Sept08 Rosen

U.S.
Outlook
September 2008
by:
Ken Rosen
Arthur Margon
Steven Blitz
Andrea Lepcio
Antoine St-Pierre
Caroline Green
Randall Sakamoto
Andrea Cross
Amber Schiada
Jeremiah Lee
Rosen Consulting Group

1995 University Avenue
Suite 550
Berkeley, CA 94704
510 549-4510
510 849-1209 fax
www.rosenconsulting.com
© 2008 Rosen Consulting Group

Table of Contents
U.S. Outlook Page
Executive Summary i
The National Economic Outlook 1
The Regional Economic Overview 8
The Real Estate Capital Markets 16
Real Estate Markets
The National Single Family Housing Market 22

The National Apartment Market 30
The National Office Market 37
The National Industrial Market 43
The National Retail Market 51
The National Hotel Market 57
Summary Tables 64
© 2008 Rosen Consulting Group, LLC

Executive Summary
National Economy loans closed in 2005, 2006 and 2007 had not been written, then
house price appreciation would not have turned negative. Weak
The extraordinary rapid sequence of economic events has made demand and rising inventories from foreclosures are driving house
it near impossible to deliver an outlook as contemporaneous as price declines. Nationally, under our hard landing base case, we
we would like. Our Economic Perspectives, available on our web expect a peak-to-trough national drop in house prices of 20.3%.
site, offer updated views on current events and their impact on Under this scenario, housing sales and starts will improve in 2010
our outlook. as the economy returns to growth.
The U.S. economic outlook continues to worsen and our base case Apartment Market
scenario is now a hard landing recession with a 60% probability.
There is only a 35% chance that the milder downturn occurs – Overall, apartment fundamentals are moderating in the face of the
what was our base case. We had been giving the economy a 5% recession. Weak job growth along with low affordability, lack of
chance that it would skirt by, but that statistical 5% outlier is now easy mortgage credit and house price uncertainty will keep current
the probability of depression. A full-blown hard landing is upon us renters in apartments and cause homeowners who lose their homes
and it will last well into 2009. Employment will shrink by 1.3% in to foreclosure or otherwise determine they cannot afford the cost
2008 and 2.4% in 2009, when the unemployment rate reaches its of owning to revert to renting. RCG forecasts a rising vacancy rate
cyclical high of 8.5%. The Federal funds rate will drop under 1% in 2008 and 2009. Demographic growth will drive improving apart-
by year-end and the yield on a 10-year Treasury will be 3.25%. The ment market fundamentals through 2012 and beyond. We expect
270 basis-point spread between mortgages and Treasury yields at rising net operating income in the later years of our forecast:
the end of this year will narrow to only 200 by the end of 2009 and
then a more normal 150 basis points by 2011. Growth will return Office Market
in 2010 when today’s wide credit spreads begin to normalize.
Because of its multi-year lease structure, office market fundamen-
Capital Markets tals generally lag changes in the economy, both on the upside and
the downside. But by the end of summer 2008, the office markets
For all intents and purposes, the capital markets have been closed nationwide reflected the weakened state of the economy and the
as the market undergoes its greatest shakeup since the Great De- financial markets. The most significant change in our office market
pression, and there is no end in sight. The near financial meltdown forecast is a result of our view that the national economic downturn
in mid-September turned the ongoing credit crunch into a crisis, will be deeper and longer than originally forecast. We expect the
and confidence in the financial system is at low ebb. The shortage consolidations in the financial services sector to continue to drag
of debt capital is clearly a huge issue for real estate, as it will office employment down for the next 24-30 months. In addition,
continue to reduce transaction volumes and sales prices and slow the previously strong sectors such as energy and state and local
the development of new real estate. Commercial lending activity government should flatten, the first as global energy demand moder-
will be slow this year and next as sources of capital remain scarce ates, the second as budget constraints inhibit hiring in the public
and the cost of capital high. Looking forward, the stabilizing dollar, sector. We believe that fundamentals will decline throughout the
the drop in property prices and concurrent rise in cap rates (some- remainder of 2008 and 2009, and that recovery will be spotty (and
what stymied by the drop in Treasury yields) is making real estate late) in 2010. Office markets will lag the general economy on the
more attractive for domestic and foreign investors, and is setting way up, and so fundamentals will not look positive until late 2010
the stage for the allocation of already-committed private equity at best, and more likely into 2011.
-- once some measure of confidence returns to the U.S. economy
and the capital markets. Industrial Market
Single Family Housing Market With import activity slowing and the rise in exports due to the weak
dollar less than expected, retail distribution facilities and freight
Under normal recessions, housing sales slow, but house price ap- forwarders are handling less activity. As the national recession
preciation remains positive. The drop in prices that has occurred deepened, many firms froze hiring plans or began to layoff employ-
since 2006 occurred ahead of economic weakness as it was caused ees. With consumer confidence at a recent low and the national
by the disastrous book of mortgage business that went bad nearly recession taking hold, the national industrial market turned down-
as quickly as it was written. If the subprime, Alt-A and Option ARM ward in the second quarter. The vacancy rate increased as tenant
© 2008 Rosen Consulting Group, LLC i September 2008

Real Estate Cycle – September 2008
Single Family- 1:30

Southern CA Condos- 10:30 12
Subprime
Limited Service/ Extended Mortgages – 2:00
Stay Hotel – 10:00 Overshooting Decline
Full Service Hotel/ Phase Phase Residential Land –
Power Center / 2:30
Industrial– 9:30
Neighborhood Strip / 9 3
Regional Mall/ Suburban
Office - 9:00
Multifamily Rental/ CBD Growth Absorption
Office - 8:30 Phase Phase
demand slowed and new buildings were delivered to the market. first time since 2001, as weak income growth and a continued
In the near term, we expect the industrial market to weaken with decline in available credit force consumers to reduce spending.
job losses and a higher vacancy rate in most metropolitan areas. Thereafter, we expect retail sales to resume positive albeit modest
The average rental rate is expected to remain positive in 2008 and growth of 0.6% in 2009, followed by growth accelerating to the low-
2009; however, it is not likely to outpace forecasted inflation. Mov- 3% range in line with the improving economy. The retail vacancy
ing forward, we expect healthier fundamentals beginning in 2010. rate will rise to 7.9% in 2009 – higher than the peak vacancy rate
As the nation recovers from the recession, we expect space to be during the previous recession of 7.8% in 2002. The primary reasons
absorbed by tenants’ expanding appetites. As a result of minimal for this are the expected announcements of additional retailer
construction in 2009 and 2010, we predict that there may be a bankruptcies, as well as reduced store expansion plans by chains
strong likelihood of a shortage of quality space in some industrial hurt by weakening sales growth and a lack of liquidity. Beginning
markets, leading to above-average rent spikes towards the end of in 2010, the retail market should begin a healthy recovery, with
the forecast horizon. sales growth accelerating in line with higher consumer confidence
levels and stronger job growth.
Retail Market
Hotel Market
Retail market conditions worsened in recent months, as mounting
financial pressures on consumers translated into reduced overall Conditions in the hospitality and hotel industry are weak across
demand for goods and services, especially discretionary items. the board and we expect that they will get worse before they get
Based on our expectations for a deep national recession, we expect better. Eroding occupancy rates combined with slower room rate
fundamentals to weaken further, with a full rebound not expected growth are yielding flat to modest revenue growth spanning vari-
until 2010. Real retail sales will decline in 2008, by 0.7%, for the ous locations, classes and property types. The market is getting
© 2008 Rosen Consulting Group, LLC ii September 2008

hit twofold: demand is pulling back at a time when new supply is
surging. Given our view that the national recession will be deeper
and last longer than we forecasted last quarter, we have revised
our hotel forecast downward. We believe demand is going to be
weak through 2009, with the occupancy rate dipping below 60%
in 2009. Recovery is expected to begin in 2010, with the occupancy
rate rising to just less than 64% by 2012. The combination of fall-
ing occupancy rates and lower room-rate growth is forecasted to
yield negative RevPAR growth in 2008 and 2009. Once the economy
rebounds, we forecast RevPAR growth to accelerate back up to the
7% range by 2012.
© 2008 Rosen Consulting Group, LLC iii September 2008

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© 2008 Rosen Consulting Group, LLC iv September 2008

The National Economic Outlook Ken Rosen and Steven Blitz
The extraordinary rapid sequence of economic events has made 3-Month LIBOR vs. Fed Funds
it near impossible to deliver an outlook as contemporaneous as
Basis points
we would like. What is written below is where the world stood at
600
the time of writing. Our Economic Perspectives, available on our
web site, offer updated views on current events and their impact 500
on our outlook. 400
300
The U.S. economic outlook continues to worsen and our base case 200 `
scenario is now a hard landing recession with a 60% probability.

100
There is only a 35% chance that the milder downturn occurs –
what was our base case. We had been giving the economy a 5% 0
chance that it would skirt by, that statistical 5% outlier is now the -100
probability of Depression.
Au 8
7
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07
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M 7
M 8
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Data is as of October 8, 2008
What happened is that the financial meltdown in mid- September Source: Federal Reserve
turned the credit crunch into a full-blown crisis. Confidence in the

financial system is at its lowest ebb since the Great Depression.
Confidence in the financial system is necessary for an economy
to function and it is slipping away at an alarming rate. As of this
National Econom ic Outlook

Deep Recession 2008-2012 (60%)
2002 2003 2004 2005 2006 2007 2008H1 2008H2 2008f 2009f 2010f 2011f 2012f
R eal G DP Growth (Annual growth rate) 1.6% 2.5% 3.6% 2.9% 2.8% 2.0% 2.1% -2.8% -0.8% -3.0% 1.5% 2.7% 3.0%
Year-over-year rate 1.9% 3.7% 3.1% 2.7% 2.4% 2.3% 2.2% -1.0% -1.0% -2.7% 2.3% 2.9% 2.8%
Inflation--CPI, 4Q/4Q rate 2.3% 2.0% 3.4% 3.8% 1.9% 4.0% 2.3% 5.2% 5.2% 4.8% 4.5% 4.0% 3.9%
Interest Rates
3-month T-B ill (average) 1.6% 1.0% 1.4% 3.2% 4.8% 4.5% 1.7% 1.1% 1.2% 2.0% 3.1% 4.1% 4.8%
Year-end (final trading day) 1.2% 1.0% 2.2% 4.1% 5.0% 3.4% 1.9% 1.0% 1.0% 2.5% 3.7% 4.5% 5.0%
3-month LIB OR (average) 1.8% 1.2% 1.6% 3.6% 5.2% 5.3% 2.8% 2.4% 2.4% 2.8% 3.7% 4.4% 5.0%
10-year T-Bond Yield (average) 4.6% 4.0% 4.3% 4.3% 4.8% 4.6% 3.9% 3.5% 3.5% 3.6% 4.5% 5.0% 5.5%
Conv. 30-year Mortgage Rate (average) 6.5% 5.8% 5.8% 5.9% 6.4% 6.3% 6.1% 6.1% 6.2% 5.9% 6.6% 7.1% 7.3%
Year-end (final week) 5.9% 5.9% 5.8% 6.2% 6.2% 6.2% 6.5% 6.0% 6.0% 5.7% 7.2% 7.0% 7.5%
Federal Budget Surplus/Deficit (NIA Basis)
$Billions (C Y) -282.1 -392.5 -369.1 -262.2 -155.0 -218.9 -547.8 -456.3 -570.4 -691.0 -650.9 -626.6 -615.8
As % of Nominal GDP -2.7% -3.6% -3.2% -2.1% -1.2% -1.6% -3.8% -5.0% -4.0% -4.7% -4.2% -3.8% -3.5%
Employment Growth, 4Q/4Q rate -0.5% -0.1% 1.6% 1.8% 1.6% 0.9% -0.2% -1.3% -1.3% -2.4% 1.1% 1.5% 1.8%
Unemployment R ate (4Q ) 5.9% 5.8% 5.4% 4.9% 4.4% 4.8% 5.3% 8.0% 8.0% 8.5% 7.5% 6.2% 4.8%
H ousing S tarts (000) 1,710 1,854 1,950 2,073 1,812 1,341 1,023 790 810 1,010 1,220 1,370 1,470
Single Family 1,363 1,505 1,604 1,719 1,474 1,034 710 500 550 700 900 1,000 1,100
Multifamily 347 349 345 354 338 307 318 290 260 310 320 370 370
S ales of Existing Homes (inc. condos and coops)
Units (000) 5,657 6,176 6,727 7,076 6,508 5,672 4,772 4,150 4,200 4,800 4,900 5,400 5,500
Non-Residential Construction
$Billions 279 277 298 338 410 480 534 160 320 250 280 315 380
R etail Sales Ex. Autos, 4Q/4Q rate 4.0% 5.8% 7.5% 7.9% 4.1% 5.7% 3.4% -1.3% -1.3% -0.4% 2.8% 3.5% 3.8%
Total Car and Truck S ales
Millions of Units 16.8 16.6 16.9 17.0 16.5 16.2 15.0 12.9 13.9 14.0 14.5 15.5 16.5
C PI - R ental C omponent, 4Q/4Q R ate 3.3% 2.7% 2.8% 3.1% 4.1% 4.0% 1.7% 2.2% 2.2% 2.8% 3.5% 3.8% 4.4%
Median House Price Gain--US, 4Q /4Q rate 8.5% 6.9% 8.8% 13.6% -2.8% -6.1% 0.3% -8.1% -8.1% -5.0% 2.0% 2.8% 3.3%
C onsumer Confidence Index, 4Q 81.7 89.7 96.1 95.8 106.8 91.2 57.3 55.0 55.0 65.0 75.0 95.0 104.0
R eal D isposable Personal Income, 4Q/4Q rate 2.9% 3.7% 4.1% 0.9% 3.6% 1.8% 2.6% 0.5% 0.5% 1.1% 2.3% 3.5% 3.9%
Inflation PPI 4Q/4Q Rate 1.0% 3.5% 4.6% 5.2% 0.3% 6.7% 4.8% -3.0% -3.0% 1.6% 2.8% 3.5% 4.0%
Industrial Production, 4Q 100.6 102.1 105.3 108.0 109.8 112.2 111.3 106.7 107.8 109.3 112.7 116.7 121.7
%change, 4Q/4Q rate 2.6% 1.5% 3.1% 2.6% 1.6% 2.2% -0.7% -6.3% -6.4% -2.4% 3.1% 3.5% 4.3%
Note: For monthly data series, 4Q is average of months

S ources: Bureau of Economic Analysis, Bureau of Labor Statistics, Census, Federal Reserve, National Association of Realtors, Bloomberg, R CG.
Material publ ished on Rosen Consulting G roup web s ite is copyri ghted by Rosen Cons ulting G roup Such material is protected by U S and international copyright laws and treaties All rights res erv ed U sers of the Rosen Consulting G roup web site may not
© 2008 Rosen Consulting Group, LLC 1 September 2008

writing, it is still unclear whether the sum of all that’s been done yields at the end of this year will narrow to only 200 by the end
by the Federal Reserve and Treasury, including the Troubled Asset of 2009 and then a more normal 150 basis points by 2011.
Relief Program (TARP), can turn the situation around soon enough.
• Growth will return in 2010 when today’s wide credit spreads
The extraordinary wide spread between three-month LIBOR and the
begin to normalize.
effective Federal funds rate illustrated in the accompanying chart is
indicative of the extent to which the credit markets are frozen.
There are internal stabilizers that come into play whenever an
The broad economy has yet to fully register the impact of the current economy contracts -- specifically lower interest rates and lower
shutdown in credit and the loss of wealth in the equity market. This prices.
takes time and the eventual impact gets larger the longer credit is
frozen and the stock market is falling. In addition, the export sector • The Federal Reserve and Treasury will eventually succeed in
that had buoyed the U.S. economy is fading as the global economy their efforts and with that, borrowing rates will begin narrow-
is buckling under from the impaired financial system, reduced U.S. ing to already-low Treasury yields. The reduced cost of credit
demand, and unfavorable terms of trade. will help household and corporate balances and, at some point,
spur borrowing.
In sum, a full-blown hard landing is upon us and it will last well • The weakening United States, Japanese and European
into 2009. economies are pulling oil and other commodity prices lower
(see chart).
• Real GDP will decline 1.0% in 2008 and 2.7% in 2009 -- on a
fourth quarter-over-fourth quarter basis. • Oil is under $100 per barrel and sinking after having peaked
at $145.29 during the beginning of July.
• Employment will shrink by 1.3% in 2008 and 2.4% in 2009,
when the unemployment rate reaches its cyclical high of • Lower oil prices will boost income and profits just as the spike
8.5%. in oil and commodity prices taxed spending and production.
• Inflation will end 2008 at 5.2%, dropping to 4.8% in 2009 and • Lower prices at the pump and lower oil prices are early holiday
easing back to 3.9% not until 2012. gifts for U.S. households.
• Median house prices will fall 8.1% this year and another 5.0% • The final low price for oil in this cycle is, in large part, depen-
next year. dent on the newly important marginal buyers -- the emerging
economies such as China and India.
• Single family housing starts will total 650,000 in 2008 and
700,000 in 2009. • Most of these nations’ economies are slowing, but not now
contracting. Booms in emerging economies often lead to busts
• The Federal budget deficit will be 4.0% of GDP in calendar year and these nations can implode.
2008 and will peak at 4.7% in 2009. It was 1.6% in 2007.
• If there is a bust or even a near bust, oil could easily drop back
• The Federal funds rate will drop under 1% by year-end and to less than $50 per barrel.
the yield on a 10-year Treasury will be 3.25%;
• The 270 basis-point spread between mortgages and Treasury Owing to the unusual forces holding the economy back, we do not
believe these stabilizers will be as much of a mitigating force as
Goldman Sachs Commodities Index they have been in the past. There is, however, a chance that they
Index might help more than we believe, and so we give our moderate
500
recession a 35% probability.
450
Energy Food
400 • GDP will decline 0.5% this year and 1.2% in 2009, on a fourth
350 quarter-to-fourth quarter basis – in our moderate recession
300
scenario.
250
• Employment will fall 0.8% this year and 1.2% in 2009 and
unemployment will peak at 6.8% next year.
200
150
• Inflation (CPI) will abate some, falling to 3.2% by the end of
2010, but never dropping back to the Fed target of 2.0%.
07
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As of September 2008
Median house prices will fall 8.1% this year and another 5.0%
Source: Standard & Poor’s
next year.

• The Federal funds rate will be 1.5% at year-end and the yield on Treasury has been feverishly swapping its debt for all sorts of
a 10-year Treasury will be 4.5%, as the record liquidity pumped mortgage-related securities in an attempt to normalize mortgage
into the economy raises inflation concerns for the future. yields and the rate at which banks lend to each other. As the ac-
companying charts illustrate, the efforts have failed. Each initiative
• The 220 basis-point spread between mortgages and Treasury
was met with initial optimism, but the good feelings quickly faded;
yields at the end of this year will narrow to 140 by the end of
risk spreads remained wide and mortgage rates failed to narrow.
2009 and then a more normal 120 basis points for the rest of
the forecast horizon.
The $700 billion TARP is but the latest in a long line of efforts to
address the illiquidity and eroding and uncertain value of mortgage
securities held or guaranteed by banks, investment banks, insurance
TARP and Our Suggestions – The Path to Restore Confi- companies, and other investors. What the program will look like
dence exactly is unknown at this writing. We do know that the final draft
Credit crunches come and go, but confidence and trust in the fi- makes provisions, finally, for loan modification at the consumer
nancial system does not. It is a mainstay, an absolutely necessary level – but it doesn’t appear to be quite as massive a program as
condition for an economy to expand. In this cycle, confidence has we believe is necessary to begin building the basis for recovery.
been damaged to an extent not seen since the Depression. Lost
confidence manifests itself in many ways and runs are one sure Solving the foreclosure problem at the consumer level, the root
sign. The recent run on money market funds and some banks was cause of the present problem, will increase the value of mortgage-
particularly troubling. Runs were the reason WaMu and Wachovia related securities and reduce the losses to the system. Foreclosures,
were put into the hands of stronger entities. As for the money all else being equal, will double the loss on mortgages versus a loan
market funds, the Fed stepped in and swapped cash for money fund modification program that keeps people in their houses. Whether
holdings (corporate commercial paper for the most part) so they or not Treasury purchases these securities, the only way to treat
could meet customer demands. Treasury also started an insurance the mortgage problem is a massive loan modification at the con-
program so that the $1 par value would not be broached. sumer level. We believe that an immediate 90-day moratorium on
foreclosures is necessary to allow the modification plan to be put
Credit Spreads & Foreign Capital in place. With the Treasury’s control of Fannie Mae, Freddie Mac,
$Billions Basis Points the Bear Stearns portfolio, and possibly the purchase of $700 bil-
1,400,000 75
lion of mortgage securities, loan modification can be accomplished
Conv. 30-Year Mortgage Yield Minus Rate on
1,200,000 10-Year Treasury 100 and save perhaps 75% of homeowners and hundreds of billions
(right scale, inverted)
1,000,000 125
for the taxpayers.
800,000 150
Getting home prices to stabilize is a difficult goal and may be coun-
600,000 175 terproductive in putting housing markets on a path to sustainable
400,000
Net Fgn Purchases of U.S. Securities,
Rolling 12 Month Sum 200
recovery. Lower house prices improve affordability for potential
(left scale)
home purchasers as well as reducing equity of existing home own-
200,000 225
ers and investors. The huge run-up in house prices from 2003 to
0 250 2006 in many markets was fueled by cheap and poorly underwritten
credit. House prices that doubled in five years in many markets were
90
91
92
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00
01
02
03
04
05
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n-
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n-
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Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
As of September 2008
Source: Federal Reserve
not sustainable. Based on income growth and normal mortgage
lending standards, house prices need to fall 20-50% in a number
of markets to foster a sustainable recovery. This inevitable decline
None of this is surprising considering the breakdown in the se- is painful to homeowners and lenders who bought or over-lent at
curitization market, the debacle in auction rate preferreds, and the peak, but the price adjustment after the bubble is the best way
the extreme loss of wealth with the collapse of equity values in to return stability to the market.
so many financial institutions. Shareholders in Bear Stearns, AIG,
the GSEs, Indymac, Lehman Brothers, WaMu, and Wachovia have The capital adequacy problem for banks, investment banks, and
effectively been wiped out. Goldman Sachs and Morgan Stanley insurance companies can be directly addressed if, first, Treasury
sought to stem a collapse in their equity prices by quickly morphing buys preferred stock at a high interest rate. (The high interest
into banks. rate will encourage companies to refinance as soon as possible.)
Second, suspend the “mark to market accounting” for illiquid but
Ever since policymakers recognized the magnitude of the credit performing loans. This will break the death spiral of asset value
crisis, the Fed and Treasury have made unprecedented large-scale markdowns that require companies to raise more capital as they
moves to backstop collateral and restore liquidity to the market. report mark to market losses.
We also believe it is important to aggressively use Fannie Mae, Deleveraging – Process, Policy, and Risk
Freddie Mac, and the Federal Housing Administration to return
the capital flow to the residential mortgage and housing sector. Ultimately, however, the capital market’s underlying problem does
We have moved from the easiest lending standards in history to not lie with housing. Housing collapsed because it was the weakest
extremely tight lending standards. We need a transition period link: the industry took credit priced too cheaply to create mortgages
where we relax current lending standards to allow refinancing of with nonexistent underwriting standards to support overbuilding on
existing problem loans and stimulate housing demand. It will be a an extraordinary scale. The key is that credit was priced too low
difficult balancing act between riskless underwriting and somewhat for too long, and the cheap pricing came from the growing inflow
more risky, but much needed, credit extensions. of foreign capital.
After solving the near-term economic and financial crisis, we need The financial system geared itself to handle these ever-increasing
a systemic reform of the financial system that recognizes the inflows of foreign capital and the intense hunt for returns by
importance of globalization and securitization in the 21st century manufacturing securities to create yield. The accompanying chart
capital market. We must move away from the “radical” free mar- illustrates the strong relationship between the trade deficit (flip
ket fundamentalism, which is just as dangerous to our country as side of capital flows) and risk spreads in the credit markets, here
religious fundamentalism. We must move back to basic principals we use the spread between 30-year home mortgages and 10-year
of risk management, reduced leverage, and sound and sustainable Treasury yields. Once the inflow ebbed, demand for the more
lending and investing practices. This would involve tougher suit- esoteric products dissipated, the poor quality of the collateral was
ability standards for lending and investing. It would involve a move revealed, and an implosion was inevitable.
back to transparent lending and investment vehicles, and away
from financially engineered opaque products. The days of credit This credit crisis is so vexing for policy makers because there is
growing to an ever-increasing share of GDP are, however, over. really very little that can be done. The U.S. economy is undergoing
One consequence is that growth in credit-dependent businesses, a deleveraging process that delivers the requirement for a narrower
such as real estate, will be curtailed. trade deficit – more saving relative to investment. Capital inflows
shrink, real interest rates move higher and consumption falls. And,
The FNMA-FHLMC Takeaway – The Attempt to Normalize as long as the trade deficit keeps narrowing, the air keeps coming
Markets out of the credit balloon.
Treasury hoped that nationalizing the GSEs would improve market The adjustment period, however, is neither easy nor painless.
confidence in the solvency of collateralized securities and in the Deleveraging on this scale is a process that has to work itself
banks and dealers that hold them. About 11% of U.S. commercial out. Policymakers cannot stop it by being the backstop for every
bank financial assets are in GSE securities, down from near 14% at security that can’t be sold. The broader risk in this process, and the
the end of 2006. With the Federal takeover of FNMA and FHLMC, one that should be the focus for Treasury and the Fed, is that the
it was hoped that the upgrade in Agency debt might mitigate at deflation in home values can spread to other assets as more and
least some concerns regarding bank capital adequacy. It was a more debt needs to be liquidated. The role of policy is to keep the
false hope. vicious cycle from taking hold. That, not inflation, is the risk that
the Fed needs to address. If policy fails to hold up prices, the U.S.
In turning the implicit guarantee on Agency debt into an explicit economy could begin looking a lot more like Japan during its lost
one, the Treasury also hoped that Agency borrowing costs would decade of the 1990s.
narrow toward more typical levels versus Treasury. The impact of
sustained high borrowing costs is that the sharp drop in the Federal We have written many times before that the Fed erred during this
funds rate and related Treasury yields did not pull down the bor- past cycle by staying on the sidelines too long because it monitored
rowing rate on 30-year, fixed-rate mortgages. low inflation and not the soaring growth in credit and the asset
prices rising with it. Today we have higher-than-targeted inflation
In past cycles, the lower cost of borrowing widened the eligibility while credit and asset prices implode. We hope the Fed is aware
pool of home buyers which, in turn, helped stabilize home prices of the risk and will keep overall deflation at bay. There remains,
and put money in consumers’ pockets through the availability however, the question of what policy tack will be taken once the
of attractive refinancing rates. Although there is evidence that U.S. economy recovers. An improving economy widens the trade
mortgage rates have narrowed some to Treasuries, there is no deficit which, by definition, means rising inflows of foreign monies
real chance that this stimulus will work in this cycle because the once again hunting for yield.
specific problem is the imbalance of housing and that is beyond
repair by lower interest rates.
The Global Economy U.S. Current Account Deficit % GDP vs. Exchange Value of the Dollar
World growth historically expands with the U.S. trade deficit Index % of GDP
and contracts when the deficit does (see ”U.S. Trade Deficit and 160
U.S. Dollar Index v Other Important Trading
-6
Global Growth”) and especially so for the emerging and developing Partners
140 -5
countries – which includes Brazil, Russia, India and China. So it is Stronger Dollar
not surprising that the global economy is finally buckling from the 120
Weaker Dollar
-4
soaring costs of food and energy, reduced U.S. consumer demand,
U.S. Dollar Index v Major
unfavorable terms of trade, and an impaired financial system. Not 100 Currencies -3
all areas of the world are being equally impacted. The larger mature
economies are heading into recession, if not there already. For the 80 -2
emerging and developing economies that have the biggest trade Current Account %GDP
60 -1
surpluses, growth continues, but is finally being restrained by policy (right scale, inverted)
in order to rein in inflation. The flow of wealth from established to 40 0

developing economies consequently goes on.
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
Sources: Federal Reserve, BEA
U.S. Trade Deficit & Global Growth

