 2,179 77,185 2.8% 2.8% 2,179 1,382 797 2008 75,145 2,277 35,678 4,063 117,163 4,711 7,513 12,224 129,387 35,678 4,063 39,741 10.2% 10.1% 4,063 3,301 762 75,145 2,277 77,422 2.9% 2.9% 2,277 1,386 891 2009 74,942 2,114 36,426 4,155 117,637 4,894 7,897 12,791 130,428 36,426 4,155 40,581 10.2% 10.1% 4,155 3,371 784 74,942 2,114 77,056 2.7% 2.7% 2,114 1,379 735 2Q 2010 75,097 1,968 37,118 4,444 118,627 4,452 8,079 12,531 131,158 37,118 4,444 41,562 10.7% 10.6% 4,444 3,453 991 75,097 1,968 77,065 2.6% 2.5% 1,968 1,380 588

Fall 2010

Source: U.S. Census Bureau, Linneman Associates

ﬁgure 31

Cumulative Shortage of Household Formations Total Population (000s) 2004 2005 2006 2007 2008 2009 293,046 295,753 298,593 301,580 304,375 307,007 Actual less Expected HH Change (468) 158 (202) 320 (451) (754) Cumulative Actual less Expected HH Change (468) (311) (513) (193) (645) (1,399)

Population Change 2,719 2,707 2,840 2,987 2,795 2,632

Y/Y % Change 0.94% 0.92% 0.96% 1.00% 0.93% 0.86% 1.05% 1.07% 0.96% 0.94%

Total HH (000s) 112,000 113,343 114,384 116,011 116,783 117,181

Actual HH Change 722 1,343 1,041 1,627 772 398

Y/Y % Change 0.65% 1.20% 0.92% 1.42% 0.67% 0.34% 1.68% 1.69% 1.22% 0.91%

Reported HH Size 2.57 2.57 2.57 2.56 2.56 2.57 2.72 2.75 2.57 2.57

Marginal HH Size 3.77 2.02 2.73 1.84 3.62 6.61 2.28 2.32 2.90 3.36

Expected HH Change* 1,190.39 1,185.18 1,243.25 1,307.43 1,223.50 1,152.04

35-Year Average (1970-2005) 30-Year Average (1970-2000) Latest 10-Year Average (1999-2009) Latest 5-Year Average (2004-2009)

* Expected HH Change = Change in Population divided by 30-Year Average (1970-2000) marginal household size of 2.28 Source: Census Bureau, Linneman Associates

ﬁgure 32

2.28 people per household, respectively. However, the marginal household size increased to 2.9 people per household over the last decade and 3.36 over the last five years. In 2009, the marginal household size was an extraordinary 6.61 people per new household formed. Applying the 35-year historical average marginal household size (2.28 people per household) to the incremental population over the last six years, we estimate

that there is pent-up demand of about 1.4 million households. This does not even include the presumed shortfall in 2010, because household …we estimate that data has not yet been released there is pent-up by the Census. Unless we are demand of about becoming Italy, where even married couples live with their 1.4 million parents, these pent-up househouseholds.
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THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Read what the experts are saying about Real Estate Finance and Investments: Risks and Opportunities.
“Peter’s book brings a much needed blend of theory and practice to the analysis of real estate finance and investment. Too often this field is presented as little more than algebra, with students assembling rows and columns of numbers, but having no idea what they mean.” Samuel Zell Chairman, Equity Group Investments “In contrast to many academic texts, Peter’s book reveals the challenges and excitement of the industry. His examples are realistic, revealing the author’s grasp of both theoretical complexity and the necessity of pragmatic decision making. The lively writing style is consistent with his approach as a valued industry advisor: clear, concise, and on target.” Albert Behler President, Paramount Group Inc. “This book offers students a rare glimpse into the tools and decision making of real estate finance. Its straightforward exposition allows one to grasp the challenges facing real estate investors, and provides them with an excellent foundation upon which to build their careers. This book will be required reading for

holds will be formed if and Unless we are when the U.S. economy adds becoming Italy, jobs. When jobs are added, these households will quickly where even married disperse into both rental and couples live with single-family housing, and in their parents, these so doing will rapidly absorb pent-up households excess inventories. will be formed if Seasonally adjusted anand when the U.S. nual single-family home starts reached an all-time low economy adds jobs. of 360,000 homes in January 2009, compared to a 48-year (1960-2008) historical average of nearly 1.1 million. This annual rate stood at 432,000 new single-family home starts as of July 2010. Similarly, multifamily starts averaged about 375,000 units per year between 1964 and 2008, hitting a low annualized rate of 62,000 new units in February 2010 and standing at 95,000 in July. As jobs are created, causing up to 1.4 million pent-up households to form, about 775,000 new single-family homebuyers and an estimated 625,000 new renters will emerge. This is on top of the 2.3 million households that will form as the result of population growth of 6 million over the next two years. Meanwhile, we anticipate that 1.2-1.3 million singlefamily and 400,000 multifamily home starts will occur
800 700 600 $ Billions 500 400 300 200 100 0 1995 1998 2001 Nominal 2004 Real 2008 $ 2007 2010

Single Family Construction Put In Place

ﬁgure 33

New Homes Inventory
700 600 Thousands 500 400 300 200 100 0 1975 1980 1985 1990 1995 2000 2005 2010 14 12 Months 10 8 6 4 2 0

new real estate professionals for many years to come.” Dean Adler CEO, Lubert-Adler Partners To order, go to www.linnemanassociates.com.

Homes for Sale

Months Supply

ﬁgure 34

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Volume 10, Issue 3 Fall 2010
2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 1959 1965 SF (LTM)

Single Family Starts Forecast
280 260 240 220 200 180 160 140 120 100 1991

U.S. National Home Price Indices

Thousands of Units

Index Value

1971

1977

1983

1989

1995

2001

2007

2013

1994 NAR (NSA)

1997

2000 FHFA (SA)

2003

2006

2009

Forecast of SF (LTM)

Forecast of SF (SA)

Case-Shiller (SA)

ﬁgure 35

ﬁgure 37
U.S. Home Price Indices Show Strengthening Markets Case-Shiller Q/Q % Y/Y % -5.2 -13.5 -3.8 -14.9 -4.6 -16.6 -6.2 -18.4 -5.6 -18.7 1.1 -14.6 2.0 -8.6 0.3 -2.3 -1.3 2.1 2.5 3.5 FHFA Q/Q % Y/Y % -1.7 -3.7 -1.8 -5.5 -2.2 -6.8 -2.8 -8.3 -0.3 -7.0 -0.7 -5.9 -0.1 -3.9 -0.3 -1.4 -2.1 -3.2 0.9 -1.6 NAR Q/Q % -4.3 4.8 -3.1 -10.6 -7.2 4.1 2.3 -4.4 -2.3 6.3 Y/Y % -7.2 -7.0 -8.8 -13.2 -15.7 -16.3 -11.6 -5.5 -0.5 1.5

Multifamily Starts Forecast
1,200 Thousands of Units 1,000 800 600 400 200 0 1959 1965 1971 1977 1983 1989 1995 2001 2007 2013 MF (LTM) Forecast of MF (LTM) Forecast of mf (SA)

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10

Source: Case-Shiller, Federal Housing Finance Agency, National Association of Realtors, Linneman Associates

ﬁgure 38 ﬁgure 36

over the next two years. The net result will be that we burn through the excess inventory. Low single-family inventory levels will create upward pressure on home values, restoring some lost confidence in homes as an investment. Housing prices reached bottom over a year ago and have since witnessed a strengthening upward movement. For the first time since early 2006, both the Case-Shiller and the National Association of Realtors home price indices registered positive year-over-year and quarter-over-quarter returns in the second quarter of 2010. The Case Shiller and the NAR indices grew by 3.5% and 1.5%, respectively, year-over-year. The broader FHFA government home price index posted positive quarter-over-quarter growth (0.9%), but negative year-over-year growth (-1.6%), albeit less negative than previous quarters. Over the past four quarters, median home prices based on the FHFA indices have consistently improved on a year-over-year basis across the 25 largest metropolitan areas. The Baltimore, Cleveland, Denver, Houston, Pittsburgh, San Diego, Orange County, and Washington, D.C. metro areas have all experienced three or more consecutive quarters of positive year-over-year growth. In the second quarter, the strongest performers (compared to the second quarter of 2009) were Oakland (9.9%), Washington, D.C. (7.5%), Houston (5.1%), and Los Angeles (4.6%).

The NAHB/Wells Fargo Housing Market Index
90 75 60 45 30 15 0 1987 1990 1993 1996 1999 2002 2005 2008 (Homebuilder Survey of Market Conditions)

ﬁgure 39

Quality Adjusted Home Prices
8 6 4 Percent 2 0 -2 -4 -6 1995 1998 2001 2004 2007 2010 Year-Over-Year Percent Change

Source: National Association of Homebuilders

ﬁgure 40

Only one-third of the markets registered negative year-over-year growth in the second quarter, but this was generally less negative than year-over-year growth in
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New and Existing Home Sales Volume

Fall 2010

8 7 6 Millions 5 4 3 2 1 0 1975

Sales at furniture and home furnishing stores rose by 0.1%, health and personal care stores by 2.7%, and restaurants and bars by 1.2%. Sales at gas stations rose by 11.4%, while electronics and appliance stores (3.6%), sporting goods, hobby, book, and music stores (4.1%), and grocery and liquor stores (0.8%) also exhibited positive growth between June 2009 and August 2010. Department stores were the
2005 2010YTD

1980

1985

1990 New Sales

1995 2000 Existing Sales

U.S. Retail Sales
360 330 $ Billions 300 270 240 210 180 150 1993 1995 1997 1999 Total 2001 2003 2005 2007 2009 (Real - 2009 $)

ﬁgure 41

the previous quarter. The weakest markets were Phoenix (-5.5%), Tampa (-4.8%) and Edison-New Brunswick, NJ (-3.5%). On a quarter-over-quarter basis, 80% of the 25 markets registered positive growth in the second quarter of 2010, with Oakland (6.5%), Atlanta (5.3%), Minneapolis (5%), and Houston (4.6%) leading the charge. The weakest second-quarter home price growth occurred in EdisonNew Brunswick, NJ (-2.9%), Phoenix (-2.6%), and St. Louis (-1.9%). Total real retail sales in the U.S. bottomed in March 2009 at about $300.6 billion, and have since risen by 6.4% to about $320 billion in August 2010. We anticipate a continued rebound into 2011 as job growth occurs. Between June 2009 and August 2010, seasonally adjusted real retail sales grew by 4.8% (4.4% excluding auto and auto parts). Stores that sell building materials, garden equipment, and supplies experienced a 1.4% increase over the same period.

Excl. Motor Veh. & Parts

ﬁgure 43

Inventory-Sales Ratio: Retail vs. Manufacturing
1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 1992 1994 1996 1998 2000 2002 2004 Retail 2006 2008 2010

Manufacturing

ﬁgure 44

Atlanta-Sandy Springs-Marietta, GA Baltimore-Towson, MD Chicago-Joliet-Naperville, IL (MSAD) Cleveland-Elyria-Mentor, OH Dallas-Plano-Irving, TX (MSAD) Denver-Aurora-Broomfield, CO Edison-New Brunswick, NJ (MSAD) Houston-Sugar Land-Baytown, TX Los Angeles-Long Beach-Glendale, CA (MSAD) Miami-Miami Beach-Kendall, FL (MSAD) Minneapolis-St. Paul-Bloomington, MN-WI Nassau-Suffolk, NY (MSAD) New York-White Plains-Wayne, NY-NJ (MSAD) Oakland-Fremont-Hayward, CA (MSAD) Philadelphia, PA (MSAD) Phoenix-Mesa-Glendale, AZ Pittsburgh, PA Riverside-San Bernardino-Ontario, CA St. Louis, MO-IL San Diego-Carlsbad-San Marcos, CA Santa Ana-Anaheim-Irvine, CA (MSAD) Seattle-Bellevue-Everett, WA (MSAD) Tampa-St. Petersburg-Clearwater, FL Warren-Troy-Farmington Hills, MI (MSAD) Washington-Arlington-Alexandria, DC-VA-MD-WV (MSAD) Source: Federal Housing Finance Agency, Linneman Associates

FHFA Home Price Index Growth Quarter-over-Quarter % Change 3Q09 4Q09 1Q10 4.8 -6.8 -3.2 1.2 -4.6 -0.4 1.9 -5.4 -2.1 2.6 -2.0 -2.6 2.0 -0.8 -1.3 1.1 -2.9 2.3 -1.0 -2.0 2.3 1.4 -0.3 -0.4 3.7 0.5 -0.8 3.8 -3.5 -0.8 0.2 -1.5 -3.5 1.7 -1.6 -0.3 -1.4 0.7 -0.7 3.4 2.0 -2.0 -1.7 1.6 -1.2 -0.7 -1.6 -0.8 1.4 -1.7 1.2 2.6 1.5 -1.7 2.4 1.0 2.8 3.7 0.1 0.6 -1.8 0.3 -1.7 -1.5 -1.6 0.4 -0.9 -3.3 0.8 -0.9 1.7 -5.7 3.0 2.6 -0.6

2Q10 5.3 2.0 3.2 2.9 3.6 0.9 -2.9 4.6 1.2 0.7 5.0 -0.2 0.8 6.5 1.0 -2.6 -0.6 1.7 -1.9 0.0 0.2 2.9 -1.6 3.8 2.3

3Q09 -4.9 -5.4 -6.9 -1.2 0.0 3.6 -4.9 0.3 -6.8 -16.5 -6.6 -4.4 -5.2 -6.7 -4.1 -22.7 2.2 -15.2 -1.8 -4.9 -2.9 -11.3 -13.5 -14.1 -0.5

Year-over-Year % Change 4Q09 1Q10 -3.3 -2.8 -3.9 -5.1 -8.2 -5.6 2.4 3.0 -0.1 0.7 4.5 4.1 -4.2 -1.6 3.1 4.3 -0.3 3.2 -12.5 2.5 -3.6 -1.4 -3.5 -2.6 -2.2 -1.8 -0.2 8.4 0.1 -0.5 -12.4 -8.1 3.7 3.3 -5.4 -1.6 0.8 1.3 1.6 7.8 4.4 4.7 -5.7 -6.4 -7.3 -8.5 -6.3 -4.3 8.8 10.8

2Q10 -0.3 -2.0 -2.6 0.8 3.5 1.3 -3.5 5.1 4.6 0.1 -0.1 -0.3 -0.6 9.9 -0.4 -5.5 0.4 4.1 0.0 4.5 4.4 -2.9 -4.8 -1.5 7.5

ﬁgure 42

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Volume 10, Issue 3 Fall 2010
Real Retail Sales Components
310 2007 $ Billions 260 210 160 110 60 10 1993 1995 1997 Other 1999 2001 2003 2005 Gasoline 2007 2009

ICSC-Goldman Sachs Weekly Chain Store Sales Index
520 510 500 490 480 470 460 450 440 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10

Vehicle Sales

ﬁgure 45

ﬁgure 47

only exception to the trend, dropping 2.2% over the same period. Certain category sales were only reported through July 2010 as we go to print. All of those retail segments, including electronic shopping and mail order (14.8%), jewelry stores (3.6%), warehouse clubs and superstores (2.9%), and clothing and shoe stores (3.5%), posted positive growth between June 2009 and August 2010. The International Council of Shopping Centers (ICSC) publishes the Shopping-Center Business Activity Index, which is a composite cyclical industry indicator of shopping-center jobs, construction, sales, and interest rates. It peaked in November 2007 and continues to decline, despite a temporary uptick in the first quarter of 2010. From its peak, the index declined by 21% through June 2010. Similarly, the ICSC-Goldman Sachs Weekly Chain Store Sales Index rose by 5.1% during the first seven months of 2010, but has since given back 2.3% heading into September. In addition, ICSC’s ShoppingCenter Executive Barometer of Future Business is a compilation of components including sales, customer traffic, occupancy rates, rent spreads, and capitalization rates. It dipped below 50% in July 2010, after reaching 57.8% in May. (A reading over 50% indicates growth). Since its low of 65.4% in June 2009, manufacturing capacity utilization has since risen 680 bps to 72.2% in

ICSC Shopping-Center Executive Survey
70 60 50 40 30 20 10 0 2003 2004 2005 2006 Current Barometer 2007 2008 Future Barometer 2009

ﬁgure 48

200 180 160 140 120 100 80 60 40 20 0 1980

ICSC Shopping-Center Business Activity Index

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

ﬁgure 46

July 2010. This is compared to a 20-year average of 79%, which is where it stood in 2007. The rebound in corporate profits is the strongest driver of job growth. On an annualized basis, real aftertax corporate profits in the second quarter of 2010 rose by $405 billion compared to the fourth quarter of 2008. This 52% increase in after-tax profits has resulted in a spike of more than 160% in undistributed profits, substantially reversing the $187 billion decline (-17%) that occurred during 2008. However, in the absence of predictable and stable rules of the game (at least until after the November elections), profits will largely be undistributed. This means that already fat corporate balance sheets will become even fatter. Companies have more cash than at any time in their history, and the reason for this is that they are not confident about financial markets or the tax and regulatory context. The financial sector has made an enormous profitability rebound. This is one of the dirty secrets of the recovery, with real profits back to the levels at the height of the boom. These profits are allowing for bank write-offs and a tentative return of business loans. Loans are being made on difficult terms, and only to those with the best credit, but they are being made. By the second quarter of 2010, financial service profits had rebounded by over 600% from their fourth-quarter 2008 low.
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Manufacturing Capacity Utilization
90 85 80 Percent 75 70 65 60 55 1984 1989 1994 1999 2004 2009

From its peak in the first quarter of 2008 through the third quarter of 2009, U.S. private commercial investment fell by 20%. It has since rebounded by 6.8%, primarily due to improved corporate profits. Specifically, private commercial investment in equipment and software has increased by 14.6%, while investment in new commercial structures declined by 12.6%, due to the excess supply of real estate associated with the loss of 8.4 million jobs.
U.S. Private Residential Investment
900 800 2000 $ Billions 700 600 500 400 300 200 100 0 1995 1997 1999 Structure 2001 2003 2005 2007 2009

ﬁgure 49

Profits as Percent of Real GDP
10 9 8 7 6 5 4 3 2 1 0 1981 1985 1989 Non-financial Corporations

Percent

Equipment & Software

ﬁgure 53
1993 1997 2001 2005 2009

ﬁgure 50

600 500 400 $ Billions 300 200 100 0 -100 2001

Financial Sector Corporate Profits
(Real 2008 $)

2003

2005

2007

2009

ﬁgure 51

After increasing in the second half of 2009, private residential investment took a step back in the first quarter of 2010, hitting a new low of $330 billion, but then jumped back to $350 billion in the second quarter. The “two steps forward, one step back” trend is driven by the increase in seasonally adjusted annual single-family home starts, from an all-time low of 360,000 in January 2009, to 432,000 as of July 2010. Real disposable personal income rose by 0.4% yearover-year through the second quarter of 2010. Real wage and salary income declined by 6.6% during the recession, but has subsequently risen by 1.3% as of July 2010. Real personal consumption expenditures were up by 1.7% year-over-year through the second quarter of 2010, and by 0.5% quarter-over-quarter. Real housing expenditures rose by 0.1% over the last four quarters,
Real Disposable Personal Income
Year-Over-Year Percent Change 7 6 5 Percent 4 3 2 1 0

U.S. Private Commercial Investment
(Real - 2000 $) 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 1995 1997 1999 Structure 2001 2003 2005 2007 2009 Equipment & Software

$ Billions

-1 1995 1997 1999 2001 2003 2005 2007 2009

ﬁgure 52

ﬁgure 54

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Net Worth as Multiple of Disposable Income
7.0 6.5 6.0 Percent Multiple 5.5 5.0 4.5 4.0 3.5 3.0 1960 1966 1972 1978 1984 1990 1996 2002 2008 (Real - 2008 $) 70 69 68 67 66 65 64 63 62 1995 1997 1999 2001 2003 2005 2007 2009

Services as a Percent of U.S. Consumption

ﬁgure 55

ﬁgure 59

140 130 120 110 100 90 80 70 60 50 1963

Index of U.S. Median Home Price to Disposable Personal Income per Capita
(Real 2005 $)

14 12

Official Personal Savings Rate

Percent

Avg Indexed to 100

10 8 6 4 2 0 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

1967

1972

1977

1981

1986

1991

1995

2000

2005

2009

ﬁgure 56

ﬁgure 60

Employment Cost Index
12 10 Percent 8 6 4 2 0 2001 2002 2003 2004 2005 2006 2007 Benefits 2008 2009 2010 Wages & Salaries Year-over-Year Percent Change

$140 $120 $100 $80 $60 $40 $20 $0 1969 1973

Historical Crude Oil Price Per Barrel

1977

1981

1985

1989

1993

1997

2001

2005

2009

WTI Spot Price

Real Price in 2007 Dollars

ﬁgure 57

ﬁgure 61

Personal Consumption Expenditures
10 8 $ Trillions 6 4 2 0 1995 1997 1999 2001 2003 2005 2007 2009 (Real 2005 $) $ Per Gallon 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 1990 1992

Retail Gas Price Per Gallon
(Regular Grade)

1994 Nominal

1996

1998

2000

2002

2004

2006

2008

Real $ 2008

Source: U.S. Dept. of Energy

ﬁgure 58

ﬁgure 62

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Volume 10, Issue 3
Net Borrowing by Households and Nonfinancial Businesses

Fall 2010

2,500 2,000

35 30 Percent 25 20 15 10 1980 1984

Financial Obligations as % of Disposable Personal Income

1,500 $ Billions 1,000 500 0 -500 -1,000 1952 1959 1966 1973 1980 1987 1994 2001 2008

1988

1992 Renter

1996

2000

2004

2008

Homeowner

ﬁgure 63

ﬁgure 66

8 7 6 Percent 5

Consumer Loan Delinquencies
43 42 41 Hours 40 39 38 1995 All 1999 2003 Credit Cards 2007 37 1964 1969 1974

Average Weekly Hours
U.S. Manufacturing

4 3 2 1 0 1991

1979

1984

1989

1994

1999

2004

2009

ﬁgure 64

ﬁgure 67
Homeowner Financial Obligations as % of Disposable Personal Income

20 16 Percent 12 8 4 0 1980

1984

1988

1992 Mortgage

1996

2000

2004

2008

low-point: average weekly manufacturing hours worked (4.3%); average weekly overtime hours (50%); new orders received by manufacturers for durable (33%) and non-defense goods (20%); single-family housing starts (20%); industrial production (10%); non-durable (2.8%) and durable (8.2%) goods consumption; and industrial inventories (3.9%). Taken together, these factors indicate that a solid cyclical economic recovery is underway. But What About Jobs? Through August 2008, we were in a typical recession concentrated in housing, autos, and a financial sector that financed the overexpansion of these sectors. Then the government caused a complete panic-induced collapse, which resulted in the needless loss of at least 6.2 million jobs. The needless job losses are underscored by the fact that only 4.6 million (about 55%) of the total 8.4 million lost jobs since year-end 2007 were in manufacturing (including autos), construction, or finance. Historically, about six quarters of prolonged profit growth are needed before companies hire aggressively. A job recovery is underway, with profitable employers finally replacing employees who died, retired, took maternity leave, or went back to school. Unfortunately, many small firms were needlessly destroyed and hampered as the

Consumer Debt

ﬁgure 65

while auto expenditures grew by 4.1% over the same period and real personal expenditures on gasoline edged up by 0.3%. Service consumption also rose by 0.3%, with medical expenditures increasing by 0.5% year-over-year through the second quarter of 2010. Quarter-over-quarter results for the second quarter 2010 were: total personal expenditures (0.5%); housing (0.3%); gasoline (1.2%); auto (1.8%); service (0.3%); and medical (0.2%). Consumer credit has fallen by roughly 3.5% over the past year through the second quarter of 2010, as consumers have reduced the use of credit and have paid down some debt. Though the economy is still very weak, almost every major economic indicator has risen from its respective
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Volume 10, Issue 3 Fall 2010

government artificially channeled scarce capital to large, politically connected firms. The result is that small firms are unable to fuel a recovery in this cycle, as they have been starved of capital. An improving job market is evidenced by: increases in the number of weekly hours worked; a 4% decline in “marginally attached” workers from 2.5 million in February 2010 to 2.4 million in August; a 22% year-over-year increase in temporary help service workers; and an increase in the number of employees quitting (because they now have improved options). Marginally attached workers include those who want a job, have searched for work during the prior 12 months, and were available to take a job, but had not looked for work in the past four weeks. Declining levels are an indication that more people are either getting jobs or actively looking. The increased use of temp workers reflects a rebounding workforce, as temp workers are a flexible means of increasing employment in the early stages of a recovery. Temporary help services increased employment by 205,000 jobs over the first eight months of 2010. Based on the Payroll Survey, total employment peaked in December 2007 at nearly 138 million jobs, and bottomed two years later with 8.36 million fewer jobs. Since year-end 2009, we have gained back 723,000 jobs through August. In comparison, the Household Survey, from which unemployment statistics are calculated, indicates that employment peaked in November 2007 at just under 146.5 million jobs, bottomed in December 2009 almost 8.7 million lower, and has since grown by over 1.5 million. Of those lost jobs, 5.23 million were concentrated among males older than 19, and only 1.95

Historically, about six quarters of prolonged profit growth are needed before companies hire aggressively.

U.S. Payroll Employment
6 4 Percent 2 0 -2 -4 -6 1973 1979 1985 1991 1997 2003 2009 Year-Over-Year Percent Change

ﬁgure 69

million among women older than 19. This reflects the high concentration of males in manufacturing, construction, and finance, while women are disproportionately employed in the less adversely impacted government, healthcare, and education sectors. We anticipate that the next three years will continue to see average job growth of 250,000 per month, for a 3-year increase of about 9 million jobs by early 2013. But this recovery will be due primarily to the restocking of jobs vacated during the panic, rather than a net employment expansion. While such job growth may seem overly optimistic, it is important to remember that our forecast would leave us with almost the same number of jobs in mid-2013 as existed at the beginning of September 2008, in spite of a population that will have grown by 15 million people. Employment today is basically the same as in November 1999, despite the fact that population has grown by more than 25 million people. If we add 9 million jobs over the next three years, we will still have an unemployment rate of roughly 7%: a robust rebound to mediocrity. The key for the real estate sector is job growth, as a recovery without jobs does not fill buildings. Total nonfarm payroll employment grew through the first five months of 2010, falling slightly thereafter, to 130.3 million jobs as of August, from 130.6 million in May.
69 64 Millions 59 54 49 44

Number of Persons Employed
160 150 140 130 120 110 100 90 80 70 60 1984 1989 1994 Payroll Survey 1999 2004 2009

Forecast Employment For All LL Metro Areas

Millions

1988

1992

1996

2000 LL Forecast

2004

2008 Actual

2012

Household Survey

ﬁgure 68

ﬁgure 70

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Payroll Survey Employment (000s) Industry Information Construction Other Services Government Mining and Logging Trade, Trans, & Utilities Manufacturing Leisure and Hosp Prof & Business Svcs ﬁgure 71 Dec-07 3,023 7,491 5,514 22,377 739 26,709 13,726 13,535 18,051 Trough Date Jun-10 Feb-10 Feb-10 Dec-07 Oct-09 Dec-09 Nov-09 Dec-09 Sep-09 Trough 2,711 5,585 5,310 22,377 669 24,653 11,552 12,991 16,349 Aug-10 2,714 5,611 5,343 22,441 741 24,757 11,679 13,124 16,714 Peak to Trough % Change Change -312 -10.3% -1,906 -25.4% -204 -3.7% 0 0.0% -70 -9.5% -2,056 -7.7% -2,174 -15.8% -544 -4.0% -1,702 -9.4% Trough to Present % Change Change 3 0.1% 26 0.5% 33 0.6% 64 0.3% 72 10.8% 104 0.4% 127 1.1% 133 1.0% 365 2.2%

Fall 2010

Monthly Change in Payroll Employment
600 400 Thousands 200 0 -200 -400 -600 -800 -1,000 Dec-07 May-08 Oct-08 -779 Mar-09 Aug-09 Jan-10 Jun-10 -54 -175 432 313

ﬁgure 72

In comparing sectoral job losses from December 2007 through each sector’s respective trough, it is clear that the pain was disproportionately distributed. While manufacturing (-16%) and construction (-25%) hemorrhaged jobs during the recession, losses in some industries were more muted. On an absolute basis from peak to respective trough, manufacturing (-2.2 million), trade, transportation, and utilities (-2.1 million), construction (-1.9 million), and professional and business services (-1.7 million) lost the most jobs. Manufacturing and trade, transportation, and utilities turned the corner in the fourth quarter of 2009, while construction did not reverse course until late in the first quarter of 2010.
Sectoral Job Losses
0.6 Construction Information Other Services Manufacturing Prof. & Bus Svc Govt Trade, Trans, Util. Leisure & Hosp. Mining & Logging 0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 Aug-10 Millions of Jobs

The obvious winner was the government sector, which effectively did not shed any jobs at all. The other relatively strong sectors (healthcare, information technology, education, and pharmaceuticals) experienced demand growth during the recession, yet still shed jobs, largely via hiring freezes. That is, job losses in those sectors were due more to the lack of replacements for employees who died, retired, or went on maternity leave. As profits have rebounded over the last 21 months, and the panic has subsided somewhat, these sectors have lifted hiring freezes and have begun replacing those who left. According to the June 2010 Job Openings and Labor Turnover Survey, 48% of industries are adding workers on a 12-month moving average basis, versus the 9-year average of 50%. This is massively improved from 29% 11 months ago. Comparing payroll employment from the December 2007 peak through August 2010 (beyond the trough), it is clear that most sectors have posted very
Payroll Survey Sector Comparison
December 2007 - Trough Government Mining and Logging Other Services Information Leisure and Hosp Prof & Business Svcs Construction Trade, Trans, & Utilities Manufacturing -1,702 -1,906 -2,056 -2,174 -2,000 -1,500 -1,000 -500 0 -544 -204 -312 -70 0

-2,500

Aug-08

Nov-08

Feb-09

May-09

Aug-09

Nov-09

Feb-10

May-10

Change in Employment (000s)

ﬁgure 73

ﬁgure 74

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Manufacturing as a % of Total Employment
40 35 30 Percent 25 20 15 10 5 0 1940 1950 1960 1970 1980 1990 2000 2010 Mining and Logging Government Other Services Construction 10.8% 0.3% 0.6% 0.5% 0.1% -100 0 100 200 300 400 Trade, Trans, & Utilities 0.4% Prof & Business Svcs Leisure and Hosp Manufacturing 1% 1.1% 2.2% (with trendline)

Payroll Survey Sector Comparison
Trough - August 2010

ﬁgure 75

Services as a % of Total Employment
100 95 90 85 80 75 70 65 60 55 50 1940 1950 1960 (with trendline) Information

Percent

Change in Employment (000s)

ﬁgure 78

1970

1980

1990

2000

2010

ﬁgure 76

Percent of Industries Adding Workers
70 60 50 Percent 40 30 20 10 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 (12-month moving average)