% of GDP
8
Emerging & Developing Economies GDP
The crosscurrents of prices, growth, and trade impacting the world
World GDP Growth
6 (Constant Prices)
Growth (Constant Prices) today make for a difficult economic environment for investors and
policymakers, and missteps could easily turn a relatively mild down-
4
turn into something much more severe. Balanced U.S. trade might
2
not, in fact, be the best long-run tack for policymakers to take. It
0 remains to be seen just how far the trade rebalancing process will
-2
go before countervailing policy initiatives are independently taken
by U.S. trading partners. From our perspective, the rebalancing
-4 U.S. Current Account % of GDP
(left scale) process will go just far enough to pull global growth lower in the
-6 near term and reduce the pace of growth longer term.
-8
70
72
74
76
88
80
82
84
86
88
90
92
94
96
98
00
02
04
06
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
As of 2007
Source: BEA, IMF
This most recent turn in economic fortune for the world is rooted in
global capital flows influenced by the managed currencies of trade
surplus nations. The world needs excess U.S. demand to stimulate
global production, and this decade has seen the same, but with
a critical difference: the U.S. trade deficit widened even as the
dollar depreciated. The main reason is that the large trade surplus
nations kept their currencies tightly pegged to the dollar even as
they took in ever-increasing amounts of the currency. With the peg
effectively guaranteeing investors a stable dollar, investing in U.S.
assets was encouraged. For the United States, this kept interest
rates too low and allowed the economic expansion to accelerate
off a base of ever-increasing inflows of foreign capital.
The U.S. trade deficit began to narrow after the revaluation of the
pegged currencies (Other Important Trading Partners) and not the
exchange value of the dollar against the major currencies (see “U.S.
Current Account Deficit % GDP vs. Exchange Value of the Dollar”).
For the rest of the world, the adjustment to a shrinking U.S. trade
deficit will be difficult, especially for those nations with economies
designed to export. When the U.S. trade deficit narrows, the rest
of the world has to see its trade surplus decline, one reason why
global growth follows the U.S. deficit.
National Economic Outlook
Moderate Recession 2008-2012 (35%)
2002 2003 2004 2005 2006 2007 2008H1 2008H2 2008f 2009f 2010f 2011f 2012f
Real GDP Growth (Annual growth rate) 1.6% 2.5% 3.6% 2.9% 2.8% 2.0% 2.1% -1.5% -0.5% -1.2% 2.6% 3.3% 3.0%
Year-over-year rate 1.9% 3.7% 3.1% 2.7% 2.4% 2.3% 2.2% -2.0% -2.0% -1.0% 2.9% 3.4% 2.8%
Inflation--CPI, 4Q/4Q rate 2.3% 2.0% 3.4% 3.8% 1.9% 4.0% 2.3% 4.6% 4.6% 3.6% 3.2% 3.3% 3.7%
Interest Rates
3-month T-Bill (average) 1.6% 1.0% 1.4% 3.2% 4.8% 4.5% 1.7% 2.0% 1.8% 2.1% 3.1% 4.0% 4.9%
3-month LIBOR (average) 1.8% 1.2% 1.6% 3.6% 5.2% 5.3% 2.8% 2.9% 2.8% 2.6% 3.3% 4.2% 5.1%
10-year T-Bond Yield (average) 4.6% 4.0% 4.3% 4.3% 4.8% 4.6% 3.9% 4.2% 4.1% 4.8% 5.2% 5.6% 5.9%
Conv. 30-year Mortgage Rate (average) 6.5% 5.8% 5.8% 5.9% 6.4% 6.3% 6.1% 6.4% 6.3% 6.6% 6.5% 6.8% 7.1%
Year-end (final week) 5.9% 5.9% 5.8% 6.2% 6.2% 6.2% 6.5% 6.7% 6.7% 6.4% 6.6% 7.0% 7.2%
Federal Budget Surplus/Deficit (NIA Basis)
$Billions (CY) -282.1 -392.5 -369.1 -262.2 -155.0 -218.9 -547.8 -387.2 -467.5 -610.5 -678.5 -691.1 -525.7
As % of Nominal GDP -2.7% -3.6% -3.2% -2.1% -1.2% -1.6% -3.8% -2.7% -3.3% -4.2% -4.4% -4.2% -3.0%
Employment Growth, 4Q/4Q rate -0.5% -0.1% 1.6% 1.8% 1.6% 0.9% -0.2% -0.8% -0.8% -1.2% 1.5% 1.7% 1.8%
Unemployment Rate (4Q) 5.9% 5.8% 5.4% 4.9% 4.4% 4.8% 5.3% 6.5% 6.5% 6.8% 5.6% 4.8% 4.3%
Housing Starts (000) 1,710 1,854 1,950 2,073 1,812 1,341 1,023 882 955 1,020 1,340 1,450 1,443
Single Family 1,363 1,505 1,604 1,719 1,474 1,034 710 590 650 700 1,000 1,100 1,100
Multifamily 347 349 345 354 338 307 318 292 305 320 340 350 343
Sales of Existing Homes (inc. condos and coops)
Units (000) 5,657 6,176 6,727 7,076 6,508 5,672 4,772 4,708 4,740 4,800 5,300 5,900 5,800
Non-Residential Construction
$Billions 279 277 298 338 410 480 534 430 482 400 410 425 440
Retail Sales Ex. Autos, 4Q/4Q rate 4.0% 5.8% 7.5% 7.9% 4.1% 5.7% 3.4% -0.7% -0.7% 0.4% 2.4% 3.5% 3.8%
Total Car and Truck Sales
Millions of Units 16.8 16.6 16.9 17.0 16.5 16.2 15.0 13.9 14.4 13.8 15.5 16.2 16.6
CPI - Rental Component, 4Q/4Q Rate 3.3% 2.7% 2.8% 3.1% 4.1% 4.0% 1.7% 3.3% 3.3% 3.1% 3.6% 3.8% 3.9%
Consumer Confidence Index, 4Q 81.7 89.7 96.1 95.8 106.8 91.2 57.3 54.5 54.5 51.0 90.0 95.0 104.0
Real Disposable Personal Income, 4Q/4Q rate 2.9% 3.7% 4.1% 0.9% 3.6% 1.8% 2.6% 1.1% 1.1% 2.2% 2.9% 3.4% 3.0%
Inflation PPI 4Q/4Q Rate 1.0% 3.5% 4.6% 5.2% 0.3% 6.7% 4.8% 6.0% 6.0% 4.0% 3.8% 3.5% 3.8%
Industrial Production, 4Q 100.6 102.1 105.3 108.0 109.8 112.2 111.3 105.7 105.7 104.6 106.2 109.5 114.2
%change, 4Q/4Q rate 2.6% 1.5% 3.1% 2.6% 1.6% 2.2% -0.7% -5.8% -5.8% -1.0% 1.5% 3.2% 4.3%
Note: For monthly data series, 4Q is average of months

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Census, Federal Reserve, National Association of Realtors, Bloomberg, RCG.
Material published on Rosen Consulting Group web site is copyrighted by Rosen Consulting Group Such material is protected by U S and international copyright laws and treaties All rights reserved Users of the Rosen Consulting Group web site may not


Regional Economic Overview Antoine St-Pierre
The U.S. economy is the sum of its parts and the outlook for regional
U.S. Employment Growth
economies must necessarily reflect the extraordinary recent events
June 2008 - Seasonally Adjusted Annual Growth
that have roiled the national and international credit markets. At
the time of writing, it is unclear what effects the Trouble Asset
Relief Program (TARP) just adopted by Congress, attempts to re-
capitalize banks, and talks with international partners will have on
the credit crisis. More than likely however, the national economy
will take a turn for the worse, and what we had been describing
G rowth R ate
as the beginning of a “mild” or “moderate” recession will lead to a B elow -1.0%
“hard landing” scenario instead. Job losses in financial centers will -1.0% to 0%
0% to 1. 49%
most certainly accelerate, but it is almost certain that impacts will 1.5% to 2.99%
be felt more widely in the broader economy. In the meantime, the 3% and
above
most recent employment data points to continued overall weakness,

with some regions faring better than others however.
Source: Bureau of Labor Statistics, Seasonally Adjusted
On a monthly year-over-year basis, only the Mountain (primarily Overall, the employment picture can only be described as less
Arizona and Colorado) and West South Central (Texas, Louisiana, than encouraging. The state economies that slowed first were the
Oklahoma, and Arkansas) regions have at any point registered an ones most affected by the housing crisis and credit squeeze – such
increase of more than 1.0% in payroll employment in the first eight as Florida, Nevada, Arizona, Missouri, Ohio and Wisconsin. The
months of 2008. Employment growth has slowed in the Mountain slowdown then spread to the broader economy as the collapse
region in recent months, thus the West South Central is the only of the collateralized securities market led to a general reduction
one of nine Census regions still registering healthy employment (and eventual quasi-interruption) in the availability of credit as
growth, a development clearly related to elevated prices in the well as a reduced demand from business to finance new capital
energy commodity sector. spending or desired growth of inventories. The direct impact on
financial institutions has since translated into large layoffs in that
Employment Growth by Region

*June/June Growth Rates (SA)
Year U.S. Midwest Northeast South W est

1995 1.9% 2.1% 0.7% 2.4% 2.7%
1996 2.4% 1.7% 1.7% 2.4% 3.3%
1997 2.8% 2.2% 2.2% 3.2% 3.6%
1998 2.4% 1.9% 1.8% 2.8% 3.1%
1999 2.5% 1.7% 2.3% 2.3% 3.1%
2000 1.5% 0.4% 1.9% 1.8% 3.0%
2001 -1.3% -2.1% -1.8% -1.5% -1.7%
2002 -0.4% -0.5% -0.5% 0.0% 0.4%
2003 0.1% -0.6% -0.3% 0.3% 0.3%
2004 1.6% 0.9% 0.9% 2.4% 2.5%
2005 1.9% 0.9% 0.9% 1.8% 2.9%
2006 1.7% 0.6% 1.0% 2.0% 2.4%
2007 0.8% 0.2% 0.7% 1.2% 0.8%
2008* 0.0% -0.2% 0.1% 0.6% 0.1%
© 2008 Rosen Consulting Group, LLC 8 July 2008

industry, and will continue to hit particularly hard in states such as market is still burdened by excess inventory. Through most of this
New York, Massachusetts, and Illinois where such employment is decade, the average has been around 4 months. The backlog of
concentrated and the income impact is far greater than the number unsold homes is having the necessary effect of depressing hous-
of jobs lost would suggest. ing starts in all four regions of the country. Home prices and starts
will continue to fall until inventory drops to levels more in keeping
Consumers’ assessments of current economic conditions began with demographic demand and average incomes. To this end, we
to drop when the subprime mortgage crisis and subsequent credit expect several years of distressed sales and falling prices before
crunch developed in late 2007. Since then, record energy prices, the housing correction completely unfolds.
eroding home values, and financial layoffs had served to deepen
consumer distress. Although showing a recent uptick, consumer Western Region
confidence indexes had remained close to their worst levels since
the previous recession, with consumers in the Midwest showing Arizona: Job losses in construction and finance continue to spill
the least confidence followed by those of the Northeast – regions over to other sectors, particularly in information services. Payroll
with high concentrations of employment in those industries most employment dropped 1.1% in the 12 months leading to June 2008,
impacted by the downturn. In the Western and Southern regions, a faster rate than earlier in the year, and we expect further losses
confidence had remained marginally higher than elsewhere. That for the rest of 2008. In the major states, none suffered steeper
said, recent events make it very difficult to envision anything but drops in construction employment than Arizona (-15.3%). Gauges
drops in confidence around the country when those measures of business activity support our outlook of further contraction in the
eventually reflect the current credit crisis. year ahead. The Arizona Business Conditions index has been below
50 in 5 of 6 months this year and on a downward trend since early
The Federal Reserve’s Beige Book survey released in early Sep-
tember reported continued weakness across most of the country,
with regions with the best economic performance characterized Western Region
as “mixed.” One area of spending that stands out as an exception Employment Growth, 1991 – June 2008
is tourism, more specifically spending by international visitors
5%
taking advantage of the weak exchange value of the dollar. This
is helping to buoy activity in areas where foreign tourists tend to 4%
go – the major coastal cities and Las Vegas. In contrast to retail, 3%
non-financial services − most notably health care and educational 2%

− remained the strongest sectors of the economy in every region
1%
in early 2008.
0%
On the goods-producing side of the economy, the ISM manufac- -1%
turing survey has been tracking very close to the 50-percent mark -2%
for a year now, a clear indication that manufacturing overall is at 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
West US
best stagnating. The survey points to weak domestic demand as Source: Bureau of Labor Statistics
it reported that new factory orders were weak in spite of strong
export demand. Export industries − technology and semiconductors,
agriculture and food manufacturing, commercial aerospace and Western Region
Consumer Confidence Index (SA)
defense-related manufacturing − have underpinned job and income
growth in a number of Western − Utah, Colorado and Washington 160
− and Southern − Texas, Louisiana and North Carolina − states, not

140
coincidentally in regions where economic performance has shown
more strength than in the nation as a whole. Of the major states 120
we are tracking, only Washington and Utah have seen any gains
100
in factory employment in the 12 months to June 2008; elsewhere,
the manufacturing sector appears to be shrinking. 80
60
Existing home sales peaked during the summer of 2005 and have
been declining ever since. Year-over-year sales of single family 40
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
homes fell in all regions of the country in the second quarter of 2008: West US
by 16.7% in the Midwest, 12.9% in the Northeast, 17.6% in the Source: Conference Board
South, and 10.2% in the West. The single family for-sale housing
Percent Change in State Employment by Sector - West
June 2008 Year-over-Year
Sector West AZ CA CO NV OR WA UT
Total 0.1% -1.1% -0.3% 1.3% -0.5% 0.1% 1.2% 1.0%
Construction* -8.1% -15.3% -9.7% -2.8% -10.3% -7.6% -2.8% -10.0%
Manufacturing -1.8% -2.4% -2.1% -2.4% -0.2% -3.3% 1.8% 0.3%
Trade 0.1% -0.9% -0.5% 1.4% 1.8% 0.6% 0.3% 2.1%
TPU 0.2% -2.6% 0.7% 1.8% 1.2% -0.3% 0.7% 0.8%
Information Svcs. -1.0% -5.0% -1.5% -1.3% -3.1% -1.4% 1.6% 0.0%
Financial Svcs. -3.0% -4.2% -3.9% -1.1% -3.8% -3.0% -1.9% -0.9%
Prof. & Bus. Svcs. 0.5% -1.6% 0.6% 2.1% -3.1% 0.4% 2.1% 2.1%
Edu & Hlth Svc 3.2% 3.4% 3.3% 4.1% 3.7% 4.3% 1.3% 4.9%
Leisure & Hosp. Svcs 0.7% 0.8% 0.2% 1.9% -0.5% 2.3% 2.9% 2.3%
Other Svcs. 1.0% 0.5% 0.9% 2.0% 0.6% -0.5% 1.5% 0.6%
Government 1.9% 2.5% 1.6% 2.0% 3.0% 1.9% 2.2% 2.1%
*Regional construction data are based on available state employment figures

2006. This statistic parallels difficulty in the real estate markets, services and professional and business services, which rebounded
particularly around Phoenix, and is consistent with our forecast of slightly in early 2008. The wholesale trade sector and export activity
continued economic slowdown in the state. had growing demand as a result of the weaker exchange value of
the dollar. The small information services sector − mostly software
California: The impact of the housing market correction is still − has been resilient. In-migration, especially from California, but
prevalent in California, and job growth remains weak. In particular, also internationally, has been high recent years.
employment in the finance, information, construction and manufac-
turing sectors all fell by more than 1% in the year ending in June Washington: The state is enjoying steady and broad economic
2008. The most vigorous regional economy in California is the San growth. All major sectors have been expanding, with the exception
Francisco Bay Area. Global demand for its technology goods and of construction and financial services, reflecting contraction at the
services has boosted local investment and hiring. Nevertheless, national level. Demand for Washington's biotech, health sciences
flat or declining employment in the office sector has translated into services and products, aerospace products and parts, and software
slower absorption in major office markets throughout the state, have kept employment growth high. Construction employment has
albeit some slower than others. contracted by 2.8% over the year ending in June 2008, but less
so than in most other states, and commercial and public works
Colorado: The state’s energy, tech and aerospace industries con- projects should support positive employment growth for the rest
tinue to fuel economic growth. In spite of significant retrenchment of the decade. As in most other states, the economy's other weak
in both the construction and manufacturing sectors, Colorado’s 5.4% spot is financial services, reflecting tight credit conditions and
unemployment rate in August is still below the national average retrenchment in the single family housing market.
(although recently catching up). Denver has attracted venture capital
to fuel its growth, and exporters of capital goods such as Lockheed Utah: After four years of rapid growth, the national downturn seems
and Ball Corporation have benefited from the weak exchange value to have caught up with Utah employment in the spring and summer
of the dollar, making their goods cheaper on world markets. A high of 2008. As in most other regions of the country, the decline was
standard of living in the metro area and above-average job growth most pronounced initially in the construction sector, with more than
will continue to draw residents to Colorado during the next few 13,000 jobs lost since the first of the year, and the financial sector.
years, where in-migration has accelerated since 2003. Utah has been among the top states in population growth however,
expanding at an annual rate higher than 2.5% in each of the past
Oregon: The state’s logging and wood-producing industries have three years as a result of high in-migration. Payroll employment
been hammered by the housing downturn and this has spilled into grew by 1.0% in the year ending in May 2008 – better than most of
the services sector of the economy. Growth remains low or nil for the major states, but significantly lower than in recent years, when
overall payroll employment – 0.1% in the year ending in June 2008. growth had been solidly ensconced in the 3% to 5% range.
There are bright spots however, including educational and health

Percent Change in State Employment by Sector - South
Sector South FL GA LA NC TX VA
Total 0.6% -1.1% 0.1% 1.7% 0.6% 2.3% 0.5%
Construction* -2.6% -13.3% -3.4% 3.1% 0.0% 3.5% -2.3%
Manufacturing -2.7% -6.7% -4.2% -0.8% -2.9% -1.0% -1.9%
Trade 0.5% -0.9% 1.1% 1.4% 0.6% 2.4% -0.2%
TPU 0.1% -1.6% 0.4% -0.6% -1.9% 1.1% 0.4%
Information Svcs. -1.1% -3.5% 0.9% -8.6% -0.7% -0.2% -0.3%
Financial Svcs. -0.3% -1.3% -1.6% 0.2% -0.6% 1.2% -0.9%
Prof. & Bus. Svcs. 1.1% -2.2% 0.6% 1.0% 0.6% 5.6% 1.0%
Edu & Hlth Svc 2.7% 3.0% 2.7% 2.8% 3.4% 3.1% 2.4%
Leisure & Hosp. Svcs 1.7% 1.8% 0.9% 2.3% 2.0% 3.5% 0.4%
Other Svcs. 0.7% -0.5% 0.5% -0.5% 3.3% 0.9% 1.1%
Government 1.0% 1.0% 1.5% 2.4% 0.5% 0.5% 1.1%
Southern Region ing effort is the availability and cost of insurance. In the year to June
2008, employment expanded by 1.7%, with strong growth in those
Florida: The housing recession has dramatically impacted retail sectors now most important to the state – construction, educational
sales, job growth and business activity. Unsurprisingly, employ- and health services, and leisure and hospitality services. The latter,
ment in the construction (-13.3%), manufacturing (-6.7%), financial in particular, added jobs at a 2.3% pace during that period. The re-
(-1.3%), information (-3.5%), and professional and business services covery in tourism, historically central to the New Orleans economy,
(-2.2%) have suffered marked decreases in the year leading to June is welcome as it is necessary for the revival of the region.
2008. Miami’s financial district, where three of the city’s largest
condo buildings are located, is now dubbed Miami’s Foreclosure Texas: The second-most populous state after California has gener-
District. Development has slowed dramatically across the state, ated jobs at a steady 2.3% pace in the year ending in June 2008,
which is why construction employment has weakened to the extent as it benefits from the upswing in the energy business. However,
that it has. the higher costs of raw materials compared with finished goods
has hurt producers who have seen their profit margins squeezed.
Louisiana: Louisiana’s economic base is still recovering from the The single family housing sector is fragile (permits for large mul-
devastating 2005 hurricane season. A major obstacle to the rebuild- tifamily structures have increased by contrast) and tighter credit
Southern Region Southern Region

Employment Growth, 1991 – June 2008 Consumer Confidence Index (SA)
5% 160
4% 140
3%
120
2%
100
1%
80
0%
-1% 60
-2% 40
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
South US South US
Source: Bureau of Labor Statistics Source: Conference Board

standards have also curtailed commercial investment. With the Northeastern Region
national recession, job growth was only slightly weaker in early Employment Growth, 1991 – June 2008
2008 than it was in late 2007, and we expect this to remain true
for the rest of the year. 5%
4%
Virginia: Job growth in Virginia has continued to decelerate in the 3%
2%
first half of 2008 and registered a mere 0.5% in June. As in many
1%
other states in this time of recession, the educational and health 0%
services sector has been leading most other sectors in job creation. -1%
Virginia has benefited from the stimulus of spending on the war -2%
in Iraq and Afghanistan with more than 30% of the Department of -3%
Defense’s increased war-related employment occurring in Virginia. -4%
-5%
The state economy is thus highly exposed to shifts in defense 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
spending. Northeast US
Source: Bureau of Labor Statistics
Northeastern Region
Massachusetts: First-half growth has been weak and the economy Northeastern Region
has slowed significantly. Job growth in the year leading to June Consumer Confidence Index (SA)
2008 was just 0.4% -- year-over-year growth has been well below
160
1% in every month so far this year, going back to September 2007.
The state is highly dependent on business spending in comparison 140
to other states, as firms that sell goods and services to other firms 120
are comparatively more concentrated in Massachusetts. The credit
100
crunch, stock market volatility, and lower profit margins have put
80
a break on growth, with the bright spot being exports, which are
likely to remain a source of stimulus for the rest of 2008. 60
40
New Jersey: After three years of strong growth in employment from
20
2004 to 2006, adding more than 90,000 new jobs over that period, 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
the New Jersey economy can best be described as stagnant, or Northeast US

Source: Conference Board
even deteriorating, since. Growth has stalled since then– the most
Percent Change in State Employment by Sector - Northeast

Sector Northeast CT MA NJ NY PA RI
Total 0.1% 0.4% 0.4% -0.4% 0.3% 0.0% -2.4%
Construction* -2.0% -0.7% -2.9% -3.9% -0.8% -2.0% -5.1%
Manufacturing -2.5% -1.2% -1.5% -3.4% -3.1% -2.5% -5.8%
Trade -0.7% -0.7% -0.9% -0.9% -0.5% -0.7% -3.1%
TPU 0.2% 0.2% 0.6% 0.0% 0.9% -0.4% -3.5%
Information Svcs. 0.4% 0.0% 2.1% 1.0% 0.5% -1.7% 4.8%
Financial Svcs. -1.5% -1.3% -0.8% -3.2% -1.3% -1.0% -4.8%
Prof. & Bus. Svcs. 0.5% -0.3% 1.4% 0.2% 0.1% 1.0% -4.6%
Edu & Hlth Svc 2.1% 2.1% 2.2% 2.1% 2.1% 2.1% 0.2%
Leisure & Hosp. Svcs 0.4% 1.0% 0.3% -1.0% 1.2% 0.7% -1.7%
Other Svcs. 0.1% -0.1% -1.3% 0.3% 0.8% 0.4% -5.4%
Government 0.7% 1.7% 0.7% -0.2% 1.2% 0.0% 0.1%

recent employment data shows almost exactly the same number Rhode Island: The economy has deteriorated substantially in the
of jobs as in early 2006, suggesting that New Jersey was among last year, even worsening in the past months, and there were
the first states to experience the national slowdown. Weakness 2.4% fewer jobs in June 2008 than the year before. Construction,
has been concentrated in the construction, manufacturing and manufacturing, finance and professional and business services
financial services sector, and given the recent events related to declined precipitously, with trade, transportation and utilities and
the credit crisis, no relief is expected in the latter sector. Beyond other services not far behind. The housing recession is in full swing
that, long-term deterrents are the high cost of living and doing with no clear end in sight. Residents are also exposed to income-
business in the state, and anemic population growth. Additionally, shock weakness in the Boston and eastern Connecticut economies.
unlike in the last recession, state coffers are stretched. The state Exports are the main bright spot in this economy.
is ill-equipped for a national recession, as government revenues
are greatly dependent on taxable sales. Midwestern Region
New York: Job growth in the state hovered around 1.0% during Illinois: Job growth in Illinois has been half the pace of national
the past four and a half years, but has edged closer to zero in the growth for more than a decade and the state has yet to attain the job
past four months, settling at 0.3% for the year ending in June 2008, levels posted at the last employment peak in 2000. Major economic
its worst performance since early 2004. New York City’s economy drivers − transportation, warehousing, finance and insurance − were
is fragile because of the shakeout in the financial sector, and the flat or contracting in the first half, and business conditions have
credit crunch continues to threaten the solvency of many firms deteriorated. Add to this the current national moderate recession
(some have succumbed already) and layoffs in the financial sector and the moving target for a full recovery is still remote. Although
are deepening (even as those that had been announced in past a weak dollar has helped exports, much of Illinois’ domestic trade
months are now showing up in the data – announced job losses is inter-regional and, due to contraction in the Great Lake region,
are not recorded in payroll surveys until severance grace periods has provided marginal stimulus to trade growth. Nine of eleven
have expired. Further indicating a mixed to negative outlook for the employment sectors were flat at less than 1% year-over-year growth
New York State economy is that the latest New York Fed’s Empire or declining in June 2008.
Manufacturing Survey (September) has shown a steep negative
ratings, much beyond the generally expected minor decline, and Missouri: Areas of the state tied to ethanol production and food
continuing the long-term trend toward decline for the state manu- processing have been driving economic growth. However, job
facturing industry. gains have been offset by recessionary conditions in the domestic
automotive industry. Losses in vehicle production and construction
translated into a slight decline (-0.2%) in overall job growth for
Percent Change in State Employment by Sector - Midwest

Sector Midwest IL IN MI MO OH WI
Total -0.2% 0.1% -0.2% -1.2% -0.2% -0.3% -0.6%
Construction* -3.4% -4.2% -2.7% -8.4% -1.7% -2.9% -3.0%
Manufacturing -2.2% -1.1% -2.6% -5.5% -3.7% -1.8% -2.4%
Trade -0.3% 0.6% -0.7% -0.7% 0.0% -0.4% -1.6%
TPU 0.4% 0.5% -1.5% 1.2% 1.9% 0.5% -0.1%
Information Svcs. -1.2% -0.7% 2.0% -1.9% 0.3% -2.7% -0.8%
Financial Svcs. -0.5% -1.6% -0.4% -2.3% -1.4% 0.0% 0.2%
Prof. & Bus. Svcs. 0.5% 0.9% -0.7% 0.4% 0.5% 0.0% -0.8%
Edu & Hlth Svc 1.7% 1.5% 1.8% 1.7% 1.6% 1.5% 2.1%
Leisure & Hosp. Svcs -0.3% 1.5% 1.8% 1.7% 1.6% 1.5% 2.1%
Other Svcs. -0.6% -1.0% 0.5% -0.4% -0.9% -1.2% -0.5%
Government 0.1% 0.2% 1.7% -1.3% 1.5% -0.4% -0.1%

the 12-month period ending in June 2008. Demand for alternative
Midwestern Region
energy sources, bio-diesel and ethanol, should continue to grow,
Employment Growth, 1991 – June 2008
and farm income was strong in 2007. Also, Missouri's business
conditions index has trended above the growth-neutral 50 in August 5%
and September, as gains in telecommunications and food process- 4%
ing offset the hard-hit automotive sector. 3%
2%
Ohio: The combination of the national downturn and domestic auto
1%
industry layoffs has impacted Ohio's economy hard and the state
0%
economy is in recession. Manufacturing employment declined
-1%
1.8% in the year ending in June 2008 and there has been a surge
-2%
of residential foreclosures and, concurrently, rapid home price
depreciation. The factory sector, though shrinking, remains the -3%
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
largest contributor to Gross State Product. Midwest US
Source: Bureau of Labor Statistics
Wisconsin: The state economy has tracked the national downturn.

Overall employment declined 0.6% in the 12 months to last June, Midwestern Region
and is expected to be flat or declining for the remainder of the Consumer Confidence Index (SA)
year, broadly in line with the national economy, expected to lose
150
1.3% of payroll jobs in 2008. Modest employment gains in financial
services and professional and business services are not expected to 130
last. Gains there and in leisure and hospitality had been offset by
110
significant layoffs in construction, manufacturing and trade. Exports
should continue to be a source of growth however, particularly as 90
the dollar has weakened against the Canadian dollar. 70
50
30
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Midwest US
Source: Conference Board


The Real Estate Capital Markets Steven Blitz
Market Environment Mortgage Spread & Foreign Capital
$Billions Basis Points
For all intents and purposes, the capital markets have been closed 1,400,000 0
as the market undergoes its greatest shakeup since the Great De- 1,200,000
25
pression, and there is no end in sight. The near financial meltdown 50
in mid-September turned the ongoing credit crunch into a crisis, and 1,000,000
Conv. 30-Year Mortgage Yield Minus Rate on 10-Year Treasury
75
confidence in the financial system is at low ebb. The combination of 800,000

(right scale, inverted) 100
closed capital markets and the weakening economy are, however, 125
600,000
creating increasingly attractive opportunities for investors with 150
cash and/or access to capital. 400,000 175
• It is too early to tell whether extraordinary measures, 200,000

200
Net Fgn Purchases of U.S. Securities, Rolling 12 Month Sum 225

including Treasury’s creation of the Troubled Asset Relief (left scale)
0 250
Program (TARP) to buy-in bad debt will have a lasting
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
n-
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n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
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effect let alone work.
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
As of June 2008
• Short term, its design should calm capital markets long Source: Federal Reserve, U.S. Department of the Treasury
enough to free up balance sheets and allow risk capital

return to the market.
recognizing that this money was levered in the capital
• Longer term, it addresses the symptoms, but not the root
markets, Treasury cannot fill this gap.
causes of the deleveraging process: still-falling home
• The U.S. economy will continue to delever as it unwinds
prices and the reduced pace of foreign net purchases of
a 25-year trend of increasingly funding growth off foreign
U.S. securities. (See Chart: “Mortgage Spread & Foreign
credit. Housing and the financial markets were first to feel
Capital).
the impact because they were the most vulnerable. The
• The net inflow of foreign capital for the 12 months ending
impact on the rest of the economy is still to come.
in June 2008 was $471 billion below the year-ago level,
when net purchases peaked at near $1.3 trillion, and
The shortage of debt capital is clearly a huge issue for real estate as
the inflow is still dropping. Looking at $471 billion and
it will continue to reduce transaction volumes and sales prices and
Real Estate Capital Market Overview

2002 2003 2004 2005 2006 2007 3Q07 4Q07 1Q08 2Q08 2008f 2009f
Debt Market
Commercial Lending Volume 1
Construction Loans Outstanding ($ Bill.) 244.8 272.2 336.8 448.7 564.9 628.9 617.2 628.9 631.8 627.2 640.9 645.9
Net Dollar Growth ($ Bill.) 12.8 27.4 64.6 111.9 116.2 64.0 17.1 11.7 2.9 -4.6 12.0 5.0
Long Term Mtg. Loans Outstanding ($ Bill.) 1866.5 2073.1 2297.5 2621.8 2950.3 3327.0 3232.5 3327.0 3389.3 3440.5 3467.0 3587.0
Net Dollar Growth (Qtrs are SAAR) ($ Bill.) 138.6 198.8 224.3 323.1 330.5 376.6 464.2 344.6 266.8 202.4 140.0 120.0
2
Domestic CMBS Issuance ($ Bill.) 52.1 77.8 97.9 169.2 205.6 230.2 59.9 33.3 5.9 6.2 30.0 70.0
10-Year Treasury Rate 3.8% 4.3% 4.2% 4.4% 4.7% 4.0% 4.6% 4.0% 3.5% 4.0% 3.3% 3.7%
10-Year Commercial Mortgage Rate 5.9% 5.8% 5.5% 5.5% 5.8% 6.4% 6.3% 6.4% 6.1% 6.2% 7.0% 6.9%
Spreads vs. Treasury (bps)
10-Year Commercial Mortgage 206 150 122 115 109 238 169 238 262 218 370 320
Super Sr AAA n/a n/a 69 83 72 153 117 153 284 230 270 190
BBB CMBS 181 129 127 180 123 790 365 790 1564 1520 2000 1800
Equity Market
2
Equity REIT Issuance ($ Bill.) 6.4 8.1 15.6 12.3 18.0 13.7 2.0 4.5 4.2 0.5 8.0 12.0
Returns for Period
NCREIF - Total (yoy) 6.7% 9.0% 14.5% 20.1% 16.6% 15.8% 17.3% 15.8% 13.6% 9.2% 5.5% 9.0%
Wilshire REIT Index 3.6% 36.2% 33.2% 14.0% 36.1% -17.6% 1.4% -17.6% 2.1% -3.4% -10.0% 5.0%
REIT Yield 7.1% 5.5% 4.7% 4.6% 3.7% 4.9% 4.1% 4.9% 5.0% 5.3% 5.5% 5.3%
1
Includes multifamily lending
2
Quarterly figures are not annualized.
Note: Interest rates and spreads are end of period
Sources: Federal Reserve, FDIC, Commercial Mortgage Alert, Morgan Stanley, Merril Lynch, NAREIT, Wilshire Associates, ULI, NCREIF, Real Capital Analytics, R CG

slow the development of new real estate. Also hurting the demand • While there is some ongoing uncertainty regarding their
for commercial real estate is the deepening recession. All market future activity, they have stated that will remain active
sectors are showing either negative net leasing (office, hotels, in multifamily.
industrial, and retail), or slowing of demand growth (apartments).
• Year-to-date through August, transaction volume is 70% Commercial Lending
below the 2007 pace.
• Offerings in the office market are outpacing closings by a The volume of net new commercial lending continues to fall off
ratio of 2 to 1, indicative of the lack of access to capital. (See Chart: “Net New Commercial and Multifamily Mortgages”).
• Without the commercial mortgage securities market, Sources of capital have diminished and the demand side is following
there exists a capital gap of $150 to $200 billion dollars. suit as the economy falters.
(See Chart: “Domestic Commercial MBS Gross Amount • Net new commercial mortgages were $137 billion (annual
Issued”). rate) in the second quarter, compared with $192 billion
• The consolidations among financial firms are also net in the first quarter.
negatives as private equity groups inside these firms are • Commercial banks were the largest lenders, financing
$128 billion of the $137 billion in net new commercial
Domestic Commercial MBS Gross Amount Issued
mortgages.
$Billions • Life insurance companies took down just under $10 billion
240 230.2
207.3
in net new mortgages after originating near $23 billion at
220
200 $150-$200 Billion Capital Gap an annual pace during the first three months of the year.
180 169.2 • ABS issuers were net liquidators of $18 billion of com-
160 mercial mortgages (excludes multifamily) in the first half
140
120
of 2008 at an annual pace. They were net buyers of almost
100
93.1 $130 billion in 2007.
77.7 77.8
80
58.5
74.4
66.4 • Net new multifamily mortgages were $65 billion in the
60 48.7
40.4 second quarter and the annualized pace for the first half
40 28.8 ?
20 7.6 14.0
17.2 17.5 17.9 of 2008 was $70 billion compared to $96 billion for all
0 of 2007.
• GSEs took down the lion’s share of mortgages: a $40 billion
f
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
Sources: Commercial Mortgage Alert, RCG annual rate in the first six months of the year.
Net New Commercial and Multifamily Mortgages
in limbo and bankruptcies such as Lehman pulls scarce
trading capital out of the commercial mortgage securities $Billions (SAAR)
500
market. 450 Multifamily Mortgages
• There has been a marked increase in the percentage of 400 Commercial Mortgages
investors coming from private sources. 350

• The office market has experienced reduced relative 300
participation by private equity, commingled and hedge 250
funds, and direct portfolio investors for pensions, trusts, 200
and endowments. 150
• Foreign investors buying real estate represent just under 100
10% of total purchases through the first eight months of 50
this year, a little above the 2007 pace, but all indications 0
4
05
08
4
7
-04
8
4
05
06
7
0
r-0
r-0
c-0
c-0
c-0
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p-0
p-0
are for a step up to a near record pace of acquisitions in

ar-
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Se
M
As of 2Q 2008
the third quarter. Source: Federal Reserve
• Nationalization of the GSEs means an explicit govern-

ment guarantee on the debt and ensures that between • The GSEs have announced a commitment to continue lend-
now and 2010, the GSEs are still in business funding the ing and securitization programs for single and multifamily
multifamily sector. homes. Whether they keep to that commitment and what
• In the second quarter of 2008, there was a net increase price remains to be seen
of $65 billion in multifamily mortgages at a seasonally • ABS issuers were net liquidators of an annualized $11.6
adjusted annual rate. Of that amount, $53 billion was billion in multifamily mortgages during the first half of
financed by the GSEs. 2008, compared with being net buyers of $21 billion in
2007.
The CMBS market remains effectively closed as a result of illiquidity REIT Valuation (Premium / Discount to Underlying Asset Value)
and suspect collateral.
• Through mid-September, only $14.7 billion of domestic 30%
CMBS have been issued, and there has been no new issue 20%
since July. Issuance is not likely to pick up soon.
10%
REITs 0%
-10%
The equity REIT sector rally in August was in sympathy with the
overall financial market and not reflective of the sector’s deteriorat- -20%
ing fundamentals. -30%

• REIT equity was not exempted from the non-shorting rule
-40%
recently imposed by the SEC in coordination with Treasury 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
and the Fed. As of September 1, 2008
Source: Green Street Advisors, RCG
REIT Performance
2008 2007 Dividend Yield** 10% to 15% undervalued. Private cap rates are quickly
FTSE NAREIT Equity REIT Index -3.59% -15.69% 5.30% moving up, however, so we would be very cautious in
Industrial/Office -2.23% -14.86% 5.04% interpreting this data series.
Retail -2.82% -15.77% 5.19% • On a year-to-date basis, industrials and hotels are the only
Residential 14.57% -25.21% 4.82% property sectors with negative performance.
Diversified 15.07% -22.29% 4.34%
Lodging/Resorts -21.73% -22.37% 8.75%
There are several longer-run positives to this market.
S&P 500* -17.50% 4.15% 2.23% • When apartments and other REITs operating in supply-
Russell Value 2000 -0.71% -9.78% 2.22% constrained markets are viewed in combination with
DJ Wilshire REIT* -5.10% -17.55% 5.03%1
the sharp drop in new development, the forward rent
environment looks very positive – although this might be
*As of 9/15/08, all other 2008 returns as of 8/31/08
**NAREIT Dividend Yield as of 8/31/08 several years away.
• Equity REIT issuance continues to fall off, after averaging
1 Merrill Lynch REIT Weekly, as of 9/12/08
Source: FTSE, NAREIT, Merrill Lynch
near $15 billion per year from 2005 to 2006. Only $8 billion
• Relative to the overall stock market, the cash flow yields is projected for this year and $12 billion for next.
on the REIT sector are still 25% below their long-term • Net inflows into real estate mutual funds were $5.4 billion
relative averages and multiples remain high from January through August of this year compared with
• Compared with bonds, REITs are more fairly valued (see a $5.6 billion outflow for all of 2007, and a $6.6 billion
chart: “REIT Cash Flow Yield vs. 10-Year U.S. Treasury inflow in 2006.
Bond”), but still are not cheap.
• Compared to private real estate (see chart: “REIT Valuta- REIT debt generally does well relative to other corporate debt
tion”), REITs, based on Green Street’s measures, may be because of the limit to the gearing of the balance sheet.
• Concerns about default risk have risen, but are not much
REIT Cash Flow Yield vs. 10-Year U.S. Treasury Bond
different from general concerns regarding Industrial
Basis Points
Baa-rated debt in general. (See Chart: “Option Adjusted
700
Spread: REITS vs. Industrial Baa”).
• REIT yields have risen to Treasuries, but not nearly to the
600
500
extent of CMBS BBB debt.
400
300
Average 264 bps
Private Equity
200 195 bps
100
Due to the consolidation in the financial sector, uncertainty over
0
valuations given the deteriorating economic conditions and the
-100
essentially closed capital markets, transaction volume is off
-200 markedly from the 2007 pace and the pace averaged in the past
93
94
95
96
97
98
99
00
01
02
03
04
05
06
08
several years.
*As of September 12, 2008
Source: Merrill Lynch

Option Adjusted Spread: REITS vs. Industrial Baa difficulties with this sector are on the upswing.
Basis points
• The recession is weakening commercial real estate
450
fundamentals, and most rapidly in financial centers
400 such as New York, whose office buildings have a siz-
350
able presence in the collateral of the overall CMBS
market
•
300
Ind. Baa In this environment, refinancing risks are heightened,
250
particularly for shorter maturity loans that are highly
200 leveraged. Refinancing poses additional downside
150 risks and creates a great deal of uncertainty for deal
100
REITs loss forecasts, especially for recent vintage loans
because of weaker underwriting standards.
50
Spreads to Treasury Yield at Mortgage Origination For Select Property Types
00
01
02
04
05
07
08
0
8
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Basis Points
Source: Lehman Brothers Bond Indicies
350
• In the first seven months of this year, only $56 billion of

300
office buildings were offered for sale, but only $34 billion
of these offerings closed. 250
• September is a big month for sellers to list properties. 200

It appears likely that the properties will be added to the Health Care
150 Hotel
2008 backlog to be offered in 2009. Industrial
• Outside of the JV partners for the GM building, only three 100
Multifamily
investors have acquired more than $1 billion in office 50

Office
property. Retail
Ju 1
Ju 6
Oc 2
Oc 7
Ju 99
No 99
Ju 4
No 04
M 02
7
Au 98
De 01
Au 03
De 06
Ja 8
Ap 9
Ja 3
Ap 4
Se 00
Se 05
Fe 0
M 01
Fe 5
M 6
0
0
-0
-0
0
t-0
9
v-9
v-0
p-0
p-0
c-0
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Monthly Data through Jan-08

The Outlook Source: Lehman Brothers
• The spread between the various tranches of CMBS

Looking forward, commercial lending activity will be slow this and Treasury yields have widened substantially of
year and next as sources of capital remain scarce and the cost of late. Spreads are impacted by the net purchases
capital high. of foreign capital (See Chart: “CMBS Spread to the
• Net dollar growth of construction lending will reach $12 Treasury vs. Net Foreign Purchases”). We do not
billion this year and $5 billion next year, compared with the foresee growth in foreign inflows.
average $90 billion per year from 2004 through 2007. • The newly proposed RTC-like structure could help
• Commercial mortgages will have net growth of $140 bil- restore liquidity and clear the way for new activity,
lion in 2008 and $120 billion in 2009, less than half the but deteriorating fundamentals of the CRE market
pace set from 2004 through 2007. make us believe that the RTC structure will help bank
• The commercial mortgage rate spread to 10-year Treasury capital ratios, but will not restore credit flows.
yields will remain wide for all property types (See Chart:
CMBS Spread to the Treasury vs. Net Foreign Purchases
“Spreads to Treasury Yield at Mortgage Origination for
Select Property Types”). Current spreads are about 270 $Billions Basis Points
650
basis points, about the same spreads that borrowers 1,400,000
Latest Spread:
600
endured during the previous recession. AA: 920 bps 550

BBB: 2170 bps
• We forecast borrowing spreads to only narrow to 190
1,200,000 500
450
basis points in 2009. 1,000,000
400
Net Foreign Purchases
(Left Scale) 350
800,000
We forecast only $30 billion CMBS to be issued this year and $70 CMBS BBB
(Right Scale)
300
billion next year. 600,000

250
CMBS AA 200
This is a problem market from several perspectives, all of which (Right Scale)
150
400,000
have contributed to the substantial widening of spreads in the 100
past several weeks. 200,000 50
• Consolidation in the financial sector will likely reduce

6
8
l-9
l-9
l-9
l-9
l-0
l-0
l-0
l-0
l-0
l-0
l-0
l-0
l-0
Ju
Ju
Ju
Ju
Ju
Ju
Ju
Ju
Ju
Ju
Ju
Ju
Ju
As of August 29, 2008

available capital for CMBS trading at a time when Source: Federal Reserve, Morgan Stanley

Looking forward, the stabilizing dollar, the drop in property prices
and concurrent rise in cap rates (somewhat stymied by the drop in
Treasury yields) is making real estate more attractive for domestic
and foreign investors, and is setting the stage for the allocation of
already-committed private equity -- once some measure of confi-
dence returns to the U.S. economy and the capital markets.
• International investors accelerated purchases of all prop-
erty types during the third quarter. They purchased $2.6
billion of $11.8 billion in transactions – a 22% share. In
2007, international purchasers were responsible for 8%
of total transactions.
• CalPER has recently made $700 million in commitments
to real estate funds.
• Avalon Bay closed a $333 million fund to acquire multifam-
ily properties in markets with high barriers to entry
• A large number of monies have already been placed in
funds looking to purchase distressed multifamily and infill
office properties. It appears that there is more money
waiting to be similarly invested.
• Private real estate equity funds are increasingly seen as
the best conduit for the petrodollars looking to invest in
U.S. real estate.
Conclusion
Any notion that the commercial real estate capital markets will re-
turn anytime soon to providing borrowers with more than sufficient
capital at cheap rates is a false hope. The damage to the market
is permanent, particularly where securitization was the preferred
conduit to channel capital from diverse sources into the real estate
market. More likely, once the financial system can be stabilized,
capital will clearly return, but from more traditional lenders, such as
life insurance companies, using basic lending principals to finance
sound developments with equity participation by the developer. We
also believe that the current economic dislocations are creating
attractive opportunities for commercial real estate.
The critical factor, however, is that credit will not be able to expand
as rapidly as before. There will be reduced net inflows of foreign
capital. In addition, banks and other lenders will be restricted, by
market forces and reregulation, to be less levered – ratio of capi-
tal to assets will be higher. The gearing of Goldman and Morgan
Stanley will, for example, be required to drop to 10 to 1 from 30 to
1 because they are now banks. With credit availability growing at
a slower pace than in previous cycles, the pace of expansion for
real estate development will, in turn, be slower as well.


The National Single Family Housing Market Andrea Lepcio
The mortgage market is broken. The junk underwriting that led to Real Estate Cycle – Single Family
this rupture is generating scores of foreclosures across the coun- Washington, DC / Atlanta /
try. Both investors and owner-occupants are forfeiting properties. San Francisco / Seattle / Boston /
Denver / Honolulu– 11:30
San Jose / Newark - 12:00
For the effected householders, the impairment of their credit and Los Angeles / Phoenix - 1:00
Dallas / Austin – 11:00 12
financial standing will weigh on them for an extended period. In Las Vegas - 1:30
contrast, speculators who may have had little equity invested will Overshooting Decline
Phase Phase Detroit / Cleveland – 2:00
be able to leave this episode quickly behind them, and even be
ready to reenter the market before the cycle is over through buying
foreclosed homes. As during the housing boom, investor activity 9 3
does not a stable market make.