ﬁgure 77

modest gains from their respective troughs, but are still significantly below their peaks. The notable exception is the government sector, which registered an increase of 64,000 jobs between December 2007 and August 2010. On an absolute basis, the biggest job losses during this period were: manufacturing (-2.1 million); trade, transportation, and utilities (-2 million); construction (-1.9 million); and professional and business services (-1.3 million). On a percentage basis, construction (-25.1 %) and manufacturing (-15 %) were the worst performers. The good news is that all major industries have registered employment gains from their respective troughs. Aside from the government sector (64,000), the largest absolute job increases were in professional

and business services (365,000), leisure and hospitality (133,000), manufacturing (127,000), and trade, transportation, and utilities (104,000). On a percentage basis, the largest gains were made in mining and logging (10.8 %), professional and business services (2.2%), manufacturing (1.1%), and leisure and hospitality (1%). As we go to print, the latest available MSA employment data are through July 2010. We examined each MSA’s respective employment peak versus where it stood in both February and July 2010. According to both the Payroll and Household Surveys, none of the markets in our analysis have reached their peak employment levels. However, most markets posted positive employment growth from February through July 2010. For the Payroll Survey, the largest 5-month percentage gains were seen in Washington, D.C. (4.6%), Baltimore (4.6%), Long Island (3.9%), Minneapolis (3.7%), and Austin (3.2%). Is it any surprise that three of the top ﬁve performers are government seats? Similarly, the markets with the top 5-month percentage growth based on the Household Survey include Cleveland (5.3%), Cincinnati (4.9%), Westchester (4.8%), Long Island (4.3%), Nashville (4.1%), and Indianapolis (4.0%). Based on the Payroll Survey, only Washington, D.C. has surpassed its December 2007 employment base. Markets that are 400 bps or fewer away from their respective peaks include Austin (-100 bps), Houston (-390 bps), and New York City (-400 bps). At the other end of the spectrum, the markets farthest from pre-recession levels are Detroit (-2,500 bps), Las Vegas (-1,550 bps), and Riverside-San Bernardino (-1,530 bps). The
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Employer Payroll Survey versus Household Survey February 2010 Thru July 2010 & Peak Thru July 2010* Strong Employers % Change Feb-July ’10 4.6 4.6 3.9 3.7 % Change Peak to Present 0.1 -4.2 -12.3 -6.2 Households % Change Feb-July ’10 3.6 3.1 4.3 3.4 % Change Peak to Present -1.1 -6.7 -3.1 -0.8 Employers % Change Feb-July ’10 0.9 0.9 0.8 0.8 0.7 0.6 0.2 0.0 % Change Peak to Present -8.5 -25.0 -9.0 -3.9 -5.1 -8.3 -10.9 -9.3 Weak Households % Change Feb-July ’10 2.0 2.3 0.6 0.3 3.6 1.4 1.2 0.6 % Change Peak to Present -18.2 -18.8 -8.9 -5.5 -1.9 -4.2 -6.2 -10.9

Fall 2010

Washington, D.C. Baltimore Long Island Minneapolis

San Jose Detroit Atlanta Philadelphia Raleigh-Durham San Diego Sacramento San Francisco

Solid Employers % Change Feb-July ’10 3.2 3.0 2.9 2.9 2.5 2.5 2.2 2.0 1.9 1.8 1.6 1.5 1.5 1.5 1.4 1.3 1.0 % Change Peak to Present -4.5 -4.3 -7.0 -5.7 -7.8 -6.5 -8.4 -4.0 -6.7 -6.3 -6.5 -6.3 -5.8 -6.2 -4.4 -1.0 -11.5 Households % Change Feb-July ’10 1.4 2.8 4.0 2.5 1.4 2.7 2.5 1.3 4.1 1.0 2.1 3.1 2.0 4.9 1.4 3.1 1.5 % Change Peak to Present 3.4 -2.5 -8.0 -5.5 -2.6 -3.4 -6.6 0.0 -3.9 -2.6 -4.9 -6.4 -6.0 -3.2 -5.1 -3.7 -7.6 Employers % Change Feb-July ’10 Orlando -0.6 Los Angeles -0.7 Charlotte -1.0 Northern/Central NJ Metro (excl LI) -1.0 -1.1 Tampa Riverside-San Bernardino -1.2 Ft. Lauderdale -1.2 West Palm Beach -1.7 Phoenix -1.8 Miami -2.0

Disaster Households % Change Feb-July ’10 2.9 0.0 1.7 0.4 2.2 -0.1 2.3 1.2 0.6 0.2 % Change Peak to Present -6.2 -8.4 -7.0 -5.1 -7.1 -10.8 -8.1 -9.6 -3.5 -2.3 % Change Peak to Present -11.1 -10.5 -10.6 -15.5 -12.4 -15.3 -13.9 -15.0 -14.3 -11.6

Austin Boston Indianapolis Denver Seattle Fairfield County Chicago Dallas/Fort Worth Nashville New York City U.S. St. Louis Kansas City Cincinnati Portland Columbus Orange County

Questionable Employers % Change Feb-July ’10 4.1 2.6 -0.1 -0.3 % Change Peak to Present -6.6 -6.7 -9.9 -9.2 Households % Change Feb-July ’10 0.4 -2.4 4.8 5.3 % Change Peak to Present 0.8 -7.7 -5.4 -7.6

Houston Las Vegas Westchester County Cleveland

* July 2010 is based on preliminary MSA data from the Bureau of Labor Statistics; MSAs have varying peak employment dates.

ﬁgure 79

Household Survey also indicates that Austin, Houston, and Dallas have all reached peak levels, if not surpassed them, while Minneapolis (-80 bps), Philadelphia (-110 bps), Miami (-160 bps), Minneapolis, (-230 bps), DallasFort Worth (-250 bps), Washington, D.C. (-110 bps), and Raleigh-Durham (-190 bps) are all fewer than 200 bps away from their respective December 2007 levels.
12 10 8 6

30 25 20 Weeks 15 10 5 0

Median Weeks Unemployed

U.S. Civilian Unemployment Rate

1995

1997

1999

2001

2003

2005

2007

2009

ﬁgure 81

60 4 50 2 0 1969 1974 1979 1984 1989 1994 1999 2004 2009 Percent 40 30 20

Percent of U.S. Unemployed

ﬁgure 80

10 0

At 9.6%, the August 2010 unemployment rate declined by 50 bps compared to its peak of 10.1% in October 2009. The median unemployment duration
20

1995

1997

1999

2001

2003

2005

2007

2009

> 26 Weeks

< 5 Weeks

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2.6 2.4 2.2 Percent 2.0 1.8 1.6 1.4 1.2 1.0 1995 1997 1999 2001 2003 2005 2007 2009

Labor Force Unemployed for Less than 5 Weeks

ﬁgure 83

stands at 19.9 weeks, a significant decline from 25.5 weeks just two months earlier. The percent unemployed more than 27 weeks declined in the last two months, and stood at 42% in August, significantly higher than the low of 17.5% in December 2007, but below the 46% high in June 2010. At the same time, short-term (five weeks or less) unemployment spells account for 18.6% of the unemployed, compared to 36.5% at the beginning of the recession. Thus, both metrics are showing early signs of improvement. Unemployment remains extraordinarily male-centric, with 9.8% of males over the age of 20 unemployed, versus 8% of females as of August 2010. In late 2007, the unemployment rates for both males and females over
30 25 20 15 10 5 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Unemployment Rate (16-19 Year Olds)

the age of 20 were 4.5% and 4.6%, respectively. At the peak, the adult male unemployment rate was 10.6% in October 2009, and the adult female unemployment rate was 8.2% in April 2010. Teens were crushed by the recession. As a result of the 32% real minimum wage increase, teen workers accounted for about 18% of the nearly 8.7 million jobs lost from the Household Survey peak. Their unemployment rate rose from 16.9% at the end of 2007 to 26.3% in August 2010. Although today’s level is below the October 2009 peak of 27.6%, it represents an increase of 1,080 bps over the pre-recession level, standing in stark contrast to the 200300-bps increase that normally occurs for teens during a recession. This dramatic increase is similar to that of the 1973-1975 recession, which also coincided with a precipitous increase in the minimum wage. If there is a bright side to this disastrous teen unemployment profile, it is that teens are not as important as adults in terms of family income generation. However, their re-employment is critical for the multifamily rental market, as absent jobs, these youths will remain at home, rather than rent their own apartments. People generally react to our forecast of 3-3.5 million new jobs for each of the next three years with great skepticism, as most believe that the U.S. unemployment rate will still be approximately 7% three years from now. But in order for the unemployment rate to fall to 7% in three years, we must add 3-3.5 million jobs each year for the next three years! That is, we expect a robust employment recovery to a very mediocre job market. The Federal Budget Deﬁcit: Will They Ever Learn? In the Spring 2005 issue of The Linneman Letter, we wrote, “…we had federal budget surpluses during the last three years of the Clinton Administration mainly due to the bubble economy, which artificially boosted government receipts via both federal income and capital gains taxes. Once the bubble burst, tax revenues fell, just as the government began spending the surplus. And not only did federal spending grow, but it grew at its fastest rate in nearly 35 years.” It turns out that this explosion was merely a warm-up, with federal spending today growing at a clip not seen since World War II. The bubble years preceding the Great Recession were hardly characterized by the budget surpluses called for by classical Keynesian counter-cyclical policy, with the U.S. recording an annual deficit of $161 billion (1.1% of GDP) in 2007. But this was fiscal sanity compared to the
21

ﬁgure 84

Percent

Federal Minimum Wage Rate
11.00 10.00 9.00 $ / Hour 8.00 7.00 6.00 5.00 4.00 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 (Real - 2009 $)

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30 25 20 15 10 5 0 -5 -10 -15 1954

Government Receipts, Outlays, and Deficit as a Percent of GDP (4-Qtr Trailing Avg.)

1959

1964

1969

1974

1979

1984

1989

1994

1999

2004

2009

Receipts

Outlays

Deficit

ﬁgure 86

Federal Deficit as a Percentage of GDP
4 2 0 Percent -2 -4 -6 -8 -10 -12 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008 (4-Qtr Trailing Avg.)

ﬁgure 87

$1.4 trillion shortfall in 2009. The relative fiscal restraint of 2007 reflected extraordinary growth in incomes and capital gains, which the government was only too happy to take off our hands. Despite significant decreases in average marginal tax rates associated with the Bush tax cuts, individual income receipts grew 47% during the boom from 2003 to 2007 (to $1.2 trillion), representing 45% of total federal revenues. In the same period, corporate income receipts grew even more astoundingly, increasing 181% to just over $300 billion, representing 7% of federal revenues. Where were all the Congressional counter-cyclical Keynesians when the boom increased receipts? They

were doing what they do best: spending instead of running surpluses and reducing outstanding debt as prescribed by Keynes. Not surprisingly, when the boom ended, tax revenues collapsed. Between 2007 and 2009, individual income receipts dropped 21%, while corporate receipts plummeted 63%. Suddenly, Congress and the White House became counter-cyclical Keynesians, with expanded government spending preferred as the surefire path out of the recession. But this was simply political expediency. Had they and their pro-spending brethren in the media and academia, truly believed in such countercyclical spending, they would have reduced spending and generated substantial surpluses from 2003-2007. In the past decade, every major federal budget outlay category increased, with the exception of net interest (this decline will be short-lived and was attributable to historically low interest rates). Defense spending has more than doubled since 2000 due to seemingly endless conflicts in Iraq and Afghanistan. Non-defense discretionary spending rose 82% in the same period, while Social Security, Medicare, and Medicaid increased by 67%, 131%, and 113%, respectively. These social support programs will generate even larger burdens as the new healthcare legislation and an aging Boomer population further stress the system. Income security
Revenues By Major Source
1.2 1.0 $ Trillions 0.8 0.6 0.4 0.2 0.0 2000 2001 2002 2003 2004 Individual Income Taxes Social Insurance Taxes 2005 2006 2007 2008 2009 Corporate Income Taxes Excise, Estate and Other Taxes 2010

Percent

Source: CBO, 2010 - CBO estimate

ﬁgure 89

Federal Deficit as a Percentage of GDP
4 2 Percent 0 Percent -2 -4 -6 -8 -10 -12 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

60 50 40 30 20 10 0 2000 2001

Revenues By Major Source
As a % of Total Revenues

2002 2003 2004 Individual Income Taxes Social Insurance Taxes

2005

2006 2007 2008 2009 2010 Corporate Income Taxes Excise, Estate and Other Taxes
Source: CBO, 2010 - CBO estimate

ﬁgure 88

ﬁgure 90

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Benefit Program Spending

Fall 2010

200 180 160 140 120 100 80 60 40 20 0 1982

Federal Purchases for National Defense
$ Trillions

0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 2000 2001

$ Billions

1985

1988

1991

1994

1997

2000

2003

2006

2009

2002 2003 2004 Social Security Income Security

2005 2006 2007 2008 2009 Medicare Medicaid Other Programs

2010

Source: CBO, 2010 - CBO estimate

ﬁgure 91

ﬁgure 94

rose by 209%, as record numbers of unemployed suffered from lagging job prospects, and benefits periods were extended. All other programs grew 186%, mostly as a result of TARP funding and Fannie/Freddie bailouts. Many of these spending increases occurred under the guidance of President Bush, who claimed to be a fiscal conservative, while the current administration’s fiscal credentials are laughable. Over the past 10 years, income taxes have decreased, while payroll tax increases have barely offset these losses, resulting in a total federal revenue increase of a mere 4%. Privately held federal debt now represents 62% of GDP, the highest level in the post-WWII era. We cannot wait for the next economic boom to restore
Outlays For Major Spending Categories
2.5 2.0 $ Trillions 1.5 1.0 0.5 0.0 2000 2001 2002 2003 Discretionary Spending 2004 2005 2006 2007 Mandatory Spending 2008 2009 2010 Net Interest

60 50 Percent 40 30 20 10 0 1970 1975

Privately-Held Federal Debt as a Percentage of GDP

1980

1985

1990

1995

2000

2005

2010

ﬁgure 95
From Budget Boom to Bust Federal Budget Item ($ in billions) 2000 Individual Income Taxes $1,004 Corporate Income Taxes $207 Social Insurance Taxes $653 Excise, Estate and Other Taxes $161 Total Revenues $2,025 Defense Non-defense Discretionary Social Security Medicare Medicaid Income Security Other Programs Net Interest Total Outlays Budget (Deficit)/Surplus $295 $320 $406 $216 $118 $113 $179 $223 $1,789 $236

2009 $915 $138 $891 $160 $2,105 $656 $581 $678 $499 $251 $348 $513 $187 $3,518 -$1,414

% Change -9% -33% 36% 0% 4% 122% 82% 67% 131% 113% 209% 186% -16% 97% -698%

Source: CBO, 2010 - CBO estimate

Source: Congressional Budget Office, Linneman Associates

ﬁgure 92

ﬁgure 96
Discretionary (Appropriated) Spending

0.8 0.7 0.6 $ Trillions 0.5

70 60 50 Percent 40 30 20 10

Privately-Held Federal Debt as a Percentage of GDP

0.4 0.3 0.2 0.1 0.0 2000 2001 2002 2003 Defense 2004 2005 2006 International 2007 2008 Domestic 2009 2010

0 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010
Source: CBO, 2010 Deficit - CBO estimate, 2010 GDP - IMF estimate

Source: CBO, 2010 - CBO estimate

ﬁgure 93

ﬁgure 97

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fiscal sanity, as history shows that politicians only embrace the “more spending” side of counter-cyclical Keynesianism, forgetting to rebalance via reduced spending in good times. Continual fiscal responsibility is the only sustainable approach. For years we have hoped that Congress would finally learn that pork spending is a loser’s game. Oh well, we can dream! The Sinking of Bismarck In 1889, Otto von Bismarck introduced the first social retirement scheme. The premise was that retired workers would be assured of minimal income to sustain them over the remainder of their lives. This concept has since been adopted by almost every major nation. Bismarck’s plan revolved around four simple principles: ß Retiree benefits would be fixed at about 10% of preretirement income. ß The number of workers would grow far more rapidly than the number of retirees, providing ever more workers per dependent. ß Real per capita income growth would allow future workers to support the fixed benefits of retirees with an ever smaller portion of their income. ß Retirees would spend most of their lives working, and only a very small proportion in retirement. Modern societies around the world face unsustainable retiree burdens due to the fact that at least three of these principles are no longer remotely true. Specifically: ß Benefits have risen substantially relative to preretirement. ß The number of retirees is growing faster than the number of workers, particularly during the recession. ß Workers are retired for a substantial portion of their lives. Elderly dependency ratios – the number of 65+ yearolds per every 100 workers – have grown steadily in
Elderly Dependency Ratios
80 70 1980 = 100 60 50 40 30 20 10 0 1950 1960 France Spain 1970 1980 1990 Germany U.S. 2000 2010 2020 2030 U.K. 2040 2050 Greece Japan (65+ y.o. per 100 workers)

ﬁgure 98

every country around the world, as the post-World War II generation moves into retirement and the impact of low birth rates emerges. In 1960, Germany, France, Spain, the U.S., and the U.K. all had elderly dependency ratios below 20%. In 2000, the U.S. rate had increased to 20.8%, while the others jumped to about 25%. France and Japan’s elderly dependency ratios were also around 25% in 2000. In 2010, Germany’s and Japan’s have jumped to 31% and 35.2%, respectively. By 2050, Japan (66.5%) and Spain (67.5%) are expected to see the greatest increases, while the U.S. (38%) and the U.K. (45%) will have relatively lower (though unsustainably high) elderly dependency ratios. Furthermore, when Bismarck’s program was introduced, the typical worker worked some 3,000 hours per year, from age 10 until death or age 65 (whichever came sooner). In fact, at that time, the typical worker died at age 62, some three years prior to the age at which they could begin receiving benefits. This meant that the typical worker worked 126,000 hours in a lifetime to support about 543,000 hours of expected life. In marked contrast, people in the U.S. now begin working at about age 21 and work until about age 63, averaging approximately 1,800 hours per year of work, and die at approximately age 83. So the typical worker works approximately 73,800 hours during a lifetime to support approximately 728,000 hours of life. We work 49% fewer hours than in Bismarck’s day to support lives that are 34% longer. And the situation in Western Europe is even more extreme in this regard, with the typical worker working only 1,400 hours each year for 35 years before retiring at about age 61. This means that the typical Western European worker works a mere 49,000 hours Bismarck’s during a lifetime to support proposition was 728,000 hours of life. that workers would Bismarck’s proposition was that workers would work 23% of the work 23% of the hours they hours they were were alive. The current U.S. alive. The current proposition is that workers U.S. proposition is work approximately 10% that workers work of the hours they are alive, approximately 10% while Europeans work a mere 6.7% of their living of the hours they hours. All this is in the are alive, while context of ever shrinking Europeans work a population growth rates, mere 6.7% of their particularly in Western living hours. Europe and Japan.

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This simple math demonstrates that the current structure simply does not pass the sustainability smell test. People cannot support themselves at a high standard of living by working a mere 6-10% of the hours they are alive, as this translates into working only 1.6-2.4 hours every day to sustain oneself from birth to death. Making the situation even more clearly unsustainable is the fact that retirement benefits have increased (and have been indexed to wages) far beyond Bismarck’s dreams. For example, the average retirement benefit in Greece is $16,000 (96% of pre-retirement earnings). In Spain, it is $15,500 (81%), in Japan $22,500 (34%), in Germany $22,500 (43%), in the U.K. $22,100 (31%), in France $22,000 (53%), and in the U.S. $28,500 (39%). While these income levels are hardly rich, for someone not working, having only worked for a limited amount of living hours, these are extraordinarily comfortable retirement levels – particularly in a world where many households have 1.5-2 such retirees. The U.S. Social Security system has been cash-flow positive from 1985 to the present, yielding an average of approximately 0.5% of GDP in excess tax receipts. This reached 0.9% of GDP in 2000 ($115 billion in 2009 dollars). But these excess revenues have been declining steadily, and are projected to turn negative in 2018. By 2025, they are projected to run a negative net cash flow equal to approximately 1% of GDP. The lost net revenues will have to be picked up, unless retirement benefits are notably reduced. And the day of reckoning is now only eight years away. All of this would not be so troubling were government budgets balanced around the globe. But this is hardly the case. Instead, the entire developed world is plagued by staggering budget deficits. The U.S. budget deficit exceeds 10% of GDP, while those in the U.K. (-10.3%), Spain (-9.9%), Greece (-9.2%), France (-8.4%), Japan (-7.5%), India (-5.5%), Italy (-5.2%), and China (-2.5%)
U.S. Life Expectancy At Birth
90 80 70 Age in Years 60 50 40 30 20 10 0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Est. 47.3 50 54.1 59.7 62.9 68.2 69.7 70.8 73.7 75.4 76.9 78.3

are also obscene. Even the world’s fiscal conservative, Germany, has a fiscal deficit of -5.2%, far in excess of the 3% limit established at the creation of the euro zone. As a result, there is a need to balance budgets around the globe, as the burden of the Boom generation hammers revenues. This problem is made even worse by the fact that life expectancies continue to rise, even as people have fewer children and have ever shorter work careers. Otto von Bismarck was prescient in stating: “It is possible that all our politics will come to nothing when I am dead but state socialism will push itself through.” Ironically, his policies were credited with offsetting Germany’s low wage rate, as compared to the U.S. pay scale in the 1880s. When young German men considered emigrating to the U.S., they considered not only the wage rate, but also the social insurance benefits offered in Germany, compelling …the simple truth many to stay. Although is that the pyramid von Bismarck’s statement created by Bismarck was on target, he could never have imagined the not only does not extent to which the social work, but fails insurance concept would spectacularly in be adopted around the a world of high world, including in the U.S. expectations, long However, the simple truth lives, fewer children, is that the pyramid created by Bismarck not only and shortening does not work, but fails work careers. spectacularly in a world of high expectations, long lives, fewer children, and shortening work careers. More Stimulus? No Thanks. President Obama and the Pelosi Congress say we need even more government spending in order to “stimulate” the economy. This defies both empirical evidence and common sense. The initial stimulus was sold as a surefire way to accelerate growth, with every dollar spent by the government supposedly triggering far more than a dollar’s growth. This multiplier has never been empirically identified with the exception of during WWII. In all other instances, and in all other countries, the evidence is that a dollar of government spending at best generates a dollar of economic growth, and more likely, just $0.80-$0.95 in growth. And while a dollar of government spending may generate a dollar of gross spending, a dollar of additional taxes reduces growth by at least
25

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a dollar. Therefore, a balanced-budget exof GDP than the U.S. Yet these countries …the evidence is have experienced far lower growth rates than pansion of government spending is neutral, that a dollar of at best, and is more likely a loss of $0.05occurred in the U.S. The same holds true government spend- of Japan. $0.15 on the dollar, due to the political targeting of government spending, as well as ing at best generThe so-called stimulus package of the lower efficiency at which government 2009 was sold as the way to assure that the ates a dollar of entities generally operate relative to their priunemployment rate would not rise above 8%. economic growth, vate sector counterparts. This contrasts with Its proponents used their multipliers to predict and more likely, that with the stimulus, the unemployment rate a dollar of private spending, which everyone just $0.80-$0.95 would rise from 7.6% in November 2008 to agrees generates at least a dollar of economic growth. As a result, though it is very possible a peak of 8% in June 2009, before falling to in growth. that perfectly targeted government spending 7.3% in June 2010. The facts are at clear odds could yield net benefits, spending on pork and in powith these forecasts, with unemployment rising to 8% litically sensitive districts – that is, normal government in February 2009, 9% in April 2009, 10.1% in October spending – has historically yielded net negative benefits. 2009, before receding to 9.5% in June 2010. Yet in spite This has been demonstrated repeatedly in the U.S., as of the clear absence of a net multiplier effect, spending well as in Japan, Latin America, and Europe. proponents want to spend even more, financed by an ever In addition, most expansions of federal spending growing federal debt burden. (except during WWII) merely offset declines in state and The Obama/Pelosi government lays off its failures local government spending. These politically motivated on the fact that “things were worse than we thought transfer payments, which in large part support bloated during the Bush years.” While things were certainly a union payrolls, mean that most increases in federal mess during the Bush years (particularly out-of-control spending do not yield any net increases in overall federal deficit spending), this was hardly a secret. In fact, government spending. it was the foundation of the Obama campaign. The plain The proponents of further federal spending increases truth is that the Obama/Pelosi government possessed argue that government spending financed by the expansion more economic information than any government in the of the federal deficit yields a net benefit, as people do history of the world, and their failure to date reflects their not fully anticipate that this borrowing will have to be flawed economic policies. The Bush administration is repaid in the form of future taxes. That is, they believe now long gone, and we are 21 months into the Obama/ that the government can fool all of its citizens all of the Pelosi government. The successes and failures occurring time. But the economic concept known as today reflect decisions of this administration Ricardian Equivalence notes that people and not merely those of the past. If expanded are not quite so dumb. Rather, they realize The Bush administration left a sad legacy government that the expanded federal budget deficit of out-of-control budget deficits caused spending were the by pork-laden government spending. The means higher future taxes, and hence they key to economic reduce their current spending accordingly. Obama/Pelosi government has massively growth, Western While the empirical evidence on Ricardian increased this problem. The federal deficit Equivalence remains murky, it is fair to Europe would have relative to GDP is higher than at any time say that the concept is theoretically correct, other than during WWII. The outstanding experienced far while empirically it appears to be close to federal debt as a percent of GDP rose from higher economic true. As a result, debt-financed expansions in 57% in 2000 to 69% in 2008. In 2010, it growth rates than stands at an estimated 94%. government spending cannot yield a notable the U.S. over the net multiplier. In 1970, “mandatory” government If expanded government spending expenditures and interest payments past 30 years. were the key to economic growth, Western represented 38% of all federal spending. By Europe would have experienced far higher economic 2010, this has risen, via entitlement creep, to 62% of all growth rates than the U.S. over the past 30 years. After federal spending. In real dollars, this represents a rise all, these governments regularly spent some 20% more from $900 billion to $3.5 trillion, almost a 4-fold increase
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Total Federal Debt as a Percent of GDP
140 120 100 Percent 80 60 40 20 0 1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000

ﬁgure 100

in real spending. Entitlement spending has crowded out classic government service roles. For example, federal spending on public capital, education, and training represented 32% of the federal budget in 1965; it is a mere 13.5% today. Our physical and intellectual capital base, which is one of the key components a government should foster, continues to erode even as federal spending explodes. Outstanding federal debt held by the public was $283 billion in 1970, rose to $2.4 trillion in 1990, and stands at $8.4 trillion today. Only 5% of this debt was held by foreigners in 1970, versus 47% today. Thus, this is not merely debt we owe to ourselves. If we are to avoid defaulting on our national obligations, we need to repay some $4.1 trillion to foreign investors. This represents roughly 30% of a year’s GDP, a massive obligation to China (which holds 11% of our federal debt), Japan (10%), the U.K. (3%), and other countries (23%). Explicit obligations of the federal government have risen from $6.9 trillion in 2000 to $14.1 trillion in 2010, while contingent liabilities for pension guarantees, Freddie/Fannie, etc., have risen from $0.5 trillion to $4 trillion over the past decade. Add to this that social insurance liabilities have risen from $13 trillion in 2000 to $46 trillion today, and the result is a $43.5 trillion increase in consolidated federal government liabilities over the past decade, much of which has occurred in the past two years. This is $140,320 per person, or roughly $300,000 per household, due to the quest for guns (U.S. defense spending equals that of the rest of the world combined), butter, and pork. Financial Reform And Other Jokes The recently passed Financial Reform Act will not eliminate future financial failures, nor will it stop financial fraud or criminality. The absurdity of a “Financial Reform

Act” that does not address the role of Fannie and Freddie is beyond comprehension. After all, Fannie and Freddie alone have already cost taxpayers some $150 billion, with another $250 billion yet to come. In fact, the losses A Financial Reform of Fannie and Freddie Act that fails to represent approximately address Freddie 65% of all credit-related and Fannie is like a losses, even though they hurricane plan that reflect a mere 24% of all credit. A Financial Reform fails to consider high Act that fails to address winds, torrential rain, Freddie and Fannie is like a and water surges. hurricane plan that fails to consider high winds, torrential rain, and water surges.
U.S. Homeownership Rate
72 70 Percent 68 66 64 62 60 1985 1990 1995 2000 2005 2010

ﬁgure 101

What should become of Fannie and Freddie? These two agencies (along with Ginny Mae) have devolved into holding 96.5% of all mortgages being issued today. This is absurd. The U.S. housing market retains great value, and not everyone with a mortgage has defaulted or will default, particularly as home prices have bottomed in almost every market and housing inventories come back into balance. But as long as the government maintains an effective monopoly on this sector, capital will be overallocated to homeownership, and private mortgage competitors will find it hard to compete effectively. The only viable solution is to sell the existing Fannie/ Freddie mortgage pools (perhaps with government guarantees), much as was done via the RTC nearly two decades ago. This represents approximately $5 trillion in face value, the vast majority of which could be easily securitized in an orderly fashion over a 12-24-month period. There is no reason why this has not already been done. As to the role of Fannie and Freddie going forward, appropriate subsidies should be provided to low-income households to ensure that they are adequately housed.
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But this requires little or no role for Fannie and Freddie, as few truly low-income households ever come into contact with their mortgage programs, with the exception of the multifamily segment. Instead, these programs have evolved into huge subsidies for middle- and upper-income mortgage borrowers in states with unduly high home prices, due to restrictive land use regulations. There is no reason why Fannie and Freddie, after liquidating their portfolios, cannot slowly fade into the sunset. Would this cause the cost of mortgages to rise by 1530 bps? Yes, but they should be priced higher, based upon the risk associated with mortgage lending. It is also likely that somewhat higher down payments will be required absent private mortgage insurance. But why should homeowners routinely have access to 80-95% LTVs at 130 bps over Treasury? We have seen the folly associated with the artificial incentives created to encourage universal homeownership. We see no reason why capital markets cannot provide fairly priced mortgage capital. The burden of proof should fall on those whose beliefs are to the contrary. The Financial Reform Act leaves huge swathes of unfinished business, with most of the details left for future rulemaking and administrative bodies. As a result, after months of lobbying and politicking, the exact form of the regulatory framework is not much clearer
240 220 200 $ Thousands 180 160 140 120 100 1973 1978 1983 1988 1993 1998 2003 2008

Single Family Mortgage Loan Amount
(Real - 2007 $)

ﬁgure 102
Single Family Mortgage Loan-to-Price Ratio

82 80 78 Percent 76 74 72 70 68 1973

1978

1983

1988

1993

1998

2003

2008

ﬁgure 103

today than it was a year ago. This leaves most elements unchanged but subject to enormous change, just as is the case with healthcare “reform.” As a result, enormous uncertainty hangs over financial and healthcare reform implementation, meaning that more politicking is yet to come. In addition, these laws face possible reversal after the upcoming elections. The absence of bipartisan political decision-making has been a major problem over the past 12 years, as incremental swings in Congress can bring about radical changes in government policy. Absent bipartisan action, policy swings from the whims of the party currently in power to those of the newly empowered party. This creates uncertainty about the rules of the game, reducing the rate of sustainable The uncertainties growth, as business and investors abhor uncertainty. created by the “let’s The uncertainties created make a deal” policies by the “let’s make a deal” of Bush/Paulson have policies of Bush/Paulson have given way to the given way to the “let’s change everything” “let’s change everything” policies of Obama/Pelosi. policies of Obama/ In short, we have replaced Pelosi. In short, we a frat boy with a social achave replaced a frat tivist, both acting without boy with a social bipartisan support. This activist, both acting absence of predictability without bipartisan in the rules of the game is a major reason why the support. U.S. economy plunged in 2008-2009 and has not experienced a more vigorous recovery in 2010. A perfect example (in addition to the uncertainties of healthcare and financial regulation) is the homeowner “stimulus” enacted on July 30, 2008. This created a “onetime” tax credit of up to $7,500 for qualifying home sales that took place between April 8, 2008 and July 1, 2009. A clear giveaway of the political character of this “stimulus” effort was that it gave a tax credit to sales which occurred for nearly 100 days prior to the law being enacted, in what we can only presume was a conjurer’s attempt to stimulate decisions which were already made. This tax credit was extended seven months later through December 1, 2009 (at up to $8,000), and was extended yet again in November 2009 through April 2010 (up to $6,500). All in all, this “one-time” effort extended the program nine months beyond its original life. More

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importantly, it has created an enormous uncertainty in the U.S. housing market, at a time when certainty and predictability are desperately needed. It has created a “wait and see” attitude about the stimulus being extended. After all, how much does someone lose by waiting 3-6 months to see if the tax credit is extended? Further, there is no evidence that any stimulus effect on housing sales resulted. In fact, sales have continually lagged behind forecasts of the proponents of the bill. Not surprisingly, this government intervention has involved the usual cases of fraud, including nearly 100 frauds perpetrated by IRS agents, as well as some 20,000 tax credit claims by people who did not even buy a home, nearly 1,500 claims by incarcerated prisoners, and nearly 1,000 by individuals under the age of 18. Uncertainty is poison for economic activity, and both the Bush and Obama/Pelosi governments have massively increased uncertainty with their partisan efforts. The Bush tax laws are scheduled to expire at year-end, and the Obama/Pelosi government has pronounced its desire for tax alterations, creating further uncertainty. This means that the November elections can change anything. So “go slowly,” “hire slowly,” “horde cash,” and “do not take any risk” remain economic watchwords, at least until after the November elections. All of this expansion of government has taken place in the absence of any All of this proof that the government has the ability to effectively expansion of government has execute its tasks. For example, it is well known that the SEC taken place in failed to identify the Madoff the absence of fraud, despite numerous tips any proof that the over many years and several government has the administrations. Similarly, the ability to effectively FDIC and the Comptroller of execute its tasks. the Currency have miserably failed repeatedly throughout history in their job of assuring the safety and soundness of financial institutions. Housing policy fraud and abuse has occurred during almost every administration, while in a rare display of bipartisan action, Congress repeatedly empowered Freddie and Fannie to take on greater risk without any regard to the fiscal consequences. The Federal Reserve has a perpetual history of well-intentioned policy mistakes. Yet the Obama administration wants to give even more power to both new and existing governmental bodies.