The credit market is broken. Just as the financial markets were Growth Absorption
Phase Phase
reeling from the government takeover of Fannie and Freddie, the
6
list of failing institutions grows. Investment banks are learning the
same lesson as many homeowners: their investments are worth
less than they thought. The crisis, already more than 12 months
old, is not over and will delay the stabilization of the mortgage
market and, therefore, of the housing market.
The economy is broken. As discussed in our National Outlook, we Existing Median Home Price Appreciation - United States
give the economy a 60% chance that the recession will be deep Annual % Change
and that is now our base case. We give only a 35% chance that 18
16 14.3
14.1
the downturn is mild. In a further reflection of our concern that 14 12.8
13.6
11.0
the economic downturn has the potential to be more severe, our 12 10.6
9.8
10 8.8
8.2 8.5 8.8
statistical 5% outlier is now the probability of Depression. In our 8 6.7
6.0
7.4
6.1 6.7 6.9
previous forecast, we had a 5% change the economy would skirt 6 4.5

3.8
4.5 4.4
3.2
4.5 4.7
3.7
4.8 4.6
3.5
2.8 3.3
4 2.0
2.8 2.4 2.0
by without a recession. 2
Under normal recessions, housing sales slow, but house price ap- 0
-2 -0.8
preciation remains positive. The drop in prices that has occurred -4 -2.8
-6
since 2006 occurred ahead of economic weakness as it was caused -8 -6.1
-5.0
by the disastrous book of mortgage business that went bad nearly -10 -8.1
as quickly as it was written. If the subprime, Alt-A and Option ARM
f
f
f
74
76
78
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
12
Note: 4Q/4Q
loans closed in 2005, 2006 and 2007 had not been written, then Source: NAR, RCG
house price appreciation would not have turned negative.
Outlook for the National Single Family Home Market
2002 2003 2004 2005 2006 2007 2Q08 2008f 2009f 2010f 2011f 2012f
New Construction (000 Starts, Annual Rate) 1,363 1,505 1,604 1,719 1,474 1,034 675 550 700 900 1,000 1,100
Sales (000, Annual Rate)** 5,657 6,176 6,727 7,076 6,508 5,672 4,910 4,200 4,800 4,900 5,400 5,500
Median Exist. Home Price (000) $ 170.7 $ 182.4 $ 198.4 $ 225.3 $ 219.0 $ 205.7 $ 206.4 $ 189.0 $ 179.5 $ 183.2 $ 188.3 $ 194.5
Price Appreciation (4Q/4Q Rate) 8.5% 6.9% 8.8% 13.6% -2.8% -6.1% -7.6% -8.1% -5.0% 2.0% 2.8% 3.3%
Affordability Index 131.0 129.0 123.4 106.5 109.4 120.8 125.2 136.8 150.4 128.9 132.4 126.7
Prime Delinquency Rate 2.6% 2.4% 2.2% 2.5% 2.6% 3.2% 3.9% 5.3% 6.0% 3.7% 3.3% 3.1%
Subprime Delinquency Rate 13.2% 11.5% 10.3% 11.6% 13.3% 17.3% 18.7% 28.0% 35.0% 20.0% 15.0% 13.0%
Subprime Foreclosure Rate 8.0% 5.6% 3.8% 3.3% 4.5% 8.7% 11.8% 20.0% 25.0% 6.0% 4.5% 3.5%
Alt-A Delinquency Rate 3.4% 3.0% 1.4% 1.2% 1.2% 6.4% 9.8% 13.0% 17.0% 5.0% 3.0% 3.0%
Interest Rate (90-Day T-Bill)* 1.2% 1.0% 2.2% 4.1% 5.0% 3.4% 1.9% 1.0% 2.5% 3.7% 4.5% 5.0%
Conventional 30-Yr. Mort. Rate* 5.9% 5.9% 5.8% 6.2% 6.2% 6.2% 6.5% 6.0% 5.7% 7.2% 7.0% 7.5%
*End of Period
**Sales of Existing Homes (inc. condos and coops)
Sources: Census, Federal Reserve, MBA, NAR, RCG

Share of Home Loans that are Delinquent and In Foreclosure REO Sales in California
7% % REO Sales
40%
6% 60+ days
35%
90+ days
5%
In foreclosure 30%
4% 25%
3% 20%
15%
2%
10%
1%
5%
0%
0%
88
90
92
94
96
98
00
02
04
06
*
08
19
19
19
19
19
19
20
20
20
20
20
*
95
96
97
98
99
00
01
02
03
04
05
06
07
08
Note: 60+ days and 90+ days delinquencies are seasonally adjusted
* As of 2Q08 * As of May 2008
Source: Mortgage Bankers Association Sources: DataQuick
The U.S. economic outlook continues to worsen and our base case Weak demand and rising inventories from foreclosures are driving
scenario is now a hard landing recession with a 60% probability. price declines.
There is only a 35% chance that the milder downturn occurs – • Foreclosures are boosting already-high inventory levels across
what was our base case. We had been giving the economy a 5% the country. Higher REO (real estate owned) sales are pushing
chance that it would skirt by, that statistical 5% outlier is now the sales prices down in hard-hit markets.
probability of Depression.
• The mix of foreclosures in sales is rising as the pace of existing
sales (including condos and co-ops) declines. As of August
of 2008, existing home sales totaled 4.9 million units versus
• According to the National Association of Realtors, the median
4.8 million units a year earlier at a seasonally adjusted annual
price of a home dropped to $206,400 at the end of the second
rate (SAAR). Sales activity has fallen off across the country
quarter of 2008 from a boom-time high of $227,600 in the third
with the sharpest decline in the South and Northeast during
quarter of 2005.
the past year ending in August.
• Month-to-month shifts in the mix of homes sold results in shifts
• At the existing pace of sales, it will take more than ten months
in the median price. After tipping up to $213, 600 in June,
to clear the inventory of existing single family homes and
prices fell to $210,900 in August. A lower price of $193,600
at least fourteen months to clear the inventory of existing
was posted in February.
condominiums.
• The S&P/Case Shiller 20-city home price index is an alternative
• The pace of growth in the inventory of existing single family
widely reported source that includes many of the harder-hit
homes has slowed. While foreclosures are adding to inventory,
markets including Miami, Phoenix and San Diego. This index
owners with discretion are holding properties off the market.
posted a 15.9% drop in May of 2008 compared with May of
2007.
U.S. Existing Single Family Housing Inventory U.S. New Single Family Housing Inventory
(Units, 000) Units (000)

4,000 600
3,500 550
500
3,000
450
2,500
400
2,000 350
1,500 300
250
1,000
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
*
08
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
20
08
*Data is as of July 2008 *Data is as of July 2008

Source: NAR Source: Census

U.S. Total Existing Home Sales (including condos and co-ops) The inventory level reached 3.9 million units in July of 2008,
up from 3.83 million units a year earlier. The level improved
Units (millions)
8.0 to 3.6 million in August. There are an additional 655,000
7.1
7.0 6.7 condominiums on the market.
6.5
6.2
6.0
5.3
5.7 5.7
5.4 5.5 • New home sales were down to 460,000 units in August (SAAR),
5.2 5.2
5.0 4.8 4.9 a drop of 35% from a year earlier. Regionally, the pace of sales
4.2
4.0
is off across the country, with the West posting the largest
drop at near 50% from one year ago.
3.0
2.0 • While the inventory of existing units continues to climb,

1.0
homebuilders have discounted to reduce the inventory of new
homes. After peaking at 573,000 units in mid-2005, the inven-
0.0
tory of unsold homes has gradually declined to 408,000 as of
f
f
99
00
01
02
03
04
05
06
07
08
09
10
11
12
Note: Seasonally adjusted annual rate
August 2008. Of the remaining units, 42% are completed, 45%
Source: NAR, RCG are under construction and 15% are not started.
• Starts fell to 675,000 units (SAAR) in the second quarter of
2008 and 630,000 in August. Homebuilders have slowed
housing starts steadily since the peak of production in the first
quarter of 2006 of 1.75 million units.
U.S. Single Family Housing Starts
• Housing starts are declining across the country. As of July, the
Units (millions)
2.0
South had the highest level of starts of all regions at 302,000
1.8 1.7
(SAAR, down 40% year-over-year) and the West posted the
1.6 1.5
1.6 second-highest level of starts at 149,000 units (down 32%
1.41.4 1.47
1.4 1.3
1.4 year-over-year.) The Midwest and Northeast typically produce
1.31.3 1.3
1.2
1.2 1.2 1.1
1.2 1.2 1.21.2
1.1
1.2 1.2
1.1 lower levels of starts. At 115,000 units, starts in the Midwest
1.11.11.1 1.1
1.0
1.1 1.04
1.0 0.90.9
1.0
0.9 0.9
1.01.0
are down 32% from the previous July. In the Northeast, the
0.9 0.8
0.8 0.7
0.7 0.7
level of starts slipped to 64,000 units, down 15%.
•
0.6 0.6
While homebuilders have sold new homes with less or no
0.4
profit, they have gained the benefit of monetizing the underly-
0.2
ing land investment.
0.0
• Homebuilders have also sold land at a discount from pur-
f
f
71
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Note: Seasonally adjusted annual rate

Source: Census, RCG chase price to opportunity funds. Most recently, Centex sold
California and Nevada land to Farallon Capital Management
and RSF Partners for $161 million compared to a book value
of $528 million. Developers are able to mitigate some of the
losses by a tax provision that allows for a two-year carry-back
of losses against income. In Centex’s case, the resulting tax
Foreclosures in Process by Loan Type
break reduces the loss to 14% of book value.
Subprime 9.5%
•
10.0%
Subprime Limited debt financing may reduce land purchases in the near
8.0%
Option ARMs term. In addition, the carry-back provision will lose value over
Alt-A Option ARMs 7.8%
Jumbo prime time as the carry-back period moves into lower profit years.
Agency prime
6.0% • Commercial banks are also marketing REO land. We expect
Alt-A 5.5% public homebuilders will join opportunity funds in considering
4.0%
these purchases.
Jumbo Prime 1.3%
2.0% • The mortgage market deteriorated in the second quarter with
Agency Prime 1.0% rising Alt-A delinquencies and foreclosures for all loan types.
0.0% According to the Mortgage Banker Association, the overall
delinquency rate was 6.4% in the second quarter of 2008, up
5
05
06
06
07
07
08
8
0
g0
1Q
3Q
1Q
3Q
1Q
3Q
1Q
Au
Note: Mortgages originated btw Jan 2004 and Aug 2008, excluding HELs. Subprime & Alt-A loans are non-agency, non-gov. loans. from 5.12% in the same period of 2007.
Source: Mortgage Bankers Association, LPS Applied Analytics, WSJ

30-Year Fixed Agency Mortgage vs. 10-Year Treasury
treasuries versus a long-term average of 163 basis points.
There has been a sharp falloff in price of AAA ABX in the past
Basis Points year. After modest improvement in April, the AAA slice hit a
275
Highest Spread in Past Year: low of 41.54 in July of 2008 from 100 a year ago.
271 bps
•
250
Latest spread: Higher mortgage rates counteracted lower house prices in the
229 bps
225 second quarter to push affordability down to 125, according
200 to the National Association of Realtors. At 100, the index
Average Spread:
175
163 bps shows that a family earning the median income has exactly
the amount of income necessary to qualify for a conventional
150
mortgage and purchase a median-priced home given current
125 mortgage rates.
100
• The proportion of owner households ticked up in the second
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
quarter of 2008 to 68.1%. After peaking at 69%, the rate had
Data current through September 11, 2008
Source: Federal Reserve declined to 67.8% at the end of 2007.
At 1:30 on the RCG clock, the single family market is in the decline
ABX Price Summary
phase of the real estate cycle. The graphic on the first page of this
Price Lowest Price in Past Month section shows clock times for selected metropolitan markets.
110 AAA: 42.19 (8/19/08)
100 A: 8.09 (9/8/08)
90
BBB-: 5.34 (9/4/08) The Outlook
80
70 Nationally, under our hard landing base case, we expect a peak to
60
trough national drop in house prices of 20.3%. Under this scenario,
50 AAA
40
housing sales and starts will improve in 2010 as the economy
A
30 BBB-
returns to growth.
20
10 We expect the median price of a home to:
0
• Bottom out at $179,500 by the end of 2009;
-07
-08
-07
-08
7
7
M 7
M 8
M 8
7
Se 08
7
8
7
Au 7
*
07
c-0
b-0
r-0
b-0
r-0
g-0
v-0
n-0
n-0
n-0
n-0
t-0
l-0
l-0
08
g-
p-
ay
ay
ar
ar
p-
Ap
Ap
Ju
Ju
Oc
De
No
Fe
Fe
Au
Ja
Ju
Ja
Ju
Se
M
*As of September 8, 2008

Sources: Markit, UBS
• Reach $194,500 by the end of 2012.
Under our deep recession scenario, the median house price bottoms
• Most troubling is the worsening performance of prime loans.
at $176,000 in 2009.
Adjustable-rate prime loans are deteriorating faster than
conventional loans, but problems for both categories are on
In this complex and unprecedented cycle, we anchor our house price
the rise. Adjustable-rate prime mortgage delinquency rates
forecast on the restoration of affordability. Critically, we base af-
climbed to 7.5% in the second quarter of 2008 from 4.2% a
fordability on conventional fixed-rate mortgages that require down
year earlier. The foreclosure rate for these loans is now up
payments, fully amortized monthly principal and interest payments,
to 4.3% from 1.3% in the second quarter of 2007. The prime
and are thoroughly underwritten with supporting documentation.
fixed-rate mortgage foreclosure rate moved toward 1%, up
While at the moment, mortgage availability is dependent on the
from 0.4% a year earlier.
government’s management of FHA, Fannie Mae and Freddie Mac,
• Equally worrisome is the weakening Option ARM segment. and is otherwise limited by investor withdrawal from the secondary
Option ARM delinquencies climbed to 14.4% in August from market, our analysis assumes a gradual increase in availability for
7% a year earlier. Foreclosures reached 7.8% in August. qualified buyers.
• Next up are Alt-A mortgages where delinquencies climbed
to 10.7% in August of 2008 from 7.7% in the first quarter Under these assumptions, affordability will be restored by a com-
and 4.4% one year ago. Alt A foreclosures climbed to 5.5%. bination of rising incomes, lower interest rates, and lower house
Subprime delinquencies soared to 24.5% in August with prices. At present, only falling house prices are going in the right
foreclosures reaching 9.5% direction.
• In the near term, the recession will slow income growth. As
• The perceived risk in mortgage credits is reflected in the widen- the economy recovers, we expect incomes to grow, but at a
ing spreads of conventional 30-year mortgages over treasuries. pace that is close to the inflation rate.
In August, spreads reached a high of 271 basis points over

Composite Housing Affordability Index – United States Homeowner Households - Proportion of Total Households
150
70%
140 69%
68%
130
67%
120 66%
110 65%
64%
100
63%
90 62%
*
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
*
08
08
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
*July 2008 *As of 2Q08
Source: NAR Source: Census
• We expect mortgage rates to end the year at 6.0% and tick market indicators based on the derivation from the mean for
down to 5.7% by the end of 2009. Thereafter, as the economy each variable. The variables are:
and housing market improve, we expect the mortgage rate to o speculative activity
gradually increase to 7.5% by 2012.
o inventory of homes for sale
We use local metropolitan-area median house prices (National
Association of Realtors, California Association of Realtors and o level of subprime loans
selected local sources) and median income (Bureau of Census) to o delinquency rate
calculate how much lower median home prices would need to fall o foreclosure rate
to restore the ratio of mortgage payment to median income back
to 2003 levels. We use 2003 as our base year because, although o forecasted job creation
housing markets were healthy with rising demand and supply, 2003
preceded the wide use of aggressive lending and investor activity • We expect to reach the downside target price by 2009, with
that drove rapid price appreciation between 2004 and 2006. the greatest percentage decline in most markets centered in
Using this benchmark, a “target” median house price can be cal- 2008. Given our 2009 price targets, we spread the remaining
culated for each market. expected price decline over the next 12 to 18 months.
• To estimate, we calculated the 2003 ratio of the mortgage pay- Given the range of economic and household growth across the 77
ment (local median house price, prevailing mortgage rates, and markets, there is a great deal of nuance to the relative performance
conventional mortgage terms including 20% down payment, of house prices.
fixed-rate, 30-year term) to median income. For some markets,
changes by the Bureau of Census in the underlying geographi-
cal definitions required us to estimate median income from • The combination of low demand and excess supply is creating
average national household income. fire-sale conditions in many formerly hot markets. Foreclosures
are rapidly becoming a large part of the sales mix.
• We calculated the target median house price for each market
assuming that the ratio will correct back to 100% of the in- • In California, the contribution of REO to total sales skyrocketed
crease from the 2003 level. We also think of this as returning to 38.3% statewide in May of 2008 from 5.4% a year earlier.
the overvaluation generated during the boom. • In this environment, foreclosures function like excess supply
• For all markets, we also calculated the target median house putting downward pressure on prices. When the foreclosed
price for an 80% affordability correction or return of overvalu- sales are done, that added supply will be gone, as will the
ation. We estimate that nationally, income gains will allow related pressure on prices.
prices to stabilize below the 100% correction. We also think
that demand will be stimulated prior to a complete retrac-
tion.
• Using the 80% and 100% target prices as our guide, we then
weighted the results in each metropolitan area for six key local

Delinquencies - Total Loans Past Due By State for 2Q08 Foreclosure Inventory Rates by State for 2Q08
U.S. Average – 6.22% U.S. – 2.75%
> 8.32%
7.32% - 8.31%
6.32% - 7.31%
5.32% - 6.31%
0 .00- 5.31% > 2.25%
1.50% to 2.24%
1.00% to 1.49%
0.00% to 0.99%
Source: MBA Source: MBA
Based on our analysis, markets fall into three categories: continue to mount. Finally, as job losses cumulate, there
1. Markets (50) that will return less than 80% of will be a rise in foreclosures from this more usual source of
overvaluation; mortgage problems.
2. Markets (11) that will return between 80% and
• By the middle of 2009, mortgage availability will begin to
100% of overvaluation; and
return to normal levels. Going forward, we expect to see
3. Markets (16) that have or will return more than
conventional loans that are fully underwritten. The subprime
100% of overvaluation, bringing the target 2009
and Alt-A business will gradually return after 2009, but remain
price above 100% of 2003 affordability.
under 5% and 10% of the market, respectively.
Of our 77 markets, we forecast that 29 markets will decline more • Lower house prices and mortgage rates will boost affordability
severely than the national average, posting peak to trough drops in the near term. As the economy returns to positive growth
of up to 46%. This list is dominated by inland California markets and mortgage availability normalizes, we expect affordability
including Stockton, Modesto and Bakersfield. Other formerly hot to reduce to near the long term average of 130.
markets posting declines that match or exceed boom-era gains • Housing market dynamics combined with age distribution and
include Phoenix, Las Vegas, and the Florida markets. Also post- other demographic factors will push down the homeownership
ing sizeable drops due more to tepid economic growth than boom rate, which will slip to 67% over the forecast horizon.
excesses are Detroit and Boise. We expect an additional 27 markets
to post home price declines between 10%-16%. These markets are • We are optimistic that positive demographic trends, particu-
spread across the country and reflect varying degrees of speculator larly growth in the 25-34 year-old age cohort will lead to rising
activity, aggressive lending and economic weakness. Finally, there demand for the decade beginning in 2010.
are 21 markets where we expect house prices to decrease by 10%
or less from peak to trough, including Central New Jersey, Dallas, Conclusion
Austin, and Jacksonville.
The hiatus of the private mortgage market coupled with the reces-
In the near term, as we approach the trough of the current cycle, we sion is a worrisome drag on housing recovery. Credit market insta-
expect demand to be dampened as house prices adjust downward bility will further delay the full recovery of the important secondary
and mortgage availability remains low. market for mortgages. Modestly countering these negative trends
• In response to the inventory overhang and retarded demand, are federal government efforts to rescue housing finance agencies
single family starts will drop to a 25-year low of 550,000 units and provide loan modification relief to some borrowers. There is
in 2008 and slowly recover to 1.1 million units in 2012. no rescue in the offing that will shorten the 18 months we predict
it will take for the housing market to stabilize. We expect that af-
• We expect existing home sales to drop as low as 4.2 million fordability will prove to be the path to recovery by 2010.
units in 2008. The pace of sales will gradually recover through
2012, but remain at a lower and more sustainable rate of just
under 6 million units.
• The credit losses will not peak until 2009 as the foreclosure
process is slow and cumbersome, and new problems will

Median Single Family Home Prices - Peak to Trough
Metropolitan Area Peak Trough Peak to Trough Metropolitan Area Peak Troug h Peak to Trough
Price ($) Ye ar Price ($) Year Price ($) Year Price ($) Year
Stockton 410,233 2005 261,826 2009 -36.2% Hartford 258,000 2007 223,054 2009 -13.5%
Modesto 359,528 2005 229,614 2009 -36.1% Colorado Springs 219,400 2006 189,857 2009 -13.5%
Vallejo 507,466 2005 331,805 2009 -34.6% Atlanta 170,200 2005 148,266 2009 -12.9%
Bakersfield 291,595 2005 201,403 2009 -30.9% Tacoma 276,506 2006 240,926 2009 -12.9%
Riverside-S an Bernardino 406,400 2006 281,882 2009 -30.6% Nassau-Suffolk 473,700 2006 413,625 2009 -12.7%
Sacramento 380,900 2005 268,192 2009 -29.6% Baltimore 277,900 2006 242,809 2009 -12.6%
Tampa 229,700 2006 164,665 2009 -28.3% New York 523,300 2007 458,430 2009 -12.4%
Santa Rosa 631,120 2005 456,842 2012 -27.6% Chicago 268,100 2006 235,249 2009 -12.3%
Las Vegas 315,900 2005 229,105 2009 -27.5% Albuquerque 195,900 2007 172,133 2009 -12.1%
Fresno 299,862 2005 219,580 2009 -26.8% Kansas City 156,500 2005 137,634 2009 -12.1%
Orlando 272,100 2006 199,327 2009 -26.7% Indianapolis 122,000 2005 107,481 2008 -11.9%
Phoenix 268,400 2005 198,224 2010 -26.1% San Antonio 151,700 2007 133,864 2009 -11.8%
Ft Lauderdale 359,803 2006 267,786 2009 -25.6% Philadelphia 226,800 2007 200,278 2009 -11.7%
San Diego 607,400 2005 454,032 2009 -25.2% Norfolk 236,000 2007 208,432 2009 -11.7%
Detroit 157,600 2003 119,141 2009 -24.4% Durham 178,100 2007 157,589 2009 -11.5%
Ventura 676,730 2005 514,729 2010 -23.9% Salt Lake City 229,100 2007 204,602 2009 -10.7%
Miami 376,050 2005 286,381 2009 -23.8% El Paso 133,600 2007 119,898 2009 -10.3%
West Palm Beach 415,895 2005 320,454 2009 -22.9% Oakland 702,049 2007 632,013 2009 -10.0%
Los Angeles 586,183 2006 456,678 2009 -22.1% Central New Jersey 383,000 2005 346,222 2009 -9.6%
Salinas 717,050 2005 563,800 2009 -21.4% Minneapolis 230,500 2005 208,462 2009 -9.6%
Memphis 144,200 2005 114,472 2009 -20.6% Jacksonville 182,200 2005 166,207 2009 -8.8%
Cleveland 136,900 2004 109,747 2009 -19.8% Ft Worth 118,449 2006 108,899 2009 -8.1%
Orange County 699,800 2005 562,635 2009 -19.6% Raleigh 235,600 2007 216,947 2009 -7.9%
Tucson 246,200 2005 199,791 2009 -18.9% Greensboro 150,700 2007 138,785 2009 -7.9%
St. Louis 143,500 2006 117,057 2009 -18.4% Winston-Salem 150,700 2007 138,870 2009 -7.9%
Washington 432,900 2005 356,618 2009 -17.6% Nashville 182,700 2007 168,513 2009 -7.8%
Santa Barbara 671,360 2005 556,432 2009 -17.1% Portland 290,500 2007 267,954 2009 -7.8%
Honolulu 625,300 2007 518,522 2009 -17.1% Houston 150,300 2007 138,861 2009 -7.6%
Newark 435,800 2007 366,972 2009 -15.8% San Jose 838,500 2007 776,090 2009 -7.4%
Boston 397,500 2005 335,225 2009 -15.7% Charlotte 204,700 2007 189,496 2009 -7.4%
Rochester 120,800 2007 102,355 2009 -15.3% Richmond 229,400 2006 212,573 2009 -7.3%
Milwaukee 219,500 2007 186,066 2009 -15.2% Louisville 137,600 2006 127,992 2009 -7.0%
Pittsburgh 116,900 2007 99,156 2009 -15.2% Stamford 468,500 2005 437,997 2009 -6.5%
Cincinnati 143,700 2005 122,557 2009 -14.7% Spokane 194,100 2007 183,420 2009 -5.5%
Denver 247,500 2005 211,729 2009 -14.5% Dallas 156,864 2005 148,366 2009 -5.4%
Boise 209,500 2006 179,463 2009 -14.3% San Francisco 913,979 2007 870,350 2009 -4.8%
Columbus 147,900 2005 127,303 2008 -13.9% Seattle 416,385 2007 404,399 2009 -2.9%
Birmingham 161,700 2006 139,187 2009 -13.9% Austin 185,700 2007 185,847 2008 0.1%
Source: RCG


The National Apartment Market Andrea Lepcio
Cap rates are trending up and total returns have slipped into single Real Estate Cycle – Multifamily
digits. On the whole apartment fundamentals are moderating in the
face of the recession. RCG forecasts a rising vacancy rate in 2008 Las Vegas / Cleveland - 11:30
Detroit - 12:30
Miami - 1:00
and 2009. Demographic growth will drive improving apartment Washington, D.C. - 11:00
Orlando / South Florida &
Atlanta / Philadelphia / 12
market fundamentals through 2012 and beyond. Southern CA Condos - 10:30
Las Vegas Condos - 1:30
Houston / Overshooting Decline

San Diego - 10:00 Phase Phase
• Weak job growth along with low affordability, lack of easy Los Angeles / San
mortgage credit and house price uncertainty will keep current Francisco / Denver - 9:30
Chicago /
renters in apartments and cause homeowners who lose their New York - 9:00
9 3
homes to foreclosure or otherwise determine they cannot af-

Growth Absorption
ford the cost of owning to revert to renting. Seattle – 8:00 Phase Phase
• After reaching 32.2% in the last quarter of 2007, the rentership 6
rate ticked down in the second quarter of 2008 to 31.9%. This

level is still well above the 31% low reached at the height of
the housing boom. Prior to the 1990s ramp-up in homeowner-
ship, the rentership rate had been 36%. We expect the recent
gain to be reversed as the housing market and economic down-
turn lead more households to remain or return to rentals.
Employment Growth and Household Formation – (Monthly y-o-y difference)
• While household formation expands and contracts on a lagged Thousands
basis with the economy, historically, growth has remained 6,000
positive even during periods of job loss. 5,000 Households Employment
4,000
• At the same time, demand for starter apartments does suffer 3,000
as the younger age cohorts double up or move back in with 2,000
their parents. Similarly, demand for Class B and C apartments 1,000
leased to lower income workers is dampened by job losses. 0
-1,000
Fundamentals vary by market based on economic woes and shadow -2,000
supply from condominiums and single family. Overall, the modest -3,000
downturn in fundamentals is evident in first quarter results:

un
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-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
• Net operating income performance has slowed, but remains
above the 3.1% long-term average. According to Green Street Source: Census, BLS
Outlook for the National Apartment Market
2002 2003 2004 2005 2006 2007 2Q08 2008f 2009f 2010f 2011f 2012f
Total Multifamily Construction (Starts, Ann., 000)* 347 349 345 354 338 307 349 260 310 320 370 370
Rental Apartment Const. (Starts, Ann., 000)* 274 264 225 202 187 187 257 200 240 240 280 275
Condominium Const. (Starts, Ann., 000)* 73 85 120 152 151 120 92 60 70 80 90 95
Overall Vacancy Rate 9.0% 9.8% 10.2% 9.9% 9.7% 9.8% 10.0% 10.3% 10.5% 9.8% 9.5% 8.2%
Vacancy Rate, 5+ Units 10.4% 11.4% 11.5% 10.4% 10.2% 10.3% 11.1% 11.3% 11.5% 10.5% 9.0% 8.7%
Gross Rent (SF/Yr.) $ 13.4 $ 13.8 $ 14.2 $ 14.6 $ 15.2 $ 15.9 $ 16.1 $ 16.2 $ 16.7 $ 17.2 $ 17.9 $ 18.7
Rent Growth* 3.3% 2.7% 2.8% 3.1% 4.1% 4.0% 3.6% 2.2% 2.8% 3.5% 3.8% 4.4%
Cap Rate 6.8% 6.7% 6.5% 5.6% 4.8% 4.7% 4.9% 5.5% 6.0% 6.2% 6.2% 6.5%
NCREIF Return ** 8.8% 8.9% 13.0% 21.2% 14.6% 11.4% 6.5% 8.2% 4.5% 5.3% 6.1% 8.1%
Delinquency Rate 0.16% 0.08% 0.07% 0.02% 0.02% 0.05% 0.05% 0.07% 0.10% 0.04% 0.02% 0.02%
* Numbers in quarterly columns are annualized. ** Trailing four quarter return