Government employees are no less venal than individuals in the private sector, and are less concerned (for good reason) about being replaced upon failure. This is particularly true in view of the high level of unionization found in the government today. Our belief is that concentrating power in the hands of the state merely increases exposure to abuse. While in a classroom, the government (or any all-powerful deity) can right the wrongs of the private sector, all too often government compounds, ignores, or is complicit in the failings of the private sector, at great cost, due to a false sense that “the government has things under control.” The Search for Yield: Part II From 2002 through mid-2005, the Fed artificially created negative real short-term interest rates, which discouraged investments in short-term and safe assets, while skewing demand towards long-term and risky assets in the search for yield. At the same time, historically low rates encouraged borrowers to finance short, creating a serious mismatch of asset and liability durations. This was in no way the intent of the Fed’s policy, but followed as surely as night follows day. The result was an artificial increase in the demand for, and price of, long-term risky assets, and the disproportionate use of cheap, short-term debt. This massive Fed error caused one of the greatest financial crises in U.S. history, as anyone who used shortterm liabilities to purchase long-term assets was crushed when this artificial interest rate regime ended. The current Fed is repeating this mistake via near-zero nominal short-term interest The current Fed is rates and negative real rates. repeating this mistake Once again investors who would otherwise invest in via near-zero nominal short-term interest reasonably priced, shortterm, safe investments are rates and negative moving to long and risky real rates.
300 250 Basis Points 200 150 100 50 0 1990 1993 1996 1999 2002 2005 2008
Note: Spread = Aaa Corporate bond yield less 10-year Treasury

U.S. Corporate Investment Grade Spread

ﬁgure 104

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800 750 700 650 600 550 500 450 400 Dec-06 Jun-07 Nov-07 May-08 Oct-08 Apr-09 Sep-09 Mar-10 Aug-10 Percent 350 12 10 8 6 4 2 0 -2 -4 -6 -8 1959 1964 1969 1974

High Yield Total Return Index

short-term liabilities. This fundamental cause (along with deposit insurance) of the financial crisis is being totally ignored.
Real Fed Funds Rate
(Net of Core CPI)

ﬁgure 105

Outstanding Commercial & Industrial Loans
1,800 1,600 1,400 $ Billions 1,200 1,000 800 600 400 Percent 200 0 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

1979

1984

1989

1994

1999

2004

2009

ﬁgure 108

10-Year Treasury vs. Fed Funds Rate
25 20 15 10 5 0 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008

ﬁgure 106

10-Year Treasury 30 25 20 15 10 5 0 -5 -10 -15 -20 -25 1979

Fed Funds Rate

Commercial Banks C & I Loan Growth Rate
Year-Over-Year Percent Growth

ﬁgure 109

Percent

4.0 3.5 3.0 Percent 2.5 2.0 1.5 1.0 0.5 0.0 2001

LIBOR Spread Over 30-Day Treasury

1984

1989

1994

1999

2004

2009

ﬁgure 107

2003

2004 Spread

2006

2007 2003-2006 Avg.

2009

2010M7

assets in the search for yield. This has led to a rebound in the pricing of long-term corporate bonds, emerging market debt, and equities, beyond what would have occurred in a neutral interest rate environment. Thus far, these investors have been unable to finance their investments with mounds of super-cheap, short-term floating-rate debt, but this could rapidly change as banks loosen their lending standards and begin putting their $1.1 trillion excess reserves to work via loans. Today’s low short-term rates have artificially increased the price of long-term risky assets, and when short rates normalize, this artificial demand will dissipate. As a result, those holding long-term assets will be squeezed, particularly if these assets are financed with
30

ﬁgure 110

100 80 60 Percent 40 20 0 -20 -40

Percent of Banks Tightening C&I Loan Standards

1990

1993

1996

1999

2002

2005 Small Banks

2008

Large and Medium Banks

ﬁgure 111

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Volume 10, Issue 3 Fall 2010

The Fed excessively manipulates short-term interest rates in the belief that it knows better than markets how money should be priced. While there is certainly a role
300 250 200 150 $ Billions 100 50 0 -50 -100 -150 1970 1975 1980 1985 1990 1995 2000 2005 2010

Money Multiplier*
14 12 10 8

Life Insurance Company Lending

6 4 2 0 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009
*M2 / Monetary Base

ﬁgure 116

ﬁgure 112

Historical Bank Excess Reserves
1,400 1,200 $ Billions 1,000 800 600 400 200 0 2002 2003 2004 2005 2006 2007 2008 2009 2010

ﬁgure 113

Recent Bank Excess Reserves
1,400 1,200 $ Billions 1,000 800 600 400 200 0 Jun-08 Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 2 59 559 797 842 723 732 860 1,077 1,046 1,121 1,045 1,022

ﬁgure 114

Monetary Base: Cash Holdings at Banks
2,200 2,000 1,800 $ Billions 1,600 1,400 1,200 1,000 800 600 Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10

ﬁgure 115

for monetary policy, it should be used sparingly rather than constantly. The Soviet Union amply demonstrated that prolonged artificial prices distort and destroy an economy. This is equally true for the U.S., where the Fed manipulates short-term interest rates, convinced of its omnipotence. Short-term interest rates must be allowed to revert back to levels set by market supply and demand, as artificially low rates misallocate precious capital. They also hurt risk-averse savers who are penalized by the artificially low, short-term interest rates. Effectively, the government is expropriating funds from the savers who desire short-term, liquid, safe investments. The political incentives for the Fed to protect banks are enormous. Low, short-term interest rates help banks’ profitability by allowing them to invest in longer-term investments using short-term liabilities. Japan over the last 20 years proves that artificially low interest rates are not a cure for weak economic fundamentals. Terrible outcomes generally arise from the confluence of a series of poor decisions, which fail to take underlying fundamentals into consideration. A clear example is the much documented collapse of the U.S. housing market. This collapse would have been minor but for the confluence of several seemingly unrelated mistakes. The first cause of the housing boom of the 2000s was the fact that the U.S. The first cause Federal Reserve mistakenly of the housing kept the Fed Funds rate far too low, for far too long. This boom of the 2000s short-term interest rate was was the fact that held artificially low by a Fed the U.S. Federal fearful of a deep recession and Reserve mistakenly a liquidity shortage post-9/11. kept the Fed Funds In addition, the Fed misread a drop in goods prices due rate far too low, for far too long. to cyclical excess supply as
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Percent

a deflationary threat, keeping the real Fed funds rate negative for four years. When the Fed finally and rapidly increased the Fed funds rate to 5.5% in early 2005, the game was over. Suddenly, investors faced an exact reverse set of incentives: ß Short-term, relatively safe investments yielded an artificially high return. ß Short-term borrowing was artificially expensive.
CMBS Spreads (Monthly)

the second quarter of 2010, compared to 0.65% in 2007. Commercial bank delinquencies are concentrated in noncash-flow-generating assets, such as broken condos,
CMBS Delinquencies
8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0

12,000 10,000 Spread (bps) 8,000 6,000 4,000 2,000 0 1996 1998 AAA

0.0 1997 2001 2005 2006 2007 2008 2009
Source: MBA; 1997-2005 annual data; quarterly thereafter.

ﬁgure 119

Foreclosure Rates
8 2000 BBB 2002 2004 BBB2006 BB 2008 B Percent 2010 7 6 5 4 3 2 1 0 1998 2000 Total 2002 Prime 2004 2006 Sub-prime 2008 2010 (Started during Year)

ﬁgure 117

This swung the artificially high demand for longterm assets to an artificially low demand, causing the price of long-term assets (including real estate and assets collateralized by real estate) to plummet. At the same time, piles of formerly cheap short-term debt came due at much higher borrowing rates. This caused a flood of defaults on all forms of risk ownership, including municipal bonds, leveraged purchases, real estate, RBS, CMBS, and junk bonds. Of all CMBS loans, 8.2% were delinquent (30+ days and REO) in the second quarter of 2010, while life company commercial loans remain only 0.29% delinquent (60+ days). In the same period, 60+ day delinquencies for commercial loans held by Fannie and Freddie were just 0.8% and 0.28%, respectively. Commercial delinquencies (90+ days) for banks and thrifts were 4.26% in
1,200 1,000 Spread (bps) 800 600 400 200 0 1996 1998 2000 2002 2004 2006 2008 2010

Sub-prime ARM

ﬁgure 120

35 30 25 Percent 20 15 10 5 0 2004 2005

Mortgage Delinquency Rates

2006 All Loans

2007 Prime

2008 FHA

2009

2010

Sub-Prime

Sub-Prime Arm

ﬁgure 121
Commercial / Multifamily Mortgage Delinquency Rates by Lender

AAA CMBS Spreads (Monthly)

9 8 7 Percent 6 5 4 3 2 1 0 2Q06

4Q06

2Q07

4Q07 CMBS

2Q08 Freddie Mac

4Q08

2Q09

4Q09

2Q10

Life Companies Banks & Thrifts

Fannie Mae

ﬁgure 118

ﬁgure 122

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Real Estate Loan Charge-off Rates

Fall 2010

3.5 3.0 2.5 Percent 2.0 1.5 1.0 0.5 0.0 1985 1989

1993

1997

2001

2005

2009

All Real Estate Loans for All Banks (SA) All Real Estate Loans for 100 largest Banks (SA)

ﬁgure 123

14 12 10 Percent 8 6 4 2 0 1991

Real Estate Loan Delinquencies

1995

1999 Residential

2003

2007 Commercial

ﬁgure 124

land, development, and acquisition loans. While these create opportunities, there are few steals to be found for cash-flow assets. The fundamentals of U.S. housing starts are very simple: ß The U.S. adds approximately 3,000,000 people each year to its population. ß On average, this amounts to approximately 1,230,000 million new households each year. ß Each of these new households requires a housing unit. It may be a rental unit or an owner-occupied unit; it may be a big unit or a small unit. But a unit is required for each new household unless people double-up. ß Approximately 500,000 housing units are destroyed annually. Some are rental units, others are owner units. But they must be replaced one-to-one if the U.S. housing stock is not to fall. ß In addition, the average net demand for second homes is approximately 70,000 units a year. Therefore, in an average year, approximately 1.8 million housing units are required to replace destroyed housing units and to satisfy new housing needs. Years when substantially more than 1.8 million housing units are created are not sustainable, nor are years with notably

fewer than this number. The history of U.S. housing, unfortunately, has been one of sustained booms, with housing production well in excess of 1.8 million units, followed by sustained busts. One of the unintended side effects of the Fed’s low interest rate policy was that many U.S. households saw flipping homes as a “can’t lose” investment proposition. These households took on non-conforming (generally referred to as subprime) ARMs to purchase speculative housing units to flip. This was an easy carry trade for many thousands of Americans, as they invested long and risky while borrowing at low short rates. These flippers caused a spike in the demand for housing units in “hot” housing markets. Our research indicates that people seemed to use the previous year’s local home price appreciation as their prediction of the long-term appreciation rate of local housing prices, believing that they would hold their empty flipper units for less than a year. Of course, it is fundamentally flawed to expected long-term housing appreciation to equal that of the past year, but this approach led flippers to focus on “hot” markets – condominiums in South Florida, homes and condos in Las Vegas, homes in Phoenix and the Inland Empire – as all of these markets had recently experienced double-digit local home price appreciation. Homebuilders failed to differentiate speculative investors buying homes to flip (rather than live in) from traditional resident buyers. As a result, major homebuilders saw the surging home prices and booming sales velocity as a change …major homebuilders in the fundamental housing demand. Their production saw the surging home prices and booming levels increased by as much as 100% above local norms sales velocity as in the hottest markets. The a change in the profits that homebuilders fundamental housing derived from these highdemand. Their priced, high-velocity sales production levels lured them into believing that it was a sustainable increased by as much demand, causing them to as 100% above local replace their inventory norms in the hottest with very expensive and markets. frequently poorly located land, as well as to sign building contracts at production costs far above norm. As a result, the high-rise condo market was flooded, while horizontal single-family construction similarly exploded in the hottest markets.
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Housing production was far in excess of sustainable norms, accompanied by ever rising unsold inventory levels. This was particularly a problem for vertical high-rise construction, which cannot be stopped part way up.
Conventional 30-Year Fixed Rate Mortgage
20 18 16 14 12 10 8 6 4 2 0 1975 1980 1985 1990 1995 2000 2005 2010

ﬁgure 125

30-Year Fixed and 1-Year ARM Rates Spread
450 400 350 Basis Ponts 300 250 200 150 100 50 0 1985 1990 1995 2000 2005 2010

ﬁgure 126

As the reality of high excess inventory levels set in, home prices began to fall, coincidentally at the same time that the Fed raised the Fed Funds rate. This caused an enormous squeeze on flippers, who saw their chance to flip profitably evaporate, due to falling home prices and rising mortgage rates. Meanwhile the mortgage markets heated up in response to investors seeking yield in the face of the Fed’s artificially low interest rates. This search for yield created the incentive for so-called private label residential mortgage issuers to utilize cheap short-term debt to issue long-term residential mortgages, repackage them as mortgage-backed securities, and quickly flip them to investors hungry for yield. These private label issuers, primarily banks and investment banks, gorged on the combined profits of the fees associated with the creation and sale of these securities, as well as the spread they realized by borrowing short, while issuing longterm mortgages. The fees and spread generated profits far
34

beyond anything imaginable for simple mortgages, and overnight, the simplest of financial instruments became the most complex and profitable financial vehicle ever seen by Wall Street. Wall Street being Wall Street, such high profitability rapidly created an abundance of packagers anxious to realize these outsized profits. This was achieved by slowly, yet continually, reducing basic mortgage underwriting standards so as to be able to have a sufficient supply of mortgage product to issue new securities yielding fees and spreads to the packagers. This increased the availability of subprime mortgages, which had been a small niche of the mortgage market. Subprime borrowers had highcash incomes, and were willing to pay high origination fees. Underwriting was based on how much income was under-reported by these cash earners. Wall Street quickly rushed into this niche, the difference being that the new borrowers had incomes substantially lower (not higher) than reported. This was the polar opposite of traditional subprime loans. These so-called liar loans, often taken out by flippers, funded the purchase of some 800,000 housing units. At the same time, Freddie and Fannie were experiencing enormous political headwinds in the wake of their accounting scandals. These political pressures ultimately led Freddie and Fannie to expand into both subprime and extremely low down payment mortgages to satisfy Congress. The result was that any subprime loan that did not meet private label standards was quickly vacuumed up by Freddie and Fannie to satisfy enormous Congressional pressures. Thus, the credit ratings of subprime loans increased (due to the prevalence of flipper borrowers) even as subprime mortgages grew to nearly one-third of all new mortgages (versus a typical level of about 8% of all mortgages). Congress was pleased with this outcome, as it allowed them to boast that they were making the American dream a reality for everyone. Wall Street and Fannie and Freddie were happy, as in the near term they could earn the spread on these long-term obligations funded with artificially cheap short-term debt. The buyers of these mortgage security products were only too happy to buy, as their alternatives were negative returns at the short and safe end of the curve, or spreads that were being squeezed at the long end of the curve. Buyers looked to the rating agencies to assure that these products were “safe,” despite the fact that they had no experience buying such products. Their ignorance was matched at the rating agencies. In particular, the explosion

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of subprime product driven by liar loans had never been experienced. Therefore underwriting such loans from the history of subprime loans to people with incomes higher than they reported seriously misrepresented the true risk of these new securities. The rating agencies were attracted by the fees, fees, and more fees available by quickly rating the flood of new securities. Even crazier was the fact that Wall Street could not Even crazier was the create mortgage securities fast enough to satisfy the profit fact that Wall Street lust, so they created synthetic could not create securities which tracked mortgage securities chosen tranches of existing securities. These synthetic fast enough to products could be created satisfy the profit cheaper and faster than actual lust, so they created mortgage securities, required synthetic securities almost no capital to create, which tracked and generated instant fees. chosen tranches of And these synthetic products existing securities. provided an after-market for the market maker to generate more fees. This created a surge of further betting on longterm risk in the search for yield, in the face of the Fed’s artificially low short-term rates, all disproportionately financed by the use of artificially cheap short-term debt. When the Fed finally raised interest rates, it all was fated to end. Housing production plunged in order to burn through the excessive inventories held by both homebuilders and flippers (whose properties were taken over by their lenders, and liquidated as empty units in foreclosure). Home prices fell, particularly in the hottest of markets, putting many borrowers under water. These losses placed financial institutions at dire risk and eroded the balance sheets of many homeowners. Further, as home prices and home production fell, the mortgage security market screeched to a halt. As the game of musical chairs ended, those holding mortgages in inventory suffered huge losses, as their long-term mortgage assets were depressed and highly illiquid in the face of plunging long-term asset prices. This was compounded by rising default rates and skyrocketing short-term borrowing rates, both because of the higher Fed Funds rate and their increased credit risk. The primary holders of mortgages were the packagers who were living off of fees and spreads, namely the large commercial and investment banks. These supposedly “safe and sound” institutions had become super-high

leveraged holders of illiquid, long-term mortgages and mortgage products financed with cheap short-term debt. And even though regulatory budgets ballooned during this time, no regulators had uttered the faintest warning sound. These regulators were still fighting the last war, and assumed that the sophisticated models they were shown concerning Value-At-Risk were meaningful, rather than simulation hocus-pocus. The final result was not only a collapse in housing prices, household balance sheets, and housing production, but also the destruction of U.S. commercial and investment banks, which almost without exception failed to avoid mismatching their assets and liabilities in the search for fees and unsustainable spreads. This all was created by a mistaken Fed policy.
Consumer Price Index
8 6 Percent 4 2 0 -2 -4 1984 1989 Core CPI 1994 1999 2004 CPI - All Items 2009 Year-Over-Year Percent Change

CPI for Services

ﬁgure 127

Core Consumer Price Index
16 14 12 Percent 10 8 6 4 2 0 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 Year-Over-Year Percent Change

ﬁgure 128
FAO Food Price Index
1998-2000 = 100

240 220 200 180 160 140 120 100 2005 2006

2007

2008

2009

2010

ﬁgure 129

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4

Long-Term Treasury Inflation-Protected Securities (TIPs)

Monetary Base: Cash Holding at Banks
2,200 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009

Percent

2

1

0 2002 2003 2004 2005 2006 2007 2008 2009 2010

ﬁgure 130

ﬁgure 133

$ Billions

Another danger associated with the Fed’s artificially low short-term interest rate policy is that the expansion of the money supply will eventually lead to inflation. It is important to remember that the definition of inflation is simply the weighted-average percentage increase of all prices. A great deal of effort goes into creating price indexes, particularly for consumer prices. Research shows that there is a modest upward bias in measuring inflation via CPI, due to the fact that people change their consumption baskets towards cheaper items, and because of the upward drift of product quality over time (as people pay more for higher quality goods, which may look the same but have higher prices because the products are better). Today’s low inflation rate is reflective of temporary excess supply, particularly in the goods sector, and not
Money Supply
Year-over-Year Percent Change 18 15 12 Percent 9 6 3 0 -3 -6 1959 1964 1969 1974 1979 M1 1984 1989 M2 1994 1999 2004 2009

$ Billions

3

Historical Total Reserves by Banks
1,400 1,200 1,000 $ Billions 800 600 400 200 0 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009

ﬁgure 134

Reserve Assets Held at Federal Reserve
145 125 105 85 65 45 25 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Assets Held in Foreign Currencies

Total Assets

ﬁgure 135

ﬁgure 131

Excess Reserves as a Percent of Required Reserves
2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 1959 to August 2008 Average = 2.8% July 2010 = 1,551% Percent

ﬁgure 132

of over-riding deflationary pressures. In particular, in periods of excess supply, prices need to fall in order to reduce excess inventories. But once excess inventories are reduced, prices will rise in line with the rate of monetary expansion relative to productivity growth. We are in a period of excess capacity, and as a result, have low inflation in spite of abnormal levels of global liquidity. But as excess capacity is eliminated by demand growth and the obsolescence of some capacity, prices will begin to rise at higher rates. This is already occurring around the world, with India having a 14% inflation rate, Australia 4%, the U.K. 3.8%, and China, the Euro zone, and Korea all about 2.5%. Inflation in the U.S. remains at approximately 1.5%, while Japan shows 1% deflation. Inflation hawks (like us) worry that if these levels of

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inflation are registered in a world of weak demand and excess supply, what inflation will we see when the excess supply is eliminated? Real Estate Capital Markets Are Alive, If Not Quite Well To date, there have been about $240 billion of distressed commercial real estate loans, of which $40 billion has been fully resolved. Another $40 billion has been restructured via some version of blend-and-extend, $30 billion has been classified as real estate-owned by banks (REO), and another $140 billion is performing but troubled. This level of distress has been relatively constant since November, with monthly additions to distress averaging about $6 billion per month, while approximately $6 billion is being
60 50 40 $ Billions 30 20 10 0 1984 1989 1994 1999 2004 2009
Source: Federal Reserve

U.S. REIT Equity Offering Proceeds
(Seasonally Adjusted Annual Rates)

ﬁgure 136
Net Inflows to Real Estate Mutual Funds
8 6 4 $ Billions 2 0 (2) (4) (6) (8) 1993 1995 1997 1999 2001 2003 2005 -0.98 -1.32 -5.75 2007 2009 0.60 0.39 0.46 2.55 0.23 0.03 4.06 4.62 3.41 3.16 1.15 6.83 6.10 5.26 3.39

resolved. This is down from a peak of $23 billion of new distress in April 2009, and $15 billion in June, July, and December of 2009. Real estate transactions have picked up from their bottom. According to Real Capital Analytics, year-to-date sales activity through July 2010 increased for all major commercial sectors (office, industrial, multifamily, retail, and hotel), compared to the same period in 2009, with the office and hotel sectors more than doubling. However, average unit prices dropped for the office, industrial, and retail sectors over the same comparative periods. Office and retail cap rates increased by 40 and 60 bps, respectively, while industrial (8.4%) and multifamily (6.9%) cap rates were both flat year-over-year. Unit pricing for the multifamily and hotel sectors increased significantly. Average hotel cap rates through July 2010 dropped 300 bps to 6.9%, compared to the same period in 2009. Using Manhattan as a proxy, Bob Knakal estimates that approximately 3.11% of the Manhattan office stock was sold in 2005, with a further 2.95% in 2006, 3.61% in 2007, 2.3% in 2008, and 1.17% in 2009. However, during the first half of 2010, 1.66% had turned in a remarkable rebound in transaction velocity. As we predicted in April 2009, the bottoming of private pricing (peaking of cap rates) occurred about 15 months after REIT pricing bottomed in March 2009.
Real Estate (Under) Over Pricing Using:
50 0 -50 Percent -100 -150 -200 -250 -300 1994 1996 1998 2000 2002 2004 2006 2008 2010
Liquidity premium assumed to be zero.

CAPM

BBB Yld Benchmark

Source: AMG, BAS-ML

ﬁgure 137

ﬁgure 139
Sales Transaction Activity Total Volume ($ billions) YTD Thru July 2009 Avg Price/SF or Unit $197 $67 $85,362 $151 $103,149 Average Cap Rate 7.9% 8.4% 6.9% 7.5% 9.9% Total Volume ($ billions) $15.9 $6.3 $11.8 $7.1 $3.6 YTD Thru July 2010 Avg Price/SF or Unit Average Cap Rate $179 $61 $104,381 $142 $119,394 8.3% 8.4% 6.9% 8.1% 6.9%

Office Industrial Multifamily Retail Hotel

$7.8 $4.6 $6.9 $4.8 $1.6

Source: Real Capital Analytics, Linneman Associates

ﬁgure 138

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THE LINNEMAN LETTER
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Real Estate (Under) Pricing as of Sept 16, 2010 Long-Term Annual Dividend Growth 1.5% 2.0% 2.5% -38.0% -69.3% -118.7% -16.7% -38.2% -69.5% -1.0% -16.8% -38.4% 10.9% -1.1% -16.9% 3.0% -209.1% -119.2% -69.8% -38.5%

Fall 2010

0.3 0.4 0.5 0.6

ﬁgure 140

REIT Div Yld Spread over U.S. Corp Baa Yld
300 200 Basis Points 100 0 -100 -200 -300 -400 1994 1996 1998 2000 2002 2004 2006 2008 2010

ﬁgure 141

1000 800 Basis Points 600 400 200 0 -200 1994

REIT AFFO Yields over 10-Yr. Treasury Yield

September 2010, REITs are approximately 6.4% undervalued relative to BBB bonds, and 4.8% over-valued based on the Capital Asset Pricing Model. A comment we often hear is that market pricing is “getting ahead of itself.” Well, duh! That is what markets are supposed to do, namely look forward. Real estate prices today are effectively being set by investors who, de facto, believe in relatively strong economic growth (and hence, reduce vacancy and increase rents) and/or high future inflation. As a “back of the envelope” calculation, and assuming that inflation remains around 2%-3%, both public and private real estate are being priced reflective of an expectation that 2.2-2.4 million jobs will be added in each of the next three years. That is to say, today’s real estate prices for cash-flowing properties reflect the assumption of a strong recovery, but one that will require 3-4 years to replace the 8.4 million jobs lost during the recession. If you believe that significantly fewer jobs are going to be created during this time, you will be outbid. On the other hand, if you believe (as we do) that job formation over the next three years will be in excess of this rate, this is a good time to buy. Real estate exists solely for the purpose of servicing the economy, so one of the reasons real estate has done really badly in the last two years is that the U.S. lost 8.4 million jobs. It does not take a genius to figure out that when the
12

BETA

1996

1998

2000 Spread

2002

2004

2006

2008

2010

Average Spread 11 10 9 Percent 8 7 6 5 4 3 2002

Implied REIT FFO Cap Rates

ﬁgure 142

800 600 Basis Points 400 200 0 -200 1994

U.S. Baa Corp Yield over 10-Yr. Treasury Yield

2003

2004

2005

2006

2007

2008

2009

2010

Total REITs Regional Malls

Multifamily Office

Shopping Centers Industrial

Source: BAS-ML

ﬁgure 144
1996 1998 2000 Spread 2002 2004 2006 2008 2010 12 11 10 9 8 7 6 5 4 3 2002 Average Spread

Implied REIT Cash Flow Cap Rates

ﬁgure 143

This lag between public and private real estate pricing is consistent with the historic patterns of a 12-18-month lag in private pricing. Since peaking in the fourth quarter of 2009, total REIT implied cap rates have fallen by approximately 260 bps, from 9.2% to 6.6%, representing an FFO multiple increase from 10.9x to 15.2x through mid-September 2010. Our analysis suggests that as of
38

Percent

2003

2004 2005 Total REITs Regional Malls

2006 2007 Multifamily Office

2008 2009 2010 Shopping Centers Industrial
Source: BAS-ML, Linneman Assoc.