Sources: Census, ACLI, NCREIF, RCG

Employment Growth and Household Formation – (Monthly y-o-y difference) Rental Inflation
Thousands Annual Change
6,000 CPI Rental Component
10%
Households Employment Professionally Managed Apartments
5,000
4,000 8%
3,000
6%
2,000
1,000 4%
0
2%
-1,000
-2,000 0%
-3,000
-2%
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un
un
un
un
un
un
un
un
un
un
un
un
un
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
-J
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008f 2012f
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
Source: Census, NMHC
Source: Census, BLS
Advisors, apartment REITs weighted-average net operating consistent high-4% gains, rent gains in the West
income growth totaled 4.5% in the second quarter of 2008, shrunk to 2.7%, below the benchmark 3% rate. For
down from 5.5% growth in 2007 and 7.6% growth in 2006. professionally managed units, rent growth eased
with the West remaining the leader (2.7%) followed
• Double-digit income gains faded for all markets except for
by the Northeast (2.3%), Midwest (2.1%) and South
still-strong Seattle in the second quarter based on our ag-
(2.1%).
gregation of net operating income returns by geography for
the public apartment companies. Growth improved, however, • With the exception of the overall Census vacancy rate, the
for several markets including Houston, New York, San Diego, vacancy rate rose for the other two series we track reflecting
Atlanta, Washington, D.C., Dallas and Phoenix. slower demand growth.
• Rent growth has slowed, but remains well above recessionary o The Census overall vacancy rate ticked down slightly
levels nationwide and stronger in select markets. to 10.0% from 10.1% in the first quarter of 2008. The
o The rental component of the Consumer Price Index rate has been relatively steady near 10% for the past
eased to 3.6% from 4.4% in the second quarter of three years.
2008. o For buildings with five or more units, the Census re-
o Rent growth for professionally managed apartments ports the vacancy rate climbed to 11.1% from 10.7%
reported by M/PF YieldStar (published by NMHC) in the first quarter and 10.1% a year earlier.
slowed to 2.3% versus 2.9% growth a year earlier. o M/PF Yieldstar’s (published by NMHC) series for
o Regionally, M/PF reports rent growth slowed sub- professionally managed apartment buildings widened
stantially in the West and Northeast. After posting to 6.0% in the second quarter from 5.8% in the first
quarter and 4.9% a year earlier. This increase is
Change in NOI for Public Companies – 2Q08 Rental Vacancy Rates
Metropolitan Area Yr/Yr NOI Metropolitan Area Yr/Yr NOI 12%

Seattle 11.6% Atlanta 5.1% 11%
San Francisco 9.4% Boston 5.0% 10%
Houston 9.4% Washington DC 4.3% 9%
Portland 9.1% Los Angeles 3.5% 8%
San Diego 8.9% Dallas 3.4% 7%
Denver 8.2% Riverside 2.8% 6%
Austin 6.4% Raleigh 2.0% 5%
New York 5.8% Phoenix 1.4% 4%
3% 5+ Units Overall Vacancy MP/F Investment Grade
2%
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008f 2010f 2012f
Note: 5+ Series revised in 1979 and 1989
No Forecast Available for MP/F Investment Grade
Source: Compiled by RCG from company reports
Source: RCG Source: Census, NMHC

Rental Multifamily Starts (000) above the long-term average of 5.5%, but well below
the 7.3% high reached in the aftermath of the last
400
recession.
o Performance varies widely across the nation, both
300 overall and for professionally managed apartments.
The West and Northeast remain the tightest markets.
In the West, the vacancy rate reached 5.4% for pro-
200
fessionally managed units and 6.9% overall. The
comparable results for the Northeast are 4.4% and
100 7.4%, respectively. The South and Midwest posted
the highest vacancy rates with the former daunted
by shadow supply and the later by weak economic
0 growth. Professionally managed units in the South
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08f 09f 10f 11f 12f
Source: Census, RCG
are 7.1% vacant, with apartments overall 13.2%
vacant. The comparable results for the Midwest are
5.6% and 10.6%, respectively.
• Rental housing starts increased to a seasonally adjusted an-

nual rate of 257,000 units, up from a low of only 160,333 units
Echo Boom Demographics (000) in the second quarter of 2007.
Population projections for 20 to 34 years-old cohort
• Shadow supply is a regional and changing story.
70,000 o While the inventory of vacant single family homes
and condominiums being offered for rent is high
65,000
in Phoenix, Las Vegas, Florida markets and Central
California, for the most part larger units do not
compete directly with the more typical one and two
60,000
bedroom apartments. In addition, renters often opt
for a professionally managed unit.
55,000
o In contrast, new condominium buildings that have
been converted to rental or rental buildings that have
50,000
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
been re-converted back to rental are fully competitive
with professional buildings.
Source: Census, RCG
o In addition, in markets with high levels of foreclo-

sures and corresponding plunging house prices, the
gap between the cost of buying versus renting is
narrowing. Countering this, however, is the reduced
availability of mortgage credit and the necessity of
Foreign-Born Renters by State
10% or higher down payments.
U.S. Average – 18.4% On balance, low supply coupled with the for-sale housing meltdown
favor rental apartments in the near term. We expect that the re-
cession will dampen, but will not eliminate rent and net operating
gains. Moreover, demographic trends favor rental apartments into
the next decade. Operating results will vary across markets, with
20.1% or more
tech-dominated outperforming markets that lack a comparably
15.1% - 20.0% strong economic driver.
10.1% - 15.0%
5.1% - 10.0%
0 - 5.0%
Based on supply/demand fundamentals, the rental apartment sec-
tor is near the end of the growth phase of the cycle at 8:30 on the
RCG clock. In the decline phase are markets with weak economic
growth such as Detroit and markets recovering from overbuilding,
Source: JCHS tabulations of the 2005 American Community Survey

like Miami. The condominium sector, depending on market, is in the Rental supply will be curtailed in 2008 by tight credit and financial
overshooting or decline phase. South Florida led the overexpansion market uncertainty. In addition, in the face of recession, developers
and decline and is at 1:00 along with Las Vegas. Southern California will be inclined to delay starts. We expect starts to lower to 200,000
condo markets are earlier in the process at 10:30. units this year and gradually increase to 280,000 units by 2011.
All of these forecasts are based on RCGs hard landing recession

The Outlook
scenario. Local market conditions, however, are expected to vary
Going forward, RCG expects the apartment sector to weather the pretty widely across the nation. Most at risk are markets charac-
deep recession with a modest diminishment of performance in terized by:
2008 and 2009. We expect rising net operating income in the later • Weak or negative economic growth including exposure to
years of our forecast: at-risk industries including financial services and automobile
• Rent growth will moderate to 2.2% as economic growth con- manufacturing;
tractions in 2008. The pace of rental growth will gradually
• High levels of shadow supply, particularly those with increasing
increase, reaching 4.4% in 2012.
levels of condominiums being converted to rentals.
• Weak demand will push the overall vacancy rate to 10.5% A number of markets, however, will be less severely impacted by
and the vacancy rate for buildings with five or more units to the downturn, including those enjoying:
11.5% through 2009. Thereafter, rising demand will match
• High concentrations of technology and Internet-related em-
increasing starts, pushing the vacancy rates down to 8.2%
ployment, including San Francisco, Silicon Valley, Austin and
and 8.7%, respectively, by 2012.
the Seattle area;
• The combination of demographic drivers and housing market
• Energy-related economies, such as Houston and Denver;
dynamics will push the proportion of renters to 33% during
the forecast period. • Low levels of new rental development relative to existing
stock.
• For many households, the ratio of home prices to rent neces-
sitates leasing. The ratio climbed to 22.8 in the second quarter Condominiums
of 2008 as measured by the ratio of median sales price for There are 655,000 condominiums on the market for sale as of
vacant for-sale-only units to median annual asking rent for August of 2008, according to the National Association of Realtors.
vacant housing units. To restore the ratio to the long-term The month to month number is variable and the inventory level
average of 15, house prices would have to drop 34.2%. We had jumped up to 775,000 the month before. Nationally, existing
expect the housing correction to lower prices by 20.3%. Rent condominium sales dropped near 19% year-over-year in August
growth will restore a portion, but not the rest of the difference, of 2008. The decline was relatively evenly spread across the
over the forecast horizon. We expect, therefore, the rent versus country with the Midwest and South slowing more than the East
buy economics to favor apartments through 2012. and West. There have been month-to-month variations, with the
As the economy improves in 2010 and beyond, demographics will lowest price posted in February of 2007, at $211,800. After holding,
favor apartment demand from young adults and immigrants as well despite slower sales, condominium prices fell 7.2% year over year
as from middle-aged adults and seniors. to $212,600 in August of 2008. The West suffered the greatest
• During the forecast horizon, 20% of the population will be discount, dropping 17.9% in the same year-over-year period.
between 20 and 34 years-old, including young immigrants.
Nationally, approximately 57% of households in this age cohort We expect the 14 months of condo/co-op supply based on sales
rent versus 31% of the total population. The pace of births rates in June of 2008 – up from 12 months a year ago – to increase,
have been relatively stable at or near 4 million for the past 20 as projects already under construction deliver and advance sales
years, which will lead to a steady stream of young adults as cancellations mount. This inventory makes up the shadow supply,
the echo boomers age. some of which competes with rental apartments.
• Those anxious to sell may be more likely to leave units vacant.
• Immigrants of all ages are an important part of household
Others may offer rent-to-buy arrangements.
formation and renter demand. As of 2005, the latest year
data is available, foreign-born renters represented 18.4% of • A portion of apartment buildings planned for sale as condos
all renters. are now being marketed as rentals. In addition, some of those
purchased for conversion to condos have or may revert to
• The demographic drivers of demand are rounded out by seniors,
rentals. These are the most competitive with professionally
at 17%, and 40-59 year-olds, at 32%
managed rentals.

Condo Starts and Conversions (000) U.S. Condos and Co-ops Housing Inventory
Units Months’ Supply
225 15
14
200
13
175 12
150 11
Conversions Starts
10
125
9
100 8
75 7
6
50 5
25 4
3
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2Q08 2
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008*
Notes: RCA did not track conversions prior to 2001;
Quarterly figures represent activity in that quarter alone *Data is as of July 2008
Sources: Census, Real Capital Analytics, RCG Source: NAR
• We reiterate that our concern is focused on the formerly hot Investment Market
Southeast and Southwest markets. As of the early September takeover of the government mortgage
agencies by the Federal government, the future of multifamily
• All of the overbuilt markets have the advantage of being
finance is up in the air. Through September, the availability of
located where people like to live, work and retire. Conse-
reasonably priced financing from these agencies made apartment
quently, over the long term, we expect rising net migration
investment more attractive than other credit-starved property types.
will gradually increase demand for rental apartments, condos
Whether or not apartments will experience a similar drought or
and single family.
continue to receive a portion of the agencies’ attention is uncertain
at this point.
The pace of condo starts has dropped steadily from a peak of
152,000 units in 2006 and 2007. As the condo inventory is gradu- According to Real Capital Analytics, only $25.1 billion in transac-
ally sold, we expect that starts will decline to a low of 60,000 units tions were closed through June, down 45% from the volume a year
this year. Demographic trends suggest to us that condo demand ago. This volume includes the purchase by DRA and Steven D. Bell
will be strong going forward, as baby boomers choose lower- of the $1.7 billion UDR portfolio. While we expect apartment sales
maintenance primary and secondary residences, and echo boomers volume to remain low in 2008, we do expect investor interest in the
choose urban living. Well-located condos are and will continue to sector to recover more quickly than for other property types given
perform strongly. We expect Sunbelt markets to improve once the favorable supply/demand fundamentals.
oversupply is absorbed. In addition, overbuilt urban markets such
as Washington, D.C., Minneapolis, Boston and Chicago will recover Nonetheless, we expect 2007 to be the last year apartments will
as new deliveries slow. Long-term demand for condo product will have posted double-digit returns as slowing capital appreciation
lift construction gradually over the forecast horizon. dampens total rates of return. According to NCREIF, annualized
Apartment Cap Rate vs. 10-Year Treasury Yield Total Rates of Return for Multifamily Properties
Basis Points 27% Income Return Capital Return

21.3%
400 24%
18.9%
21%
15.6%
18%
14.6%
14.1%
200
13.1%
13.1%
12.9%
12.9%
12.1%
8.7%
15%
11.7%
11.7%
11.6%
11.5%
11.4%
10.3%
8.1%
12%
9.3%
7.20%
8.9%
8.8%
8.7%
8.2%
6.9%
0
7.1%
5.8%
9%
6.1%
5.3%
4.5%
6%
-200 3%
0%
-400 -3%
-6%
-9%
-1.4%
-600
-12%
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
*
08
*2Q08 82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f

125 basis points subtracted Percentage values represent total returns
Source: ACLI, Federal Reserve, RERC Source: NCREIF. RCG

private-sector apartment returns totaled 6.5% in the second quar-
ter of 2008, down from 9.6% in the first quarter. In contrast to the
private market, apartment REITs outperformed other commercial
property sectors year-to-date through August 31st, posting returns
of near 15%.
We expect rising cap rates will counter healthy income gains,

pushing total returns below 5% in 2009. Positive appreciation
gains will return with improving fundamentals in 2011. Coupled
with rising income gains, total returns will increase to near 8%
through 2012.
Conclusion
The apartment market is entering the economic recession in good
supply demand balance. While slower job growth is a negative,
housing market turmoil creates demand for rentals. We expect
occupancies to rise again in 2010 and beyond. Rent growth slows
in the next 18 months, but will pick-up thereafter.
We expect investors to price apartment buildings based on rental

fundamentals, not condominium conversion. Higher borrowing costs
will also push cap rates higher. We expect developers will favor
markets with strong economic and demographic growth. Despite
rising construction levels, we expect supply to remain in balance
in most markets.
Overall, demographics will favor apartments and result in strong

performance beginning in 2010. Although our current forecast ends
in 2012, these demographic trends will continue to drive demand
for the remainder of the decade.


The National Office Market Arthur Margon
The office market, by no means immune from the effects of a severe Real Estate Cycle – Office
economic downturn and a global credit crunch, capitulated during
the summer of 2008. Because of its multi-year lease structure, of-
fice market fundamentals generally lag changes in the economy, 12
both on the upside and the downside. But by the end of summer San Francisco - 10:30
Washington, D.C. / Denver / Overshooting
2008, the office markets nationwide reflected the weakened state Miami / San Jose- 10:00 Phase
Decline
Phase
of the economy and the financial markets. Whatever the official New York - 9:30
designation of the downturn, the office employment sector had Los Angeles / Boston /
9 3
Atlanta - 9:00
clearly turned to recession:
Houston /
Seattle - 8:30
•
Growth Absorption
Employment growth, negative throughout the first half of the Phase Phase
Chicago / Minneapolis - 7:30
year, turned dramatically weaker at the end of the summer, with 6
average monthly job losses in August and September nearly 5:00 - Dallas
doubling the monthly average for the first half of the year;
• Office employment losses, which had been relatively modest
earlier in the year, accelerated during the summer. While industries, such as Denver, Dallas and San Francisco began to
manufacturing continued to deteriorate, and health care, register softening demand and weakening fundamentals;
education and government employment actually grew, the
retrenchment in financial services and related economic sec- • As a result of these pressures, availability rates (direct vacancy
tors finally began to show up in job statistics in August; plus sublet space available to the market) have increased in
virtually every market. RCG expects this to continue into 2008,
• In addition to actual employment shrinkage, the worsening with national vacancy rates likely to exceed 15%. Negative
economy led to less ambitious business planning throughout absorption has become widespread, and should linger through
the economy, resulting in slower hiring (or hiring freezes) 2010 in most markets, longer in suburban markets and the
and delayed or diminished plans for space expansion. These weaker CBDs. However, in this instance, national averages
lowered assumptions about business growth began to show are likely to be unhelpful: some markets, such as Washing-
up in increased sub-lease space hitting the office markets in ton D.C. and West Los Angeles should retain relatively low
cities around the country; vacancy rates, and even Midtown Manhattan is likely to see
• Previously strong economic sectors, such as energy, began to its available space peak in the low double digits; other loca-
retrench as well. The signs of a global economic slowdown tions, particularly suburban markets that are not centers for
affected assumptions about demand for all sorts of products, the technology industry, are likely to see vacancy rates much
and led businesses nationwide to lower their sights for 2009. higher than the national average;
As a result, markets not directly linked to the financial services
Outlook for the National Office Market

2002 2003 2004 2005 2006 2007 2Q08 2008f 2009f 2010f 2011f 2012f
New Construction* (Put in place, 2000 $ Bill.) 32.2 26.9 27.1 27.7 30.1 33.9 35.7 38.1 39.0 34.4 35.5 36.3
Office Employment Growth* -1.1% 0.7% 2.0% 2.9% 2.3% 0.9% -0.2% -0.8% -1.2% 1.8% 2.6% 2.6%
Office Vacancy Rate 18.3% 18.7% 17.3% 15.1% 13.1% 12.6% 13.4% 13.4% 14.2% 14.7% 13.9% 12.7%
Downtown Vacancy Rate 14.8% 15.2% 14.5% 12.5% 10.6% 9.7% 10.2% 10.8% 11.6% 12.2% 11.1% 10.8%
Suburban Vacancy Rate 20.5% 20.8% 19.0% 16.7% 14.5% 14.3% 15.2% 15.0% 15.8% 16.3% 15.6% 13.8%
Downtown Rent Growth -5.7% -2.6% -3.1% 2.1% 13.2% 15.5% 15.4% 2.2% -2.5% -1.0% 1.8% 3.6%
Suburban Rent Growth -6.1% -5.9% -0.2% 2.4% 7.2% 9.1% 8.3% 1.1% -2.0% -2.2% 1.1% 2.4%
Cap Rate 7.9% 7.4% 7.0% 6.1% 5.7% 5.1% 5.5% 6.3% 7.0% 7.3% 7.0% 6.8%
NCREIF Return ** 2.8% 5.7% 12.0% 19.5% 19.2% 20.5% 11.5% 10.2% 3.1% -4.6% 3.2% 9.6%
* Numbers in quarterly columns are annualized. ** Trailing four quarter return

Sources: Cushman & Wakefield, CBRE, ACLI, BLS, NCREIF, RCG

• Asking rents moderated in most markets during the most re- when financing largely dried up. When we last reviewed the market
cent survey period, and even where they held steady, tenant in mid-summer, well-capitalized property owners –both public and
concession packages have begun to expand rapidly. In most private –were only beginning to feel the effects of credit tightening.
of the markets we have investigated, the concessions are still That, as economists are fond of saying, was then.
focused on richer tenant improvement allowances; we expect
that during 2009, expanded free rent periods will become more It should not be surprising that during a period of several months
common. In those markets most directly affected by the finan- when banks demanded huge premiums to extend overnight credit
cial crisis – the center of the office sector’s weakness –lease to one another, that real estate entrepreneurs and investors had a
terms softened markedly in all but the most prestigious build- difficult time accessing the debt markets. But for real estate, which
ings. RCG expects this weakness to continue through 2009 and is a highly capital intensive industry, the generalized troubles of
into 2010, with cumulative office rental declines approaching the credit markets were heightened by the central role real estate
20%, and exceeding that number in many markets; securitized debt played in the financial crisis. Of course the troubled
securitizations that led to the financial squeeze were entirely con-
• Construction delivery levels, which generally surge late in the
fined to residential mortgages, but investors haven’t discriminated.
business cycle, have leveled off. RCG expects them to decline
Their concerns about residential securitizations quickly spread to
during late 2009 as the current crop of projects is completed,
securitized commercial loans, which have had virtually no problems
and then to fall off significantly in 2010. The entire post-2000
to date. The index that measures the secondary market value of
economic cycle has seen delivery of approximately 2% of the
CMBS issues plummeted, investors shunned proposed new secu-
existing national office stock, which is barely one-third of the
ritizations, and the market literally closed down.
office stock expansions in the late 1990s and the mid-1980s.
With the credit crunch making virtually all new construction
The resulting investor aversion to real estate-related securitized
starts impossible for the next 12 – 24 months, delivery of new
debt has had a dramatic effect on the commercial property sector
space will be reduced to a trickle until 2011 or later. This his-
in general, and the office markets in particular. A robust CMBS
torically modest delivery of new space as a downturn begins
market that funded over $200 billion in commercial property in
will moderate the decline of office markets nationwide. It will
each of 2006 and 2007 has closed down. In the first three quarters
also allow fundamentally strong markets to rebound quickly
of 2008, about $20 billion of CMBS were issued, none of it in the
when job growth resumes, and in fact RCG is predicting post-
third quarter. The prospects for the market opening up by early 2009
2011 office rent spikes in several key CBD markets.
are considered negligible, and the prospects for later in that year
are cloudy at best. Since CMBS became the financing vehicle for
In short, the slow deterioration in office market fundamentals commercial property transactions in the past ten years, its virtual
that we noted in our last forecast has accelerated. The weaken- disappearance will require the development of new capital sources,
ing economy, now likely to fall into a deep recession, and the and new assumptions about the capital structure of commercial
global financial squeeze, are taking an increasingly obvious toll. real estate transactions.
More to the point, RCG expects the deterioration of office market
fundamentals to continue, and at a quicker pace. We have bee While the financial community struggles with the larger credit
predicting that the large announced layoffs in the financial services squeeze, and the property sector searches for a way to fill the
sector would begin to show up in employment statistics late this capital void left by the CMBS window’s closing, investment sales
year; this has already begun, and the impact will grow over the volumes have slowed to a trickle. In this environment, it is nearly
next six months. The change since mid-year is the slowdown in impossible to make statements about current capitalization rates,
the global economy, the heightened chance of recession in numer- or projected movements in them. Based on the few unforced
ous developed countries, and the increasing probability of a deep sales which have occurred, many of them on smaller properties,
recession in the United States. More than just the financial services capitalization rates for non-trophy office buildings appear to have
sector is affected here: the entire office employment complex is increased nearly 100 basis points since their low-point in the spring
looking at the near certainty of a significant contraction over the of 2007. Just as important, investors now do make significant dis-
next 18 – 24 months. tinctions between buildings –whereas eighteen months ago there
was little difference in capitalization rates between superior and
These deteriorating fundamentals currently form the backdrop to a inferior properties; today the less desirable buildings are the ones
still moribund investment market. Very few office building transac- with elevated cap rates.
tions are going forward, and many of those have a “story” that in-
cludes significant seller financing or large assumable mortgages. This distinction between different types of building within an asset
class marks the first step in a return to a more traditional, or normal,
The summer and fall of 2008 will be remembered broadly in the office market. We expect this trend to continue past the current
U.S. economy, and particularly in real estate circles, as the period

recession, and to characterize the office investment market well Office Employment Growth - Annual Percent Change in Jobs
into the next decade. When financial markets reopen for office
7%
property, we expect that several things will be different:
5.7%
6%
• Loan to value ratios, which became very high during 2006-07, 5% 4.7% 4.5%
4.3%4.3% 4.2%
will be significantly lower. We expect first mortgage loans to 4%
3.1%
settle at between 60% and 70% of value; 3% 2.4%
2.7% 2.9%
2.3% 2.4%
2.9%
2.6%
2.0%
• Lenders at all levels of the market are consistent in saying that 2%