ﬁgure 145

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Volume 10, Issue 3
NOI Cap Rate Spreads over 10-Yr Treasury
600 400 Basis Points 200 0 -200 -400 -600 -800 -1,000 1980 1984 1988 1992 Industrial 1996 2000 Office 2004 Retail 2008 Apartment (18-month lag)

Fall 2010

ﬁgure 146
NCREIF Cap Rates
16 14 12 Percent 10 8 6 4 2 0 1980 1984 1988 Retail 1992 1996 Industrial 10-yr Treasury 2000 2004 Office 2008 Apartment (18-month lag)

U.S. economic recovery, because if we add lots of jobs, real estate will do very well. But if the U.S. economy loses another 8 million jobs over the next two years, real estate will be killed no matter how well it is managed. Year-to-date through August, the U.S. economy added 723,000 jobs. If the economy keeps up this pace, we are going to see real estate get a lot healthier over the next three years. The critical question facing real estate investors today is, “With 10-year Treasury rates hovering around 2.5% for the past two months, what if the bond market is right?” Rates have not been this low since 1954. Based upon the historical real expected return of 200 bps, this suggests an annual expected inflation rate of just 0.5% over the next
Return Components of Wilshire REIT Index
60 Cumulative Percent 50 40 30 20 10 0 -10 -20 1-Year 3-Year Dividend Return 5-Year 10-Year Price Return YTD August 2010 (thru May 2010)

ﬁgure 147

Public and Private Market Real Estate Values
350 300 250 200 150 100 50 Percent 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 40 30 20 10 0 -10 -20 -30 -40 -50 1980 1984 (2001 = 100)

ﬁgure 150

NAREIT Equity REIT Annual Returns

MSCI U.S. REIT Index (Public) Moody's/REAL Commercial Property Price Index (Private)

ﬁgure 148
Private Real Estate Values by Property Type
240 220 200 180 160 140 120 100 80 60 40 2001 2002 2003 Apartment 2004 (2001 = 100)

1988

1992 Income

1996 Price

2000

2004

2008

ﬁgure 151

Index Value

2005 Industrial

2006

2007 Office

2008

2009 Retail

2010

ﬁgure 149

45 40 35 30 25 20 15 10 5 0 1980 1984

Total vs. Price Return of NAREIT Equity Index

Percent

1988

1992 Total

1996

2000 Price

2004

2008

U.S. went from adding 2 million jobs per year to losing 8.4 million jobs in 18 months, it was a problem. The challenge for real estate investing today is establishing a view on the

ﬁgure 152

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THE LINNEMAN LETTER
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NCREIF Index
2,500 4.5 2,000 $ Billions 1,500 1,000 500 0 1978 1982 1986 1990 1994 1998 2002 2006 Price Index 2010 Total Return Index Income Return Index 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1999 2001 2003 2005 2007 2009

Fall 2010

REIT Bond Issuance

ﬁgure 153

ﬁgure 155
Treasury Yields

6 5 Percent 4 3 2 1 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

30-Day T-Bill

10-Year Treasury

ﬁgure 154

…the bond market is saying that it believes the U.S. can sustain huge federal budget deficits and substantial liquidity injections from the Fed without any inflation for the next decade. Were this to occur, à la Japan, we would be shocked.

10 years. Stated differently, the bond market is saying that it believes the U.S. can sustain huge federal budget deficits and substantial liquidity injections from the Fed without any inflation for the next decade. Were this to occur, à la Japan, we would be shocked. There is nothing that bond traders know that you do not know. They have no greater insights than you, as to either what will happen to the huge amounts of global liquidity, or how the spectacular government budget deficits will be funded. As a long-term commercial real estate investor, you must make your own determination of expected inflation over this time horizon, and cannot “outsource” this task to the bond market. If the bond market is right, and inflation is a mere 0.5% annually over the next decade, it will have dramatic implications for commercial real estate pricing. First, real estate borrowing costs will fall dramatically. If 2.5% is the base interest rate, then yields on commercial real estate

debt will fall accordingly. This has already occurred in the multifamily sector, with 10-year debt running below 4.5%. But if 10-year Treasury yields remain at 2.5%, borrowing rates for commercial real estate will fall to 3.5-4.25% for 60-70% LTVs on cash-flowing assets. Over the next three years, such low rates will allow much of the maturing debt on cash-flowing properties to be refinanced much more easily than anticipated. This is because lower interest rates will greatly improve interest coverage ratios, and because low long rates will push down cap rates. Consider a piece of real estate which deserves a total return premium of 200 bps above the 10-year Treasury. This premium is consistent with the return earned on BBB (Baa equivalent) bonds relative to 10-year Treasuries, and as we have noted in the past, the portfolio risk of commercial real estate is roughly equal to that of BBB bonds. For a 2.5% 10-year Treasury yield, the total expected return for commercial real estate is 4.5%. Since future cash flows into perpetuity are expected to grow at about the same rate as expected inflation, 50 bps of this expected return will come via expected appreciation, as cash flows increase. Thus, in order to achieve the 4.5% total return, cash flow cap rates will fall to approximately 4%. Depending on the property type, this suggests NOI cap rates in the range of 4.5% for well-tenanted strip centers, 4.5-4.9% for quality apartments, and 5.5-6% for prime office properties. While such cap rates seem extremely low, when viewed as the alternative to a 2.5% yield on a 10year government bond, they seem about right. This is particularly true in view of the fact that real estate will fare better than bonds if inflation is higher than expected. That is, higher than expected inflation will be reflected in future real estate cash flows, while the coupon on a government bond remains unchanged. Lower cap rates,

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combined with lower borrowing costs, mean that most cash-flow assets maturing in the near term would be able to renew their debt upon maturity, in spite of drops in cash flow since the loans were originated. Another implication of 2.5% 10-year Treasury yields is that the underwriting of commercial real estate cannot assume 3% inflation. Such an assumption simply makes no sense in a world where 10-year Treasury yields are 2.5%. Further, 20% returns will be almost impossible to achieve in a world of modest leverage and extremely low cap rates. How do you protect yourself? Normally, investors ask, “What kind of liquidity and operating risk premium over the 10-year Treasury does real estate offer?” I respond, “Well, I think the 10-year Treasury guys know what they are talking about inflation-wise.” Today, we are not so certain about that. While they are not necessarily wrong, and they may think they have great information, keep in mind that they too have never faced today’s market conditions. You have to ask, “Am I happy with a 200-300-bpspread over the current 10-year Treasury with my cap rate? Am I willing to buy an asset at that absolute yield?” If you buy an asset at 300 bps over a 10-year Treasury today, you are buying at a 5.5-5.7% cap rate. Are you happy at that cap rate? You might be happy with 300 bps, but bond markets historically move very fast, and yields could move quickly from 2.5% to 4.5%. But your cap rate is locked in. Thus, the real question you need to answer is, “What is the absolute return I believe I need in a market like this?” We believe that the 10-year Treasury yields belong in the 4.5-5% range, and hence establish pricing from there. We may be wrong, and the bond market clearly disagrees, but the commodity market generally agrees with us. It is absolutely Today’s investor must critical to have have clear views about the growth of the economy consistent and well (jobs) and inflation over the thought-out views of next few years. In normal both inflation and times, the range among sophisticated and knowledge- job growth. The fact that there is huge able investors on these variables is quite tight; today, the variability among range is enormous. Hence, potential bidders while “micro” aspects of the means that bids property and the manager by intelligent generally determine the performance of an asset, mac- investors can be 2050% apart. roeconomic considerations

are of predominant importance today. If the economy adds 3 million jobs each year, and inflation is 5% per year over the next few years, it will overshadow whether one is a 10% more or less efficient manager. And, even the most efficient manager will be wiped out if there is deflation and more lost jobs. It is absolutely critical to have consistent and well thought-out views on both inflation and job growth. The fact that there is huge variability among potential bidders means that bids by intelligent investors can be 20-50% apart. One can no longer use “2-3% per year increase” and “stable cap rate” underwriting. While no one knows what will happen with inflation and job growth, you cannot invest today without clearly articulating what your views are in this regard. Publicly traded real estate appears to be far more volatile, as it trades in real time, while privately owned piece real estate trades infrequently. But as we have repeatedly told institutional investors, “If you do not like the volatility associated with publicly traded real estate, stop looking at the daily quotes and simply check the last day of the year.” Private real estate values have fallen, but not by as much as REIT pricing. Interestingly, REIT pricing peaked in early 2007, while private real estate values peaked well into 2008, or about 16 months later. Joseph Gyourko’s research at Wharton demonstrates that this is a long-standing pattern. That is, the public market responds far earlier to both good and bad news than private real estate. So in the next few quarters, private real estate will go up. Of course, some investors are probably investing simply because they have money which, if not invested, must go back to their capital sources. But this is not unique to the current times. There are plenty of people with money today versus in the 1990s. Hence, the current pricing distress is much less severe than in the early 1990s. As pricing has improved, more owners (including financial owners of foreclosed assets) believe that prices have peaked, as they believe that future growth will be substantially below what is being priced into the market. Only time will tell who is right, but as bullish bidders have appeared, it is not surprising that sales have recovered. In some cases, owners are selling because the asset no longer matches the owner’s skill set. The most common example is a property owned by a developer, which was foreclosed upon by the lender. In other cases, developers may be under sufficient distress as to lack the necessary capital to execute the required tenant improvements and capital expenditures.
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Another reason to sell today is if you need to recycle capital due to end dates of finite life funds. In particular, research indicates that approximately $0.65 of every dollar returned to investors goes back into subsequent investment vehicles. Therefore, the rebound in pricing provides an opportunity to meet the deadlines of a finite life fund while hopefully signing up investors for a new fund. A final reason is that many of the partners are no longer viable entities to execute the original business plan. Extreme examples of this are the planned conversion of an apartment building into a badly broken condo. In any case, it is essential that asset owners asked themselves how bullish they are on future growth and inflation relative to their skill sets and capital needs, and on market pricing which anticipates a moderately robust economic recovery over the next three years. It is interesting to note that as loans are retired, either via sale upon foreclosure, a fresh capital injection, or thirdparty refinancing, new lending has picked up. That is, “If you pay me what you owe, I can give you a new loan.”
U.S. CDO Annual Market Volume
450 400 350 $ Billions 300 250 200 150 100 50 0 1996 1998 2000 2002 2004 2006 2008 2010
Source: SIFMA

Annual Historical U.S. CMBS Issuance
250 203 200 $ Billions 150 100 50 3 0 1990 1994 1998 2002 26 8 14 17 18 16 37 74 57 47 67 78 52 93 169

230

12 3 2006

4

2010YTD

Source: Commercial Mortgage Alert

ﬁgure 158

Monthly Historical U.S. CMBS Issuance
45 40 35 30 25 20 15 10 5 0 1999 2001 2003 2005 2007 2009
Source: Commercial Mortgage Alert

ﬁgure 159

ﬁgure 156

U.S. CDO Monthly Market Volume
160 140 120 $ Billions 100 80 60 40 20 0 1Q05 4Q05 3Q06 2Q07 1Q08 4Q08 3Q09 2Q10
Source: SIFMA

138.0 124.6 92.9 73.7 53.7 41.8 26.0 9.4 6.2 0.2 0.2 0.6 0.5 2009 Total: $2.2 Billion 1H10: $1.1 Billion

ﬁgure 157

The improved outlook for new CMBS issuance and the recent improvement in mortgage lending means that the upcoming refinance wave will resolve itself, much as we suggested two years ago. Specifically, huge chunks
42

of land, unfinished developments, and broken condos will simply be written off and sold for $0.05-$0.25 on the dollar. On the other hand, maturing debt on cash-flow assets with good interest coverage will be refinanced with a high degree of success, particularly with both long- and short-term interest rates at historic lows. These low interest rates allow owners to refinance with greater proceeds than otherwise possible, and also yield additional net of interest payment cash flow with which to service tenant improvements and capital expenditure. Assets with coverage ratios of 0.8-1.1x will go through some type of restructuring or sale that requires additional equity capital. But many of these projects require more equity from day one, and it was only the misuse of cheap and abundant debt that put this excess financing in place. For owners of these properties, the day of reckoning for a poor capital structure is upon them. Many seemingly sophisticated investors utilize the weighted-average cost of capital (WACC) as an indicator of the cost of their long-term capital, with an eye to investing as long as their expected return exceeds their WACC. When debt becomes abnormally cheap and plentiful, the WACC declines instantaneously, meaning that investment prices can rise as lower returns are required to exceed the current WACC. This leads to rising asset prices, as investors use

$ Billions

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

large amounts of artificially cheap short-term debt, such as in 2002-2006. But what investors using this approach fail to realize is that a perpetuity asset requires much longer debt than 1-10 years for WACC to be a true indicator of the long-run cost of capital. This is because upon maturity, the risk of more equity being needed rises dramatically, as large amounts of abnormally cheap debt are utilized today. That is, by shifting from equity to debt, particularly super-cheap short-term debt, investors are using abnormally large levels of unsustainable cheap debt. As this debt matures, they will not necessarily be able to refinance it. For example, if an asset is historically comfortably financed at 60% debt, and 85% debt financing is currently available at the same interest rate, the investor faces the risk that upon maturity, debt levels will need a 25% (or more) equity infusion. Stated differently, in the presence of abnormal debt availability, the risk of the equity – hence, the required rate of return on equity – must rise accordingly so as to leave WACC essentially unchanged. Since and abundance of cheap debt generally coincides with an abundance of commensurately cheap equity, investors tend to view their short-term WACC as much lower than it is, even though when viewed over the life of the asset, it is largely unchanged. Since periods of cheap and plentiful debt and equity are generally followed by periods of expensive and scarce debt and equity, at a minimum, when debt is plentiful and cheap, investors should keep abnormally high levels of equity reserves. This will offset the potential for future equity injections when capital markets normalize. Failure to do so means that investors seriously mismatch asset and liability duration, increasing the potential that they will not survive difficult capital windows. The good news is that recovery rates on corporate debt have been better in this cycle than in the recessions of 19901991 and 2001-2002. Specifically, over the past two years, recovery rates on corporate The real problem in debt have run about $0.51 on the dollar, versus $0.48 the recent financial during 1990-1991 and $0.47 crisis was not in 2001-2002. excessive leverage, The real problem in the but rather excessive recent financial crisis was pricing, or more not excessive leverage, but fundamentally the rather excessive pricing, or more fundamentally the under-pricing of risk. under-pricing of risk. As Miller-Modigliani noted long ago, whether it is called debt or equity matters little. What matters is whether the

availability of debt and eqThe primary uity lead to the mispricing difference between of assets relative to their true risk. After all, typical mispricing associated LBO multiples of EBITDA with equity and that rose from historic norms of of debt is that equity 7-8x to 9-11x in the presprices adjust almost ence of cheap capital. But instantly, whereas it was not the debt, per se, that was the problem, but the contractual rather that pricing rose nature of debt can be by 20-30% and then fell. fought over for years When overpricing occurs, at enormous legal there will be losses, as was drainage. driven home by the Tech Wreck, an almost exclusively equity phenomenon. The primary difference between mispricing associated with equity and that of debt is that equity prices adjust almost instantly, whereas the contractual nature of debt can be fought over for years at enormous legal drainage. But dumb pricing relative to the risk of the asset is what causes losses; the amount of debt merely determines how the losses associated with dumb pricing are allocated. Construction Costs After a brief rise to 31.7 million square feet of commercial and industrial contracts awarded in December 2009, the two-year downward trend resumed, standing at 28.1 million square feet in May 2010. We expect construction levels to remain low through 2011, due to the lag in demand for space after the overall economy picks up momentum, high vacancy rates, and an absence of construction debt. Commercial construction trends continue to post large year-over-year declines as of July 2010, with monthto-month declines also still negative, but moderating. In real dollars, year-over-year construction growth was down across the board: -40.6% (-$15.4 billion) in the office sector; -36.1% (-$24.3 billion) in the industrial sector; -52.1% (-$14 billion) in the multifamily sector; -25.2% (-$8.2 billion) in retail; and -56.3% (-$14.2 billion) in lodging. The Linneman Construction Cost Index (LCCI) is based on a hypothetical building consisting of lumber (5%), concrete (5%), gypsum (10%), iron and steel (10%), labor (50%), and land (20%). We track the costs of all of these components except land using producer price indices from the U.S. Bureau of Labor Statistics. For land, we set the 1995 base value to 100 and assume that it has increased
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THE LINNEMAN LETTER
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U.S. Commercial Construction
80 70 60 $ Billions 50 40 30 20 10 0 1995 1998 Office Hotel 2001 2004 Industrial Multifamily 2007 Retail 2010 (Real - 2008 $)

Fall 2010
Construction Cost Indices

250 225 200 175 150 125 100 75 50 1990 1994

1998

2002

2006

2010

Linneman - Nominal Turner - Nominal

Linneman - Real Turner - Real

ﬁgure 160

ﬁgure 163
Change in Cost Indices Through 2Q10

140 Millions of Square Feet 120 100 80 60 40 20 0 1963

Commercial & Industrial Construction Contracts
LCCI (Nominal) LCCI (Real) Turner Index (Nominal) Turner Index (Real) Lumber Concrete Gypsum Iron & Steel Labor (Benefits + Wages) CPI (all items)
1968 1973 1978 1983 1988 1993 1998 2003 2008
Source: McGraw Hill

Y/Y 4.3% 2.0% -4.7% -6.7% 21.7% -2.0% -2.9% 37.9% 0.3% 2.2%

Q/Q 2.7% 2.5% -0.1% -0.3% 6.9% -0.3% 6.0% 9.8% 0.4% 0.2%

Over 3 Yrs 1.2% -4.1% -5.8% -10.7% -0.3% 3.5% -13.8% 12.3% 8.0% 5.5%

20-Yr CAGR 3.0% 0.3% 3.0% 0.4% 1.6% 3.2% 3.5% 4.0% 3.0% 2.6%

Source: Bureau of Labor Statistics, Linneman Associates, Turner Construction

ﬁgure 161

ﬁgure 164

2.5 2.0 1.5 1.0 0.5 0.0 1969

Ratio of C&I Construction Contracts to Real GDP

1974

1979

1984

1989

1994

1999

2004

2009

ﬁgure 162

by CPI (all goods) over time. We add up all of the nominal values of the component indices to arrive at the nominal LCCI, and then convert to a real basis using CPI. In comparison, the Turner Building Cost Index (TBCI), published by Turner Construction, tracks the overall cost of construction on a national basis, taking into account major construction cost categories such as “material prices, labor rates, productivity, and the competitive condition of the marketplace.” As with the LCCI, we converted the TBCI to a real basis using core CPI. On a real basis, the LCCI and the Turner Index exhibited 20-year compounded annual growth rates of just 0.3% and 0.4%, respectively. Recall that three years
44

ago, when construction costs were surging, we warned that construction (and hence replacement) costs would revert back to the long-term trend. This has occurred, with recent declines pushing the real cost index back down to historical norms. In the second quarter of 2010, the real LCCI declined by 2% year-over-year and 2.5% since the previous quarter. The 4.1% drop in the LCCI over the last three years has been driven by two steep input-factor declines. First, the gypsum producer price index dropped by nearly 30% from its mid-2006 peak through the February 2009 low-point. On a year-over-year basis, the gypsum producer price index declined by 2.9%, but increased by 6% quarter-over-quarter through the second quarter of 2010. Current gypsum pricing reflects a 26% decline since its peak in the third quarter of 2006. More recently, the cost of iron and steel rose sharply (43%) through August 2008, dropped by 43% through April 2009, and then rose 34% through August 2010. The lumber price index peaked in the third quarter of 2004. It declined by nearly 33% through the second quarter of 2009, but increased by 22% over the last year. Concrete prices have been on an upward trend for the last 20 years through mid-2009, but have declined by 2.9% since then.

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010
Leading Indicator of Remodeling Activity
LIRA 160 140 LIRA $ Billions 120 100 80 60 40 20 0 1995 1998 2001 2004 2007 2010 4-Qtr Mvg Avg Change 20 15 10 5 0 (5) (10) (15) (20)
Source: Joint Center for Housing Studies

ﬁgure 165

Index of Residential Renovations to GDP
140 130 120 110 100 90 80 70 60 50 1993 1995 1997 1999 2001 2003 2005 2007 2009 1993-2005 Avg Indexed to 100 (Real 2005 $)

ﬁgure 166

200 150 100 50 0 -50 -100 -150 1993

Cumulative Excess Renovations based on Index of Residential Renovations to GDP

1995

1997

1999

2001

2003

2005

2007

2009

ﬁgure 167

500 400 300 200 100 0 1980 1985 Lumber

Producer Price Index

1990 Concrete

1995

2000 Gypsum

2005

2010

Iron and Steel

ﬁgure 168

Oil Spill Nonsense Numbers We read with amusement the estimates of the costs associated with the recent BP oil spill. Daily, so-called experts are spewing numbers ranging from tens of billions to trillions of dollars as the social costs associated with the spill. The real truth is that it will take years to determine the true costs of this environmental disaster. And any estimate of the costs will not only have to estimate the number of birds, fish, plankton, and coral lost due to the oil spill, but will have to place values on these affected species. This is neither easy, nor uncontroversial. The losses associated with the devastation of tourism and fishing in the affected areas are generally not social costs, as consumers largely switched to fish caught elsewhere and vacations enjoyed at other locales. That is, a Gulf fisherman’s loss is a New England fisherman’s gain, and a Gulf resort loss is a gain for a resort on the Outer Banks. The substitution effects largely negate the food and tourism impacts for the nation as a whole, though true losses are suffered by fishermen and tourist destinations in the Gulf region. The BP spill was a dream come true for Democrats, Republicans, environmentalists, and the media. The Democrats loved it (at least for a while) because it allowed them to torture big business and big oil in particular. It neatly fit into their “Snidely Whiplash” characterization of business and executives. Republicans loved it because it showed that the Obama administration was every bit as helpless (and hopeless) at solving unsolvable problems as was the Bush administration. The serial incompetence of the Obama administration to quickly resolve the disaster was a gift from Mother Nature in the run-up to the November elections. For environmentalists, it was the best thing since the Exxon Valdez, as it allowed them to simultaneously vilify Big Oil and drum up financial support for their cause. And the media loved this event because it was an easy story of good and evil, combined with a dash of incompetence and a pinch of arrogance that could be neatly packaged into 30-second sound bites by concerned-looking reporters. The result was much hand-wringing, finger-pointing, and nonsense loss estimates. The BP spill was surely a disaster for nature and society, but not for politicians, environmentalists, and media, and underscores how the interests of those groups and other special interests are generally poorly aligned with the interests of the nation.
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Moving Avg % Change

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Volume 10, Issue 3 Fall 2010

Market Close-up: Philadelphia Ofﬁce Overview and Economy. For only the second time in the last eight quarters, the Philadelphia office market witnessed positive net absorption, although it was minimal at 0.2 million square feet. This compares to the negative net absorption of 0.52 million square feet experienced in the first quarter. The MSA’s availability rate was 20.1% in the second quarter. Average office rents in Philadelphia fell by $0.04 to $24.04 per square foot over the quarter, even as Class A space increased by $0.16 to $26.27 during the same period. The construction pipeline is minimal due to the restrictive credit environment and a lack of demand, with only five projects totaling approximately 554,000 square feet. In comparison, there were over three million square feet under construction 3 years ago.
Philadelphia Employment Forecast
2.70 2.65 Millions 2.60 2.55 2.50 1999 2001 2003 2005 2007 2009 2011 2013 (net of construction employment)

2010: 1Q-2Q Actual; 3Q-4Q Forecast

ﬁgure 169

12 10 Percent 8 6 4 2 0 1994

Philadelphia vs. U.S. Unemployment Rate

1996

1998

2000 2002 Philadelphia

2004 U.S.

2006

2008

2010

ﬁgure 170

The top employers in the region, excluding government employment, include the University of Pennsylvania and Penn Health System, Jefferson Health System and Thomas Jefferson University, Lockheed Martin, Comcast, Temple University and Health System, Merck & Co, Wal-Mart Stores, UPS, and Catholic Health East. In September of this year, the new Sugarhouse Casino will open in Philadelphia, and is expected to add approximately 800 jobs, as well as modestly increase tourism in the area.
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In previous issues we have discussed a covariance analysis that was published in the Spring 2007 Wharton Real Estate Review. In that analysis, we examined how various economic indicators behave in individual metropolitan areas, based on national economic changes. For each MSA, we calculated a “beta,” which summarizes how a 100-basis point change in the national variable affects the local indicator. The beta for the U.S. as a whole is defined as 1.0. Thus, an MSA with a beta of 1.0 registers (on average) an increase of 100 bps in employment growth (around its trend) when national employment rises by 100 bps. A beta that is less than 1.0 indicates that the MSA does not boom (or bust) to as great an extent as the national economy, while a beta greater than 1.0 indicates that such an MSA will experience swings of much greater magnitude (compared to the local trend) than the changes at the national level. With an employment beta of 0.75, Philadelphia’s employment base responds 25% less (around its mean) than national movements, meaning that Philadelphia employment is significantly less vulnerable to declining U.S. employment. This reflects the strength of the new Philadelphia economy: health care, pharmaceuticals, and education. Metropolitan area payroll employment hit a 12-year low in the first quarter of 2010 at 2.56 million jobs, but improved in the second quarter by about 53,000 jobs. Still, regional payrolls have shed 16,500 employees (0.6%) in the last 12 months. The peak in employment occurred in the fourth quarter of 2007 at 2.72 million, 4.1% higher than today. Unemployment in the MSA hit a low of 3.9% in April of 2007, and has been rising steeply since. The unemployment rate was 6.2% by year-end 2008, before jumping to 9.5% and 9.7% in June and July of 2010, respectively. In comparison, the U.S. unemployment rate was also 9.5% in June and July, and 9.6% in August 2010. Absorption and Vacancy. In the second quarter, the Philadelphia office market registered 0.2 million square feet of positive net absorption. This marks only the second quarter of positive net absorption over the past two years, while the last four quarters experienced significant cumulative negative net absorption. Only 50% of all submarkets have reported negative absorption through the first half of 2010, while downtown Philadelphia has experienced eight consecutive quarters of negative net absorption.

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The overall vacancy rate remained at 18.9% in the second quarter of 2010, while availability was 20.1%. Class A vacancy rates fell from 18.3% to 17.7%, while Class B vacancy rates rose from 19.9% to 20.9% quarter-over-quarter. Transaction velocity has declined 30% over the past year due to persistent capital market challenges. Rental Rates and Leasing. Asking rents fell by 0.2% in the second quarter of 2010, to $24.04 per square foot, while effective rents declined 0.9% to $19.52 per square foot. Class A space asking rents have increased 0.6% to $26.27 per square foot. The margin between asking and actual deal prices has been widening over the past year, particularly in favor of tenants of Class B and C space. Major second-quarter leases included the Environmental Protection Agency (304,750 square feet) at 1650 Arch Street in the Philadelphia CBD, Beneficial Savings Bank (128,352 square feet) at Penn Mutual Towers in the Philadelphia CBD, Publicis Touchpoint Solutions (60,000 square feet) at 1000 Floral Vale Boulevard in the Southern Bucks County submarket, 1&1 Internet (26,500 square feet) at 701 Lee Road in the King of Prussia/Valley Forge submarket, Goldman Sachs (22,430 square feet) at 1735 Market Street in the Philadelphia CBD, Microsoft (21,894 square feet) at 45 Liberty Boulevard in the King of Prussia/Valley Forge submarket, World Gate Service Inc. (17,713 square feet) at 3800 Horizon Boulevard-Building 1 in the Southern Bucks County submarket, Drucker & Scaccetti, P.C. (15,000 square feet) at 1600 Market Street in the Philadelphia CBD, and Offit Kurman (13,536 square feet) at 1801 Market Street in the Philadelphia CBD. Development/Construction Pipeline. At the end of the second quarter, the Philadelphia office pipeline consisted of just five projects totaling 554,000 square feet. These projects are scheduled for delivery throughout the second half of the year. Most projects have been delayed due to the harsh, restrictive credit environment and weak demand. Investment and Sales. Tight capital markets have created financing challenges for both sellers and developers, particularly for large properties. Total transaction volume for Philadelphia declined by 80% from last year, after retreating just 58% in the preceding year. Over the past 10 years the Philadelphia office cap rate has been above the U.S. average, but both followed a steep downward trend. The only exception occurred from 2007 to early 2009, when U.S. prices surged, but

Philadelphia cap rates continued to increase. In June of 2009, Philadelphia’s cap rate dropped to 7.1%, 40 bps below the national average of 7.5%. It has since remained below U.S. office cap rates. There was only one second-quarter sale transaction in the Philadelphia office market. In May 2010, First Federal Savings & Loan Association of Bucks County purchased 107 Floral Vale Boulevard, in Morrisville, for $2.75 million ($259 per square foot) from Deluca Office Associates. Major sellers over the past 10 years, in descending order of properties transacted, include Brandywine Realty Trust ($248 million in dispositions), Fox Companies ($283 million), Florida State Board of Administration ($253 million), Berwind Property Group ($257.8 million), Rubenstein Real Estate ($877 million), and Equity Office Properties ($370 million). Major buyers over the last decade, in descending order of properties acquired, include Pitcairn Properties ($342.3 million in acquisitions), SEB Group ($253.4 million), DRA Advisors ($125.3 million), Brandywine Realty Trust ($839.3 million), Bresler & Reiner ($223.2 million), and Keystone Property Group ($175 million). Submarket Review ß University City. The second-quarter vacancy rate was 7.2%, an increase of 40 bps over the previous year, yet still the lowest in the overall market. This submarket has the highest effective rental rates at $24.87 per square foot, a 0.6% increase from the second quarter of 2009. ß Center City. The submarket is also one of the higherpriced markets, with average rents of $20.77 per square foot in the second quarter, down 2.6% from last year. Vacancy was 9.4%, a 110-bp increase from the second quarter of 2009. ß North Philadelphia. One of the lower priced submarkets at $17.55 per square foot, North Philadelphia has a vacancy rate of 12.1%, a 310-bp increase from last year. ß Delaware County. Average rents dropped 2.4% from the second quarter of 2009 to $21.53 per square foot. The vacancy rate is 12.2%, a decrease of 60 bps from last year. ß Lower Merion. This submarket has the second highest effective rental rates at $24.82 per square foot. The vacancy rate is 14.2%, a 480-bp increase from last year. ß Burlington County. One of the least costly submarkets, Burlington County’s effective rents have dropped 1.3% from last year to $16.59 per square foot. The vacancy rate is 15.5%.
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ß King of Prussia. King of Prussia has a vacancy rate of 18.7%. This is a 150-bp increase from the second quarter of 2009. The effective rental rates are down slightly from last year, at $19.44 per square foot. ß Bucks County. The vacancy rate is 19.9%, a 330-bp increase from last year. Effective rental rates are $18.37 per square foot. These prices are the largest annual drop in the market, falling 4.9% from the second quarter of 2009. ß Horsham. Falling 20 bps from last year, the vacancy rate is tied for the highest in the market at 21.3%. The submarket also has the lowest effective rents at $15.86 per square foot, a 2% decrease from the second quarter of 2009. ß North Montgomery County. The submarket shares the highest vacancy rate at 21.3%. This is a massive increase of 780 bps from last year. In this second least pricey submarket, effective rents have fallen 2.2% from last year to $16.33 per square foot. Opportunities and Challenges. The region shows strength within the CBD, but weaknesses in suburban submarkets are evident. University City and Center City both have vacancy rates under 10%, but some of the suburban markets are quite high, with four submarkets around 20% or higher. A large boost for the Philadelphia market should come from the opening of the new Sugarhouse Casino, which is expected to create about 800 new jobs in the third quarter of 2010, and should also draw in additional tourism revenue in the downtown markets. Outlook The market will weaken slightly through the third quarter of 2010 before commencing a modest recovery. We forecast that the market will add about 24,000 jobs
Philadelphia Office Market
20.5 20.0 Vacancy Rate (%) 19.5 19.0 18.5 18.0 17.5 17.0 16.5 2Q10 4Q10 2Q11
Vacancy Rate

in the second half of 2010, and an additional 24,000 new jobs by year-end 2011. From 2012 through 2015, we estimate that the Philadelphia region will add approximately 90,000 jobs. The second-quarter Philadelphia office availability rate was 20.1%. By year-end 2010, we expect it to drop to 19.7%. Our projections indicate that vacancies will then slowly decline, reaching 18.9% in 2011, 17.9% in 2012, and 17.3% by year-end 2013. Market Close-up: Seattle Industrial Overview and Economy. Amidst manufacturers’ continued concerns about lagging consumer demand, Seattle’s industrial market saw vacancy rise 20 bps to 8.9%, due to negative net absorption of 600,000 square feet in the second quarter of 2010. Although bad news, this represents a significant improvement from the 1.2 million square feet of negative net absorption in the first quarter. Both asking and effective rental rates were relatively flat for the region, with asking rates averaging about $5.75 per square foot. Development has been held in check during the recession. The current construction pipeline has just one speculative project (140,000 square feet) and a 200,000-square foot buildto-suit cold storage facility. While Seattle’s economy has a mix of industries, the industrial market is particularly reliant on its port activities. The combined tonnage through the ports of Tacoma and Seattle was the second largest on the west coast in 2009. The ports serve as a primary entry point for southeast Asian imports. According to Seaport data, cargo transported through the Seattle port is up 45.2% (from a horrendous low) year-to-date through June compared to the same period in 2009. This improvement is an encouraging sign for the regional industrial sector, and will improve as global trade and consumer demand continue their rebound. Seattle is home to numerous corporate headquarters, including Microsoft. The tech industry has shown resilience through the recession, as companies have turned to technology to help cut costs. The metro area is also home to the headquarters of Nordstrom, Eddie Bauer, and Amazon.com, and has thus benefitted from improving U.S. retail sales since October 2009. Strong biotechnology efforts in the region, partially funded by the Gates Foundation, have increased demand for industrial space, while Boeing’s 787 jets are being built in Everett, north of the CBD. While the aerospace

400 350 300 250 200 150 100 50 0 4Q11 2Q12
Absorption

4Q12

ﬁgure 171

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Absorption (000’s SF)

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industry has lost some traction in the region, its intensive manufacturing process necessitates a highly specialized labor pool, giving Seattle a “sticky” advantage. With an employment beta of 1.16 (see discussion in the Philadelphia Office Market Close-up), Seattle’s employment base historically responds 16% more (around its mean) than changes in employment at the national levels. That is, the Seattle MSA experiences larger swings in employment (in either direction) than what occurs in the U.S. during the same period. As such, it is poised to benefit disproportionally from a rebound in the U.S. economy.
Seattle Employment Forecast
(net of construction employment) 1.6 1.5 1.4 Millions 1.3 1.2 1.1 1.0 1999 2001 2003 2005 2007 2009 2011 2013

2010: 1Q-2Q Actual; 3Q-4Q Forecast

ﬁgure 172

The Seattle MSA held strong through the early part of the recession, reaching an all-time high in employment in August 2008, at 1.49 million jobs. The troubles facing the rest of the country eventually took their toll, and Seattle employment bottomed in November 2009 at 1.37 million jobs, an 8% drop from its peak (reflecting its high beta). Since then, the region has slowly regained some of those lost jobs with the preliminary data for June 2010 pinning employment at 1.39 million jobs. With a heavy weighting of technology and retail firms, Seattle will be reliant on the return of consumer demand to pre-recession employment levels.

Seattle vs. U.S. Unemployment Rate
12 10 Percent 8 6 4 2 0 1994 1996 1998 2000 2002 2004 U.S. 2006 2008 2010 Seattle

ﬁgure 173

After bottoming at 3.7% in April 2007, the Seattle metro area unemployment rate increased steadily, peaking at 9.5% in early 2010. By June 2010, it had fallen to 8.6%, where it stayed in July. This is in comparison to the U.S. unemployment rate of 9.5% during the same months. The national unemployment rate stands at 9.6% as of August 2010. Absorption. The second quarter of 2010 saw negative net absorption of 0.6 million square feet, bringing year-todate net absorption to -1.8 million square feet. However, this negative absorption was largely concentrated in the suburban Kent Valley between Tacoma and Seattle. The Seattle Close-In submarket had positive absorption for the quarter, as did the Tacoma/Fife region. Vacancy Rates. Seattle’s second-quarter vacancy rate was 8.9%, a 20-basis point increase over the previous quarter. Vacancy rates were lowest in the downtown Seattle and Tacoma submarkets at 3.8% and 8%, respectively, with suburban rates as high as 15% in the Northend. The total metro area availability rate reached 9.8%, ranging from 6.2% in Seattle Close-In, to 19% in the Northend. Construction has been almost non-existent for the past few quarters, with only one speculative project (140,000 square feet) in the pipeline scheduled for delivery in August. We anticipate little new construction in the next two years. Rental Rates and Leasing. Asking rents have held up over the past two quarters, but have been offset by increasing tenant improvements and landlord concessions. Average rents for the region held steady at $5.76 per square foot. Seattle Close-In was the only submarket to post a decline, dropping $0.60 to $6.00 per square foot. The Tacoma/Fife submarket, with the lowest rates in the region at $4.08 per square foot, has been winning the battle for tenants. With no major construction slated for the near future and a modest recovery underway, rental rates should rise over the next two years. Several large leases signed during the quarter provide encouraging signs, including some tenants moving back into space they previously had vacated. Holman Distribution re-leased 192,000 of the 433,000 square feet it vacated last quarter at Northwest Corporate Park in Kent; Service Paper moved into Rainier Park in Sumner (179,000 square feet); Pregis Corporation occupied Valley Centre Building 1 in Auburn (126,000 square feet); Domtar moved into the Kingsport Industrial Park in Kent (100,000 square feet); and Funworld West reoccupied 77,000 square feet of the 246,000 square feet it gave up last year in the Snoqualmie Building in Sumner.
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Construction. There are 1,350,000 square feet in the construction pipeline through 2013, with only 340,000 square feet currently under construction. Given that 200,000 square feet of this construction is a build-to-suit cold storage building, the effect of further construction on vacancy rates should be minimal for the near future. Developers will hold off on speculative development until the region shows unambiguous economic growth. Submarket Review ß Seattle Close-In. The submarket comprises the entire urban area of Seattle west of Lake Washington. With 62.4 million square feet, the submarket is Seattle’s second largest. Vacancy rates are the lowest in the region at 3.8%, yet the submarket was the only one to see a decrease in rents over the second quarter, down $0.60 to $6.00 per square foot. Landlords will continue to give concessions to shore up occupancy, but with the best real estate and access to the Seattle port, the region should remain strong. ß Kent Valley. The suburban region between Seattle and Tacoma is the largest in the metropolitan area, with nearly 115 million square feet. It has also been hit the hardest in recent quarters with 2.6 million square feet of negative net absorption over the last year. Rental rates held steady last quarter at $4.20 per square foot, and vacancy stands at 10%. ß Tacoma/Fife. Tacoma is the third biggest census division in Washington, just narrowly behind Spokane. The Tacoma/Fife region comprises of 31 million square feet of industrial space, the third most in the region. It has the lowest rents in the region at $4.08 per square foot, and as a result has fared the best in recent quarters. Over the past four quarters, it is the only submarket to experience positive absorption at a total of 1.2 million square feet. It is also the only submarket with buildings under construction, containing all of the region’s 340,000 square feet currently in the pipeline. It stands at 8% vacancy, the second lowest in the region. ß Eastside. The Eastside has 24 million square feet of industrial space, making it the second smallest in the MSA. The submarket had the second highest rents in the region and also the second highest vacancy rate, at $6.60 per square foot and 14.3%, respectively. Over the last four quarters, it has experienced negative net absorption of 239,000 square feet, putting it in the middle of the five submarkets in terms of performance. ß Northend. The Northend is the smallest submarket in the region, with 14.5 million square feet of industrial
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space. It has the highest rents and the highest vacancy for the region at $6.96 per square foot and 15%, respectively. Over the past four quarters, it has only seen 85,000 square feet of negative net absorption, but it will likely require significant landlord concessions to get back to stabilized occupancy. Sales and Investments. According to Real Capital Analytics, investment opportunities have picked up noticeably as investors look to capitalize on landlord distress, including several owner-user purchases. Most of the sales were concentrated in the Kent Valley to the south of the CBD. In total, 11 transactions closed, totaling $72 million. Three transactions topped the $10 million mark, including Northwest Building’s purchase of the three buildings comprising the Valley Freeway Corporate Park in Kent for $15.5 million ($68 per square foot) from Alexander & Baldwin Inc. The two other large transactions were LaSalle Investment Management’s purchase of 1025 Valley Avenue NW in Puyallup for $15 million ($42 per square foot) from GA Development, and Industrial Income Trust’s acquisition of a 127,000 square foot building in Renton for $10.2 million ($80 per square foot) from Hunter Douglas, which traded at an 8% cap rate. Major sellers of industrial properties in the region over the past 10 years include REEFF ($213.5 million in dispositions, 16 properties), Opus ($156.8 billion, 11 properties), Panattoni Development ($181.8 million, 10 properties), CalPERS ($81.5 million, 10 properties), Mastro Properties ($114 million, 9 properties), and Cabot Properties ($78.6 million, 9 properties). Major buyers over the last decade include ING Clarion ($178 million, 14 properties), AMB Property Corp ($328 million, 12 properties), REEFF ($268.3 million, 11 properties), Walton Street Capital ($319.1 million, 8 properties), TIAA-CREF ($242.1 million, 8 properties), and Dividend Capital Trust ($72.5 million, 8 properties). Market Opportunities and Challenges. While the recovery of industrial real estate in the Seattle region has lagged and is still on the decline, there are some bright spots. Investment activity picked up noticeably in the last quarter, and there are some significant deals under agreement for the third quarter. Leasing activity has improved as well, with several tenants re-leasing previously vacated space. Speculative construction is negligible and absorption has been improving. The strong rebound in port traffic should be a positive leading

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indicator for the region’s economy. Ultimate return to balance will depend on a recovery in consumer demand and global trade to boost demand for industrial space. Outlook Our forecast indicates that employment in the Seattle industrial market will continue to rise through the end of 2013. About 22,300 jobs will be added in the second half of 2010, and another 75,200 jobs in 2011. From 2012 through 2015, we estimate that the Seattle region will add approximately 163,000 new jobs in total. We expect the current availability rate of 9.8% to decrease to 8.4% by the end of 2010. Availability rates are then projected to decline to 2.42% and -4.14% by yearend 2011 and 2012, respectively. Negative vacancy will obviously not occur, because developers will ultimately meet the excess demand. However, it is an indication of our belief that the Seattle industrial market will have very strong supply and demand fundamentals over the next five years.
Seattle Industrial Market
12.0 10.0 8.0 6.0 4.0 2.0 0.0 (2.0) (4.0) (6.0) 2Q10 4Q10 2Q11
Vacancy Rate

government sectors. Qwest Communications, HealthOne, King Soopers, United Airlines, Lockheed Martin, and Centura Health are the major employers in the region. With increasing effective rents, the area ended the second quarter of 2010 with a vacancy rate of 6.1%.
Denver Employment Forecast
(net of construction employment) 1.18 1.16 1.14 1.12 1.10 1.08 1.06 1.04 1.02 1999 2001 2003 2005 2007 2009 2011 2013
2010: 1Q-2Q Actual; 3Q-4Q Forecast

ﬁgure 175

6,000 5,000 4,000 3,000 2,000 1,000 0 4Q11 2Q12
Absorption

Non-construction employment peaked in the second quarter of 2008 at nearly 1.17 million, but fell to 1.09 million by the first quarter of 2010, a decline of nearly 80,000 or 6.7%. The region added about 20,000 jobs (2% quarter-over-quarter) in the second quarter, marking the first quarterly increase since the 2008 peak.
Denver vs. U.S. Unemployment Rate
12 10 Percent 8 6 4 2 0 1994 1996 1998 2000 2002 Denver 2004 U.S. 2006 2008 2010

4Q12

ﬁgure 174

Market Close-up: Denver Multifamily Overview and Economy. Increased housing demand in the Denver MSA has pushed multifamily vacancy lower, allowing owners to boost rents slightly while scaling back concessions. The increased demand is due to hiring in May and June. Additionally, an increase in the number of 20-34-year olds (the primary renter segment) created even more demand for apartments. As market fundamentals improve, the region has seen an increase in prospective multifamily investors. With 6-7% cap rates on quality assets, buyers are interested in acquiring properties that fared well during the recession, as well as distressed properties. The regional Denver economy is supported by jobs in the retail, telecommunications, healthcare, and

Absorption (000’s SF)

Vacancy Rate (%)

ﬁgure 176

With an employment beta of 0.98, Denver’s employment base generally responds in line (around its mean) with any change in employment at the national level. It does not experience economic booms or busts to any greater extent than what is occurring nationwide. As the state capital, Denver enjoys the luxury of having a core employment base supported by government presence. From a cyclical low of 2.6% in May 2000, the MSA unemployment rate climbed to 9.3% in June of 2009. Since then, rates have fluctuated around a slight downward trend, ending July 2010 at 8.1%, still substantially lower than the U.S. unemployment rates of 9.5% in July and 9.6% in August.
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Millions

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Vacancy Rates and Absorption. Vacancy rates continue to decrease, led by strong demand for Class A properties. The metro area experienced net absorption in the first and second quarters, and the overall multifamily vacancy rate fell by 40 bps in the second quarter, to 6.1%. Over the first six months of 2010, Class A vacancy decreased by 210 bps to 5.8%, while Class B/C vacancy rates fell by 180 bps over the same period, and by 40 bps in the second quarter alone, to 6.3%. Rents. Asking and effective rental rates increased by 0.9% and 1.2%, respectively, through the second quarter of 2010. Metro area asking rents are now $861 per month, while effective rents stand at $769 per month. Due to strong demand for luxury apartments, Class A rents increased 0.9% to $1,022 per month, while Class B/C rents rose by 0.5% to $708 per month. Increased demand has prompted some owners to eliminate concessions. Construction. Multifamily permits issued in the MSA fell year-over-year by more than 50% to 1,300 permits, continuing the decline over the past few years. More than 2,300 units came online during the 12 months through the second quarter of 2010, down from 3,300 the previous year. Many new units (over 570) are in the adjoining Denver-Central and Denver-South/Glendale submarkets. Currently 2,100 units remain underway. Submarket Review ß Douglas County. Effective monthly rents were high relative to other submarkets, averaging $932, a 1.4% increase year-over-year through the second quarter of 2010. Vacancy was the lowest of all the submarkets at 4.6%, down 280 bps over the last 12 months. ß Denver-Downtown. The second-quarter vacancy rate was 5.4%, down 190 bps from 2009, as effective rents were up 1.6% year-over-year to $956 per month, the second highest in the metro area. ß Lakewood-South. This submarket had a vacancy rate of 5.4%, down 170 bps over the last year. Effective rents increased 1.8% year-over-year to $809 per month. ß Littleton. This submarket commands effective monthly rents of $744, up 1.8% from last year. Vacancy increased by 60 bps in the past year, to 5.4%. ß Westminister. Second-quarter 2010 vacancy was 6.3%, a 190-bp decrease. Effective rents decreased 0.1% yearover-year and currently stand at $713. ß Denver-Far Southeast. With effective monthly rents of $669 (1.4% decrease over 2009), this area had a first52

quarter vacancy rate of 6.6%, a year-over-year decrease of 50 bps. ß Denver-Central. With a 180-basis point decrease over 2009, this submarket had a vacancy rate of 6.7% in the second quarter. Effective rents remained steady at $896. ß Aurora-South. With effective monthly rents decreasing 0.8% year-over-year, Aurora-South commanded an $884 average rent in the second quarter of 2010. Vacancy stood at 6.9%, down 430 bps over the past 12 months. ß Denver-Northeast. The vacancy rate was relatively high in the second quarter, at 7.0%, though it was down 140 bps from 2009. Effective rents were up 3.6% yearover-year, to $805 per month. ß Arapahoe County. This area had the highest vacancy rate in the MSA (17.5%) in the second quarter of 2010, up 20 bps over the previous year. Effective rents decreased 0.4% year-over-year to $970 per month, the highest of all submarkets. Sales and Investment. Over the past 12 months, multifamily properties sold for a median price of $64,300 per unit, up 4% from the year earlier, largely due to an increase in the number of prospective buyers bidding on properties. In that same period, transaction velocity decreased by 20%. This statistic is somewhat deceptive, as there were 22% more deals in the past six months than during the prior half year. Area cap rates for Class A properties were about 6%, while cap rates for Class B assets were in the mid-6% to low-7% range. According to Real Capital Analytics (RCA), nine sale transactions were recorded in the second quarter of 2010, following 10 in the first quarter. Two transactions closed in April, four in May, and three in June. In April, CandleLight (52 units), a garden property at 6985 Stuart Street in Westminster, was put under contract for an undisclosed amount. The Twin Arms Apartments (34 units in two buildings), a garden property at 1205 Yukon Street in Denver, sold for $1.35 million ($39,706/unit) to Central Development from JP Morgan. In May, Security Properties purchased Diamond at Prospect (142 units), a mid/high-rise building at 3001 Fox Street from Trammell Crow for an undisclosed amount. Case & Eberts Addition (44 units in eight buildings), a garden property located at 3301 Arapahoe Street in Denver, sold for $2.3 million ($52,273/unit). Transwestern Investment Group purchased Retreat at City Center (225 units), a garden property at 820 S Cimarron Way in Denver, from AmStar Group for $21.96 million ($97,000/unit). A mid/high-rise property at 7166 W Custer

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Avenue (308 units in two buildings) was purchased by Behringer Harvard from Trammell Crow for $41 million ($133,117/unit). In June, Marine Apartments (26 units), a garden property at 2939 Marine Street in Boulder, sold for $3.04 million ($116,927/unit). Weidener Investment Services purchased Silver Cliff (312 units), a garden property at 5109 S Delaware Street in Greenwood, for $20.5 million ($65,705/unit) from Asher Investments. Pine Gardens (97 units in five buildings), a garden property located at 9200 Elm Court in Denver, was sold by First Regional Bank for $3.417 million ($35,224/unit) to Bart Macgillivray. Major sellers of multifamily properties in the region over the past 10 years include Archstone ($583.5 million, 14 properties), Fairfield Residential ($356.3 million, 14 properties), Equity Residential ($263.5 million, 14 properties), Baron Properties ($164.4 million, 9 properties), and JPI Multifamily Inc. ($313.8 million, 7 properties). Major buyers over the last decade include Bascom Group ($547.5 million, 18 properties), Fairfield Residential ($277.1 million, 11 properties), Equity Residential ($509.6 million, 10 properties), JP Morgan ($394.6 million, 9 properties), and Hamilton Zanze & Company ($182 million, 9 properties). Market Opportunities and Challenges. As Denver is the largest city within 500 miles, it has become a central location for storage and distribution throughout the Midwest and Mountain States. Due to its central location, many major corporations have been attracted to Denver and have established headquarters in the region. Though hurt by the recent recession, Denver is bolstered by strong demographics, its government seat, and an ambitious program to upgrade its mass transit system. Several development projects are underway that will make Denver more attractive to both individuals and corporations, while creating thousands of jobs. The FasTracks Project, which aims to add over 120 miles of light and commuter rail to the Denver MSA, has been underway for the past several years. While the project is creating many jobs and will decrease congestion in the long term, the project is already $1.8 billion over the original budget of $4.7 billion. Because the project is funded by an increase in the sales tax, and tax revenues are coming in much lower than expected, the project may take several years longer than originally planned. Several stations are also being renovated, most notably Denver Union Station. The Union Station project alone is estimated to add more than $3 billion to the local economy and generate thousands of jobs.

Additionally, the Denver International Airport (DIA) South Terminal Development Project, which includes a new terminal, FasTracks station, and hotel, will enable many more flights to arrive and depart from Denver. This increased traffic should stimulate the economy as the area may become more attractive to businesses. Over the life of the project, it is expected to create 6,600 jobs in the metro area. Outlook We forecast that the market will add about 8,500 jobs in the second half of 2010, and an additional 10,000 new jobs by year-end 2011. From 2012 through 2015, we estimate that the Denver region will add approximately 77,000 non-construction jobs. The second-quarter Denver multifamily vacancy rate was 6.1%. By year-end 2010, we expect it to be flat. Our projections indicate that vacancies will then slowly decline, reaching 5.4% in 2011, 4.2% in 2012, and 3.2% by year-end 2013.
Denver Multifamily Market
7.0 Vacancy Rate (%) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

1,200 1,000 800 600 400 200 0 (200) (400) 4Q12 2Q13

Vacancy Rate

ﬁgure 177

Market Close-up: Phoenix Hotel Overview and Economy. The Phoenix metropolitan area is the 12th largest MSA, and the fifth most-populated city, in the U.S. The city is a major transportation hub, as well as a financial, industrial, cultural, and economic center of the southwestern United States. Phoenix is currently home to seven Fortune 500 company headquarters, including Honeywell’s, American Express, U-Haul and Best Western. Many of Phoenix’s residents are employed by the government, as well as by Arizona State University. Over the past few years, numerous hightech and telecommunications companies have relocated to the area, and as a result of the warm winter climate, Phoenix benefits greatly from seasonal tourism and recreation, at a lower cost than southern California.
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With an employment beta (see discussion in the Philadelphia Office Market Close-up in this issue) of 1.54, Phoenix’s employment base responds 54% more (around its mean) than national movements, meaning that Phoenix’s employment base is much more vulnerable to large swings in either direction than U.S. employment. As such, it is one of the most pro-cyclical USA metros. Employment. Employment growth in the region grew steadily from 2000 to the end of 2007, hitting a peak of about 1.78 million jobs in the fourth quarter of 2007. Jobs then bottomed at 1.59 million in the third quarter of 2009, but 2009 ended with 1.62 million jobs. In the first quarter of 2010, the region gave back about 20,000 jobs, regaining some of these again in the second quarter. As the U.S. economy weakened significantly in the face of the recession, Phoenix’s unemployment rate reversed from its remarkable low of 2.8% in May 2007, hitting 4% and 6.9% by years-end 2007 and 2008, respectively, and a high of 9.2% in January and February of 2010. It stood at 9% in June and 9.1% in July 2010, notably below the national rate during the same periods. The U.S. unemployment rate hit 9.6% in August 2010. Hotel Market Statistics. Phoenix is one of the largest hotel markets in the U.S., ranking ninth out of the top 25, with about 60,000 hotel rooms in approximately 430
Phoenix Employment Forecast
2.2 2.0 1.8 Millions 1.6 1.4 1.2 1.0 1999 2001 2003 2005 2007 2009 2011 2013 (net of construction employment)

2010: 1Q-2Q Actual; 3Q-4Q Forecast

ﬁgure 178

Phoenix vs. U.S. Unemployment Rate
12 10 Percent 8 6 4 2 0 1994 1996 1998 2000 2002 Phoenix 2004 U.S. 2006 2008 2010

ﬁgure 179

hotels, according to Lodging Econometrics. Although occupancy has risen minimally in Phoenix, ADRs, and RevPAR declined significantly over the past year. Smith Travel Research (STR) reported that the Phoenix hotel market’s running 12-month occupancy rate increased by 50 bps, rising from 53.8% in July of 2010 to 54.3% in July of 2010. Of the 27 cities surveyed for highest occupancy rate, Phoenix places in the bottom six. STR reported that running 12-month average daily rates in the Phoenix metro decreased by 9.3% over the year through July 2010, to approximately $102 from about $112 in 2009. Phoenix ranks 14th among the 27 markets surveyed, coming in just ahead of Denver ($93) and Austin ($99) and right behind Philadelphia and Seattle ($109). Similarly, running 12-month revenue per available room (RevPAR) decreased by 8.5% from about $60 to $55 over the 12 months through July 2010, ranking Phoenix in the bottom 10, on par with St. Paul ($54) and Orlando ($55). There is a “checkout” tax rate of 13.27%, allocated to the state of Arizona (6.50%), the city of Phoenix (2.20%), Maricopa County (1.77%), and the Transient Occupancy Tax (3.00%). Visitor Trends. Each year, 13-15 million people visit Phoenix. Although there were no MSA visitor statistics from the Greater Phoenix Convention and Visitor’s Bureau, according to the Arizona Office of Tourism, 37.4 million people visited Arizona in 2008, a 3% decline from 2007. About 26 million of these were leisure travelers, a decline of 3.3%, while business travelers declined by 7.6%, to 6.3 million visitors. A study conducted by the Arizona Office of Tourism showed that leisure visitors are likely to be younger and spend more money than those traveling on business. Direct spending by visitors to the state declined by just over 3% in 2008, to $18.5 billion. The state of Arizona welcomed about 35.3 million national and international overnight guests during 2009, according to the Office of Tourism. Visitors spent a total of $16.6 billion for the year. According to Dean Runyan Associates, Arizona travelers generated $2.4 billion in local, state and federal tax revenues in 2009. Tourists were also responsible for helping to create 157,000 travel industry-related jobs. The 2009 statistics represent about a 10% decline from spending in 2008, largely due to the recession. A study conducted by Nichols Tourism Group for the Arizona Office of Tourism found the state’s tourism industry has experienced a loss of $2 billion in annual visitor spending since 2007. The numbers also

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show the impact of residents staying closer to home. While non-resident travel to the state decreased by about 4%, to 22.6 million, about 9.8 million Arizonans traveled within the state, a decline of only 2%. Investment and Sales. According to Real Capital Analytics, only seven sales transactions were recorded year-to-date through July 2010, with two in March, one in April, two in June and two in July. In March, the 65-room Rodeway Inn was acquired at 7110 E. Indian School Road for an undisclosed amount, and the 120-room Highland at Biltmore at 2310 E Highland Avenue was sold for $14.78 million (approximately $123,000/room). In April, the 87-room Mainstay Suites was bought at 9455 N. Black Canyon Highway for $3 million (approximately $35,000/room). In June, the Best Western at 1625 E Main Street traded for $2.6 million (approximately $26,805/room). Also in June, America’s Best Value Inn was acquired at 1005 E. Apache Boulevard for $1.75 million (approximately $20,000/room). The final two transactions occurred in July, with the acquisition of the Best Western at 11201 Grand Avenue for $3.1 million (approximately $41,300/room) and the Holiday Inn at 1500 N. 51st Avenue for $4.4 million (approximately $30,600/room). The average room price for Phoenix was recorded at $123,100, as compared to the U.S. price per room average of $128,400. A year ago, Phoenix room price averages were $92,500, versus a national average of $113,000. Major sellers of hotel properties in the region over the past 10 years, in descending order of properties transacted, include Blackstone ($222.5 million in dispositions, 19 properties), CNL Financial Group ($1.3 billion, 6 properties), Hilton Worldwide ($435 million, 5 properties), La Quinta Inns ($41.6 million, 4 properties), Wyndham International ($254.5 million, 3 properties), and Marriott International ($128 million, 3 properties). Major buyers over the last decade, in descending order of properties acquired, include: Arbor Realty, Chetrit Group, Lightstone Group, and Polar Trust (all at about $210 million, 17 properties); Blackstone ($519.8 million, 11 properties); and Goldman Sachs ($372.8 million, 9 properties). Construction Pipeline. According to Lodging Econometrics, the Phoenix hotel market grew by 6.1% in 2008 (18 hotels) and by 4.7% in 2009 (20 hotels). Five hotels totaling approximately 770 rooms were under construction in the second quarter of 2010. The pipeline includes 16 hotels (2,000 rooms) slated to start within the

next 12 months, and 32 hotels (6,000 rooms) in the early planning stages, for a total of 8,300 rooms in 53 hotels. But few of these will be built in the next 2-3 years. Our forecast conservatively assumes that only those rooms currently under construction will be added to inventory. Opportunities and Challenges. Despite the new Arizona immigration law deterring many Mexicans from visiting Arizona, as well as the worldwide recession, the hotel market in Phoenix is fairing “okay.” Occupancy rates are up year-over-year through July 2010 according to STR, but ADRs are down by 7% year-over-year and RevPAR is down 8.5% year-over-year, resulting in a modest decline in revenue for hotels. As the economy starts to regain momentum, the hotel industry will slowly recover lost revenue but this will take time and patience. Until then hotel prices will remain low and vacation deals will continue to pop up, enticing people to leave their homes. Outlook Our proprietary forecasting model indicates that by the end of 2010, Phoenix’s employment base will have gained about 86,000 jobs. We expect the Phoenix area to gain another 170,000 jobs in 2011, and increasing another 116,000 in 2012. On an aggregate basis, our projections indicate that the region will add about 400,000 jobs from the second quarter of 2010 to the end of 2015. In the second quarter of 2010, the 12-month rolling average hotel occupancy rate in Phoenix was 54.4%, which we expect to increase through the end of the year to 56%. Our model indicates that growth will continue, rising to 68.8% in 2013 and to 69.1% to end 2015, using conservative pipeline estimates. That is, our forecasting model only accounts for projects that have already broken ground. We assume that other projects in various planning stages will not occur during our projection period.
Phoenix Hotel Market
80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

1,200 1,000 800 600 400 200 0 4Q12 Absorption (Rooms)

Occupancy Rate (%)

Occupancy Rate

ﬁgure 180

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Ofﬁce Market Outlook For the second quarter of 2010, 23 of the 40 U.S. office markets we cover saw increasing vacancy rates, one remained flat, and 16 decreased. Of the metros with increasing rates, 13 of them increased by fewer than 100 bps, with two metros growing by 20 bps and two by 10 bps. By the end of the second quarter of 2010, Detroit, the Inland Empire, Phoenix, and San Diego exhibited the highest vacancy rates, while Washington D.C. displayed the lowest vacancy rate, followed by New York City, Fort Worth, and Boston. By year-end 2010, we expect Westchester County, Columbus, Detroit, and San Francisco to see the greatest vacancy increases, but by no more than 160 bps. Meanwhile 32 cities will see decreasing rates, with Phoenix and Charlotte leading the pack. We do not expect market conditions to be in general balance until at least 2013, when we foresee 37 markets improving. By that time, the best markets are expected to be Orlando, Washington D.C., and Seattle, while the worst markets will be Detroit, St. Louis, and Denver. Using a benchmark of 10% vacancy to proxy a relatively balanced market, no markets were in balance as of year-end 2009, with only New York City in balance as of the first quarter of 2010, and none in balance as of the second quarter of 2010. Vacancy rates are expected to rise through 2010. Two markets will be in balance by the end of 2011; eight markets will be in balance by year-end 2012; and 11 markets will be in balance through 2013. Given the known construction pipeline, by 2013, Phoenix, Orlando, and the Inland Empire are projected to exhibit the largest decreases in vacancy rates – 2,020 bps, 1,900 bps, and 1,710 bps, respectively – while Detroit, Westchester County, and St. Louis are projected to show the greatest vacancy increases. The good news is that the Linneman Real Estate Index (LREI), which compares the fundamental demand
Vacancy Rates by Property Type

Linneman Real Estate Index
180 160 140 120 100 80 60 40 20 0 1980 1984 LREI and NCREIF Vacancy Rates 20.0 15.0 10.0 5.0 0.0 1988 1992 Industrial 1996 2000 Office 2004 2008 Multifamily Vacancy Rate (%)

ﬁgure 182

Index (4Q82 =100)

Multifamily and Commercial Mortgages Outstanding
3,500 3,000 2,500 $ Billions 2,000 1,500 1,000 500 0 1997 1999 2001 Multifamily 2003 2005 2007 2009 Commercial

ﬁgure 183

for space with the supply of real estate capital, finally reversed course in the third quarter of 2009, after a 12year run-up. For our new subscribers, the supply of real estate capital (the numerator) is proxied by the aggregate flow of commercial real estate debt, while the demand for space (the denominator) is proxied by nominal GDP. Excluding the net real estate equity flows from the numerator slightly understates an oversupplied market and overstates an undersupplied market. That is, this index tends to understate capital oversupply situations. An index of 100 (base year = 1982) indicates that the supply of real estate capital is roughly justified by the current demand for commercial space.