0.7% 0.9%
1%
they will require significant cash equity in any deal that they 0%
finance, and in this they will likely have the support of and be -1% -0.8% -0.5%-0.6%
following the guidance of regulators; -2%
-1.1%
• Property pro-forma and appraisals will show less aggressive -3% -2.6%
-4%
leasing and rental assumptions, and likely will show higher 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08f 09f 10f 11f 12f
terminal capitalization rates and – reflecting more robust
Sources: U.S. Census Bureau, RCG
assumptions of real estate risk – higher discount rates. The
result will be that both prospective purchasers and their capi-
Office Vacancy Rates - Downtown and Suburban
tal sources will use lower property valuations in negotiating
transactions and financing; 30%
• Many lenders may, at least initially, restrict or even prohibit the 25%
use of mezzanine financing. Other restrictions on borrowers will
mark the return of substantial covenants to property loans; 20%
15%
In the new lending environment, with borrowers required to put
up cash equating to one-third or more of the project cost, values 10%
would fall even if market fundamentals remained stable. However, Downtown
as noted above, markets fundamentals are deteriorating, and 5% Suburban
we expect them to continue their slide at least through 2010. In 0%

these circumstances, investors will have to recalibrate their return 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f
expectations, and sellers will have to reduce property price-points Sources: Cushman & Wakefield, CB Richard Ellis, RCG
to consummate a sale.
• Rent growth has turned negative, although embedded rent
The Outlook growth is still characteristic of most CBD markets. However,
in a probable harbinger of things to come, publicly traded office
The specifics of office market fundamentals are daunting: companies reported in the second quarter that their NOIs, while
still growing, were growing more slowly in buildings owned
• The vacancy rate, which increased by about 100 basis points for a year or longer. Fewer old leases were turning over, and
in the first half of the year, increased by nearly another 100 market rents were no longer spiking, so property performance
basis points during the summer. This accelerating availability was deteriorating. Whatever one thinks about the relationship
of space reflects the spreading economic slowdown in the between movements in REIT share prices and property market
overall economy: the specific (and targeted) effects of financial values, the slowing rate of NOI growth supports our view that
sector layoffs lay largely in the future; the markets have turned and that declining fundamentals and
property-level results can be expected through at least the
• Suburban vacancies continue to move more quickly than CBD
end of 2010;
vacancies. Adding to the downward pressure is that most
of the new space being delivered at this point in the cycle is • Rent spikes, which characterized many markets just a few
being delivered to suburban markets; quarters ago, are over. Focus on rapidly rising rents has been
replaced by analysis of potential increases in space availability.
• Space absorption has turned negative in numerous markets.
The most intense focus is on Manhattan, because it is the
Up to now, this has reflected deliveries rather than job losses.
central actor in the financial services sector’s implosion. Most
Beginning in mid-2008, the loss of office sector jobs became
analysts agree that for every 10,000 Manhattan office jobs
the main driver, and will remain the prime cause of negative
lost, the availability rate increases by 25 basis points. Thus a
absorption through 2010;
loss of 100,000 office jobs in Manhattan–a true catastrophe,

similar to the very deep recessions of the early 1970s and the If the economic rebound has a strong high-tech component,
1980s –would increase availability by 250 basis points, or to we would also expect the balance to shift back to property
just over 10%. There would be little or no impact from newly owners in places such as San Francisco and Seattle.
delivered space – there is very little new supply coming on
board next year, and none after that for several years – so the The most significant change in our office market forecast is a result
impact of a deep national downturn focused on the financial of our view that the national economic downturn will be deeper
services industry would be a vacancy rate of, say, 10.5% at and longer than originally forecast. While RCG has believed that
its peak in 2010. Similar calculation, reflecting the space use the United States was in recession since spring of 2008, and that
conventions of local markets, show varying results around the the bursting housing bubble would spill over into the broader mort-
country. But in virtually all locations, even a deep recession gage markets, we did not envision the structural damage to global
results in lower availabilities than the downturn of the early financial markets that has occurred since mid-2008. The financial
1990s, because of lower levels of new space deliveries; squeeze has broad implications for economies globally, and we
believe that its severity will deepen and prolong the downturn that
Office Construction Put in Place began domestically earlier this year. As a result, we have revised
our forecast in several ways:
60
50 • We previously expected office employment growth to rebound

in 2009, and we now forecast declines through 2010. We
40 expect the consolidations in the financial services sector to
continue to drag office employment down for the next 24-30
2000 $ Billions
30
months. In addition, the previously strong sectors such as
20 energy and state and local government should flatten, the first
as global energy demand moderates, the second as budget
10 constraints inhibit hiring in the public sector;
0 • As noted earlier, office supply increases will not have a big
76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f
impact on supply/demand dynamics. In our last report, for ex-
Sources: U.S. Census Bureau, RCG
ample, we suggested that high-profile projects such as Lower
Manhattan’s rebuilding of the World Trade Center site would
• RCG does expect that when the markets have stabilized and
likely be delayed. In the past several months, all aspects of
employment growth resumes there is a strong possibility for
the project have in fact been delayed even further. Similar
renewed rent spikes in several key markets. Because of the
large-scale projects in other metropolitan areas are also either
long lead times for office development, especially in CBDs, it
being rethought, delayed, or slowed down;
is unlikely that supply and demand will stay in balance as the
employment market recovers. We expect space shortages to • We had previously expected that capitalization rates would
show up in Midtown Manhattan after 2011, and in markets increase to 7% by early 2010. Under current credit conditions,
such as Washington, D.C. and West Los Angeles before that. we expect that to be an early 2010 milepost and believe that
capitalization rates will be 50 basis points higher than that
by mid-2011;
Private Market Total Return (NCREIF) - Office
• Highly leveraged buyers, who defined the office investment
30%
26.0%
market in 2005-2007, are already “missing in action” when
25% properties come to market, as their investment style is difficult
20.3% 19.2%
20.5%
20% 19.6%
17.9%
19.5%
in an environment without available high leverage. We expect
15% 12.7%
12.4%
13.6%
14.2% this to continue, and that more traditional buyers – institu-
12.3% 12.0%
10%
9.8%
9.0%
10.2% 9.6% tional investors, REITs, private partnerships – will dominate
7.2%
5.7% 6.0%
4.0% 4.2% 3.9%
6.2% 5.8% the market for the next few years, supplemented by offshore
5% 3.1% 3.2%
2.8%
investors and sovereign wealth funds. Because most of these
0%
-1.1%
investors concentrate on CBD trophy properties, we expect
-5% -4.0% -4.6% demand for those buildings to remain strong and pricing to
-10% -8.0% remain elevated. Other office building types, and secondary
-11.4%
-15% locations, should see the largest capitalization rate increases
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f in this environment.
Source: NCREIF

Conclusions
Unlike our previous market review, we now believe that the office
market is vulnerable to a precipitous decline. Depending upon
the depth and length of the current recession, declines in rents,
operating profits and market value could be substantial. This is
not certain; the Herculean efforts of central banks worldwide may
quickly stabilize the financial markets, which in turn would make the
downturn shorter and shallower. But the real risk at this juncture is
that the recession will become substantially deeper and last longer
than anything since the 1970s. While we do not have this as our
base case, we nevertheless believe that fundamentals will decline
throughout the remainder of 2008 and 2009, and that recovery will
be spotty (and late) in 2010. Office markets will lag the general
economy on the way up, and so fundamentals will not look positive
until late 2010 at best, and more likely into 2011. While we still
believe that the current downturn will be milder than the collapses
of the 1970s and the 1990s, the continuing financial crisis bears
watching. If the measures of financial liquidity have not improved
substantially by the end of the first quarter 2009, we could be in
for a truly bumpy ride.


The National Industrial Market Randall Sakamoto
The industrial market began to reflect the nationwide recession. Real Estate Cycle – Industrial
At the end of 2007 and into the early months of 2008, many ten-
ants and developers took a “wait and see” approach, at times out
Oakland – 11:00
of necessity due to the credit crunch. However, the tightening of
Inland Empire / Miami – 10:30 12
consumer and corporate wallets began to weigh on the industrial Dallas / Newark /
market by mid-year 2008. With import activity slowing and the rise San Diego / Seattle – 10:00
Overshooting Decline
in exports due to the weak dollar less than expected, retail distri- Atlanta / Chicago / Phase Phase
Portland /
bution facilities and freight forwarders are handling less activity. San Jose – 9:30
3 Detroit – 3:00
Despite falling fuel prices in recent weeks, drayage costs remain Los Angeles – 9:00 9
high and fuel surcharges are in many cases increasing.

Growth Absorption
Boston – 8:00 Phase Phase
The major industrial employment sectors slowed further as the
year progressed. As the national recession deepened, many firms 6
froze hiring plans or began to layoff employees. Manufacturers

and shippers continue to battle a slumping domestic economy,
slowing global prospects for export activity, and higher energy
and input prices. tor payrolls grew at an average rate of 2.1% year-over-year.
• In August, manufacturing employment fell to a seasonally Since then, sector employment increased at an average rate
adjusted level of 13.5 million, a decrease of 3.04% from one of only 0.8% year-over-year.
year prior. This was the first time the year-over-year decrease o In August, transportation and utilities sector employment
in employment exceeded the 3% threshold since 2004. fell to 5.02 million, a decrease of 0.6% from August 2007.
o Year-to-date, approximately 277,000 manufacturing jobs In spite of recent decreases in fuel prices, higher costs are
were lost. still impacting large transportation firms and independent
owner/operators.
• Trade sector employment fell into negative territory for the first
Both temporary and long-term layoffs are increasing as companies
time since 2003. The wholesale trade component has shed
face declining revenue and are unable to secure financing at af-
payroll throughout the year, totaling more than 38,000 jobs in
fordable rates.
the first half of 2008.
• Manufacturing mass layoff events totaled more than 3,400
o Through the second quarter, trade sector employment
through July, approximately one-third of layoffs across all
fell by 0.7% year-over-year, a loss of more than 153,000
industries. These layoffs totaled nearly 267,000 workers.
jobs.
• There were 153 mass layoff events in the wholesale trade
• Hiring in the transportation and utilities sector has slowed segment, producing more than 12,700 initial claimants.
significantly since 2007. From 2005 and into early 2007, sec-
Outlook for the National Industrial Market

2002 2003 2004 2005 2006 2007 2Q08 2008f 2009f 2010f 2011f 2012f
New Construction (Put in place, 2000 $ Bill.) 10.0 9.6 9.0 8.5 8.9 9.6 9.4 9.2 8.8 9.1 10.0 11.3
Manufacturing Empl. Growth* -5.4% -4.5% 0.0% -0.8% -1.1% -1.9% -2.5% -7.3% -8.1% -0.1% 0.1% 0.1%
Trade Employment Growth* -1.2% -0.5% 1.4% 1.5% 0.9% 1.1% -0.7% -2.9% -1.4% 0.9% 1.4% 1.2%
Transport. & Utilities Empl. Growth* -0.9% -1.2% 1.8% 2.1% 2.5% 0.8% 0.1% -0.7% -1.2% 1.1% 1.6% 1.3%
Indust. Production ('92=100) 100.6 102.1 105.3 108.0 109.8 112.2 111.3 107.8 109.3 112.7 116.7 121.7
Indust. Production Percent Change 2.6% 1.5% 3.1% 2.6% 1.6% 2.2% 0.2% -6.4% -2.4% 3.1% 3.5% 4.3%
Vacancy Rate 10.1% 10.3% 9.7% 8.3% 7.3% 7.2% 7.7% 8.0% 8.6% 8.2% 7.8% 7.6%
Rent Growth* 1.2% 1.3% 3.9% 3.8% 10.3% 4.1% 2.4% 2.9% 3.1% 3.9% 5.5% 6.1%
Cap Rate 7.6% 7.5% 7.3% 6.7% 6.0% 5.7% 6.0% 6.2% 6.9% 7.3% 7.4% 7.3%
NCREIF Total Industrial Return ** 6.7% 8.2% 12.1% 20.3% 17.0% 14.9% 8.5% 13.1% 5.6% 1.9% 5.5% 11.2%
* Numbers in quarterly columns are annualized. **Trailing four quarter return

Sources: Cushman & Wakefield, CB Richard Ellis, ACLI, Korpacz, BLS, Census, Federal Reserve, NCREIF, RCG

Mass Layoffs: Manufacturing Index of Industrial Production: Percent Change
1,000 2.5%
900 2.0%
800 1.5%
700
1.0%
600
0.5%
500
0.0%
400
-0.5%
300
-1.0%
200
-1.5%
100
0 -2.0%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
96 97 98 99 00 01 02 03 04 05 06 07 08
Source: BLS Source: Federal Reserve
• In the transportation and warehousing industry, mass layoff • Reduction in loops and shipping capacity between the U.S.
events increased to 743 in July, impacting more than 86,000 and potential export markets.
people.
• Quicker than expected slowdown of the global economy.
• The transportation equipment manufacturing industry is one of
the hardest hit due to the combination of a national recession The industrial production index fell slightly in the second quarter
and higher fuel prices. According to the Bureau of Labor Sta- to 111.3, down from 112.3 in the first quarter. Preliminary data for
tistics, of the ten industries with the largest number of initial August indicate that the index has fallen further to 110.3, a drop
layoff claims in July, six involved transportation equipment of 1.1% from July. After little movement in recent months, the
manufacturing. These segments included: significant decline in August is attributed to a reduction in produc-
o Light truck and utility vehicle manufacturing – 8,825 initial tion among motor vehicle and parts manufacturers. Excluding this
claimants sector, the drop in August would have been only 0.3%.
o Motor vehicle metal stamping – 7,033 initial claimants
Industrial Real Estate Market
o Heavy duty truck manufacturing – 6,790 initial claim-
ants With consumer confidence at a recent low and the national reces-
o Automobile manufacturing – 6,636 initial claimants sion taking hold, the national industrial market turned downward in
the second quarter. The vacancy rate increased as tenant demand
o All other motor vehicle parts manufacturing – 5,986 initial slowed and new buildings were delivered to the market. By the
claimants second quarter, the vacancy rate reached 7.7%, an increase of 0.5
o Motor vehicle seating and interior trim manufacturing percentage points following several quarters of little movement.
– 4,459 initial claimants
The majority of industrial markets across the nation produced higher
or flat vacancy rates in the second quarter. In both primary ports
The weak dollar has helped many exporters sell goods abroad. In of entry and regional distribution hubs, slower leasing demand
July, exports of goods reached $120.8 billion, an increase of $4.5 bil- and construction deliveries conspired to provide upward pressure
lion, on a balance of payments basis. Year-to-date, exports totaled on vacancy rates.
$775.9 billion, an increase of 19.9% from the same period in 2007.
• In Chicago, the vacancy rate increased to 9.4% from 8.7% at
Many analysts expected a larger boost to exports; however, several
year-end 2007.
factors conspired to constrain some export activity, including:
• Higher fuel costs around the world. Fuel surcharges are • The vacancy rate increased to 11.2% in Dallas, one percentage
increasing in many cases, in spite of the recent fall in the point higher than the end of last year.
price of oil. • In one of the largest increases in the first half of the year, the
• Lack of shipping containers in certain geographies. vacancy rate in the Inland Empire reached 10%, a 380 basis
point increase from the end of 2007.
• Scarcity of specialized containers, such as reefers, to handle
exports.

in Los Angeles South, the submarkets immediately surrounding
Industrial Vacancy Rate
the sister ports of Los Angeles and Long Beach, totaled nearly
12% 5.1 million square feet. This was an increase of 34.2%, or
nearly 1.3 million square feet, from the same period in 2007.
10%
• The fuel efficiency of rail over trucks will likely further empha-
size the importance of rail access to distribution centers.
8%
Although significant overbuilding did not occur in the majority

6%
of markets, the vacancy rates in some localities have increased
recently as speculative product delivered just as tenant demand
4%
slowed significantly. As the residential real estate bubble expand-
ed, industrial-zoned land and older buildings were removed from
2%
82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f the inventory by demolition and conversions, helping to maintain
Sources: Cushman & Wakefield, CB Richard Ellis, RCG
healthy vacancy rates. This is no longer occurring on a large scale
and functionally obsolete buildings are remaining on the market
• The Phoenix vacancy rate jumped three percentage points to and providing upward pressure on the vacancy rate.
9.2%. • In recent quarters, the amount of new product increased but
• The second quarter vacancy rate in Kansas City increased two new inventory was typically absorbed by most markets. Lower
percentage points to 10%. consumer spending and decreased import activities is causing
many new buildings to remain vacant and on the market for
• The vacancy rate remained relatively flat from the fourth quar- longer than expected.
ter of 2007 in Los Angeles, New Jersey and Boston.
• Markets with significant year-to-date construction activity
include:
Tenant demand remained soft in the second quarter, with leasing
activity nationally reaching nearly 176.3 million square feet year- o Chicago – 13.2 million square feet
to-date, a 6.6% decrease from the same period in 2007. Many o Inland Empire – 14.4 million square feet
businesses adopted a cautious approach in the first half of 2008
as economic uncertainty weighed on the minds of most corporate o Dallas – 10.3 million square feet
real estate decision makers. Even tier one distribution markets are o Phoenix – 8.3 million square feet
not immune to lower demand for warehouse space.
• In Chicago, new leases totaled 14.7 million square feet in the • In the second quarter, the value of put in place construction
first half of the year, a 10.3% decline from one year ago. totaled $9.4 billion and has remained at less than $10 billion
since 2003.
• The Inland Empire produced more than 10.7 million square
feet of leasing activity year-to-date, just 75.8% of the total • The relatively short construction timeline of industrial buildings
at mid-year 2007. led to the removal of some projects from the active pipeline
prior to groundbreaking. This has helped prevent gross over-
building on a national scale.
Despite falling fuel prices in recent weeks, the high energy costs are
impacting industrial real estate decisions. Logistics professionals • In the first half of the year, nearly 92 million square feet were
are seeking to reduce the length of networks, as well as focusing delivered throughout the country. Approximately 90.6% of this
on fuel efficiency and full loads. As drayage costs increase, both new product was warehouse/distribution. In comparison, more
distribution and manufacturing tenants are eschewing locating than 71.8 million square feet were built in the first six months
in affordable submarkets on the periphery and paying the rent of 2007, of which 89.4% was warehouse product.
premiums of close-in submarkets. Location and transportation
options will regain their primary significance versus lower cost The softening of tenant demand is leading landlords to limit asking
rent options. rent increases.
• Some of the increased demand in Los Angeles County reflects • Year-to-date in the second quarter, the national average asking
tenants choosing to locate closer to the ports due to escalating rent increased 2.4%. In comparison, the average rent increased
drayage costs. There were nearly 17.1 million square feet of 4.1% in 2007 and 9.2% at the halfway point of 2007.
leases in Los Angeles County, an increase of 6.7% from the
• Through the first six months of the year, average rents in major
same point in 2007. In the first half of the year, leasing activity
distribution markets were typically flat or decreased slightly.

• Available properties located in outer submarkets tend to have • Many well-capitalized investors and opportunity funds
the most negative rent prospects as many tenants are focused remain on the sidelines, unconvinced that valuations have
on close-in locations due to the cost of diesel. bottomed.
• The industrial component of the NCREIF Property Index ended
The credit market turmoil continues and is constraining industrial its run of consecutive double-digit annualized total returns in
investment activity. The lack of viable financing options has meant the second quarter. After 16 quarters of double-digit returns,
that the majority of successful deals now center on cash transac- the second quarter totaled just 8.5%, a 390 basis point drop
tions, seller financing or assumable mortgages. from the first quarter and 600 basis point drop from year-end
• In the 12 months ending in July, more than $34.2 billion of 2007. Both the warehouse/distribution and R&D components
industrial properties were sold, according to Real Capital Ana- fell significantly, to 8.5% and 8.7%, respectively.
lytics. This was a decrease of 31.6% from the previous year.
o Year-to-date through July, only $13.9 billion of industrial The Outlook
buildings transacted, a decrease of 54.2% from the same
period in 2007. As the local recessions deepen and spending is reduced nationwide,
we expect industrial markets to weaken further. Consumer confi-
• Unlike other property types, the inventory of for-sale buildings dence remains battered, despite recent decreases in the price of
has not spiked even with lower acquisition volume. gas. We expect both personal and corporate consumption to slow,
• The 12-month average price paid per square foot was $75 in driving a reduction in demand for industrial space. Additionally,
July, on par with results throughout the year. import cargo flows will continue to slow. The global slowdown will
reduce export activity potential even if the dollar remains weak.
As projects underway are delivered just as demand slumps, there
is a risk of overbuilding in selected markets. Once this wave of
Total Rates of Return: Warehouse Properties development is completed, construction activity should diminish
rapidly, potentially leading to a brief shortage of quality space once
25%
the economy resumes expansion in 2011 and 2012.
19.8%
20%
14.7%
17.1%
The national recession should continue to take hold and we ex-
14.5%
15% 12.7% 13.1% 13.5%
13.1% 12.7% 12.6%
pect:
12.4% 12.1% 11.4%
10%
10.2%
9.1%
9.1%
10.8%
9.7% 9.8% • Manufacturing employment will decrease by 7.3% by the end
8.4% 8.8% 8.5%
7.1% of 2008. In the second half of the year, this would be a loss
5% of more than 991,000 jobs. The industry is confronted with
2.3%
not only a slowing economy, but financial trouble at several
0%
-1.5%
large employers as well as potential labor strife at companies
-5%
-2.6%
-2.2%
including Boeing.
82 84 86 88 90 92 94 96 98 00 02 04 06 2Q08
• Trade employment will contract 2.9% by the end of the year.
Sources: NCREIF, RCG
Total Rates of Return: R&D/Office Properties Industrial Employment: Percent Change
30% 6% Manufacturing Trade Transportation & Utilities

26.3%
25% 4%
21.4% 20.3%
19.8% 19.9%
20% 18.4% 2%
17.4%
15.6% 16.0%
15% 12.3% 13.2% 0%
11.5% 11.0%
9.7% 8.7%
10% 8.1% 8.4% -2%
6.8% 7.4%
5.4%
5% 3.9% 4.0%
2.9% -4%
1.1% 0.7%
0% -6%
-5% -8%
-5.5%
-10% -8.6%
-10%
82 84 86 88 90 92 94 96 98 00 02 04 06 2Q08 90 92 94 96 98 00 02 04 06 08f 10f 12f
Sources: NCREIF, RCG Sources: BLS, RCG

• Transportation and utilities employment will fall by 0.7% by
Industrial Construction Put in Place
the fourth quarter.
$25
• Each of the three major industrial employment sectors to also
reduce payroll through 2009.
$20
In the near term, we expect the industrial market to weaken with
2000 $ Billions
$15
job losses and a higher vacancy rate in most metropolitan areas.
• The national vacancy rate should reach the 8% level by the $10
end of 2008 and rise to the mid-8% level in 2009.
$5
• The average rental rate is expected to remain positive in 2008
and 2009; however, it is not likely to outpace forecasted infla-
tion. We expect annual rent growth to total 2.9% by the end $0
74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f
of 2008. In 2009, asking rents should increase at an average
Sources: Census, RCG
rate of 3.1%, less than the projected rate of inflation.
• Of the industrial markets tracked by RCG, we expect approxi- metropolitan areas. The current drayage costs are shifting focus
mately half of the MSAs to have average rent declines by the to infill facilities closer to customers and suppliers.
end of 2008. • Higher costs are forcing some supply chain professionals to
o Buildings on the periphery and with less attractive ame- re-examine distribution networks and port diversification plans.
nities are likely to have the most downward pressure on With fuel surcharges expected to remain for the foreseeable
asking rents. We expect owners of these properties will future, some supply chains will consolidate locations and re-
likely need to offer larger concession packages in order duce mileage within networks. This will place more emphasis
to attract tenants concerned about fuel costs. on project location and transportation options.
• Construction activity should fall significantly once current • Tenants are more likely to focus on larger warehouses in
projects are completed. New development is expected to be order to maximize efficiency of operations. By consolidat-
difficult, due mainly to the lack of viable construction financing facilities, distribution centers aim to reduce energy and
ing. fuel costs. Additionally, as fuel costs override some of the
o We expect the value of put in place construction to slow savings from just-in-time inventory practices, tenants are
further to $9.2 billion by the end of 2008. In 2009, we likely to increase their footprints in order to maintain larger
expect even less development due to the lack of viable inventories on site.
construction finance options, and put in place construction
should fall to $8.8 billion. Moving forward, we expect healthier fundamentals beginning
in 2010. As the nation recovers from the recession, we expect
o Markets at risk of short-term overbuilding due to a large space to be absorbed by tenants’ expanding appetites. Many
amount of space currently underway include: trends highlighted in the current environment, such as fuel cost
o Inland Empire – 11.3 million square feet under con- reduction, longer storage times and focus on infill industrial sites,
struction or 3.0% of existing inventory are likely to remain over the long term. The national vacancy
rate should return to 7% territory by 2011. As a result of minimal
o Dallas – 7.0 million square feet under construction
construction in 2009 and 2010, we predict that there may be a
or 1.8% of existing inventory
strong likelihood of a shortage of quality space in some industrial
o Phoenix – 5.2 million square feet under construction markets, leading to above average rent spikes towards the end of
or 2.0% of existing inventory the forecast horizon.
o Returns on industrial property should continue to de-
Logistics Trends
crease. We expect the average cap rate to approach
the 7% threshold in 2009.
An unexpected surge in tonnage or container volume in July at
some major port facilities led many to hope for a normal peak
In recent years, tenant preferences favored state-of-the-art facili- shipping season in September and October. However, with data
ties offering greater clear heights, larger turning radii, super flat indicating that export activity fueled much of the July increase,
floors and high-output/high-efficiency lighting. The land required we do not have the same optimistic view for cargo flows in the
for such facilities often necessitated locating at the outskirts of remainder of the year.