20 18 16 14 12 10 8 6 4 2 0 1983 Office

U.S. Office Vacancy Rates
20 15 Percent 10 5 0

Percent

1988 Retail

1993

1998 Apartment

2003 Industrial

2008
Source: NCREIF

1995

1998

2001 Grubb & Ellis

2004 NCREIF

2007

2010

ﬁgure 181

ﬁgure 184

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Office Vacancy Rates YE 2010 Est. 22.3% 23.0% 16.4% 16.0% 17.2% 17.4% 23.5% 19.6% 19.6% 21.7% 24.1% 30.7% 19.4% 18.7% 11.6% 16.9% 17.9% 28.2% 17.8% 17.5% 24.1% 19.8% 17.0% 11.3% 21.9% 17.6% 18.9% 19.7% 23.7% 19.6% 22.0% 21.4% 23.5% 20.4% 21.2% 15.9% 20.9% 10.5% 20.2% 19.2%

Fall 2010

Market Atlanta Austin Baltimore Boston Charlotte Chicago Cincinnati Cleveland Columbus Dallas Denver Detroit Fairfield County Fort Lauderdale Fort Worth Houston Indianapolis Inland Empire Long Island Los Angeles Miami Minneapolis Nashville New York City North & Central NJ Orange County Orlando Philadelphia Phoenix Portland Raleigh-Durham St. Louis San Diego San Francisco San Jose Seattle Tampa Bay Washington, D.C. Westchester County West Palm Beach

2Q 2010 Act. 23.0% 24.1% 16.7% 16.6% 18.8% 17.3% 23.8% 20.0% 19.3% 23.2% 24.2% 30.4% 19.8% 19.3% 12.4% 18.5% 19.0% 29.0% 18.4% 17.4% 24.1% 20.2% 17.2% 11.5% 21.7% 18.2% 19.9% 20.1% 25.9% 19.7% 22.9% 21.6% 24.4% 20.2% 21.3% 17.1% 21.4% 11.4% 19.9% 20.5%

YE 2011 Est. 18.9% 20.4% 15.7% 14.4% 12.5% 16.3% 21.8% 19.8% 19.5% 17.0% 23.4% 31.9% 18.7% 17.6% 9.8% 16.7% 14.0% 23.0% 16.3% 16.8% 23.3% 19.0% 16.0% 10.7% 21.6% 14.3% 13.2% 18.9% 14.7% 17.5% 18.2% 21.2% 20.1% 19.5% 20.6% 10.5% 17.6% 7.6% 20.6% 14.4%

YE 2012 Est. 15.0% 17.5% 15.4% 13.7% 7.8% 14.4% 20.8% 19.6% 18.8% 13.7% 22.3% 33.3% 17.8% 16.3% 7.7% 15.4% 11.6% 15.8% 15.1% 15.9% 22.1% 17.5% 14.3% 9.9% 20.8% 10.1% 5.2% 17.9% 6.9% 13.0% 13.8% 21.4% 16.6% 17.5% 19.6% 4.6% 12.7% 4.1% 20.6% 9.6%

YE 2013 Est. 13.1% 15.6% 15.5% 13.4% 5.2% 12.7% 20.7% 19.5% 18.2% 12.9% 21.2% 34.4% 17.2% 14.8% 6.1% 14.5% 11.1% 11.9% 14.3% 15.4% 21.2% 16.3% 12.7% 9.4% 19.9% 8.1% 0.9% 17.3% 5.7% 9.6% 11.1% 21.7% 14.8% 15.7% 18.7% 1.9% 9.6% 1.9% 20.4% 7.2%

Highlighted entries indicate market at supply-demand balance, or better. * Inland Empire = Riverside/San Bernardino Metropolitan Area Note on Negative Vacancy: In order to calculate estimated vacancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show negative vacancy rates, it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space. Of course, negative vacancies cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of negative vacancy should be viewed as a strong excess demand indicator.

ﬁgure 185

40 35 30 $ Billions 25 20 15 10 5 0 1995 1998

U.S. Office Construction

2001 Nominal

2004 Real 2008 $

2007

2010

ﬁgure 186

In the second quarter of 2010, the Linneman Real Estate Index (LREI) declined to 155, from its first-quarter level of 159. This was also a year-over-year decrease from 169 in the second quarter of 2009. The current LREI level indicates that the balance of commercial mortgage debt in the market exceeds demand for the space financed by that debt by 55%. We have long said that property markets are overleveraged on a national level. The index has been increasing steadily since 1997, when it stood at 91. At
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that time, the market had a capital shortage and vacancies were declining steadily. Previously, we indicated that the LREI would fall in the face of the current credit crisis. In fact, commercial debt outstanding has fallen precipitously, but given the weak economy, corresponding GDP had declined at a faster rate. As a result, the LREI continued to increase through the second quarter of 2009, but then finally reversed as GDP strengthened. We expect the LREI to continue to decline as the rebound in GDP growth outpaces commercial mortgage lending. In the second quarter of 2010, the national office vacancy rate rose to 18%, a 10-bp increase from the previous quarter, according to Grubb & Ellis. This puts U.S. office vacancy above the “natural rate” of roughly 10%. Severe job losses have resulted in increasing shadow

or sublease space, along with tenant inducements. These availabilities are expected to increase through 2010. Industrial Market Outlook According to CBRE, the U.S. industrial vacancy rate increased by 10 bps from the first quarter of 2010 to 14.1% in the second quarter of 2010. The first quarter of 2009 registered a short-lived decline – the first since 2006. In comparison, NCREIF’s U.S. industrial vacancy rate (primarily representing institutional-quality properties) dropped significantly, from 12.4% in the first quarter of 2010 to 9.9% in the second quarter of 2010. The two data series moved in lock-step from 1987-2004. The NCREIF series subsequently trended downward more sharply, but changed course in 2009, peaking in the first quarter of

Market Atlanta Austin Baltimore Charlotte Chicago Cincinnati Cleveland Columbus Dallas-Fort Worth Denver Detroit Fairfield County Fort Lauderdale Houston Indianapolis Inland Empire* Las Vegas Long Island Los Angeles Miami Minneapolis Nashville North & Central NJ Orlando Philadelphia Phoenix Portland St. Louis San Diego San Francisco Seattle Tampa Bay Washington, D.C. Westchester County

Industrial Vacancy Rates 2Q 2010 Act. YE 2010 Est. 14.3% 13.6% 21.0% 19.9% 19.4% 19.0% 8.0% 6.0% 11.6% 11.7% 10.3% 9.7% 9.1% 8.8% 12.9% 13.2% 11.5% 9.8% 10.1% 10.0% 17.1% 17.4% 22.1% 21.8% 9.7% 9.1% 10.5% 8.7% 12.3% 11.3% 15.7% 14.8% 13.2% 12.8% 8.0% 7.3% 7.7% 7.8% 11.6% 11.4% 11.8% 11.4% 13.1% 12.9% 11.9% 12.1% 19.8% 18.8% 14.5% 14.1% 18.8% 16.3% 8.6% 8.5% 16.0% 15.7% 16.3% 15.2% 8.5% 8.7% 9.8% 8.4% 12.0% 11.5% 15.5% 14.6% 11.6% 11.9%

YE 2011 Est. 9.9% 17.3% 18.0% 0.4% 10.5% 7.4% 9.1% 13.1% 5.1% 9.1% 18.8% 21.0% 7.8% 8.3% 7.2% 8.6% 9.2% 5.6% 7.1% 10.4% 10.6% 12.0% 11.8% 13.0% 13.2% 6.4% 6.1% 15.5% 11.2% 7.8% 2.4% 7.8% 11.8% 12.3%

YE 2012 Est. 5.6% 14.4% 17.4% -5.5% 8.4% 5.7% 9.0% 12.3% 3.1% 7.7% 20.5% 20.2% 6.3% 6.8% 5.0% 0.0% 4.9% 4.2% 6.1% 8.8% 8.9% 10.3% 10.8% 5.0% 12.1% -2.3% 1.0% 15.6% 7.1% 5.5% -4.1% 2.3% 8.4% 12.3%

YE 2013 Est. 3.6% 12.4% 17.2% -8.7% 6.6% 5.2% 9.0% 11.6% 3.1% 6.4% 21.8% 19.6% 4.6% 5.7% 4.7% -4.5% 2.3% 3.3% 5.6% 7.5% 7.6% 8.7% 9.9% 0.8% 11.4% -3.7% -3.0% 15.8% 4.7% 3.6% -7.2% -1.1% 6.2% 12.2%

Highlighted entries indicate market at supply-demand balance, or better. * Inland Empire = Riverside/San Bernardino Metropolitan Area Note on Negative Vacancy: In order to calculate estimated vacancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show negative vacancy rates, it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space. Of course, negative vacancies cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of negative vacancy should be viewed as a strong excess demand indicator.

ﬁgure 187

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20 15 Percent 10 5 0 1990 1994 1998 CBRE 2002 NCREIF 2006 2010

U.S. Industrial Vacancy Rates

to achieve balance by year-end. By year-end 2011, four markets will be in balance, with 10 more coming into balance by year-end 2012. Eighteen of the 34 markets are expected to be in balance by the end of 2013. Detroit, Fairfield County, and Baltimore are projected to have the highest vacancy levels in 2013, while Charlotte, Seattle, and the Inland Empire are projected to have the lowest vacancy levels. Multifamily Market Outlook The Census Bureau’s quarterly Housing Vacancy Survey indicates that the U.S. multifamily vacancy rate remained stable in the second quarter of 2010 at 10.6%. This series has generally been hovering around 10% since late 2003. For NCREIF’s more institutional properties, the national vacancy rate declined by 106 bps, from 6.96% in the first quarter to 5.9% in the second quarter of 2010. This discrepancy in vacancy rates is due to the fact that the NCREIF properties are generally of higher quality than the Census properties. Thus, better-quality properties are exhibiting better fundamentals. During the recession, the Census vacancy rate peaked in the third quarter of 2009 at 11.1%, just 160 bps above the 2007 low point. In contrast, the NCREIF series exhibited a sharp increase of nearly 275 bps from 2006 to 2008, as unsold high-end condos were converted to rental units. It has since declined for six consecutive quarters, indicating that the condo market overhang is subsiding. Multifamily starts (5+ units) have declined significantly to 95,000 in the second quarter of 2010, versus 20- and 40-year averages of 395,000 and 429,000 units, respectively. This reflects the confluence of weak recessionary demand (due to doubling up of households), an absence of construction financing, and a 5.9% vacancy rate. We anticipate that multifamily starts will remain weak well into 2010, in the face of continuing soft demand and a dearth of construction debt.
U.S. Multifamily Vacancy
12 10 Percent 8 6 4 2 0 1980 1984 1988 1992 1996 2000 NCREIF 2004 2008 U.S. Census Bureau

ﬁgure 188

U.S. Industrial Construction
80 70 $ Billions 60 50 40 30 20 1995 1998 2001 Nominal 2004 Real 2008 $ 2007 2010

ﬁgure 189

2010. This divergence indicates that the institutionalgrade properties in the NCREIF survey recover sooner than the overall market, but were not immune to the wide-reaching economic downturn. In the second quarter of 2010, 14 markets saw increased vacancy and eight remained flat, with the rest decreasing by as much as 140 bps. The greatest improvements came from Miami (-140 bps), Fort Lauderdale (-120 bps), and Austin (-80 bps). The highest increases in vacancy were in Columbus (130 bps), Denver (90 bps), Las Vegas (70 bps), and Baltimore (60 bps), with all other increases by 50 bps or less. At the end of the second quarter of 2010, the highest vacancy was in Fairfield County, at 22.1%; the lowest was in Los Angeles at 7.7%. By 2013, 32 of the 34 markets we cover are projected to improve. Compared to the second quarter of 2010, Phoenix (-2,250 bps), the Inland Empire (-2,020 bps) and Orlando (-1,900 bps) are expected to show the greatest improvements. Detroit is expected to experience the largest increase (470 bps) in vacancy rate, followed by Westchester County (60 bps). Using a 6% benchmark vacancy rate to proxy supplydemand balance for industrial markets, no markets were in balance for the first quarter of 2010, none were in balance for the second quarter, and none are expected

ﬁgure 190

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The lack of construction is not such a horrible problem in the near term (unless you are a developer), because there is a fair amount of vacancy due to the fact that when the economy shed jobs, people doubled up households. As labor markets improve and we start to add jobs, these
New Condominium Completion & Absorption
100 Absorption Percent 80 60 40 20 0 1995 1997 1999 2001 2003 2005 2007 2009 Thousands Completed 100 80 60 40 20 0

young people will move into their own space, absorbing the empty units. The lack of construction means that excess inventory is being absorbed. For the second quarter of 2010, multifamily vacancy rates improved in 24 of our 31 markets. The biggest

60 50 Percent 40 30 20 10 0 2000

Percentage of New Units Intended for Sale in MultiUnit Buildings

2002

2004

2006

2008

2010

90-Day Absorption Rate

Completions, Trailing 4 Quarters

ﬁgure 191

ﬁgure 193

Market Atlanta Austin Baltimore Boston Charlotte Chicago Cincinnati Cleveland Columbus Dallas-Fort Worth Denver Detroit Houston Indianapolis Inland Empire* Los Angeles Miami Minneapolis Nashville New York City Orlando Philadelphia Phoenix Portland St. Louis San Diego San Francisco San Jose Seattle Tampa Bay Washington, D.C.

2Q 2010 Act. 11.4% 9.6% 6.0% 6.2% 10.5% 6.6% 7.7% 6.7% 9.7% 9.3% 6.1% 7.9% 12.4% 9.6% 7.8% 5.5% 6.2% 5.1% 9.6% 1.9% 11.0% 6.3% 11.5% 5.8% 8.8% 4.9% 5.0% 4.2% 7.0% 9.8% 6.3%

Multifamily Vacancy Rates YE 2010 Est. 10.8% 8.5% 4.9% 5.6% 9.0% 6.7% 7.0% 6.3% 10.1% 7.6% 6.1% 8.3% 10.7% 8.5% 7.0% 5.6% 6.1% 4.7% 9.6% 1.9% 10.0% 5.9% 9.0% 5.9% 11.8% 3.8% 5.3% 4.4% 5.9% 9.3% 5.4%

YE 2011 Est. 7.1% 5.7% 3.2% 4.0% 4.4% 5.6% 4.6% 6.6% 10.1% 3.1% 5.4% 10.1% 10.5% 4.5% 0.4% 5.0% 5.0% 4.0% 9.0% 1.7% 4.0% 5.2% -1.4% 3.8% 11.6% -0.4% 4.6% 4.2% 0.4% 5.8% 2.5%

YE 2012 Est. 2.9% 2.6% 1.4% 3.4% -0.3% 3.4% 2.9% 6.5% 9.4% 1.4% 4.2% 12.1% 9.1% 2.2% -8.7% 4.1% 3.4% 2.4% 7.7% 1.4% -4.5% 4.3% -10.3% -1.1% 11.8% -4.8% 2.4% 3.4% -5.7% 0.3% -1.0%

YE 2013 Est. 1.0% 0.6% 0.2% 3.2% -2.6% 1.6% 2.3% 6.4% 8.8% 1.7% 3.2% 13.7% 8.2% 1.9% -13.5% 3.6% 2.0% 1.2% 6.3% 1.3% -8.8% 3.7% -11.3% -4.8% 12.1% -7.1% 0.7% 2.8% -8.1% -3.0% -3.1%

Highlighted entries indicate market at supply-demand balance, or better. * Inland Empire = Riverside/San Bernardino Metropolitan Area Note on Negative Vacancy: In order to calculate estimated vacancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show negative vacancy rates, it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space. Of course, negative vacancies cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of negative vacancy should be viewed as a strong excess demand indicator.

ﬁgure 192

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Multifamily Unit Construction
80 70 60 Thousands 50 40 30 20 10 0 2000 2002 2004 Built For Sale 2006 2008 2010

Fall 2010

Built For Rent

ﬁgure 194

U.S. Multifamily Housing Starts & Permits
1,400 1,200 Thousands 1,000 800 600 400 200 0 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009

Starts

Permits

ﬁgure 195

70 60 50 $ Billions 40 30 20 10 0 1993 1995

U.S. Multifamily Construction

1997

1999 Nominal

2001

2003

2005

2007

2009

Real 2008 $

ﬁgure 196

Multifamily Construction and Vacancy Trends
350 Thousands of Units 300 250 200 150 100 50 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 Total in Bldgs w/ 5 or More Units (Thousands) Vacancy 11 9 8 7 6 5 4 2008 2010Q1 Vacancy Percent 10

improvements came from Denver (-300 bps) and New York City (-160 bps), with the rest decreasing by 130 bps or fewer. Four markets remained flat, with three markets increasing vacancy by 20 bps or less. The highest vacancy rates for the second quarter of 2010 were found in Houston, Phoenix, Atlanta, Orlando, and Charlotte, while New York City, San Jose, San Diego, and San Francisco experienced the lowest rates. By 2013, the laggards are expected to be Detroit, St. Louis, and Columbus, while the Inland Empire, Phoenix, and Orlando will boast the lowest vacancy levels. Using a 5% vacancy rate proxy for supply-demand balance, three of our markets were in balance at the end of the first quarter 2010, with two more coming online at the end of the second quarter. By year-end 2010, five markets are expected to be in balance. By 2013, we project that 25 of our 31 markets will be in balance. To a large degree, the sector’s high vacancy rates reflect the fact that as the economy plunged, household formation rates also plunged. Simply stated, when jobs are lost, young people double up either with families or friends, forestalling household formation. In 2008 and 2009, household formations were 772,000 and 398,000, respectively, versus a norm of 1.1-1.2 million per annum. This means that there is a pent-up demand of roughly 1.1-1.2 million households, of which approximately one-third will flow into multifamily, two-thirds into single family housing. This is consistent with our analysis outlined earlier in this issue, which indicates that the cumulative 6-year housing formation shortfall is approximately 1.4 million. As consumer confidence returns and job formation resumes, these people will form their own households, leading to a surge in housing demand. As a result, we are bullish on the long-term investment prospects for multifamily housing. In addition, given the sector’s shortterm leases, the multifamily sector will be able to best combat rising debt costs should the economy experience a severe inflationary spike. Through 2011, we expect aggregate demand growth to be about 810,000 units, with no net increase in supply. Thus, the current excess vacancy of 1 million units will fall to about 200,000 units, leaving the multifamily vacancy rate at roughly 7.5% by mid-2012. Retail Market Outlook At 10.1%, NCREIF’s second-quarter 2010 retail vacancy rate fell from 10.8% in the first quarter, but
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THE LINNEMAN LETTER
Volume 10, Issue 3
Retail Vacancy Rates Market Atlanta Austin Boston Charlotte Chicago Cincinnati Cleveland Columbus Dallas-Fort Worth Denver Detroit Houston Indianapolis Los Angeles Miami Minneapolis Nashville New York City Orlando Philadelphia Phoenix Portland St. Louis San Diego San Francisco San Jose Seattle Tampa Bay Washington, D.C. 1Q 2010 Act. 12.0% 9.9% 7.3% 9.1% 9.2% 13.6% 12.9% 11.8% 12.5% 10.1% 12.7% 12.3% 12.5% 6.5% 8.2% 9.6% 7.3% 2.2% 11.1% 9.3% 12.3% 7.5% 10.2% 5.7% 4.3% 6.2% 6.7% 10.1% 6.5% YE 2010 Est. 11.3% 8.2% 6.5% 6.6% 9.5% 12.9% 13.2% 12.3% 10.1% 10.1% 13.3% 9.5% 11.2% 6.7% 8.1% 9.8% 7.2% 1.8% 9.8% 8.8% 9.2% 7.6% 9.9% 4.2% 4.8% 6.1% 5.4% 9.5% 5.1% YE 2011 Est. 7.4% 5.1% 4.7% 1.1% 8.4% 10.5% 13.5% 12.2% 5.3% 9.2% 14.9% 9.0% 6.9% 5.9% 7.1% 8.9% 6.3% 1.1% 3.3% 7.8% -1.4% 5.2% 9.7% -0.4% 3.8% 5.3% -0.4% 5.6% 1.8% YE 2012 Est. 2.9% 1.7% 3.9% -4.5% 6.3% 8.8% 13.4% 11.4% 3.2% 7.7% 16.9% 7.5% 4.5% 4.8% 5.5% 7.2% 4.6% 0.2% -5.7% 6.7% -10.6% 0.0% 9.9% -5.1% 1.2% 4.0% -6.7% -0.2% -2.1% YE 2013 Est. 0.8% -0.6% 3.5% -7.6% 4.5% 8.2% 13.3% 10.5% 3.1% 6.4% 18.3% 6.4% 4.0% 4.2% 4.2% 5.9% 2.9% -0.5% -10.7% 5.9% -11.9% -4.0% 10.3% -7.7% -0.9% 2.8% -9.3% -3.8% -4.7%

Fall 2010

Highlighted entries indicate market at supply-demand balance, or better. Note on Negative Vacancy: In order to calculate estimated vacancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show negative vacancy rates, it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space. Of course, negative vacancies cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of negative vacancy should be viewed as a strong excess demand indicator.

ﬁgure 198

12 10

U.S. Retail Vacancy
70 60 $ Billions 50 40 30 20

U.S. Retail Construction

8 Percent 6 4 2

10 0 1995 1998 2001 2004 2007 2010 1995 1998 2001 Nominal 2004 Real 2008 $ 2007 2010

ﬁgure 199

ﬁgure 200

was 26 bps higher than one year earlier. The vacancy rate broke 6% in the second quarter of 2008, for the first time since 1999. It is important to note that much of this retail vacancy exists in centers built to service residential communities that never materialized in the outer reaches of markets like Las Vegas and Phoenix. They were
62

built in anticipation of a soon-to-be thriving residential community, but as reality set in and home building ceased, these centers are now serving communities 6090% smaller than anticipated. This type of vacancy stands in contrast to rising vacancy in established market areas, which is occurring to a lesser degree.

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

The University of Michigan consumer confidence index dropped to 67.8 in July 2010, compared to its low of 55.3 in November 2008. The index had not seen the low of 2008 since 1980. Real retail sales peaked in November 2007 at $349 billion, and have since declined to $323 billion through July 2010. Retail construction has been declining steadily on a monthly annualized basis, and was recorded at $25 billion as of June 2010, down from its October 2007 high of $62.6 billion. Second quarter vacancy rates were not yet published by the time we went to print, therefore we are using first quarter numbers with updated forecasts. By the end of the first quarter of 2010, nine of our 29 covered retail markets saw rising vacancy rates, one market remained flat, and 19 experienced decreasing rates over year-end 2009. San Francisco saw the highest increase (120 bps), followed by Detroit (110 bps). Seven markets increased by 100 bps or less, with St. Louis, Seattle, and Columbus, increasing by only 10 and 20 bps, respectively. For the second quarter of 2010, Cincinnati (13.6%), Cleveland (12.9%), and Detroit (12.7%) had the highest vacancy rates, while New York City (2.2%), San Francisco (4.3%), and San Diego (5.7%) exhibited the lowest levels. By 2013, 26 of our 29 markets are projected to register decreasing vacancy rates over first quarter 2010 fig-

ures, with Phoenix, Orlando, and Charlotte exhibiting the lowest rates. No market will remain flat, while three markets will exhibit rising vacancy rates. Detroit will experience the highest increase in vacancy, 560 bps, and will lead the list in terms of the highest vacancy rate (18.3%), followed by Cleveland (13.3%) and Columbus (10.5%). Using 8.5% vacancy as a benchmark for a balanced market, 11 of our 30 markets were in balance by the end of the first quarter 2010, with 21 coming into balance by year-end 2011, and 24 by year-end 2012. That number will increase to 25 by year-end 2013. Hotel Market Outlook Smith Travel Research reports that the 12-month rolling average U.S. hotel occupancy rate declined from 1995-2002. Occupancy peaked again in June of 2006 at 63.7%, declining through February 2010 to 53%, but regaining ground to finish July 2010 at 56.2%. Levels have not been this low in 20 years. The 12-month rolling average revenue per available room (RevPAR) ceased its 5-year ascent, peaking in May 2008 at $66.20 and then falling to $54.56 as of July 2010. STR also reported that the change in the nation’s supply of rooms lagged the change in demand for those rooms on a 12-month rolling average basis. U.S. hotel markets have continued

Hotel Occupancy Rates Market Atlanta Austin Boston Chicago Dallas Denver Detroit Houston Las Vegas** Los Angeles Miami Minneapolis Nashville New York City Orlando Philadelphia Phoenix St. Louis San Diego San Francisco Seattle Tampa Bay Washington, D.C. 2Q 2010 Act. 54.8% 61.4% 66.4% 58.9% 52.6% 60.0% 50.3% 54.2% 58.7% 66.0% 67.8% 58.3% 56.4% 80.3% 60.8% 63.0% 54.4% 55.6% 65.0% 73.9% 63.6% 53.7% 65.5% YE 2010 Est. 55.1% 62.0% 66.8% 58.8% 53.4% 59.9% 50.1% 55.0% 58.8% 66.0% 67.7% 58.6% 56.4% 79.5% 61.5% 63.2% 56.0% 55.7% 65.8% 73.8% 64.5% 54.0% 66.0% YE 2011 Est. 57.3% 63.6% 68.0% 59.5% 56.2% 60.2% 49.1% 54.6% 61.0% 66.4% 67.9% 59.2% 56.9% 78.1% 65.8% 63.6% 62.4% 55.8% 68.6% 74.6% 68.5% 56.2% 67.7% YE 2012 Est. 59.9% 65.4% 68.5% 60.8% 58.1% 60.8% 47.9% 54.9% 63.5% 67.2% 68.6% 60.4% 57.9% 76.8% 71.8% 64.0% 68.0% 55.7% 71.5% 76.6% 72.8% 59.5% 69.8% YE 2013 Est. 61.1% 66.8% 68.7% 62.0% 58.5% 61.5% 47.1% 55.3% 65.3% 67.6% 69.3% 61.3% 58.9% 76.4% 75.0% 64.4% 68.8% 55.5% 73.2% 78.2% 74.9% 61.6% 71.2%

Highlighted entries indicate market at supply-demand balance, or better. * Source: Smith Travel Research. ** LV sample accounts for less than 15% of LV market.

ﬁgure 201

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40 35 30 $ Billions $/Room 25 20 15 10 5 0 1995 1998 2001 Nominal 2004 Real 2008 $ 2007 2010 30 1990 1994 1998 2002 2006 2010
Source: Smith Travel Research

U.S. Lodging Construction
70 60 50 40

U.S. Hotel Revenue Per Available Room
(12-Month Moving Average)

ﬁgure 202

ﬁgure 204

U.S. Hotel Occupancy
70 65 Percent 60 55 50 45 1990 1994 1998 2002 2006 2010
Source: Smith Travel Research

Demand vs. Supply of U.S. Hotel Rooms
6 4 2 Percent 0 -2 -4 -6 -8 -10 1990 1994 Supply % Change 1998 2002 Demand % Change 2006 2010 (Y/Y % change of 12-month mvg avgs)

(12-Month Moving Average)

Source: Smith Travel Research

ﬁgure 203

ﬁgure 205

to weaken through the second quarter of 2010, despite a slight increase in demand at the end of 2009. For the second quarter of 2010, almost all hotel markets saw increasing occupancy rates over the first quarter of 2010, with just one market, Houston, decreasing. Boston experienced the greatest decrease in occupancy at 420 bps, New York City at 390 bps, and Detroit and Miami at 270 bps each. New York City, San Francisco, and Miami had the highest occupancy rates, while markets with the lowest occupancy included Detroit (50.3%), Dallas (52.6%), and Tampa Bay (53.7%). By 2013, 20 cities are expected to have increasing rates from the second quarter of 2010, with Phoenix leading the pack with a 1,440-bp improvement. No markets will remain flat, while the other three markets will continue to exhibit decreasing occupancy rates. New York City will be leading the group, with a 390-bp decrease in occupancy rate relative to the second quarter of 2010, followed by Detroit (-320 bps), and St. Louis (-10 bps). Though New York City exhibits the highest decreases in occupancy, by year-end 2013, it will maintain the second highest occupancy rate at 76.4%, coming in right behind San Francisco at 78.2%. Using a 70% occupancy rate to proxy market balance, only two markets (New York City and San
64

Francisco) were in balance at the end of the second quarter of 2010, with the list expected to remain the same through year-end 2011. By year-2010, the list is expected to grow to five markets in balance with six markets expected to be in balance by year-end 2013. By year-end 2013, San Francisco, New York City, and Orlando will show the highest occupancy rates, while Detroit, Houston, and St. Louis are projected to be the worst performing markets. Seniors Housing and Care Market Outlook All current and historical seniors housing market statistics are provided by the National Investment Center for the Seniors Housing and Care Industry (NIC) through its NIC MAP database. From this historical data, we generate our 5-year occupancy forecasts for independent living (IL) and assisted living (AL) for NIC’s top 31 MSAs. NIC MAP measures occupancy, revenue per occupied room (REVPOR), supply, demand, and other metrics by the following property types: majority independent living (IL); majority assisted living (AL); and majority nursing care (NC). (At this time, we do not provide NC forecasts in The Linneman Letter.) The memory care segment and majority memory care properties will be included under the majority AL property type. A majority IL property is

THE LINNEMAN LETTER
Volume 10, Issue 3
Independent Living Occupancy Rates Market Atlanta Baltimore Boston Chicago Cincinnati Cleveland Dallas Denver Detroit Houston Inland Empire Kansas City Las Vegas Los Angeles Miami Minneapolis New York City Orlando Philadelphia Phoenix Pittsburgh Portland Sacramento St. Louis San Antonio San Diego San Francisco San Jose Seattle Tampa Bay Washington, D.C. 2Q 2010 Act. 88.1% 93.7% 87.1% 85.4% 87.5% 86.2% 80.6% 84.8% 87.9% 84.0% 85.9% 85.3% 82.8% 89.0% 85.8% 93.1% 90.1% 84.1% 90.0% 87.8% 92.2% 84.6% 87.6% 88.5% 86.0% 88.1% 91.3% 89.9% 86.0% 86.7% 88.3% YE 2010 Est. 88.8% 94.2% 87.8% 85.6% 88.3% 86.7% 82.4% 85.0% 87.6% 86.0% 86.9% 85.0% 83.3% 89.0% 85.9% 93.7% 90.5% 85.3% 90.5% 90.5% 92.6% 84.8% 87.7% 89.0% 86.3% 89.5% 91.2% 90.1% 87.3% 87.4% 89.3% YE 2011 Est. 92.8% 95.4% 89.7% 87.3% 91.0% 86.6% 87.6% 86.0% 86.1% 86.8% 93.2% 84.6% 87.0% 89.7% 86.9% 94.7% 91.4% 91.5% 91.5% 101.3% 92.8% 87.3% 90.0% 89.7% 87.8% 94.0% 92.4% 90.9% 93.1% 91.2% 92.4% YE 2012 Est. 97.4% 96.1% 90.4% 89.3% 92.7% 86.8% 91.1% 87.5% 84.3% 88.3% 102.0% 84.4% 91.5% 90.8% 88.5% 96.6% 92.2% 100.1% 92.6% 110.6% 93.0% 91.9% 93.0% 89.7% 90.3% 98.1% 94.8% 92.2% 99.4% 96.7% 96.0% YE 2013 Est. 99.7% 96.4% 90.8% 91.0% 93.3% 87.0% 92.0% 88.8% 83.0% 89.4% 106.7% 84.4% 94.4% 91.4% 89.8% 98.1% 92.8% 104.8% 93.4% 112.2% 93.1% 95.6% 94.4% 89.5% 92.5% 100.5% 96.8% 93.4% 102.4% 100.2% 98.4%

Fall 2010

Highlighted entries indicate market at supply-demand balance, or better. *Source: The National Investment Center for the Seniors Housing & Care Industry Note on occupancy greater than 100%: In order to calculate estimated occupancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show 100%+ occupancy rates, it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space. Of course, 100%+ occupancy cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of 100%+ occupancy should be viewed as a strong excess demand indicator. ﬁgure 206

any property that has a majority of IL units. Majority IL properties will include freestanding IL, combination IL (such as IL/AL, IL/AL/Memory Care), and continuing care retirement communities (CCRC), which provide the entire continuum of care segments. Stabilized occupancy rates for the assisted living segment increased in the second quarter of 2010 by 20 bps, from 88.1% to 88.3%. However, the average occupancy for majority IL properties declined by 50 bps in the second quarter, to 87.4%. Occupancy rates continue to track employment trends, though with lower correlations than just one year ago. The correlations between employment and IL and AL occupancy rates between 2005 and the second quarter of 2009 were 95% and 92%, respectively. However, when the last four quarters of data are included

in the analysis, the correlations decline significantly to 47% for IL and 64% for AL, primarily because jobs have been added, but IL and occupancies continue to decline
Changes in Nonfarm Payroll Employment and Majority Assisted Living Occupancy

1.0 Employment Change (Millions) 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5

4Q05

2Q06 4Q06 2Q07 4Q07 Nonfarm Payroll Change Majority IL Occupancy

2Q08

94 93 92 91 90 89 88 87 86 85 84 4Q08 2Q09 4Q09 2Q10 Majority AL Occupancy

Source: NIC MAP® Data & Analysis Service

ﬁgure 207

Average Stabilized Occupancy (Percent)

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and the pace of AL improvements lag job growth. As employment grows and housing markets improve, we expect to see modest improvements in the seniors housing sector. The declining correlations are a sign that improvements in the sector will lag job growth. Independent Living In the first quarter of 2010, 22 of the 31 markets we cover experienced decreasing occupancy rates, only San Francisco and St. Louis remained flat, and seven markets experienced increasing occupancy. Of the strengthening markets, no MSA experienced occupancy rate increases of more than 150 bps, while in nine cities, occupancy rates declined by 200 bps or more. Baltimore displayed the highest first-quarter occupancy rate at 93.7%, followed by Minneapolis at 93.1% and Pittsburgh at 92.2%. Dallas exhibited the lowest occupancy rate at 80.6%, followed by Las Vegas at 82.8%, Houston at 84%, and Orlando at 84.1%. By 2013, only two MSAs will see decreasing occupancy rates, Detroit and Kansas City, while all others will start to improve. Phoenix will lead the pack with a 2,450bp increase over the second quarter of 2010, followed by the Inland Empire (2,070 bps), Orlando (2,070 bps), and Seattle (1,640 bps). The highest occupancy rate will be in Phoenix (100%+), where given the scheduled supply and growth in expected demand, sufficient demand pressure will exist to more than absorb all available space. Of course, in reality, this will be offset by new development. The Inland Empire, Orlando, Seattle, San Diego, and Tampa Bay (100%+) are also expected to register strong occupancy rates by year-end 2013. The lowest occupancy rates will be in Detroit (83%), followed by Kansas City (84.4%), Cleveland (87%), and Denver (88.8%). (Editor’s note: Occupancy projections over 100% are simply an indication of expected excess demand given existing inventory and pipeline data).

Using a 95% occupancy rate to proxy market balance, no markets were in balance for the second quarter of 2010, and none are expected by year-end. Phoenix and Baltimore are expected to come into balance in 2011. 2012 will fare slightly better, with 10 markets in balance, and by 2013, 12 markets are expected to be in balance. Assisted Living In the second quarter of 2010, 20 of our 31 covered markets saw decreasing occupancy rates in assisted living, seven of which decreased by more than 100 bps. One market remained flat, and of the 10 strengthening markets, four improved by 200 bps or more, with Kansas City occupancy jumping by 330 bps. By the end of the first quarter, New York City boasted the highest occupancy rate at 93.5%, followed by Tampa Bay (92.6%), Cincinnati (92.6%), and Pittsburgh (92.5%). Chicago exhibited the lowest occupancy rate at 82%, followed by St. Louis (83.7%) and Detroit (84%). By 2013, 27 of the 31 covered markets will see increasing occupancy rates. Phoenix will lead the pack with a 2,440-bp increase over the second quarter of 2010, followed by Orlando (2,150 bps), the Inland Empire (1,140 bps), and Seattle (1,640 bps). The highest occupancy rates will be in Orlando, Phoenix, the Inland Empire, Tampa Bay, Seattle, Washington, D.C., and Portland (100%+). The lowest occupancy rates in 2013 will be in Minneapolis (89.1%), followed by Detroit (84%), Los An geles (84.9%), and Chicago (82%). (Editor’s note: Occupancy projections over 100% are simply an indication of expected excess demand given existing inventory and pipeline data). Using a 95% occupancy rate to proxy market balance, no markets were in balance for the second quarter of 2010, and none are expected for year-end. Six markets are expected to be in balance for 2011, 12 markets in 2012, and 15 markets by year-end 2013, breaking the 95% occupancy threshold.

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Assisted Living Occupancy Rates YE 2010 Est. YE 2011 Est. 84.9% 88.8% 90.1% 91.5% 92.1% 93.9% 82.1% 83.7% 93.3% 95.8% 89.9% 89.8% 87.1% 92.5% 86.8% 87.8% 83.7% 82.2% 92.0% 92.7% 89.6% 96.1% 89.2% 89.0% 88.2% 92.1% 84.9% 85.5% 88.7% 89.7% 2.6% 5.8% 93.8% 94.5% 92.7% 99.3% 88.1% 89.2% 90.5% 101.3% 92.8% 93.0% 88.8% 91.2% 88.0% 90.1% 92.5% 92.9% 84.4% 86.4% 88.6% 92.9% 87.2% 88.2% 85.7% 87.0% 87.8% 93.7% 93.3% 97.3% 92.1% 95.3%

Fall 2010

Market Atlanta Baltimore Boston Chicago Cincinnati Cleveland Dallas Denver Detroit Houston Inland Empire Kansas City Las Vegas Los Angeles Miami Minneapolis New York City Orlando Philadelphia Phoenix Pittsburgh Portland Sacramento St. Louis San Antonio San Diego San Francisco San Jose Seattle Tampa Bay Washington, D.C.

2Q 2010 Act. 84.1% 89.4% 91.4% 82.0% 92.6% 89.5% 85.3% 86.6% 84.0% 90.1% 88.6% 89.4% 87.6% 84.9% 88.6% 89.1% 93.5% 91.2% 87.6% 87.8% 92.5% 88.7% 87.9% 83.7% 92.2% 87.4% 87.4% 85.3% 86.4% 92.6% 91.0%

YE 2012 Est. 93.1% 92.1% 94.7% 85.7% 97.7% 90.0% 96.1% 89.2% 80.5% 94.3% 105.1% 88.8% 96.8% 86.6% 91.4% 5.8% 95.3% 108.0% 90.2% 110.6% 93.2% 96.2% 93.3% 92.9% 88.7% 97.2% 90.5% 88.2% 99.8% 103.3% 99.0%

YE 2013 Est. 95.2% 92.3% 95.1% 87.3% 98.4% 90.1% 97.1% 90.6% 79.2% 95.5% 110.0% 88.8% 99.9% 87.2% 92.7% 5.9% 95.9% 112.8% 90.9% 112.2% 93.4% 100.1% 94.6% 92.7% 90.7% 99.8% 92.5% 89.3% 102.8% 107.1% 101.5%

Highlighted entries indicate market at supply-demand balance, or better. *Source: The National Investment Center for the Seniors Housing & Care Industry Note on occupancy greater than 100%: In order to calculate estimated occupancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show 100%+ occupancy rates, it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space. Of course, 100%+ occupancy cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of 100%+ occupancy should be viewed as a strong excess demand indicator. ﬁgure 208

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Office Market Vacancy and Absorption Projections
Notes on Negative Vacancy: In order to calculate estimated vacancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show negative vacancy rates, it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space. Of course, negative vacancies cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of negative vacancy should be viewed as a strong excess demand indicator.
Atlanta Office Market
25.0 Vacancy Rate (%) 20.0 15.0 10.0 5.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

Austin Office Market
1,500 Vacancy Rate (%) 1,000 500 0 (500) (1,000) 3Q12 Absorption (000’s SF) 30.0 25.0 20.0 15.0 10.0 5.0 0.0 1Q10 3Q10 1Q11
Vacancy Rate

300 250 200 150 100 50 0 3Q11 1Q12
Absorption

3Q12

Vacancy Rate

Baltimore Office Market
17.0 16.8 Vacancy Rate (%) 16.6 16.4 16.2 16.0 15.8 15.6 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

Boston Office Market
300 Absorption (000’s SF) 200 100 0 (100) (200) 3Q12 Vacancy Rate (%) 17.5 17.0 16.5 16.0 15.5 15.0 14.5 14.0 13.5 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

600 400 200 0 (200) (400) 3Q12 Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF)

Vacancy Rate

Vacancy Rate

Charlotte Office Market
25.0 Vacancy Rate (%) 20.0 15.0 10.0 5.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 800 700 600 500 400 300 200 100 0 (100) (200) Absorption (000’s SF) 17.5 Vacancy Rate (%) 17.0 16.5 16.0 15.5 15.0 14.5 14.0 1Q10 3Q10

Chicago Office Market
800 600 400 200 0 (200) (400) (600) (800) (1,000) 1Q11 3Q11 1Q12
Absorption

3Q12

Vacancy Rate

Absorption

Vacancy Rate

Cincinnati Office Market
23.0 22.5 22.0 21.5 21.0 20.5 20.0 19.5 19.0 18.5 1Q10 3Q10 1Q11
Vacancy Rate

Cleveland Office Market
200 Absorption (000’s SF) Vacancy Rate (%) 150 100 50 0 (50) (100) (150) 19.5 19.0 18.5 18.0 17.5 17.0 16.5 16.0 1Q10 3Q10 1Q11
Vacancy Rate

250 200 150 100 50 0 (50) (100) (150) (200) 3Q11 1Q12
Absorption

Vacancy Rate (%)

3Q11

1Q12
Absorption

3Q12

3Q12

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Absorption (000’s SF)

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Office Market Vacancy and Absorption Projections (cont.)
Columbus Office Market
19.8 Vacancy Rate (%) 19.6 19.4 19.2 19.0 18.8 18.6 18.4 18.2 2Q10 4Q10 2Q11
Vacancy Rate

Dallas Office Market
100 80 60 40 20 0 (20) (40) (60) (80) (100) 25.0 Absorption (000’s SF) Vacancy Rate (%) 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

3,500 3,000 2,500 2,000 1,500 1,000 500 0 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Denver Office Market
24.5 Vacancy Rate (%) 24.0 23.5 23.0 22.5 22.0 21.5 21.0 20.5 2Q10 4Q10 2Q11
Vacancy Rate

Detroit Office Market
350 300 250 200 150 100 50 0 (50) (100) (150) 34.0 Absorption (000’s SF) Vacancy Rate (%) 33.0 32.0 31.0 30.0 29.0 28.0 2Q10 4Q10 2Q11
Vacancy Rate

0 (100) (200) (300) (400) (500) (600) 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Fairfield County Office Market
20.0 Vacancy Rate (%) 19.5 19.0 18.5 18.0 17.5 17.0 16.5 2Q10 4Q10 2Q11
Vacancy Rate

Fort Lauderdale Office Market
90 80 70 60 50 40 30 20 10 0 25.0 Absorption (000’s SF) Vacancy Rate (%) 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

160 120 100 80 60 40 20 0 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Fort Worth Office Market
14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Houston Office Market
400 Absorption (000’s SF) Vacancy Rate (%) 350 300 250 200 150 100 50 0 4Q12 20.0 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

3,500 3,000 2,500 2,000 1,500 1,000 500 0 (500) 4Q12 Absorption (000’s SF)

Vacancy Rate

Vacancy Rate

Absorption (000’s SF)

140

Absorption (000’s SF)

Absorption (000’s SF)

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Volume 10, Issue 3 Fall 2010

Office Market Vacancy and Absorption Projections (cont.)
Indianapolis Office Market
20.0 Vacancy Rate (%) 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

400 Absorption (000’s SF) 350 300 250 200 150 100 50 0 4Q11 2Q12
Absorption

Inland Empire Office Market (Riverside - San Bernardino)
35.0 Vacancy Rate (%) 30.0 25.0 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

500 400 300 200 100 0 (100) 4Q11 2Q12
Absorption

4Q12

4Q12

Long Island Office Market
20.0 Vacancy Rate (%) 15.0 10.0 100 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Los Angeles Office Market
250 Absorption (000’s SF) 200 150 Vacancy Rate (%) 18.0 17.5 17.0 16.5 16.0 15.5 15.0 14.5 2Q10 4Q10 2Q11
Vacancy Rate

1,200 1,000 800 600 400 200 0 (200) (400) 4Q11 2Q12
Absorption

50 0 4Q11 2Q12
Absorption

4Q12

4Q12

Miami Office Market
24.5 24.0 Vacancy Rate (%) 23.5 23.0 22.5 22.0 21.5 21.0 20.5 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Minneapolis Office Market
160 140 120 100 80 60 40 20 0 4Q12 Absorption (000’s SF) Vacancy Rate (%) 21.0 20.0 19.0 18.0 17.0 16.0 15.0 2Q10 4Q10 2Q11
Vacancy Rate

400 300 200 100 0 (100) (200) (300) (400) (500) 4Q11 2Q12
Absorption

4Q12

Vacancy Rate

Nashville Office Market
Absorption (000’s SF) 20.0 Vacancy Rate (%) 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

New York City Office Market
180 160 140 120 100 80 60 40 20 0 12.0 Vacancy Rate (%) 11.5 11.0 10.5 10.0 9.5 9.0 8.5 2Q10 4Q10 2Q11
Vacancy Rate

1,000 800 600 400 200 0 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

70

Absorption (000’s SF)

Absorption (000’s SF)

Absorption (000’s SF)

Absorption (000’s SF)

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Office Market Vacancy and Absorption Projections (cont.)
Northern & Central NJ Office Market
22.0 Vacancy Rate (%) 21.5 21.0 20.5 20.0 19.5 2Q10 4Q10 2Q11
Vacancy Rate

Orange County Office Market
500 400 300 200 100 0 (100) (200) (300) (400) 20.0 Absorption (000’s SF) Vacancy Rate (%) 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 4Q12

4Q11

2Q12
Absorption

4Q12

Vacancy Rate

Orlando Office Market
25.0 Vacancy Rate (%) 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Philadelphia Office Market
800 700 600 500 400 300 200 100 0 Absorption (000’s SF) Vacancy Rate (%) 20.5 20.0 19.5 19.0 18.5 18.0 17.5 17.0 16.5 2Q10 4Q10 2Q11
Vacancy Rate

400 350 300 250 200 150 100 50 0 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Phoenix Office Market
30.0 Vacancy Rate (%) 25.0 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Portland Office Market
2,500 Absorption (000’s SF) Vacancy Rate (%) 2,000 1,500 1,000 500 0 4Q12 25.0 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

700 600 500 400 300 200 100 0 (100) (200) 4Q11 2Q12
Absorption

4Q12

Vacancy Rate

Raleigh-Durham Office Market
25.0 Vacancy Rate (%) 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

St. Louis Office Market
600 Absorption (000’s SF) Vacancy Rate (%) 500 400 300 200 100 0 21.7 21.6 21.5 21.4 21.3 21.2 21.1 21.0 2Q10 4Q10 2Q11
Vacancy Rate

80 60 40 20 0 (20) 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Absorption (000’s SF)

Absorption (000’s SF)

Absorption (000’s SF)

Absorption (000’s SF)

71

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Office Market Vacancy and Absorption Projections (cont.)
San Diego Office Market
30.0 Vacancy Rate (%) 25.0 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

San Francisco Office Market
700 Absorption (000’s SF) Vacancy Rate (%) 600 500 400 300 200 100 0 21.0 20.0 19.0 18.0 17.0 16.0 15.0 2Q10 4Q10 2Q11
Vacancy Rate

1,000 800 600 400 200 0 (200) (400) (600) 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

San Jose Office Market
21.5 Vacancy Rate (%) 21.0 20.5 20.0 19.5 19.0 18.5 18.0 2Q10 4Q10 2Q11
Vacancy Rate

Seattle Office Market
250 Absorption (000’s SF) 200 150 100 50 0 Vacancy Rate (%) 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

2,500 2,000 1,500 1,000 500 0 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Tampa Bay Office Market
25.0 Vacancy Rate (%) 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Washington, D.C. Office Market
600 500 400 300 200 100 0 (100) Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF) 700 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Westchester County Office Market
20.8 Vacancy Rate (%) 20.6 20.4 20.2 20.0 19.8 19.6 19.4 2Q10 4Q10 2Q11
Vacancy Rate

West Palm Beach Office Market
20 Absorption (000’s SF) Vacancy Rate (%) 0 (20) (40) (60) (80) (100) (120) 25.0 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

400 350 300 250 200 150 100 50 0 4Q11 2Q12 4Q12

4Q11

2Q12
Absorption

4Q12

Absorption

72

Absorption (000’s SF)

Absorption (000’s SF)

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Industrial Market Vacancy and Absorption Projections
Notes on Negative Vacancy: In order to calculate estimated vacancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show negative vacancy rates it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space, Of course, negative vacancies cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of negative vacancy should be viewed as a strong excess demand indicator.
Atlanta Industrial Market Austin Industrial Market
25.0 Absorption (000’s SF) Vacancy Rate (%) 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

16.0 14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10

8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

450 400 350 300 250 200 150 100 50 0 4Q11 2Q12
Absorption

2Q11
Vacancy Rate

4Q11

2Q12
Absorption

4Q12

4Q12

Baltimore Industrial Market
20.0 Vacancy Rate (%) 19.5 19.0 18.5 18.0 17.5 17.0 16.5 16.0 2Q10 4Q10 2Q11
Vacancy Rate

Charlotte Industrial Market
500 Absorption (000’s SF) Vacancy Rate (%) 400 300 200 100 0 10.0 8.0 6.0 4.0 2.0 0.0 (2.0) (4.0) (6.0) (8.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

2,500 2,000 1,500 1,000 500 0 4Q12 Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF)

4Q11

2Q12
Absorption

4Q12

Vacancy Rate

Chicago Industrial Market
12.0 14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Cincinnati Industrial Market
8,000 6,000 4,000 2,000 0 (2,000) (4,000) Absorption (000’s SF) Vacancy Rate (%) 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

10.0 8.0 6.0 4.0 2.0 0.0 4Q12

4Q11

2Q12
Absorption

4Q12

Vacancy Rate

Cleveland Industrial Market
9.3 Vacancy Rate (%) 9.2 9.1 9.0 8.9 8.8 8.7 8.6 8.5 2Q10 4Q10 2Q11
Vacancy Rate

Columbus Industrial Market
2,000 1,500 1,000 500 0 (500) (1,000) (1,500) (2,000) (2,500) 13.4 13.2 13.0 12.8 12.6 12.4 12.2 12.0 11.8 11.6 2Q10 4Q10 2Q11
Vacancy Rate

600 400 200 0 (200) (400) (600) 4Q11 2Q12
Absorption

Absorption (000’s SF)

4Q11

2Q12
Absorption

4Q12

Vacancy Rate (%)

4Q12

Absorption (000’s SF)

73

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Industrial Market Vacancy and Absorption Projections (cont.)
Dallas-Fort Worth Industrial Market
14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Denver Industrial Market
12,000 Absorption (000’s SF) Vacancy Rate (%) 10,000 8,000 6,000 4,000 2,000 0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

1,000 800 600 400 200 0 (200) (400) 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Detroit Industrial Market
25.0 Vacancy Rate (%) 20.0 15.0 10.0 5.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Fairfield County Industrial Market
Absorption (000’s SF) 22.0 Vacancy Rate (%) 21.5 21.0 20.5 20.0 19.5 19.0 18.5 2Q10 4Q10 2Q11
Vacancy Rate

100 80 60 40 20 0 4Q11 2Q12
Absorption

(500) (1,000) (1,500) (2,000) (2,500) 4Q11 2Q12
Absorption

4Q12

4Q12

Fort Lauderdale Industrial Market
12.0 Vacancy Rate (%) 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Houston Industrial Market
700 Absorption (000’s SF) Vacancy Rate (%) 600 500 400 300 200 100 0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

6,000 5,000 4,000 3,000 2,000 1,000 0 (1,000) 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Indianapolis Industrial Market
14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Inland Empire Industrial Market
3,000 Absorption (000’s SF) Vacancy Rate (%) 2,500 2,000 1,500 1,000 500 0 20.0 15.0 10.0 5.0 0.0 (5.0) 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 10,000 8,000 6,000 4,000 2,000 0 (2,000) Absorption (000’s SF)

4Q11

2Q12
Absorption

4Q12

Vacancy Rate

Absorption

74

Absorption (000’s SF)

Absorption (000’s SF)

0

22.5

120

Absorption (000’s SF)

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Industrial Market Vacancy and Absorption Projections (cont.)
Las Vegas Industrial Market
14.0 12.0 Vacancy Rate (%) 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Long Island Industrial Market
1,400 1,200 1,000 800 600 400 200 0 (200) Absorption (000’s SF) Vacancy Rate (%) 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

800 700 600 500 400 300 200 100 0 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Los Angeles Industrial Market
9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Miami Industrial Market
3,500 3,000 2,500 2,000 1,500 1,000 500 0 (500) (1,000) 14.0 Absorption (000’s SF) Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

1,200 1,000 800 600 400 200 0 (200) 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Minneapolis Industrial Market
14.0 12.0 Vacancy Rate (%) 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Nashville Industrial Market
2,000 1,500 1,000 500 0 (500) (1,000) (1,500) (2,000) (2,500) 14.0 Absorption (000’s SF) Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

900 800 700 600 500 400 300 200 100 0 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Northern & Central NJ Industrial Market
25.0 12.5 Vacancy Rate (%) 12.0 11.5 11.0 10.5 10.0 9.5 2Q10 4Q10 2Q11
Vacancy Rate

Orlando Industrial Market
2,500 2,000 1,500 1,000 500 0 2Q10 4Q10 2Q11
Vacancy Rate

Absorption (000’s SF)

2,000 1,000 0 (1,000) (2,000) (3,000) 4Q11 2Q12
Absorption

Vacancy Rate (%)

20.0 15.0 10.0 5.0 0.0 4Q11 2Q12
Absorption

4Q12

4Q12

Absorption (000’s SF)

3,000

Absorption (000’s SF)

Absorption (000’s SF)

Vacancy Rate (%)

Absorption (000’s SF)

75

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Industrial Market Vacancy and Absorption Projections (cont.)
Philadelphia Industrial Market
16.0 Vacancy Rate (%) 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Phoenix Industrial Market
1,200 Vacancy Rate (%) 1,000 800 600 400 200 0 Absorption (000’s SF) 20.0 15.0 10.0 5.0 0.0 (5.0) 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 8,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF) 7,000

4Q11

2Q12
Absorption

4Q12
Vacancy Rate Absorption

Portland Industrial Market
10.0 Vacancy Rate (%) 8.0 6.0 4.0 2.0 0.0 (2.0) 2Q10 4Q10 2Q11
Vacancy Rate

St. Louis Industrial Market
3,000 Vacancy Rate (%) 2,500 2,000 1,500 1,000 500 0 (500) Absorption (000’s SF) 16.1 16.0 15.9 15.8 15.7 15.6 15.5 15.4 15.3 15.2 2Q10 4Q10 2Q11
Vacancy Rate

500 400 300 200 100 0 (100) 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

San Diego Industrial Market
18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

San Francisco Industrial Market
2,500 Absorption (000’s SF) Vacancy Rate (%) 2,000 1,500 1,000 500 0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

800 600 400 200 0 (200) (400) 4Q11 2Q12
Absorption

Vacancy Rate (%)

4Q11

2Q12
Absorption

4Q12

4Q12

Seattle Industrial Market
12.0 10.0 8.0 6.0 4.0 2.0 0.0 (2.0) (4.0) (6.0) 2Q10 4Q10 2Q11
Vacancy Rate

Tampa Bay Industrial Market
6,000 Absorption (000’s SF) Vacancy Rate (%) 5,000 4,000 3,000 2,000 1,000 0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

2,500 2,000 1,500 1,000 500 0 (500) 4Q12

Vacancy Rate (%)

4Q11

2Q12
Absorption

4Q12

Vacancy Rate

76

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Industrial Market Vacancy and Absorption Projections (cont.)
Washington, D.C. Industrial Market
18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11
Vacancy Rate

Westchester County Industrial Market
2,000 Absorption (000’s SF) 1,500 1,000 500 0 Vacancy Rate (%) 12.4 12.2 12.0 11.8 11.6 11.4 11.2 2Q10 4Q10 2Q11
Vacancy Rate

20 0 (20) (40) (60) (80) (100) (120) 4Q11 2Q12
Absorption

4Q11

2Q12
Absorption

4Q12

4Q12

Absorption (000’s SF)

Vacancy Rate (%)

77

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Multifamily Market Vacancy and Absorption Projections
Notes on Negative Vacancy: In order to calculate estimated vacancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show negative vacancy rates it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space, Of course, negative vacancies cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of negative vacancy should be viewed as a strong excess demand indicator.

Atlanta Multifamily Market
12.0 Vacancy Rate (%) 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Austin Multifamily Market
5,000 Vacancy Rate (%) 4,000 3,000 2,000 1,000 0 Absorption (Units) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

1,600 1,200 1,000 800 600 400 200 0 4Q12 2Q13 Absorption (Units) Absorption (Units) Absorption (Units) Absorption (Units) 1,400

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Baltimore Multifamily Market
7.0 6.0 Vacancy Rate (%) 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Boston Multifamily Market
1,400 Absorption (Units) Vacancy Rate (%) 1,200 1,000 800 600 400 200 0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

1,200 1,000 800 600 400 200 0 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Charlotte Multifamily Market
12.0 10.0 8.0 6.0 4.0 2.0 0.0 (2.0) (4.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Chicago Multifamily Market
1,400 Absorption (Units) 1,000 800 600 400 200 0 Vacancy Rate (%) 1,200 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Vacancy Rate (%)

3,000 2,500 2,000 1,500 1,000 500 0 (500) (1,000) 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Cincinnati Multifamily Market
10.0 Vacancy Rate (%) 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Cleveland Multifamily Market
800 700 600 500 400 300 200 100 0 6.9 6.8 6.7 6.6 6.5 6.4 6.3 6.2 6.1 6.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

800 600 400 200 0 (200) (400) (600) (800) (1,000) 4Q12 2Q13

Absorption (Units)

4Q12

2Q13

Vacancy Rate (%)

Vacancy Rate

Vacancy Rate

78

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Multifamily Market Vacancy and Absorption Projections (cont.)
Columbus Multifamily Market
10.4 10.2 10.0 9.8 9.6 9.4 9.2 9.0 8.8 8.6 8.4 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Dallas-Fort Worth Multifamily Market
400 Absorption (Units) 300 200 100 0 (100) (200) (300) (400) Vacancy Rate (%) 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

8,000 6,000 5,000 4,000 3,000 2,000 1,000 0 4Q12 2Q13 Absorption (Units) Absorption (Units) Absorption (Units) Absorption (Units) 7,000

Vacancy Rate (%)

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Denver Multifamily Market
7.0 Vacancy Rate (%) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Detroit Multifamily Market
1,200 1,000 800 600 400 200 0 (200) (400) 14.0 Absorption (Units) 12.0 Vacancy Rate (%) 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

0 (200) (400) (600) (800) (1,000) (1,200) 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Houston Multifamily Market
14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Indianapolis Multifamily Market
8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 (1,000) 12.0 Absorption (Units) Vacancy Rate (%) 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

1,400 1,200 1,000 800 600 400 200 0 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Inland Empire Multifamily Market
10.0 Vacancy Rate (%) 5.0 0.0 (5.0) (10.0) (15.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Los Angeles Multifamily Market
3,500 Absorption (Units) 3,000 2,500 2,000 1,500 1,000 500 0 (500) Vacancy Rate (%) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

2,500 2,000 1,500 1,000 500 0 (500) (1,000) 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

79

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Multifamily Market Vacancy and Absorption Projections (cont.)
Miami Multifamily Market
7.0 Vacancy Rate (%) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Minneapolis Multifamily Market
600 Vacancy Rate (%) Absorption (Units) 500 400 300 200 100 0 4Q12 2Q13 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

1,000 500 0 (500) (1,000) (1,500) 4Q12 2Q13 Absorption (Units) Absorption (Units) Absorption (Units) Absorption (Units)

Vacancy Rate

Vacancy Rate

Nashville Multifamily Market
12.0 Vacancy Rate (%) 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

New York City Multifamily Market
500 Absorption (Units) 400 300 200 100 0 Vacancy Rate (%) 2.0 1.5 1.0 0.5 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

400 350 300 250 200 150 100 50 0 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Orlando Multifamily Market
15.0 Vacancy Rate (%) 10.0 5.0 0.0 (5.0) (10.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Philadelphia Multifamily Market
3,500 Absorption (Units) Vacancy Rate (%) 3,000 2,500 2,000 1,500 1,000 500 0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

700 600 500 400 300 200 100 0 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Phoenix Multifamily Market
15.0 Vacancy Rate (%) 10.0 5.0 0.0 (5.0) (10.0) (15.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Portland Multifamily Market
8,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Absorption (Units) Vacancy Rate (%) 7,000 8.0 6.0 4.0 2.0 0.0 (2.0) (4.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

1,600 1,400 1,200 1,000 800 600 400 200 0 (200) (400) 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

80

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Multifamily Market Vacancy and Absorption Projections (cont.)
St. Louis Multifamily Market
14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

San Diego Multifamily Market
250 Vacancy Rate (%) Absorption (Units) 200 150 100 50 0 (50) (100) 4Q12 2Q13 6.0 5.0 4.0 3.0 2.0 1.0 0.0 (1.0) (2.0) (3.0) (4.0) (5.0) (6.0) (7.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

2,500 Absorption (Units) Absorption (Units) Absorption (Units) 2,000 1,500 1,000 500 0 4Q12 2Q13

Vacancy Rate

Vacancy Rate

San Francisco Multifamily Market
6.0 Vacancy Rate (%) 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

San Jose Multifamily Market
1,200 1,000 800 600 400 200 0 (200) (400) (600) 5.0 Absorption (Units) Vacancy Rate (%) 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

500 450 400 350 300 250 200 150 100 50 0 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Seattle Multifamily Market
8.0 Vacancy Rate (%) 6.0 4.0 2.0 0.0 (2.0) (4.0) (6.0) (8.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Tampa Bay Multifamily Market
7,000 Absorption (Units) Vacancy Rate (%) 6,000 5,000 4,000 3,000 2,000 1,000 0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 (2.0) (4.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

2,500 2,000 1,500 1,000 500 0 (500) 4Q12 2Q13

4Q12

2Q13

Vacancy Rate

Vacancy Rate

Washington, D.C. Multifamily Market
7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 (1.0) (2.0) (3.0) 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 4Q12 2Q13

Vacancy Rate (%)

Vacancy Rate

Absorption (Units)

81

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Retail Market Vacancy and Absorption Projection
Notes on Negative Vacancy: In order to calculate estimated vacancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show negative vacancy rates it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space, Of course, negative vacancies cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of negative vacancy should be viewed as a strong excess demand indicator.