• According to the Pacific Maritime Association, containers disruption of port activities along the West Coast, other potential
handled reached 11.7 million twenty-foot equivalent units issues remain and could prove to be challenging to cargo flows
(TEUs) year-to-date in July along the West Coast. This was across the nation.
a decrease of 6.2% from the previous year and a return to • In October, the clean trucks program at Los Angeles and Long
container levels of 2005. Beach will ban trucks built in 1988 and earlier. By 2012, all
• Containerized cargo activity decreased at the ports of Los trucks entering the port complex must meet 2007 federal
Angeles and Long Beach, where combined year-to-date vol- emission standards. In order to offset some of the cost of
ume was lower by 7.0% in August from last year. At the Port replacing trucks, the ports will levy an additional fee on loaded
of Los Angeles, slightly more than 5.2 million TEUs passed containers. Additionally, under the concession programs,
through the facility, a decrease of 4.6% from the same time trucks must be registered at the ports, file a maintenance plan
in 2007. At the neighboring Port of Long Beach, nearly 4.4 and driver information must be supplied for security reasons.
million TEUs were processed, a decrease of 9.9% from August The uncertain availability of trucks as well as concerns regard-
of last year. ing the implementation timeline will likely have the effect
of creating congestion at the ports similar to a typical peak
• The National Retail Federation noted that retailers are tighten- shipping season.
ing inventories as they expect a challenging holiday season.
• The compliance date for the Transportation Worker Identi-
• In recent weeks, commodities pricing has retreated as pros- fication Credential program (TWIC) was delayed into 2009.
pects for a global recession increased. This retrenchment will This will allay concerns of significant disruptions in drayage
likely constrain agricultural export prospects. capacity.
• Air cargo traffic is declining as fuel surcharges peak and the • Port diversification plans following the 2002 Pacific Coast
economy stagnates. In the first half of the year, freight tonnage strike helped shift volume to the Pacific Northwest, Canada
at John F. Kennedy International Airport fell 4.2% from the and the East Coast. However, with a labor agreement extending
same period in 2007. June was the 16th consecutive month into 2014 ensuring uninterrupted operations and supply chain
of lower cargo traffic at the airport. professionals’ desire to shorten networks, port diversification
• The rapidly diminishing global growth prospects are hamper- may soon transform into consolidation.
ing export activity. The lack of space on backhauls and fuel • All-water service to the East Coast and Gulf ports is becom-
surcharges are cannibalizing some of the advantage created ing more competitive as overland intermodal costs increase.
by the weak dollar. In addition, there continues to be a short- Despite oil falling below the $100-per-barrel mark recently,
age of empty containers in certain geographies and of certain fuel surcharges have not yet reflected lower energy costs.
types, such as reefers. It appears that most supply chain professionals continue to
prioritize fuel efficiency in spite of the lower fuel costs per
Following reports of work slowdowns in July by the International gallon.
Longshore and Warehouse Union (ILWU), the union and the Pacific
• The Port of Prince Rupert in British Columbia is exceeding
Maritime Association agreed on a new six-year labor agreement.
expectations in its first year of operation and may continue to
Although the labor negotiations circumvented any significant
absorb cargo from U.S. ports.
TEU Growth: Ports of Los Angeles & Long Beach Spot Price Per Gallon: Los Angeles
$4
30%
Los Angeles Long Beach
25% Diesel Jet Fuel Bunker Fuel
20% $3
15%
10%
$2
5%
0%
-5% $1
-10%
-15%
$0
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08*
* YTD August 2008 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Sources: POLA, POLB Source: Energy Information Administration

o In the first half of 2008, the port handled 43,555 TEUs. Conclusion
Construction on the second phase of the container termi-
nal is set to commence in 2010 and will bring capacity to The industrial market is at a turning point, both in terms of market
two million TEUs in 2013. By 2020, Prince Rupert could fundamentals as well as user preference. The recession will reduce
handle up to five million TEUs. spending by both consumers and corporations, negatively impact-
ing national, regional and local distribution centers. Additionally,
o The new port will likely continue to benefit from shorter
manufacturing output will slow as domestic consumption falls
transit times, lack of congestion and all-rail access to
and the rapidly slowing global economy moves toward the brink
the Midwest.
of recession. The return of manufacturing to the U.S. is likely
Overcapacity on the world’s oceans may be looming as newly- overstated, with firms still wary of high domestic production costs.
launched ships are not only more efficient and faster, but can carry We expect that manufacturing will continue to decline, though
more tonnage. Between 1990 and 2005, total global container high-end manufacturing and final assembly may have a brighter
capacity expanded by 400%. The easy credit environment of recent outlook. Although overlooked in recent years with the exponential
years was not limited to real estate, but also led to a large amount growth of Chinese manufacturing capacity, Mexico may return
of shipbuilding. In 2007, the latest year for which data is available, as a primary producer of goods aimed at the U.S. market. The
60.9% of the 10.7 million TEUs in service is on order. Older ships closer location and intermodal options will likely combine with the
in the fleet are typically shifted to shorter loops rather than being benefits of NAFTA to attract manufacturers to locate in Mexico.
decommissioned, further enhancing the risk of overcapacity. As ports such as Punta Colonet are built and capacity on railways
• Larger ships carry larger risk. The super post-Panamax ships such as Kansas City Southern’s NAFTA Railway is expanded, raw
work well during booms, but are inflexible and vulnerable materials and semi-finished products could be efficiently shipped
during recessions as they rely upon transhipment activity to Mexico and then assembled for shipping to distribution centers
and require longer times in port. The economies of scale of and stores in the U.S.
these ships can be quickly negated by empty slots as shipping
demand decreases. While the recession and credit woes will constrain the near-term
performance of the market, demand preferences will shift focus
• The largest ships with a capacity in excess of 8,000 TEUs have away from some developments. Many logistics firms and intricate
been deployed to the Asia-Europe loop in recent months as supply chains are trying to maximize efficiency and reduce energy
the U.S. economy slowed. However, with European economies costs. Whereas timeliness was the priority, cost reduction is now
slowing quickly, the demand for space on these container the most important factor as drayage costs account for a larger
ships is weakening. As additional ships are brought online share of operational costs. We expect this trend to continue, just
with capacities exceeding 10,000 TEUs, it will be interesting as the increasing usage of technology to better manage the sup-
to note where lines place these vessels. ply chain has grown in recent years. The high drayage costs and
• Charter ship owners have begun to cancel their most specu- ever-growing concerns of congestion and environmental impact
lative orders. Evergreen Line canceled eight 12,000-plus will continue to shift industrial tenants back to city cores. Once
TEU vessels. NSB of Germany, the world’s largest container the economy returns to expansion, this should bode well for older
charter owner, canceled an eight-vessel contract totaling industrial areas within center cities that suffered in recent years
34,000 TEUs. due to gentrification and a shift towards residential and retail ten-
ants. Although the current economic environment is difficult and
• Many carriers are adding additional vessels to loops while
the domestic economy should prove its resiliency, we expect that
slowing ship speeds to save fuel. On the Asia to Europe loop,
tenants and developers alike will evolve and adapt to a changing
most lines now have nine vessels in their loops. These loops
industrial world.
have become more fuel-efficient, but have added capacity at
the same time.
• While talk of manufacturing returning to the U.S. from abroad
may be premature, several Western European manufacturers
are looking shift operations out of China and to Eastern Europe.
In addition to quality control issues, the high cost of shipping
from China to Europe is cited as a primary reason. Should this
trend continue, demand on the Asia-Europe loop may be lower
over the long-term.


The National Retail Market Andrea Cross
Retail market conditions worsened in recent months, as mounting Real Estate Cycle – Retail
financial pressures on consumers translated into reduced overall
demand for goods and services, especially discretionary items.
These pressures included: Phoenix - 11:00
12
Atlanta - 10:30
• High food and energy costs, including (despite recent declines) Washington, D.C. - 10:00 Overshooting
Phase
Decline
Phase
Philadelphia /
gas prices; San Jose /
San Francisco - 9:30
• Tighter lending standards, limiting consumers’ abilities to Los Angeles - 9:00 9 3
obtain lines of credit;

Growth Absorption
• Sustained employment declines, directly affecting those losing Phase Phase
their jobs as well as creating uncertainty among those still
6
employed regarding their job security;
• Declining home prices, reducing the ability of consumers to
borrow against the value of their homes;
levels on retail sales at stores open at least one year. Despite a
• Tumbling stock prices, which, along with declining home prices,
boost from government stimulus checks, which caused year-over-
are contributing to a “reverse wealth effect” as consumers feel
year sales growth to jump to 4.2% in June, the impact was tem-
less financially secure.
porary. Sales growth steadily decelerated to 1.7% in August and
As the economy weakened, consumer confidence hit its lowest level
in 16 years in June, at 51.0. Since then it has ticked up slightly but Consumer Confidence and Gasoline Price Index
remained low, with a reading of 56.9 in August, largely because of 360
lower gas prices. The present situation index, measuring consumer 340
320
sentiment about current conditions, actually continued to decline, 300
280
falling from 65.4 in June to 63.2 in August. In comparison, this 260
240
index was in the 120-130 range in mid-2007, indicating the extent 220
200
and speed of the decline in consumers’ confidence levels. The 180
consumer expectation index fell to the low-40 range in June and 160
140
July, which had the lowest readings on record. Although it ticked 120
100
up slightly in August, it remained very low, at 52.8, indicating 80
60
consumers’ pessimistic outlook regarding the future. 40
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08*
The most recent monthly reports from the International Council Consumer Confidence Gasoline Price Index
*Consumer confidence as of August 2008; Gasoline Index as of July 2008
of Shopping Centers (ICSC) indicate the negative impact of the Source: Conference Board, BLS
economic pressures facing consumers and their low confidence
Outlook for the National Retail Market
2002 2003 2004 2005 2006 2007 2Q08 2008f 2009f 2010f 2011f 2012f
New Construction (Put in Place, 2000 $ Bill.) 32.5 30.8 33.3 31.3 31.3 34.7 35.3 33.8 29.0 31.0 32.0 33.4
Retail Sales Excl. Autos (2000 $Bill) 2,573.9 2,671.6 2,786.3 2,912.8 2,976.8 3,040.2 3084.6 3018.9 3037.0 3103.8 3197.0 3302.5
% Change (Yr./Yr.) 2.2% 3.8% 4.3% 4.5% 2.2% 2.1% 1.8% -0.7% 0.6% 2.2% 3.0% 3.3%
Real Per Capita Disp. Income Growth 2.9% 3.7% 4.1% 0.9% 3.6% 1.8% 3.6% 0.5% 1.1% 2.3% 3.5% 3.9%
Consumer Confidence 81.7 89.7 96.1 95.8 106.8 91.2 57.3 55.0 65.0 75.0 95.0 104.0
Vacancy Rate 7.8% 7.6% 7.3% 7.2% 6.9% 7.3% n/a 7.6% 7.9% 7.4% 7.1% 7.0%
Neighborhood Strip: Rent Growth 2.2% 2.2% 2.6% 2.6% 2.8% 2.9% 2.8% 2.5% 2.1% 2.6% 2.7% 2.7%
Power Center: Rent Growth 2.9% 2.4% 2.5% 2.6% 3.0% 2.9% 2.4% 2.3% 2.2% 2.6% 2.8% 2.9%
Regional Mall: Rent Growth 2.8% 2.5% 2.5% 2.8% 2.9% 2.9% 2.6% 2.5% 2.3% 2.8% 2.9% 3.0%
Cap Rate 7.8% 7.4% 6.9% 6.1% 5.9% 5.5% 5.9% 6.2% 6.5% 6.6% 6.9% 7.0%
NCREIF Return* 13.7% 17.1% 23.0% 20.0% 13.4% 13.5% 8.7% 7.2% 5.2% 2.8% 5.7% 7.3%
* Trailing four quarters return

Sources: U.S. Commerce Dept., ABA, ACLI, BEA, Korpacz, The Conference Board, NCREIF, Viewpoint, RCG

was slightly negative when sales at Wal-Mart were not included, Superstores’ Sales Cannibalization
although poor weather was partially to blame for the weak sales
Percentage of total grocery store, warehouse club, super store, department store,
figures. Also, although retailers have generally benefited from the Internet and catalog sales
increased speed at which they are able to adjust inventory levels 60%
in response to shifting market conditions, some retailers reduced
inventories too much, ending the summer shopping season with Grocery Stores
empty shelves which hurt sales growth. Some other retailers opted 40%
Department Stores
for heavy discounts to unload merchandise. As consumers become
increasingly price-conscious, discounters and wholesalers have
20%
been the biggest beneficiaries: Warehouse Clubs and Superstores
Internet and Catalog
0%
Comparable Store Sales 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 20072008*
Y-O-Y % Change *As of June 2008

Source: Census
8%
Nordstrom’s Rack discount concept continues to post strong

6%
sales growth, indicative of the importance of low prices in
4%
attracting customers in the current environment.
• Both a reduction in discretionary spending as well as a lack
2%
of compelling fashion trends have hurt apparel stores, which
in aggregate have posted year-over-year sales declines every
0%
month since November 2007. Relatively high rents for mall
-2% space, where many apparel and department stores are located,
are also squeezing these retailers’ profits. The lone bright spot
03
04
05
06
07
*
08
20
20
20
20
20
20
*Through Aug-08 in this category in terms of same-store sales has been Ross,
Source: ICSC
which has attracted shoppers with its low prices. Foreign
retailers could provide a boost to demand for space vacated by
• Year-over-year sales growth at wholesale clubs averaged 9.0% domestic retailers, particularly in regional malls, as a slew of
per month between April and August, with BJ’s, Costco and international brands, including H&M, Zara, Mango, Germany’s
Sam’s Club all posting strong gains. Bogner, South Korea’s Who.A.U., Canada’s Lululemon and
• Wal-Mart’s comparable-store sales averaged 4.4% growth Britain’s Topshop, are looking to enter or expand in the U.S.
during the same period, as the discounter’s low prices attracted market. Foreign retailers’ investment in U.S. clothing and ac-
shoppers across a wide range of income groups. However, cessories stores totaled $4.1 billion in 2007 – a 60% increase
because of its focus on nondiscretionary items such as apparel from ten years earlier.
and home furnishings, Target struggled, posting year-over-year • Parents’ financial woes are negatively impacting their chil-
sales declines in five of the first eight months of the year. TJX drens’ spending capacity, and therefore the teen segment
and Family Dollar both benefited from consumers “trading of the retail market, previously considered recession-proof.
down” to less expensive products. Year-over-year sales declined by an average of 3.4% per month
Nearly ever other retailer category is suffering as a result of the between May and August.
pullback in consumer spending: • The luxury segment, which benefited from so-called “aspira-
tional” shoppers trading up to more expensive retail when the
• Year-over-year sales at furniture stores have been declining in economy was strong, is feeling the negative impact of those
tandem with home prices, falling every month since May 2006. shoppers now trading down to lower-priced stores. Same-store
Furniture sales are unlikely to improve significantly during the year-over-year sales declined by an average of 7.2% per month
next several years as the housing market remains weak. between June and August. Upscale retailers, such as Saks and
• Even without struggling Macy’s, which stopped reporting Nordstrom, are facing a difficult choice between discounting
sales to ICSC earlier this year, department store sales have merchandise for quick sale and potentially losing the cachet
been declining consistently as consumers curbed their discre- associated with their brands. However, spending by foreign
tionary spending. Both high- and low-end stores have been tourists has increased in recent years as the dollar weakened,
impacted, as Kohl’s, J.C. Penney, Dillard’s and Nordstrom all which is benefiting stores in this segment, particularly those in
reported year-over-year sales declines in August. However, tourist destinations such as New York and Las Vegas.

• Although not included in the ICSC statistics, many restaurants, or all of their stores. Also, Steve & Barry’s, previously sought
especially mid-level, sit-down eateries, are struggling, as high after and given substantial concessions by mall owners around
food and labor costs and weakening sales erode profits. An the country to become an anchor tenant at their properties,
August Technomic survey reported that 35% of consumers recently filed for bankruptcy and will reorganize.
are eating out less often than one year ago, primarily to save
• Starbucks’s and Gap recently announced plans to close hun-
money, and the National Restaurant Association reported that
dreds of stores. Starbucks will close an additional 600 stores
42% of restaurants surveyed posted monthly sales declines,
this year and scale back expansion plans, and long-struggling
with mid-scale restaurants feeling the brunt of the consumer
Gap plans to reduce its footprint by 10%-15% in the next
spending pullback. Among the chains forced to negotiate with
three to five years.
their lenders in recent months were Uno Chicago Grill, Real
Mex Restaurants (owner of Chevy’s and El Torito), Perkins and Retailers and landlords are anxiously awaiting the final results of
Marie Callender’s. Bennigan’s, Steak and Ale, Bakers Square the back-to-school shopping season – the second-largest annual
and Village Inn already have filed for bankruptcy. sales event after the December holiday shopping season – but
except for discounters and wholesalers, expectations are low. An
Weakening sales and high debt burdens that currently are difficult
ICSC survey found that the percentage of respondents planning
to refinance are forcing a growing number of retailers to declare
to shop at discount stores increased to 90%, from 49% one year
bankruptcy. The resulting disposition of some or all of these
earlier. Also, the National Retail Federation predicted flat sales
retailers’ assets is a major concern to owners of retail properties
compared with 2007, totaling $51.4 billion, although a Deloitte
throughout the nation.
survey found that 71% of respondents planned to reduce their
back-to-school spending. Record-low consumer confidence and
Annual Store Closings decelerating sales do not bode well for the holiday shopping season
8,000
either, with declining cargo volumes indicating that retailers are
2nd Half Forecast stocking less inventory than during 2007 in anticipation of disap-
7,000 2nd Half
1st Half pointing sales totals.
6,000
5,000 Real Retail Sales (excl. autos) Year over Year % Change (SAAR)
4,000 10%
3,000 8%
2,000 6%
1,000 4%
0 2%
01
02
03
04
05
06
07
08
20
20
20
20
20
20
20
20
0%
Sources: ICSC, Cushman & Wakefield
-2%
• Through the first half of 2008, the number of chain store -4%
closures totaled 2,831 – an 86% increase from the first half -6%
of 2007. Nearly 35% of the store closures were in the strug- 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08*
Note: Gray bars represent recessions

gling apparel segment, and roughly 29% were entertainment *Through July 2008
Source: BLS
retailers. As a result of these higher-than-expected numbers,
the ICSC increased its expected chain store closings for the On the retail investment side, the current lack of liquidity in the
year from 5,770 to 6,500 – the highest annual total since 7,041 financial system and the increasingly negative outlook for tenant
store closures in 2001. demand have stymied transaction activity. Also, a disconnect
• The ICSC now predicts a 7% increase in the number of stores remains between buyer and seller expectations, as many sellers
of all types that will close in 2008, to 144,000. Mom-and-pop are unwilling to accept the lower bids being offered. As a result,
stores, particularly reliant on home equity and other types Real Capital Analytics reported that the July 2008 total of $818
of loans, have been especially vulnerable to the economic million in sales was the lowest since January 2002, and the ratio of
downturn so far. new offerings-to-closings was 4-to-1. Also, year-to-date closings
declined 73% from 2007, to $13 billion.
• A growing number of national and regional retailers are de-
claring bankruptcy. Linens ‘n Things, Boscov’s, Mervyn’s, Mrs. Investment activity is likely to remain depressed because of ongoing
Field’s, Sharper Image and Mattress Discounters are among turmoil in the financial markets. The inability of some debt-laden
the latest chains filing for bankruptcy and are shuttering some owners to refinance will force them to sell, increasing the bargain-

ing power of potential buyers. The highest-profile example of this is • Consumer confidence, already near all-time lows, will end
Australian retail-owner Centro Properties, which is seeking to dis- the year at 55.0, increasing slowly to 65.0 in 2009 and 75.0 in
pose of assets in order to meet mounting debt obligations. Because 2010. As consumer confidence is typically a volatile statistic
of low investor demand for CMBS, the company has been unable entering and coming out of recessions, we expect it to spike
to refinance the sizeable debt it took out to purchase multiple U.S. up 95.0 in 2011 in conjunction with the recovering economy,
retail assets. An announced deal with a prospective buyer to sell with a more modest increase to 104.0 likely in 2012.
29 of the 31 properties in its Centro America Fund for $714 million,
• The retail vacancy rate will rise to 7.9% in 2009 – higher
representing a 10% discount to book value, recently fell through,
than the peak vacancy rate during the previous recession of
although talks with the buyer continue. The eventual discounts on
7.8% in 2002. The primary reasons for this are the expected
this portfolio and other distressed retail sales could be even larger
announcements of additional retailer bankruptcies, as well as
than 10% as the pressure on owners to sell increases.
reduced store expansion plans by chains hurt by weakening
sales growth and a lack of liquidity. In particular, poor holiday
The Outlook
sales could result in a large spike in bankruptcies and store
closures in early 2009, as retailers are dependent on these
Based on our expectations for a deep national recession, we expect
sales to meet payroll and other financial obligations incurred
fundamentals to weaken further, with a full rebound not expected
during the year. We forecast the vacancy rate to lower steadily
until 2010. Our forecast calls for the following:
after 2009, falling to 7.0% by 2012.
• The inflation-adjusted value of put-in-place construction will
fall to $29.0 billion in 2009, compared with a cyclical peak of Retail Vacancy Rate
$34.7 billion in 2007, as a lack of liquidity, deteriorating market
14%
conditions and high construction costs constrain development
activity. Annual put-in-place construction should accelerate 12%
thereafter, reaching $33.4 billion in 2012.
10%
Retail Space Construction Put in Place

8%
40
6%
35
4%
2000 $ Billions
30 2%
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f
25 Sources: Viewpoint, RCG
20
• The average cap rate will continue increasing throughout the
forecast period as investors reevaluate the historically low risk
15 premiums assessed to retail real estate during recent years.
78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f
Also, as liquidity in the financial markets remains scarce,
Sources: Census, RCG
investors will continue to demand higher returns to make up
for higher borrowing costs. As refinancing difficulties force
• Real per capita personal income growth will decelerate in 2008 more owners to sell, the current standoff between buyers and
and trail the inflation rate through most of the forecast period, sellers will give way to more realistic pricing. Consequently,
further eroding consumer purchasing power. We expect in- we expect the average cap rate to rise from 5.9% in the
come growth to average 2.3% per year through 2012, compared second quarter of 2008 to 7.0% in 2012. A flight to quality
with a 4.5% average annual increase in the CPI. by investors and more stringent underwriting standards are
• Real retail sales will decline in 2008, by 0.7%, for the first time resulting in widening spreads between cap rates for Class A
since 2001, as weak income growth and a continued decline in properties and assets in secondary and tertiary markets – a
available credit force consumers to reduce spending. There- trend we expect to continue.
after, we expect retail sales to resume positive albeit modest • NCREIF returns will lower to the single digits, following six
growth of 0.6% in 2009, followed by growth accelerating to consecutive years of double-digit gains. In particular, we ex-
the low-3% range in line with the improving economy. pect negative annual capital returns to weigh on total return,
which will decelerate to 2.8% in 2010, before accelerating to
7.3% in 2012.
Total Rates of Return - Retail Properties but also tenants currently posting significant declines in sales,
including home improvement chains. A risk to the sector is the
30%
outsized importance of every tenant to sustaining a center’s
25% 23.1%
vitality because of the large percentage of total space that each
20.0% tenant occupies. Also, the potential loss of additional tenants
20%
16.9%
17.6% because of co-tenancy provisions could cripple a power center.
14.9%
15%
12.8%
13.8% 14.4%
12.5%
12.4% 12.5% 12.9%
13.7% 13.5%
13.4% After remaining in the 3% range during the last few years, we
10%
11.0%
8.5%
9.5% expect annual rent growth to decelerate, lowering to a cyclical
6.0% 7.8%
7.0%
6.0%
6.8% 7.2%
5.2% 5.7%
7.3%
nadir of 2.2% in 2009 before accelerating to 2.9% in 2012.
4.8% 4.9%
5% 4.0%
•
2.8%
We expect neighborhood strip properties to post the weak-
0%
est rent growth of the three property types that we forecast,
-1.9%
-5%
-2.3%
averaging 2.5% annually through 2012, largely because of
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f
their exposure to mom-and-pop stores. Many strip owners
Sources: NCREIF, RCG currently are sacrificing rent increases in favor of keeping their
centers occupied. Also, grocery chain profit margins are being
• The delinquency rate will reach its highest level since 1996, squeezed as retailers are unable to pass on higher costs to
peaking at 1.5% in 2009 and 2010, because of the difficulty their financially strapped shoppers. Grocers are also facing
in refinancing debt. In the longer term, the delinquency rate increasing competition from discounters and wholesalers, as
should decrease, but remain higher than during the recent well as new entrants to the market such as Tesco.
period of easy lending.
• Lifestyle centers are particularly vulnerable to the pullback
Markets that are undergoing particularly severe housing market cor-
in consumer spending because of their large concentrations of
rections, including Florida, California’s Central Valley, Las Vegas and
apparel stores, many of which are struggling, and other retail-
Phoenix, are particularly vulnerable to the retail downturn because
ers dependent on discretionary spending. The large amount of
of the reverse wealth effect caused by falling home prices. Also,
new supply delivered in the last ten years also could hurt the
retail developers overstated demand in many of these speculator-
sector’s performance. We expect store closings and slower
driven markets, resulting in a surfeit of retail space. In contrast,
expansion plans by retailers including Starbucks, Gap and Ann
infill markets with established demographic bases are likely to
Taylor to hurt short-term tenant demand in this sector.
weather the downturn relatively well. However, while the location
and quality will remain the most important determinants of a retail • The outlet center sector is currently one of the strongest
center’s success during the national recession, the property type retail property types, as it is attracting cash-strapped consum-
also will be a key consideration: ers seeking the same brands that they purchased when the
• The long length of regional mall leases, generally high levels economy was stronger. Foreign tourists seeking to capitalize
of embedded NOI growth and relatively little new supply in on the dollar’s weakness also are boosting sales, although
recent years should benefit the property type. However, malls this trend could reverse with the slowing global economy
with struggling or bankrupt anchor tenants, such as Mervyn’s and recent gains by the dollar against various other curren-
and Steve & Barry’s, could suffer from those retailers closing cies. Retailer interest in opening outlet stores remains strong
stores, as well as the departure of other tenants citing co- because of both healthy sales growth and the low common
tenancy provisions in their leases that require the presence area maintenance (CAM) expenses incurred at outdoor outlet
of the closing tenant. Sustained weakness in the department centers, while the typically low level of annual outlet center
store segment threatens store expansion plans and could result completions limits tenant options and boosts landlords’ bar-
in additional closures by anchor tenants in centers across the gaining power.
nation. Despite these risks, we are forecasting the strongest
rent growth in this property type, averaging 2.7% annually Conclusion
through the forecast period, because of its relative stability.
Landlords in less desirable properties will have to become in- We expect the deep national recession to result in a challenging
creasingly creative in attracting tenants to maintain occupancy few years for retailers and landlords alike. The declining health of
levels, including allowing start-up companies, perhaps for trial the consumer and a lack of liquidity stemming from recent turmoil
periods, as well as non-traditional tenants such as government in the financial markets will continue to put financial pressure on
agencies and fitness centers. retailers, leading to additional bankruptcies and reduced store
opening plans. A weaker-than-expected upcoming holiday shopping
• Power centers boast tenants with some of the strongest cur-
season could contribute to a slew of bankruptcies in early 2009,
rent retail sales growth, such as wholesalers and discounters,

with few tenants willing to fill the vacated space. Properties in
secondary and tertiary markets as well as metropolitan areas hit
the hardest by the housing boom will be the weakest, while infill
markets with relatively strong economies will perform the best.
Beginning in 2010, the retail market should begin a healthy recov-
ery, with sales growth accelerating in line with higher consumer
confidence levels and stronger job growth.
We expect retail investment activity to remain muted as the liquidity

squeeze continues. Owners with debt payments coming due will
likely continue to struggle to refinance because of low demand for
CMBS, while potential buyers will face high borrowing costs. As
a result, we expect cap rates to rise, even in the longer term, as
yields move closer to historical levels. Investors able to obtain
financing should find attractive opportunities as a growing number
of financially strapped owners are forced to dispose of assets.