Atlanta Retail Market
14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

Austin Retail Market
1,200 Absorption (000’s SF) 1,000 800 600 400 200 0 (200) (400) 3Q12 1Q13 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 400 300 250 200 150 100 50 0 Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF) 350

Vacancy Rate

Vacancy Rate

Absorption

Boston Retail Market
8.0 7.0 Vacancy Rate (%) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

Charlotte Retail Market
1,000 Absorption (000’s SF) Vacancy Rate (%) 800 600 400 200 0 (200) 3Q12 1Q13 10.0 8.0 6.0 4.0 2.0 0.0 (2.0) (4.0) (6.0) (8.0) 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

600 500 400 300 200 100 0 3Q12 1Q13

Vacancy Rate

Vacancy Rate

Chicago Retail Market
12.0 Vacancy Rate (%) 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 800 Absorption (000’s SF) Vacancy Rate (%) 600 400 200 0 (200) (400) (600) 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10

Cincinnati Retail Market
700 600 500 400 300 200 100 0 (100) 1Q11 3Q11 1Q12 3Q12 1Q13

Vacancy Rate

Absorption

Vacancy Rate

Absorption

Cleveland Retail Market
13.8 Vacancy Rate (%) 13.6 13.4 13.2 13.0 12.8 12.6 12.4 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 150 Vacancy Rate (%) 100 50 0 (50) (100) (150) (200) Absorption (000’s SF) 12.5 12.0 11.5 11.0 10.5 1Q10 3Q10

Columbus Retail Market
150 100 50 0 (50) (100) (150) (200) 1Q11 3Q11 1Q12 3Q12 1Q13

Vacancy Rate

Absorption

Vacancy Rate

Absorption

82

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Retail Market Vacancy and Absorption Projection (cont.)
Dallas-Fort Worth Retail Market
14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

Denver Retail Market
5,000 Absorption (000’s SF) 4,000 3,000 2,000 1,000 0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 500 400 300 200 100 0 (100) (200) (300) (400) Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF)

3Q12

1Q13

Vacancy Rate

Vacancy Rate

Absorption

Detroit Retail Market
20.0 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

Houston Retail Market
0 Absorption (000’s SF) (50) (100) (150) (200) (250) (300) 3Q12 1Q13 Vacancy Rate (%) 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 2,500 2,000 1,500 1,000 500 0 (500)

Vacancy Rate (%)

Vacancy Rate

Vacancy Rate

Absorption

Indianapolis Retail Market
14.0 Vacancy Rate (%) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 1,400 1,200 1,000 800 600 400 200 0 (200) 7.0 Absorption (000’s SF) 6.0 Vacancy Rate (%) 5.0 4.0 3.0 2.0 1.0 0.0 1Q10

Los Angeles Retail Market
1,200 1,000 800 600 400 200 0 (200) (400) 3Q10 1Q11 3Q11 1Q12
Absorption

3Q12

1Q13

Vacancy Rate

Absorption

Vacancy Rate

Miami Retail Market
9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 1Q10 3Q10 1Q11
Vacancy Rate

Minneapolis Retail Market
600 Absorption (000’s SF) Vacancy Rate (%) 500 400 300 200 100 0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

400 300 200 100 0 (100) (200) (300) (400) (500) 3Q12 1Q13

Vacancy Rate (%)

3Q11

1Q12
Absorption

3Q12

1Q13

Vacancy Rate

83

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Retail Market Vacancy and Absorption Projection (cont.)
Nashville Retail Market
Absorption (000’s SF) 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 1Q10 3Q10 1Q11
Vacancy Rate

New York City Retail Market
150 Vacancy Rate (%) 100 50 0 (50) 2.5 2.0 1.5 1.0 0.5 0.0 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 120 100 80 60 40 20 0 Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF) Absorption (000’s SF)

Vacancy Rate (%)

3Q11

1Q12
Absorption

3Q12

1Q13

Vacancy Rate

Absorption

Orlando Retail Market
15.0 Vacancy Rate (%) 10.0 5.0 0.0 (5.0) (10.0) 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

Philadelphia Retail Market
1,000 Absorption (000’s SF) Vacancy Rate (%) 800 600 400 200 0 (200) 3Q12 1Q13 10.0 8.0 6.0 4.0 2.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 800 700 600 500 400 300 200 100 0

Vacancy Rate

Vacancy Rate

Absorption

Phoenix Retail Market
15.0 Vacancy Rate (%) 10.0 5.0 0.0 (5.0) (10.0) (15.0) 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 (500) 10.0 Absorption (000’s SF) Vacancy Rate (%) 8.0 6.0 4.0 2.0 0.0 (2.0) 1Q10 3Q10

Portland Retail Market
700 600 500 400 300 200 100 0 (100) (200) (300) 1Q11 3Q11 1Q12
Absorption

3Q12

1Q13

Vacancy Rate

Absorption

Vacancy Rate

St. Louis Retail Market
10.3 Vacancy Rate (%) 10.2 10.1 10.0 9.9 9.8 9.7 9.6 9.5 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 60 Absorption (000’s SF) 40 30 20 10 0 (10) (20) Vacancy Rate (%) 50 8.0 6.0 4.0 2.0 0.0 (2.0) (4.0) (6.0) (8.0) 1Q10 3Q10

San Diego Retail Market
1,400 1,200 1,000 800 600 400 200 0 (200) 1Q11 3Q11 1Q12
Absorption

3Q12

1Q13

Vacancy Rate

Absorption

Vacancy Rate

84

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Retail Market Vacancy and Absorption Projection (cont.)
San Francisco Retail Market
6.0 Vacancy Rate (%) 5.0 4.0 3.0 2.0 1.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

San Jose Retail Market
800 600 400 200 0 (200) (400) (600) Absorption (000’s SF) Vacancy Rate (%) 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 1Q10 3Q10 1Q11 3Q11 1Q12
Absorption

350 Absorption (000’s SF) Absorption (000’s SF) 300 250 200 150 100 50 0 3Q12 1Q13

3Q12

1Q13

Vacancy Rate

Vacancy Rate

Seattle Retail Market
8.0 6.0 4.0 2.0 0.0 (2.0) (4.0) (6.0) (8.0) (10.0) 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 1,000 Absorption (000’s SF) Vacancy Rate (%) 800 600 400 200 0 (200) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 (2.0) 1Q10 3Q10

Tampa Bay Retail Market
2,500 2,000 1,500 1,000 500 0 (500) 1Q11 3Q11 1Q12 3Q12 1Q13

Vacancy Rate (%)

Vacancy Rate

Absorption

Vacancy Rate

Absorption

Washington, D.C. Retail Market
8.0 Vacancy Rate (%) 6.0 4.0 2.0 0.0 (2.0) (4.0) 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12
Absorption

1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 1Q13

Vacancy Rate

Absorption (000’s SF)

85

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Hotel Market Occupancy and Absorption Projection
Atlanta Hotel Market
61.0 60.0 59.0 58.0 57.0 56.0 55.0 54.0 53.0 52.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Austin Hotel Market
800 Occupancy Rate (%) 600 500 400 300 200 100 0 4Q12 Absorption (Rooms) 700 67.0 66.0 65.0 64.0 63.0 62.0 61.0 60.0 59.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

200 150 100 50 0 4Q12 Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) Absorption (Rooms)

Occupancy Rate (%)

Occupancy Rate

Occupancy Rate

Boston Hotel Market
69.0 68.5 68.0 67.5 67.0 66.5 66.0 65.5 65.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Chicago Hotel Market
200 Absorption (Rooms) Occupancy Rate (%) 150 100 50 0 4Q12 61.5 61.0 60.5 60.0 59.5 59.0 58.5 58.0 57.5 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

500 400 300 200 100 0 (100) (200) 4Q12

Occupancy Rate (%)

Occupancy Rate

Occupancy Rate

Dallas Hotel Market
59.0 58.0 57.0 56.0 55.0 54.0 53.0 52.0 51.0 50.0 49.0 2Q10 4Q10 2Q11
Occupancy Rate

Denver Hotel Market
700 500 400 300 200 100 0 Occupancy Rate (%) 600 Absorption (Rooms) 61.0 60.8 60.6 60.4 60.2 60.0 59.8 59.6 59.4 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

120 100 80 60 40 20 0 (20) (40) 4Q12

Occupancy Rate (%)

4Q11

2Q12
Absorption

4Q12

Occupancy Rate

Detroit Hotel Market
50.5 50.0 49.5 49.0 48.5 48.0 47.5 47.0 46.5 46.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Houston Hotel Market
0 Absorption (Rooms) Occupancy Rate (%) (20) (40) (60) (80) (100) (120) 4Q12 55.2 55.0 54.8 54.6 54.4 54.2 54.0 53.8 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

600 500 400 300 200 100 0 (100) 4Q12

Occupancy Rate (%)

Occupancy Rate

Occupancy Rate

86

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Hotel Market Occupancy and Absorption Projection (cont.)
Las Vegas Hotel Market
65.0 64.0 63.0 62.0 61.0 60.0 59.0 58.0 57.0 56.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 1,600 1,400 1,200 1,000 800 600 400 200 0 (200) 67.5 Absorption (Rooms) Occupancy Rate (%) 67.0 66.5 66.0 65.5 65.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Los Angeles Hotel Market
250 150 100 50 0 (50) (100) 4Q12 Absorption (Rooms) 90 80 70 60 50 40 30 20 10 0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Occupancy Rate (%)

200

Occupancy Rate

Absorption

Occupancy Rate

Miami Hotel Market
68.8 68.6 68.4 68.2 68.0 67.8 67.6 67.4 67.2 67.0 2Q10 4Q10 2Q11
Occupancy Rate

Minneapolis Hotel Market
180 160 140 120 100 80 60 40 20 0 (20) 61.0 Occupancy Rate (%) 60.5 60.0 59.5 59.0 58.5 58.0 57.5 57.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

150 Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) 100 50 0 (50) (100) (150) (200) 4Q12

Occupancy Rate (%)

4Q11

2Q12
Absorption

4Q12

Absorption (Rooms)

Occupancy Rate

Nashville Hotel Market
58.5 Occupancy Rate (%) 58.0 57.5 57.0 56.5 56.0 55.5 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

New York City Hotel Market
120 Absorption (Rooms) Occupancy Rate (%) 100 80 60 40 20 0 4Q12 81.0 80.0 79.0 78.0 77.0 76.0 75.0 74.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

200 150 100 50 0 4Q12

Occupancy Rate

Occupancy Rate

Orlando Hotel Market
74.0 72.0 70.0 68.0 66.0 64.0 62.0 60.0 58.0 56.0 54.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Philadelphia Hotel Market
2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 4Q12 64.2 64.0 63.8 63.6 63.4 63.2 63.0 62.8 62.6 62.4 4Q12 Absorption (Rooms) Occupancy Rate (%)

Occupancy Rate (%)

Occupancy Rate

Occupancy Rate

87

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Hotel Market Occupancy and Absorption Projection (cont.)
Phoenix Hotel Market
80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

St. Louis Hotel Market
1,200 1,000 800 600 400 200 0 4Q12 55.9 55.9 55.8 55.8 55.7 55.7 55.6 55.6 55.5 55.5 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Occupancy Rate (%)

Occupancy Rate (%)

Absorption (Rooms)

40 30 20 10 0 (10) 4Q12

Occupancy Rate

Occupancy Rate

San Diego Hotel Market
74.0 72.0 70.0 68.0 66.0 64.0 62.0 60.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 Occupancy Rate (%) Absorption (Rooms) Occupancy Rate (%) 600 500 400 300 200 100 0 78.0 77.0 76.0 75.0 74.0 73.0 72.0 2Q10

San Francisco Hotel Market
400 300 200 100 0 (100) (200) 4Q10 2Q11 4Q11 2Q12 4Q12 Absorption (Rooms) Absorption (Rooms)

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Seattle Hotel Market
76.0 74.0 72.0 70.0 68.0 66.0 64.0 62.0 60.0 58.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Tampa Bay Hotel Market
600 Absorption (Rooms) 500 400 300 200 100 0 4Q12 Occupancy Rate (%) 62.0 60.0 58.0 56.0 54.0 52.0 50.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

Occupancy Rate (%)

500 400 300 200 100 0 (100) 4Q12

Occupancy Rate

Occupancy Rate

Washington, D.C. Hotel Market
71.0 70.0 69.0 68.0 67.0 66.0 65.0 64.0 63.0 2Q10 4Q10 2Q11 4Q11 2Q12
Absorption

800 700 600 500 400 300 200 100 0 4Q12

Occupancy Rate (%)

Occupancy Rate

88

Absorption (Rooms)

Absorption (Rooms)

50

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Independent Living Market Occupancy and Absorption Projections
Note on occupancy greater than 100%: In order to calculate estimated occupancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show 100%+ occupancy rates, it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space. Of course, 100%+ occupancy cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of 100%+ occupancy should be viewed as a strong excess demand indicator.
Atlanta Independent Living Market
100.0 98.0 96.0 94.0 92.0 90.0 88.0 86.0 84.0 82.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 100 Absorption (Rooms) Occupancy Rate (%) 80 60 40 20 0 96.5 96.0 95.5 95.0 94.5 94.0 93.5 93.0 92.5 92.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 Occupancy Rate (%)

Baltimore Independent Living Market
40 30 25 20 15 10 5 0 Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) 35

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Boston Independent Living Market
91.0 Occupancy Rate (%) 90.0 89.0 88.0 87.0 86.0 85.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 60 Absorption (Rooms) 50 40 30 20 10 0 Occupancy Rate (%) 91.0 90.0 89.0 88.0 87.0 86.0 85.0 84.0 83.0 2Q10

Chicago Independent Living Market
150 100 50 0 (50) (100) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Cincinnati Independent Living Market
94.0 93.0 92.0 91.0 90.0 89.0 88.0 87.0 86.0 85.0 84.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 45 40 35 30 25 20 15 10 5 0 87.0 Absorption (Rooms) Occupancy Rate (%) 86.8 86.6 86.4 86.2 86.0 85.8 85.6 2Q10 Occupancy Rate (%)

Cleveland Independent Living Market
30 20 10 0 (10) (20) (30) (40) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Dallas Independent Living Market
94.0 92.0 90.0 88.0 86.0 84.0 82.0 80.0 78.0 76.0 74.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 200 Occupancy Rate (%) 150 100 50 0 Absorption (Rooms) 89.0 88.0 87.0 86.0 85.0 84.0 83.0 2Q10 Occupancy Rate (%)

Denver Independent Living Market
35 30 25 20 15 10 5 0 (5) (10) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

89

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Independent Living Market Occupancy and Absorption Projections (cont.)
Detroit Independent Living Market
89.0 Occupancy Rate (%) 88.0 87.0 86.0 85.0 84.0 83.0 82.0 81.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 0 Occupancy Rate (%) Absorption (Rooms) (10) (20) (30) (40) (50) (60) (70) 90.0 89.0 88.0 87.0 86.0 85.0 84.0 83.0 82.0 81.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12

Houston Independent Living Market
120 Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) 100 80 60 40 20 0 (20)

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Kansas City Independent Living Market
85.4 Occupancy Rate (%) 85.2 85.0 84.8 84.6 84.4 84.2 84.0 83.8 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 (25) (30) (10) (15) (20) 0 Absorption (Rooms) (5) Occupancy Rate (%) 94.0 92.0 90.0 88.0 86.0 84.0 82.0 80.0 78.0 2Q10

Las Vegas Independent Living Market
30 25 20 15 10 5 0 (5) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Los Angeles Independent Living Market
91.5 Occupancy Rate (%) 91.0 90.5 90.0 89.5 89.0 88.5 88.0 87.5 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 60 Occupancy Rate (%) 40 30 20 10 0 (10) (20) Absorption (Rooms) 50 90.0 89.0 88.0 87.0 86.0 85.0 84.0 2Q10

Miami Independent Living Market
70 60 50 40 30 20 10 0 (10) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Minneapolis Independent Living Market
98.0 Occupancy Rate (%) 97.0 96.0 95.0 94.0 93.0 92.0 91.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 80 40 20 0 (20) (40) (60) (80) Absorption (Rooms) Occupancy Rate (%) 60 93.0 92.5 92.0 91.5 91.0 90.5 90.0 89.5 89.0 88.5 2Q10

New York City Independent Living Market
35 30 25 20 15 10 5 0 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

90

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Independent Living Market Occupancy and Absorption Projections (cont.)
Orlando Independent Living Market
120.0 Occupancy Rate (%) 100.0 80.0 60.0 40.0 20.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 140 Absorption (Rooms) Occupancy Rate (%) 120 100 80 60 40 20 0 93.5 93.0 92.5 92.0 91.5 91.0 90.5 90.0 89.5 89.0 88.5 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12

Philadelphia Independent Living Market
80 60 50 40 30 20 10 0 Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) 70

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Phoenix Independent Living Market
120.0 Occupancy Rate (%) 100.0 80.0 60.0 40.0 20.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 200 100 0 500 400 300 Absorption (Rooms) Occupancy Rate (%) 93.2 93.0 92.8 92.6 92.4 92.2 92.0 91.8 2Q10

Pittsburgh Independent Living Market
14 12 10 8 6 4 2 0 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Portland Independent Living Market
94.0 Occupancy Rate (%) 92.0 90.0 88.0 86.0 84.0 82.0 80.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 140 120 100 80 60 40 20 0 (20) (40) 120.0 Occupancy Rate (%) Absorption (Rooms) 100.0 80.0 60.0 40.0 20.0 0.0 2Q10

Riverside Independent Living Market
140 120 100 80 60 40 20 0 (20) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Sacramento Independent Living Market
94.0 Occupancy Rate (%) 92.0 90.0 88.0 86.0 84.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 35 30 25 20 15 10 5 0 (5) (10) (15) 90.0 Absorption (Rooms) Occupancy Rate (%) 89.5 89.0 88.5 88.0 87.5 2Q10

St. Louis Independent Living Market
20 15 10 5 0 (5) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

91

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Independent Living Market Occupancy and Absorption Projections (cont.)
San Antonio Independent Living Market
92.0 91.0 90.0 89.0 88.0 87.0 86.0 85.0 84.0 83.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 40 35 30 25 20 15 10 5 0 (5) 100.0 98.0 96.0 94.0 92.0 90.0 88.0 86.0 84.0 82.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 Occupancy Rate (%) Occupancy Rate (%)

San Diego Independent Living Market
120 Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) 100 80 60 40 20 0

Occupancy Rate

Absorption

Absorption (Rooms)

Occupancy Rate

Absorption

San Francisco Independent Living Market
96.0 Occupancy Rate (%) 95.0 94.0 93.0 92.0 91.0 90.0 89.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 60 50 40 30 20 10 0 (10) (20) (30) 93.0 92.5 92.0 91.5 91.0 90.5 90.0 89.5 89.0 88.5 2Q10 Absorption (Rooms) Occupancy Rate (%)

San Jose Independent Living Market
16 14 12 10 8 6 4 2 0 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Seattle Independent Living Market
105.0 Occupancy Rate (%) 100.0 95.0 90.0 85.0 80.0 75.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 300 Absorption (Rooms) 250 200 150 100 50 0 Occupancy Rate (%) 100.0 98.0 96.0 94.0 92.0 90.0 88.0 86.0 84.0 82.0 80.0 2Q10

Tampa Independent Living Market
200 150 100 50 0 (50) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Washington, D.C. Independent Living Market
98.0 Occupancy Rate (%) 96.0 94.0 92.0 90.0 88.0 86.0 84.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 160 120 100 80 60 40 20 0 Absorption (Rooms) 140

Occupancy Rate

Absorption

92

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Assisted Living Market Occupancy and Absorption Projections
Note on occupancy greater than 100%: In order to calculate estimated occupancy rates, we adjust beginning inventory for new construction completions and compare that to net absorption (including sublease space). If we show 100%+ occupancy rates, it simply means that given the scheduled supply and growth in expected demand, sufficient demand pressure exists to more than absorb all available space. Of course, 100%+ occupancy cannot occur, as in the face of such demand pressure additional development will occur and rents will increase in order to dampen demand. Therefore, forecasts of 100%+ occupancy should be viewed as a strong excess demand indicator.
Atlanta Assisted Living Market
96.0 94.0 92.0 90.0 88.0 86.0 84.0 82.0 80.0 78.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 90 80 70 60 50 40 30 20 10 0 92.5 92.0 91.5 91.0 90.5 90.0 89.5 89.0 88.5 88.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 Occupancy Rate (%) Occupancy Rate (%) Absorption (Rooms)

Baltimore Assisted Living Market
14 Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) 12 10 8 6 4 2 0

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Boston Assisted Living Market
96.0 Occupancy Rate (%) 95.0 94.0 93.0 92.0 91.0 90.0 89.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 45 40 35 30 25 20 15 10 5 0 87.0 Absorption (Rooms) Occupancy Rate (%) 86.0 85.0 84.0 83.0 82.0 81.0 80.0 79.0 2Q10

Chicago Assisted Living Market
60 50 40 30 20 10 0 (10) (20) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Cincinnati Assisted Living Market
99.0 98.0 97.0 96.0 95.0 94.0 93.0 92.0 91.0 90.0 89.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 16 Absorption (Rooms) Occupancy Rate (%) 14 12 10 8 6 4 2 0 90.2 90.0 89.8 89.6 89.4 89.2 89.0 2Q10 Occupancy Rate (%)

Cleveland Assisted Living Market
20 15 10 5 0 (5) (10) (15) (20) (25) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Dallas Assisted Living Market
98.0 96.0 94.0 92.0 90.0 88.0 86.0 84.0 82.0 80.0 78.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 100 80 60 40 20 0 Absorption (Rooms) Occupancy Rate (%) 90.0 89.0 88.0 87.0 86.0 85.0 2Q10 Occupancy Rate (%)

Denver Assisted Living Market
20 15 10 5 0 (5) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

93

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Assisted Living Market Occupancy and Absorption Projections (cont.)
Detroit Assisted Living Market
85.0 Occupancy Rate (%) 84.0 83.0 82.0 81.0 80.0 79.0 78.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 (20) (5) (10) (15) 0 Occupancy Rate (%) Absorption (Rooms) 96.0 95.0 94.0 93.0 92.0 91.0 90.0 89.0 88.0 87.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12

Houston Assisted Living Market
70 50 40 30 20 10 0 (10) Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) 60

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Kansas City Assisted Living Market
89.6 Occupancy Rate (%) 89.4 89.2 89.0 88.8 88.6 88.4 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 0 Absorption (Rooms) Occupancy Rate (%) (1) (2) (3) (4) (5) (6) (7) (8) 100.0 98.0 96.0 94.0 92.0 90.0 88.0 86.0 84.0 82.0 2Q10

Las Vegas Assisted Living Market
20 15 10 5 0 (5) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Los Angeles Assisted Living Market
87.0 Occupancy Rate (%) 86.5 86.0 85.5 85.0 84.5 84.0 83.5 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 50 Occupancy Rate (%) Absorption (Rooms) 40 30 20 10 0 (10) (20) 92.0 91.0 90.0 89.0 88.0 87.0 86.0 2Q10

Miami Assisted Living Market
30 25 20 15 10 5 0 (5) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Minneapolis Assisted Living Market
7.0 Occupancy Rate (%) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 40 Absorption (Rooms) 20 10 0 (10) (20) (30) (40) Occupancy Rate (%) 30 96.0 95.5 95.0 94.5 94.0 93.5 93.0 92.5 2Q10

New York City Assisted Living Market
45 40 35 30 25 20 15 10 5 0 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

94

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Assisted Living Market Occupancy and Absorption Projections (cont.)
Orlando Assisted Living Market
115.0 Occupancy Rate (%) 110.0 105.0 100.0 95.0 90.0 85.0 80.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 70 Occupancy Rate (%) Absorption (Rooms) 60 50 40 30 20 10 0 91.0 90.5 90.0 89.5 89.0 88.5 88.0 87.5 87.0 86.5 86.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12

Philadelphia Assisted Living Market
25 Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) Absorption (Rooms) 20 15 10 5 0

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Phoenix Assisted Living Market
120.0 Occupancy Rate (%) 100.0 80.0 60.0 40.0 20.0 0.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 180 160 140 120 100 80 60 40 20 0 93.4 Absorption (Rooms) Occupancy Rate (%) 93.2 93.0 92.8 92.6 92.4 92.2 92.0 2Q10

Pittsburgh Assisted Living Market
14 12 10 8 6 4 2 0 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Portland Assisted Living Market
98.0 Occupancy Rate (%) 96.0 94.0 92.0 90.0 88.0 86.0 84.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 120 Absorption (Rooms) Occupancy Rate (%) 100 80 60 40 20 0 (20) 120.0 100.0 80.0 60.0 40.0 20.0 0.0 2Q10

Riverside Assisted Living Market
140 120 100 80 60 40 20 0 (20) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Sacramento Assisted Living Market
96.0 Occupancy Rate (%) 94.0 92.0 90.0 88.0 86.0 84.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 35 30 25 20 15 10 5 0 (5) (10) (15) 93.0 Absorption (Rooms) Occupancy Rate (%) 92.8 92.6 92.4 92.2 92.0 91.8 2Q10

St. Louis Assisted Living Market
5 4 3 2 1 0 (1) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

95

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Assisted Living Market Occupancy and Absorption Projections (cont.)
San Antonio Assisted Living Market
90.0 89.0 88.0 87.0 86.0 85.0 84.0 83.0 82.0 81.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 25 Occupancy Rate (%) Absorption (Rooms) 20 15 10 5 0 (5) 100.0 98.0 96.0 94.0 92.0 90.0 88.0 86.0 84.0 82.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 Occupancy Rate (%)

San Diego Assisted Living Market
45 40 35 30 25 20 15 10 5 0 Absorption (Rooms) Absorption (Rooms) Absorption (Rooms)

Occupancy Rate

Absorption

Occupancy Rate

Absorption

San Francisco Assisted Living Market
92.0 Occupancy Rate (%) 91.0 90.0 89.0 88.0 87.0 86.0 85.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 60 50 40 30 20 10 0 (10) (20) (30) 89.0 Absorption (Rooms) Occupancy Rate (%) 88.0 87.0 86.0 85.0 84.0 83.0 2Q10

San Jose Assisted Living Market
7 6 5 4 3 2 1 0 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Seattle Assisted Living Market
105.0 Occupancy Rate (%) 100.0 95.0 90.0 85.0 80.0 75.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 120 Absorption (Rooms) 100 80 60 40 20 0 Occupancy Rate (%) 110.0 105.0 100.0 95.0 90.0 85.0 2Q10

Tampa Assisted Living Market
100 80 60 40 20 0 (20) 4Q10 2Q11 4Q11 2Q12 4Q12

Occupancy Rate

Absorption

Occupancy Rate

Absorption

Washington, D.C. Assisted Living Market
102.0 Occupancy Rate (%) 100.0 98.0 96.0 94.0 92.0 90.0 88.0 86.0 2Q10 4Q10 2Q11 4Q11 2Q12 4Q12 20 10 0 50 40 30 Absorption (Rooms)

Occupancy Rate

Absorption

96

THE LINNEMAN LETTER
Volume 10, Issue 3 Fall 2010

Editoral Staff
Editor-in-Chief Managing Editor Contributing Editor Contributors Peter Linneman, Ph.D. Deborah Moy Mukund Krishnaswami Lisa Anderson, Ph.D. James Foreman Adam Leslie Minal Melwani Nick Newburger Robyn Yie Lyn Choo James Foreman Karren E. Henderson Jared Joella Adam Leslie Minal Melwani Nick Newburger Jillian Popadak Dan Short Boris Siperstein Frances Wan Douglas Linneman

Research

Layout Subscriptions

About Dr. Peter Linneman
Dr. Linneman, who holds both Masters and Doctorate degrees in economics from the University of Chicago, is the Principal of Linneman Associates. For over 25 years he has provided strategic and financial advice to leading corporations. Through Linneman Associates, he provides strategic and M&A analysis, market studies, and feasibility analysis to a number of leading U.S. and international companies. In addition, he serves as an advisor to and a board member of several public and private firms. Dr. Linneman is the author of the leading real estate finance textbook, Real Estate Finance and Investments: Risks and Opportunities. His teaching and research focuses on real estate and investment strategies, mergers and acquisitions, and international markets. He has published over 100 articles during his career. He is widely recognized as one of the leading strategic thinkers in the real estate industry. He also serves as the Albert Sussman Professor of Real Estate, Finance, and Business and Public Policy at the Wharton School of Business, the University of Pennsylvania. A member of Wharton’s faculty since 1979, he served as the founding chairman of Wharton’s Real Estate Department and the Director of Wharton’s Zell-Lurie Real Estate Center for 13 years. He is the founding coeditor of The Wharton Real Estate Review. All inquiries and comments can be directed to Doug Linneman at dlinneman@linnemanassociates.com. Please visit our website at: www.linnemanassociates.com.
COPYRIGHT DISCLOSURE: The Linneman Letter, a publication of Linneman Associates, is intended solely for use by paid subscribers. Reproduction or distribution in whole or part without written permission is prohibited and subject to legal action. Copyright laws apply. The purpose of this publication is to analyze, opine upon, and forecast macroeconomic conditions and real estate market fundamentals. Source and Copyright © 2010 Linneman Associates.

© 2010 Linneman Associates

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