The National Hotel Market Caroline Green
Conditions in the hospitality and hotel industry are weak across Real Estate Cycle – Hotel
the board and we expect that they will get worse before they get
better. Eroding occupancy rates, combined with slower room rate
growth, are yielding flat to modest revenue growth spanning vari-
Extended Stay Hotel / 12
ous locations, classes and property types. The market is getting Limited Service
Hotel – 10:00
hit twofold: demand is pulling back at a time when new supply is Overshooting Decline
Phase Phase
surging. Full Service /
Business Hotel – 9:30
• Leisure travel is waning as consumers reduce discretionary
9 3
purchases.
• Business travel is slowing because of cutbacks in corporate Growth Absorption
spending. Phase Phase
•
6
Poor global economic conditions have decreased demand
from international travelers, recently the one bright spot in
our hotel outlook.
• Adding to the weakness in the market, new hotel deliveries budgets. In doing so, consumers have trimmed unnecessary
are peaking. expenditures, with vacations among the first to go. As such,
the leisure sector has witnessed a retraction in demand.
RCG believes that the hotel market is situated past equilibrium • With corporate profits falling, many companies have been in
in the real estate market cycle given the pullback in demand and cost-cutting mode and have slashed budgets as a result. Busi-
peaking supply levels. We place full-service hotels at 9:30 in the ness travel has been hindered by this reduction in spending.
real estate cycle, and limited-service and extended-stay hotels at
10:00. As the economic recession deepens, there will be growing • The airline industry is battling high fuel costs and weak travel
potential for hotels to move further into the overshooting phase of demand. In response, airlines have been canceling flights and
the cycle. The medium- to longer-term outlook is positive, as we raising ticket prices. This strategy will increase costs for both
expect prospects for growth will likely resume in 2010. the business and leisure traveler and thus deter travel, causing
further deterioration in demand for hotel rooms.
Demand for hotel rooms has retrenched across both the leisure • A softening global economy, coupled with a slowly strengthen-
and business travel segments, throughout all markets and seg- ing dollar, has hampered demand for U.S. travel from outside
ment types, as the industry begins to feel the effects of a fragile of the country. Additionally, strict travel requirements have
economy. dampened interest in traveling to the States in recent years.
• On top of everything else, high energy costs are digging into
• Falling home values, eight consecutive months of job losses, the pocketbooks of both the consumer and business sectors
and tightened credit conditions have battered the consumer. worldwide.
After spending their way to record-high debt levels in recent
years, Americans are attempting to balance their household
Outlook for the National Hotel Market
2002 2003 2004 2005 2006 2007 2Q08 2008f 2009f 2010f 2011f 2012f
Occupancy 59.1% 59.2% 61.3% 63.1% 63.4% 63.2% 61.4% 60.9% 59.5% 60.8% 62.3% 63.7%
Avg. Daily Room Rate (ADR) $83.35 $83.28 $85.97 $90.84 $97.31 $103.64 $107.64 $106.96 $107.81 $111.37 $116.38 $121.97
RevPAR Growth -2.5% 0.1% 7.7% 8.8% 7.5% 5.7% 1.5% -0.6% -1.5% 5.6% 7.1% 7.2%
Construction (2000 $Bill.) $ 9.5 $ 8.7 $ 9.9 $ 9.4 $ 11.6 $ 17.4 $ 23.1 22.7 23.4 17.5 16.5 15.2
Cap Rate 8.2% 7.9% 8.0% 6.7% 6.5% 5.9% 5.7% 7.2% 7.5% 7.7% 7.8% 8.0%
Delinquency Rate (ACLI) 0.37% 0.57% 0.22% 0.01% 0.00% 0.11% 0.11% 0.2% 4.0% 6.0% 0.2% 0.2%
Total Return- (NCREIF) 7.6% 6.1% 10.2% 19.0% 23.6% 18.1% 10.5% 7.7% 4.8% 0.7% 9.7% 9.0%
Notes: Figures in quarterly columns represent year-to-date activity

Sources: Smith Travel Research, ACLI, NCREIF, U.S. Census Bureau, RCG

Hotel fundamentals are weakening as the occupancy rate ticked Total U.S. Tourism-Related Spending on Accommodations
down to 61.4% year-to-date as of June 2008.
$ Billions
• Room-rate growth slowed to 4.2% year-to-date through June
$131.3
$132.1
$128.5
$128.2
$140.0
$126.8
$124.9
$123.5
2008 after peaking in the 6% to 7% range in 2006 and 2007.
$119.6
$119.5
$119.3
$116.9
$113.4
$111.9
$110.7
$108.2
$120.0
$107.3
$105.7
$103.1
• Lower occupancy levels and room-rate growth have yielded
$100.0
$89.0
$88.0
lower RevPAR growth. After peaking at 8.8% in 2005, RevPAR
$85.0
$83.9
growth slowed to 1.5% between June 2007 and June 2008. $80.0
$60.0
RevPAR Growth $40.0
Annual Change $20.0
10%
$0.0
03
03
03
03
04
04
04
04
05
05
05
05
06
06
06
06
07
07
07
07
08
08
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
5%
Source: US Bureau of Economic Analysis
0% • Small metro/town locations reported the lowest occupancy

rate again in July 2008 with 56.3% year-to-date, a 100 basis-
-5%
point drop from the same period in 2007. Interstate locations
-10%
recorded a slightly higher occupancy rate with 56.7%.
• Resort locations posted the largest decrease in the occupancy
-15% rate of 220 basis points to 66.5% year-to-date as of July 2008
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
Ja 6
f
f
f
f
f
0
08
09
10
11
12
0
n-0
from the same period in 2007.

Source: Smith Travel Research, RCG
•
Source: Smith Travel Research, RCG
Another sign of its resilience in hard economic times compared
with other locations, urban locations posted the largest RevPAR
The top 25 markets, as defined by Smith Travel, posted trends that increase with 4.5% to $103.99 year-to-date as of July 2008.
were slightly more positive than the United States as a whole
during this period, but were also notably affected by the slowing • Resort locations recorded a 0.9% decline in RevPAR year-to-
economy. date as of July 2008 to $100.82, from $101.70 in July 2007.
• The occupancy rate stood at 67.6% year-to-date through June • Compared with the strong growth recorded during recent
2008, from 69.1% this time last year. years, revenue growth has slowed significantly in 2008 across
all locations. RCG attributes this largely to reduced demand
• Average daily room rate growth slowed to 5.2%, resulting in
caused by a consumer slowdown. With job losses mounting
slower RevPAR growth of only 2.8%.
and home values continuing to fall, we expect that this trend
will likely extend through the short term.
As the national economy worsened, hotel occupancy rates by loca-
tion segments fell through July 2008. Despite lower occupancy,
Performance by Price Class
RevPAR increased for every location except resorts on a year-to-
date basis. Despite slowing conditions, urban locations have fared
Occupancy YTD RevPAR YTD
better than other locations thus far in the recession with only a 70 July 2008 July 2007 July 2008 July 2007 % change
basis-point drop in the occupancy rate. Urban locations are typically Luxury 70.3% 72.2% $120.25 $120.19 0.0%
buoyed by business travel and conferences, despite companies cut- Upscale 64.2% 65.9% $74.72 $74.39 0.4%
Midprice 59.6% 61.3% $50.42 $49.85 1.1%
ting back on less-than-necessary expenditures. Additionally, high
Economy 56.6% 58.4% $35.69 $35.64 0.1%
gas prices are causing leisure travelers to minimize car rentals, Budget 58.5% 59.8% $30.22 $29.86 1.2%
instead favoring locations (such as urban centers) with plentiful
public transportation. Source: Smith Travel Research
Following trends in other hotel segments, hotels by price class

• Despite posting a larger drop in the occupancy rate (100 recorded a drop in occupancy levels year-to-date in July 2008, as
basis points) than urban locations, airport locations recorded compared with the prior year. Despite lower occupancy, RevPAR
the highest occupancy rate year-to-date as of July 2008 with increased for all hotel segments except luxury hotels, which re-
69.2%. ported essentially flat growth during the same period. Although
RevPAR growth remained positive in the first seven months of 2008,
it slowed dramatically from year-ago levels.
• A sign of shifting consumer attitudes, budget hotels reported • Another market combining a strong business travel market
both the smallest drop in the occupancy rate (130 basis points) with ongoing tourist appeal is New York City, which posted a
and highest (albeit low from recent history) RevPAR growth 40 basis-point increase in the occupancy rate to 82.1% year-
of 1.2% in the first seven months of 2008, as compared with to-date in July 2008 from the same period the prior year, the
the same period the prior year. highest occupancy rate of all markets covered by Smith Travel.
New York also recorded the second-highest RevPAR growth
• Conversely, luxury hotels posted the largest decrease in the
with an 8.0% increase during the same period.
occupancy rate, with a 180 basis-point decline to 70.3% year-
to-date as of July 2008, compared with July 2007. However, • Atlanta recorded the worst performance among business
the luxury segment still reported the highest occupancy rate markets through July 2008. Occupancy dropped 310 basis
of all price points. Luxury hotels also recorded the slowest points to 62.5% year-to-date from the same period the prior
RevPAR growth with only a slight increase to $120.25 from year. Additionally, Atlanta posted a decline in RevPAR of 2.7%
$120.19 during the same period, the highest revenue rate of during the same period, the largest decrease of any business
all segments. market.
• Upscale, mid-price and economy hotels all performed similarly, • The dismal housing markets of Phoenix, Orange County and San
with a 170 to 180 basis-point drop in the occupancy rate. Diego have caused economic contractions, leading to weak ho-
RevPAR growth ranged from 0.1% for economy hotels to 1.1% tel fundamentals in 2008. In the case of Arizona, more than half
for mid-price hotels. of all overnight visitors in 2006 came from either elsewhere in
the state or California, a trend we believe continued through
Performance by Location 2007 and 2008. With the bulk of hotel demand originating
from markets greatly affected by the housing collapse, it is no
Occupancy YTD RevPAR YTD surprise that fundamentals have deteriorated faster in these
July 2008 July 2007 July 2008 July 2007 % change markets than in markets where visitors generally originate from
Urban 68.5% 69.2% $103.99 $99.48 4.5% diverse locations, such as in Hawaii. As we have mentioned in
Suburban 62.6% 64.5% $58.38 $58.05 0.6%
recent reports, the economies of many of these markets where
Airport 69.2% 71.2% $71.70 $70.94 1.1%
Interstate 56.7% 58.6% $39.40 $38.79 1.6% the housing bubbles were concentrated exhibited a run-up in
Resort 66.5% 68.7% $100.82 $101.70 -0.9% hotel construction as other sectors were also exploding. The
combination of the oversupply and the severe pullbacks in
Source: Smith Travel Research
other sectors of these local economies has resulted in weak
As previously mentioned above, with the credit crunch and declin- hotel conditions.
ing profits pinching business budgets and falling home values • Phoenix posted the worst performance year-to-date as of July
and overstretched home budgets dampening consumer spending, 2008. The occupancy rate decreased by 640 basis points to
the double-pronged nature of this recession has resulted in poor 64.4%, the lowest of any leisure market. Additionally, RevPAR
conditions for the hotel market. Both leisure and business markets declined by 4.1% to $86.99 during the same period. With a
reported lower occupancy levels and slower RevPAR growth, though large hotel development pipeline, RCG expects this market to
not across the board. Urban areas with both a relatively stronger get much worse before it gets better.
business and leisure travel appeal, particularly to international trav-
elers, reported the strongest performance year-to-date as of July • Anaheim, San Diego and Orlando also posted lower occupancy
2008, although still well below levels reached just two years ago. rates year-to-date in July 2008, ranging from an 80 to 240
On the other hand, leisure markets, particularly those hit hardest basis-point drop, although only Anaheim posted a decrease
by the housing collapse, posted the weakest performance. in RevPAR of 0.9% from the same period in 2007.
• San Francisco reported the best performance thus far in 2008, • Miami and Honolulu posted the best performance among
with a 180 basis-point increase in the occupancy rate to 75.0% leisure markets, with 60 and 20 basis-point increases in the
year-to-date in July 2008 from 73.2% in July 2007. Additionally, occupancy rate, respectively. Honolulu posted the strongest
it was the only market to report double-digit RevPAR growth RevPAR growth with 4.0%. Strong international demand stem-
with 10.5% during the same period. San Francisco reported ming from South America and Asia has buoyed travel to these
one of the highest RevPAR rates with $116.33 in 2008, second markets. Miami International Airport, for example, posted a
only to New York at $214.70. San Francisco was one of the 5.9% increase in international passengers year-to-date as of
fastest-growing economies during the year to July 2008 with July 2008 as compared with the same period the prior year. At
0.8% employment growth, a product of the relatively healthy the same time, the number of domestic passengers decreased
tech sector. This continued economic expansion helped spur by 1.2%.
business travel to the area, while a weak dollar continued to
beckon international leisure travelers.
Recent Performance in Key Markets • Suburban locations posted both the largest total pipeline figure
Occupancy YTD RevPAR YTD with approximately 310,000 rooms in more than 2,600 hotels,
July 2008 July 2007 July 2008 July 2007 % change as well as the largest number of rooms under construction with
Business Travel Markets
Atlanta 62.5% 65.6% $57.35 $58.95 -2.7%
approximately 77,500 in the second quarter of 2008. Highway
Boston 66.4% 66.0% $100.80 $95.73 5.3% locations were a close second, with approximately 185,500
Chicago 63.9% 66.8% $83.46 $83.67 -0.2%
Dallas 60.8% 62.4% $58.02 $57.33 1.2%
rooms in 2,000 hotels in the pipeline and 55,500 rooms under
Denver 65.3% 66.2% $67.12 $64.94 3.3% construction.
Houston 66.9% 68.2% $66.53 $62.21 6.9%
Los Angeles/Lg. Beach
New York
74.2%
82.1%
76.0%
81.7%
$96.13
$214.70
$93.22
$198.79
3.1%
8.0%
• In terms of hotel fundamentals, the two locations that have
San Francisco 75.0% 73.2% $116.33 $105.31 10.5% fared best thus far in 2008 also have the smallest pipelines.
Washington, D.C. 70.6% 71.1% $109.30 $106.56 2.6%
Supply constraints in CBD locations kept the total pipeline
Leisure Travel Markets
Anaheim-Santa Ana 72.5% 74.9% $90.77 $91.62 -0.9% to approximately 100,000 rooms in 537 hotels, with only ap-
Miami 75.8% 75.2% $130.90 $126.88 3.2% proximately 30,000 rooms under construction. Airport locations
Oahu Island 77.0% 76.8% $132.93 $127.84 4.0%
Orlando 72.2% 73.0% $80.60 $79.80 1.0% have a total pipeline of only 53,000 rooms with 17,000 under
Phoenix
San Diego
64.4%
73.1%
70.8%
74.4%
$86.99
$106.48
$90.71
$104.48
-4.1%
1.9%
construction as of the second quarter.
Source: Smith Travel Research • New York has the largest total pipeline in absolute terms, with
more than 27,000 rooms in 165 buildings. It also recorded the
Hotel Construction - Value of Construction Put in Place largest number of rooms under construction as of the second
quarter with nearly 11,000. However, this market has histori-
24 22.723.4
cally posted one of the highest occupancy rates and a high
level of international tourism. Therefore, we expect New York
18 16.6 16.3
17.4 17.5
16.5
City should absorb this new supply more quickly than other
15.9
14.4 15.2 markets could, despite the total pipeline accounting for 33.2%
2000 $ Billions
13.0 13.8
13.2
12.3
12.8
12.4 12.0
12.7
11.6
of its current supply. This percentage was the second-highest
12 11.2
10.2
9.5 9.9
9.4
of the 25 top markets as defined by Smith Travel.
9.0 8.7
8.1 8.5 8.5
7.1 • San Francisco, which posted the most improvement in funda-
5.9 5.8
5.3
6 mentals year-to-date as of July 2008, also claims the smallest
development pipeline of the top 25 markets, in terms of both
number of rooms under construction and ratio of total pipe-
0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f line to current supply as of the second quarter. Only Honolulu
Source: US Census Bureau posted a lower number of rooms in the total pipeline. With
strong fundamentals, a relatively healthy economic outlook,
The construction pipeline continued to increase through the second and only 303 rooms under construction, we expect the hotel
quarter of 2008. sector in San Francisco to outperform the national average
• More than 785,000 rooms are in some stage of planning or through the forecast period.
under construction, up from approximately 718,000 rooms at
• The Phoenix hotel market is in danger of a serious supply and
the end of 2007.
demand imbalance. Phoenix posted the largest drop in the
• Approximately 242,000 of those rooms were currently under occupancy rate and RevPAR year-to-date as of July 2008, as
construction as of the second quarter, up from 224,000 at year- compared with the same period the prior year. Additionally, it
end 2007, according to Lodging Econometrics. has the largest pipeline in terms of the ratio to current sup-
• We believe many of the rooms in the early planning stages ply (34.5% as of the second quarter of 2008). Many of these
(approximately 215,000 as of the second quarter) will not make projects were conceived in the rapidly expanding economic
it to construction because of a lack of financing or weak funda- environment of the housing boom. Now, with nearly 20,000
mentals, or likely both. However, even with the credit crunch rooms in 129 hotels comprising the total Phoenix pipeline, we
slowing future development, hotel construction is reaching its believe hoteliers will be hard-pressed to fill rooms and raise
cyclical peak just as hotel demand is dropping significantly. rates as consumers tighten their purse strings. Fortunately,
only nearly 5,400 of these rooms were under construction as
• The annualized dollar volume of hotel construction rose further of the second quarter of 2008, and the collapse of many local
in the second quarter to $23.1 billion. We expect this figure lenders has put a hold on much of Phoenix’s hotel construction.
to peak in 2009 at $23.4 billion, before trending downward to We expect a large amount of planned space not yet under
$15.2 billion in 2012. construction to be either delayed or cancelled given Phoenix’s
current economic conditions.

Hotel Investment • Combined, the total year-over-year return for hotel properties
was 10.5% in the second quarter of 2008.
As signs of a consumer pullback accelerated and credit conditions
became increasingly tight, hotel investment slowed accordingly. Hotel Occupancy Rate
• Transaction volume in the 12 months to June 2008 increased 70%
7% from the prior 12 months to approximately $50 billion; 68%
65.7%
however, the only reason for this increase was the $26 billion
65.5%
65.2%
64.5%
66%
64.0%
63.7%
63.7%
63.7%
acquisition of Hilton Hotels by Blackstone in July 2007.
63.4%
63.2%
63.2%
63.3%
63.1%
64%
62.3%
62.3%
62.4%
62.0%
61.9%
61.3%
•
60.9%
60.8%
Quarterly transaction volume was only $3.3 billion in the sec-
60.9%
62%
59.8%
59.5%
59.2%
59.1%
ond quarter of 2008, compared with $25.7 billion in the second 60%
quarter of 2007, representing an 87.2% decrease. 58%
•
56%
The average price paid for hotel properties dropped 14% to
54%
$138,900 per unit in the 12 months to July 2008 as compared
52%
with the previous 12 months.
50%
• The average capitalization rate for the 12 months to June 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08f09f 10f11f 12f
2008 increased 16 basis points to 7.6% as compared with the Sources: Smith Travel Research, RCG
prior 12 months, according to Real Capital Analytics, despite

downward pressure from the Hilton transaction.
The Outlook
• The Western region claimed the highest transaction volume
with $7.5 billion trading hands in the 12 months trailing July Given our view that the national recession will be deeper and last
2008, followed closely by the Southeast with $7.1 billion. longer than we forecasted last quarter, we have revised our hotel
• The Southeast claimed the lowest average cap rate with 7.8% forecast downward.
and the Southwest, the eye of the housing storm, posted the • We believe demand is going to be weak through 2009, with
highest average cap rate with 9.3% during the same period. the occupancy rate dipping below 60% in 2009. Recovery is
expected to begin in 2010, with the occupancy rate rising to
• The Northeast region recorded the highest price paid per unit
just less than 64% by 2012.
with an average of $168,000 in the 12 months to July 2008.
The Midwest reported the lowest price paid per unit with ap- • We forecast room-rate growth will remain positive through
proximately $100,000 during the same period. the forecast horizon, but will be low in 2009. The combina-
tion of falling occupancy rates and lower room-rate growth is
• Manhattan once again garnered the highest investment volume
forecasted to yield negative RevPAR growth in 2008 and 2009.
of any city in the 12 months to July 2008 with $2.8 billion.
Once the economy rebounds, we forecast RevPAR growth to
However, Miami posted the highest price per unit paid with
accelerate back up to the 7% range by 2012.
$435,000 during the same period, with Manhattan in second
at $404,000. • With construction levels rising in 2008, we have revised our
completion forecasts up in the short term.
• The average cap rate reported by the American Council of Life
Insurers (ACLI) stood at 5.7% in the second quarter of 2008, • RCG believes delinquencies will likely increase in 2009 and
down from 5.9% at year-end 2007; however, this figure tends 2010, as the credit crunch reduces the ability of hotel owners
to lag actual trends. We expect the ACLI cap rate to increase to refinance loans that have reached maturity. We expect this
to 7.2% by year-end, rising further through the forecast period rate to jump to 2.5% by year-end 2009 and increase further
to reach 8.0% by 2012. to 6.0% in 2010, before trending back downward to 0.2% in
2012.
• The ACLI delinquency rate remained unchanged from year-end
2007 to the second quarter of 2008 at 0.11%. • We expect to see NCREIF returns remain positive but slow
significantly through 2009, at which point we forecast a low
• NCREIF total returns for hotel properties decreased greatly dur-
of 0.7% annual return. The sector should quickly recover, with
ing the second quarter of 2008, with the bulk of the slowdown
9.7% and 9.0% annual returns predicted for 2011 and 2012,
attributed to appreciation trends.
respectively.
• Capital appreciation increased only 3.7% in the second quarter
of 2008 from the second quarter of 2007.
• Income posted a still-healthy 6.6% return.

Private Market Total Return: Hotels
35%
30.5%
29.0%
30%
23.6%
25%
19.0%
18.1%
20%
16.5%
15.8%
12.7%
15%
10.6%
10.1%
9.9%
9.7%
9.0%
8.0%
7.7%
7.7%
7.7%
10%
7.1%
6.1%
5.8%
5.5%
4.8%
4.6%
4.5%
3.5%
3.2%
5%
0.7%
0%
-1.4%
-1.3%
-2.3%
-3.6%
-5%
-10%
82 84 86 88 90 92 94 96 98 00 02 04 06 08f 10f 12f
Source: NCREIF, RCG
Conclusion
The hotel market is in a period of correction, with this property

type suffering weak to anemic returns through 2010. The combina-
tion of a pullback in demand, a surge of hotel deliveries, and the
capital markets at a standstill threaten hotel values. We predict
continued deterioration of hotel fundamentals, with annual declines
in nationwide RevPAR and occupancy rates forecasted for 2008
and 2009.
These poor market conditions, coupled with a lack of capital,

should contribute to lackluster hotel returns and investment activ-
ity through the near term. While we forecast a correction in hotel
fundamentals in the next 12 to 18 months, the hotel market will
avoid the kind of collapse that characterized the market post 9/11.
The longer-term prospects for growth are favorable. An improving
economy in 2010 should yield a return to a healthy hotel environ-
ment in 2011 and beyond. Solid operating incomes should return
healthy levels of capital appreciation.


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U.S.

Rosen Consulting Group

© 2008 Rosen Consulting Group

U.S. Outlook Page

The National Economic Outlook 1

The Regional Economic Overview 8

The Real Estate Capital Markets 16

Real Estate Markets

The National Single Family Housing Market 22

© 2008 Rosen Consulting Group, LLC

© 2008 Rosen Consulting Group, LLC i September 2008

Single Family- 1:30

© 2008 Rosen Consulting Group, LLC ii September 2008

© 2008 Rosen Consulting Group, LLC iii September 2008

© 2008 Rosen Consulting Group, LLC iv September 2008

on our outlook. 400

scenario is now a hard landing recession with a 60% probability.

turned the credit crunch into a full-blown crisis. Confidence in the

National Econom ic Outlook

Note: For monthly data series, 4Q is average of months

© 2008 Rosen Consulting Group, LLC 1 September 2008

© 2008 Rosen Consulting Group, LLC 2 September 2008

in order to rein in inflation. The flow of wealth from established to 40 0

U.S. Trade Deficit & Global Growth

Note: For monthly data series, 4Q is average of months

© 2008 Rosen Consulting Group, LLC 6 September 2008

© 2008 Rosen Consulting Group, LLC 7 September 2008

most recent employment data points to continued overall weakness,

Employment Growth by Region

Year U.S. Midwest Northeast South W est

© 2008 Rosen Consulting Group, LLC 8 July 2008

go – the major coastal cities and Las Vegas. In contrast to retail, 3%

non-financial services − most notably health care and educational 2%

On the goods-producing side of the economy, the ISM manufac- -1%

− and Southern − Texas, Louisiana and North Carolina − states, not

*Regional construction data are based on available state employment figures

© 2008 Rosen Consulting Group, LLC 10 July 2008

Southern Region Southern Region

© 2008 Rosen Consulting Group, LLC 11 July 2008

Virginia: Job growth in Virginia has continued to decelerate in the 3%

Defense’s increased war-related employment occurring in Virginia. -4%

the New Jersey economy can best be described as stagnant, or Northeast US

Percent Change in State Employment by Sector - Northeast

© 2008 Rosen Consulting Group, LLC 12 July 2008

Percent Change in State Employment by Sector - Midwest

© 2008 Rosen Consulting Group, LLC 13 July 2008

Wisconsin: The state economy has tracked the national downturn.

the dollar has weakened against the Canadian dollar. 70

© 2008 Rosen Consulting Group, LLC 14 July 2008

© 2008 Rosen Consulting Group, LLC 15 July 2008

pression, and there is no end in sight. The near financial meltdown 50

confidence in the financial system is at low ebb. The combination of 800,000

cash and/or access to capital. 400,000 175

• It is too early to tell whether extraordinary measures, 200,000

Net Fgn Purchases of U.S. Securities, Rolling 12 Month Sum 225

enough to free up balance sheets and allow risk capital

Real Estate Capital Market Overview

© 2008 Rosen Consulting Group, LLC 16 September 2008

investors coming from private sources. 350

participation by private equity, commingled and hedge 250

funds, and direct portfolio investors for pensions, trusts, 200

and endowments. 150

Data is as of July 2008 Data is as of July 2008